Sustainable Corporate Governance Directive

09 May 2022 – Vanessa Galhardo-Galhetas

Corporate governance is a corporate structure made up of legal, cultural, and institutional arrangements and processes that ensure an effective division of powers within an organization, a sufficient control on decision-makers, and that a proper risk assessment of activities is performed.

A sound Corporate Governance of a company is a guarantee that decisions are taken by the right persons with the necessary competences, that necessary controls are in place and that the most optimal decision is taken. Customers and investors value companies with sound Corporate Governance, as this indicates that a company has processes in place that will ensure that decisions will be taken on the basis of all available parameters and that reliable outcome can be expected.

Over the years, companies and regulators alike have taken initiatives in the area of Corporate Governance.

Study on Directors’ Duties and Sustainable Corporate Governance

Recently, in 2020, the European Commission has launched an initiative on “Sustainable Corporate Governance” aiming to improve the EU regulatory framework on company law and corporate governance. It would enable companies to focus on long-term sustainable value creation rather than short-term benefits. It aims to better align the interests of companies, their shareholders, managers, stakeholders and society. It would help companies to better manage sustainability-related matters in their own operations and value chains as regards social and human rights, climate change, environment, etc.

In this context, the European Commission requested EY to conduct a study on Directors’ Duties and Sustainable Corporate Governance. One of the main topics of the study was the focus of corporate decision-makers on short-term shareholder value maximization rather than on the long-term interests of the company reduces the long-term economic, environmental and social sustainability of European businesses. The objective of this study was to assess the root causes of “short termism” in corporate governance, discussing their relationship with current market practices and/or regulatory frameworks, and to identify possible EU-level solutions, also with a view to contributing to the attainment of the UN Sustainable Development Goals and the goals of the Paris Agreement on climate change. The study focused on issues contributing to “short-termism” in company law and corporate governance, which have been grouped around seven key problem drivers, covering aspects such as directors’ duties and their enforcement, board remuneration and composition, sustainability in the business strategy, and stakeholder involvement.

The study suggested that a possible future EU action in the area of company law and corporate governance should pursue the general objective of fostering more sustainable corporate governance and contributing to more accountability for companies’ sustainable value creation. For this reason, for each driver, alternative options characterized by an increasing level of regulatory intervention have been assessed against the baseline scenario (no policy change).

Proposal for a Directive on Corporate Sustainability Due Diligence to tackle human rights and environmental impacts across global value chains

On 23 February 2022, the European Commission issued its long-awaited Proposal for a Directive on Corporate Sustainability Due Diligence to tackle human rights and environmental impacts across global value chains. The aim of this Directive is to foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance.  The Proposed Directive will complement the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation.

The proposed Directive has already become controversial, with its potential high costs for companies and its potential penalties and civil liability. The text of the proposed Directive defines the objective of the Directive “setting out a horizontal framework to foster the contribution of businesses operating in the single market to the respect of the human rights and environment in their own operations and through their value chains, by identifying, preventing, mitigating and accounting for their adverse human rights, and environmental impacts, and having adequate governance, management systems and measures in place to this end”.

The current proposal introduces a Directors’ duty of care for the covered companies. The text proposes Member States to adopt legislation ensuring that, when fulfilling their duty to act in the best interest of the company, directors of companies take into account the consequences of their decisions for sustainability matters, including, where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term. Moreover, Member States will have to ensure that directors of companies are responsible for putting in place and overseeing the due diligence actions and in particular the due diligence policy, with due consideration for relevant input from stakeholders and civil society organisations. The directors shall report to the board of directors in that respect.  The European Commission proposes enforcement by administrative measures imposed by national supervisory authorities who would have powers of investigation, as well as potential civil liability.

A novelty is that the proposed Directive suggests to create a European Network of Supervisory Authorities to facilitate cooperation and alignment. EU-based companies covered by the Proposed Directive would be supervised by the competent supervisory authority of the Member State in which they have their registered office. A non-EU company would be supervised by the supervisory authority of the Member State in which it has its branch. Should the covered company not have a branch in a Member State, or have branches in different Member States, the competent supervisory authority would be that of the Member State in which it generates the most turnover within the EU.

If this legislative proposal would be adopted, then this would mean that companies falling within its scope will have to adopt a due diligence policy, a code of conduct with rules and principles on human rights and environmental impact, make an assessment of its business relationships, and install at least an annual assessment of its own operations.


Next steps

Important to note is that this initiative is still at the stage of a legislative proposal for adoption by the European Parliament and the Council, consequently the proposed measures are subject to change. A final Directive will have to be transposed into national law by the Member States within two years of the entry into force of the Directive for the largest companies covered, with a further two-year transitional period for those smaller companies operating in high-risk sectors specified by the Proposed Directive.