EU mandatory due diligence legislation: What investors need to know and why they should care

Johannes Blankenbach & Saskia Wilks, Business & Human Rights Resource Centre

Since its beginning a year ago, the ongoing COVID-19 pandemic has exposed once more the vulnerabilities in value chains, the precarity of global business operations, and the weakness of voluntary corporate action in addressing these issues. Organizations like the Business & Human Rights Resource Centre take up hundreds of grassroots allegations of abuse each year. During the COVID-19 crisis, we have seen a spike in allegations as millions of workers and communities around the world feel the consequences of corporate inaction in the face of a global pandemic. Yet there are signs of change.

In April last year, under its Sustainable Corporate Governance Initiative, the European Commission committed to introducing EU-wide legislation that would mandate companies to respect human rights and the environment. Momentum towards mandatory due diligence, based on the UNGPs and the OECD MNE Guidelines, has been growing worldwide among governments, companies, investors and civil society. Regulation is already in place or under discussion in a number of European countries, paving the way towards regional harmonization.

While the Commission prepared to conclude a public online consultation seeking input on its initiative, the European Parliament’s Committee on Legal Affairs (JURI) on January 27 adopted a report requesting the Commission submit a mandatory due diligence legislative proposal. It provided detailed suggestions as to what such a law covering EU businesses (and those active in the internal market) could look like. The committee’s report will be voted in plenary in March.

An EU due diligence and corporate accountability law covering all sectors, including finance, is a key piece in a set of legislative measures broadly framed by the European Green Deal and the EU Action Plan on Financing Sustainable Growth. These include e.g. EU Regulation on Investor Disclosure, requiring European investors to disclose their due diligence policies and impacts on people and planet, as well as the EU Taxonomy Regulation, which is meant to encourage private investments into economic activities classified as ‘sustainable’. The social ‘minimum safeguard’ attached is that activities need to be carried out in line with the UNGPs and OECD MNE Guidelines. Other important processes include discussions around a Social Taxonomy, and the current reform of the EU Non-financial Reporting Directive. Hopes are high that the latter will lead to more “comparable, concise and relevant” disclosure on sustainability issues, including due diligence.

But what makes mandatory due diligence legislation unique is that it is potentially the only component that will directly require ongoing business action to address adverse impacts, holding businesses accountable if they fail to act as well as ensuring access to remedy for affected people. Improved transparency and reporting are necessary for civil society stakeholders and investors to assess responsible business conduct, but these requirements alone are insufficient to drive the change needed both in board rooms and for rights-holders.

So how will mandatory due diligence contribute towards this change?

Civil society has been outspoken on what principle elements the law should include to be effective. Firstly, it should establish a binding obligation to respect human rights and the environment across operations, value chains and business relationships, to be integrated into all business practices including purchasing practices. Due diligence is the standard of care to achieve this goal, but it should not become an end in itself, nor a ‘tick-box’ compliance exercise granting blanket immunity from any legal claims.

The effective, meaningful and informed involvement of rights-holders in due diligence and remediation, without fear of reprisal, is another important element – it not only allows workers, defenders and communities to be “agents of their own well-being” but also encourages businesses to move beyond top-down audit-based or overly formalistic approaches.

Crucially, civil liability as part of due diligence legislation will provide an avenue to judicial remedy for affected people and a strong incentive for businesses to prevent harm. More and more corporate voices acknowledge the importance of liability in ensuring effective implementation and a real level playing field.

What does this mean for investors?

Investment portfolios comprised of companies showing greater responsibility have outperformed others and proved more resilient during the pandemic. Nevertheless, the irresponsible practice of squeezing profits and returns out of suppliers or investments while externalizing social and environmental costs remains endemic in the broader market. In the worst case this even goes unnoticed in ESG ratings. Responsible investors therefore have much to gain from mandatory due diligence legislation: it would substantively complement their own leverage with companies to drive change, as well as reducing (short-term) competitive disadvantages they might still face under current unsustainable market and investment conditions.

UN and OECD guidance and commentary are clear that institutional investors, like all businesses including banks, have their own responsibility to respect human rights, good governance and the environment, and conduct meaningful due diligence across their operations, value chains and business/investment practices and relationships. This has been reiterated in investor toolkits and frameworks, and is also the subject of targeted research during the UN Working Group’s UNGPs 10+ project. Formalizing this responsibility and turning it into a legal duty for all is the next logical step.

An effective cross-sectoral due diligence law will be a key driver of a “just recovery”, as well as a fast and fair transition towards a low-carbon economy. The Investor Alliance for Human Rights has been a welcome leader and is outspoken on the “Investor Case for Mandatory Human Rights Due Diligence” and the need for a stronger legal framework for investors. Despite the JURI vote and other initial successes, there is still a long way to go before the Commission’s legislative proposal (expected by summer 2021) will be adopted by both the European Parliament and the EU Council of member states, and then translated into national legislation within two years (if passed as Directive).

We are now at a watershed moment, and responsible companies and investors stand to gain when reform comes into effect. However, tangible benefits for workers and communities around the world will be the only real measure of success. They have been waiting for this moment too long already.