The proposed initiative would embed sustainability in companies’ corporate governance frameworks and their business strategies.

By Paul A. Davies and Michael D. Green

On 26 October 2020, the European Commission (the Commission) launched a public consultation on a proposed sustainable corporate governance framework. The Commission is seeking views from a broad range of stakeholders, including, in particular, businesses and their directors as well as investors, environmental organisations, and public authorities that may have a role in supervising the new rules.

Background

Even before the COVID-19 pandemic, sustainability was considered key to the future of the European Union — the Commission has confirmed this is even more the case now. In the Commission’s view, taking an approach that emphasises sustainability will contribute to the post-pandemic recovery by nurturing the long-term resilience of companies and improving the predictability and management of risks.

Earlier this year, the European Green Deal and the Commission’s Communication on the COVID-19 recovery plan confirmed that sustainability should be further embedded in companies’ corporate governance framework. According to the European Green Deal, “many companies still focus too much on short-term financial performance compared to their long-term development and sustainability aspects”.

In a similar vein, the Next Generation EU plan, adopted in May 2020, confirms the Commission’s intention to ensure that environmental and social interests are “fully embedded into business strategies”.

The Commission’s Studies

In order to assess further obstacles to businesses’ transitions to an environmentally and socially sustainable economy, the Commission undertook two market studies. The current consultation builds on the below studies, which also form a substantial part of the preamble to the Commission’s questionnaire.

Study on directors’ duties and sustainable corporate governance

This study shows a trend of listed companies focussing on the short-term benefits of shareholders rather than on the long-term interests of the company. It suggests that sustainability is often overlooked and that EU intervention is required to strengthen the role of directors pursuing long-term company profitability and integrating sustainability.

Study on due diligence requirements through the supply chain

This study focuses on due diligence’s role in addressing adverse sustainability impacts, such as climate change and human rights issues. It shows that only one in three businesses claim to undertake due diligence “takes into account all human rights and environmental impacts”. The research concludes that a cross-sectoral regulatory measure at the EU level is preferable to specific frameworks.

The Consultation

The consultation aims to gather the views of stakeholders on the need and objective for EU intervention as well as different policy options, and to assess the costs and benefits of each option. The consultation also seeks to gain an overview of national frameworks, enforcement mechanisms, and current jurisprudence. (To read about stakeholders’ efforts to harmonise frameworks, see Latham’s blog post The Road to Developing an ESG Global Standard.)

The consultation questionnaire contains 26 substantive questions and enquires on matters including:

  • Whether companies and their directors should take account of stakeholder interests alongside the financial interests of shareholders
  • The interests that are relevant to the long-term success and resilience of companies
  • Whether directors should be required to balance the interests of all stakeholders, instead of focusing on the short-term financial interests of shareholders, as part of their duty of care
  • Whether sustainability risks and opportunities should be integrated into companies’ strategies
  • Whether stakeholders should be given a role in the enforcement of directors’ duty of care
  • A possible corporate due diligence duty requiring companies to establish and implement adequate processes with a view to preventing, mitigating, and accounting for human rights, health, and environmental impacts in companies’ operations and supply chains
  • Options to counter executive remuneration promoting a short-term focus
  • Options to enhance sustainability expertise in the board

Notably, the Commission’s current initiative is complementary to the review of the Non-Financial Reporting Directive, which requires large public-interest companies to disclose non-financial information.

In addition, environmental law charities such as ClientEarth have advocated for introducing mandatory due diligence rules in relation to sustainability issues in supply chains. Through its consultation, the Commission appears to be receptive to such proposals.

The consultation closes on 8 February 2021. Latham & Watkins will continue to monitor developments in this area.

This post was written with the assistance of Sabina Aionesei in the London office of Latham & Watkins.