Legal briefing | 08 Mar 2024 |

Travers Smith's Sustainability Insights: Supply chain due diligence in Europe

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A regular briefing for the alternative asset management industry.

The EU's Corporate Sustainability Reporting Directive, or CSRD, will require many large companies (including many alternative asset managers) to report their harmful environmental and social impacts. The CSRD's detailed rules may be unnecessarily complex and expensive to implement, including for private markets investors, but few in Europe take issue with the principle. Most agree that the law should require companies to report publicly on their ESG performance – at least to some extent.

But what about the logical next step: requiring companies to take action to avoid doing harm? Is that a step too far?

The EU's proposed Corporate Sustainability Due Diligence Directive, or CS3D, is certainly the most notable European attempt to force businesses to mitigate their adverse impacts, with direct liability for those that fail to do so. It's pan-EU (indeed, extra-territorial) reach, across all sectors, marks it out from any existing rules.

Of course, the proposal did not go far enough for some – particularly when the financial sector was partially exempted, following pressure from a number of national governments, especially France. And, even though a text was apparently agreed among lawmakers earlier this year, some member states are now pushing to have it watered down even further.

Tensions are running very high in Brussels, and it remains unclear whether the draft Directive will make it across the line before June's European Parliamentary elections. Time is running out for the EU Council to approve a final text and, since most predict a shift to the right in the elections, if the CS3D does fall at the final hurdle, it may struggle to get back on the agenda – at least without some modifications.

But these last-minute shenanigans should not be taken to indicate that the principle behind the Corporate Sustainability Due Diligence Directive is not accepted by EU lawmakers. On the contrary, there is a growing expectation that companies should not just report their adverse ESG impacts, but act to prevent or mitigate them.

requirements in Europe for companies to mitigate their harmful impacts … are here to stay

Just this week, for example, European lawmakers reached an in-principle agreement on the Commission's 2022 proposal to ban products from the EU market that are made with forced labour. That will impose a de facto supply chain due diligence requirement on a wide range of businesses that sell products in the EU, or export them. The US already has a more specific version of this, the US Uyghur Forced Labor Prevention Act, and there is pressure for the UK government to upgrade its 2015 Modern Slavery Act, likely to be fuelled by a recent call for evidence issued by an influential Parliamentary Committee.

But forced labour is not the only harm that policymakers are concerned with, as our recent note on similar European rules explained.

For example, the 2017 Conflict Minerals Regulation requires importers of gold, tantalum, tin and tungsten to conduct due diligence to ensure that their products are sourced responsibly. More recently, the EU's Deforestation Regulation requires those selling or exporting certain commodities (including, for example, cocoa, soy, beef, coffee, wood and some rubbers) to prove that they did not originate from recently deforested land, or contribute to deforestation. The extent of this obligation is significant, requiring the collection of specific information, including the geolocation of the plots of lands where the commodities were produced.

Similarly, the EU Batteries Regulation requires companies to conduct due diligence to address a broad spectrum of social, environmental and climate risks, basing their due diligence on international regimes such as the OECD Due Diligence Guidance for Responsible Business Conduct.

These sectoral rules are proliferating, but are supplemented by more general obligations that are emerging in a number of EU Member States, including Germany and France.

France's law – known as the Duty of Vigilance – applies to the largest French companies. It requires those in-scope to explain publicly how they map, evaluate and mitigate risks, prevent serious violations, and establish alert mechanisms and monitoring systems. The law lacks clarity and there are a number of cases (most brought by NGOs) currently in front of the French courts.

Germany's supply chain diligence law maps more closely to CS3D, although narrower in scope and without direct liability to affected third parties. In force for the largest companies since January 2023, and now extended to those with over 1,000 employees in Germany, the law obliges in-scope companies to diligence their up- and downstream value chains for adverse impacts.

Similar measures are proliferating throughout Europe. For instance, the Netherlands obliges companies to conduct due diligence into child labour risks in the value chain, and is working on a more general supply chain law. Norway has a law on Transparency and Human Rights, which also obliges in-scope undertakings to conduct diligence on human rights impacts and 'decent working conditions' in the value chain.

Such a fragmented approach to sustainability due diligence makes a pan-EU law very likely in the near future, even if it takes a bit longer than the architects of CS3D originally planned.

Proposals in the UK for a CS3D equivalent remain at an earlier stage, but are gaining traction – and supply chain liability risks continue to grow as the UK courts seem willing to open the door to novel claims. (See our more detailed ESG risk map here.)

So, whatever happens in the next few weeks to the Corporate Sustainability Due Diligence Directive, requirements in Europe for companies to mitigate their harmful impacts – whether in their own operations or in their supply chains – are here to stay. Responsible investors, especially those with control or significant influence over their portfolio companies, should remain alert to these developing expectations.