Background to the Consultation
Since the launch of the EC’s Action Plan for Financing Sustainable Growth in 2018 (Action Plan), sustainable corporate governance has been a central and recurring theme throughout the many related European initiatives. Embedding sustainability into the corporate governance framework is considered a key driver to ensure companies focus on long-term sustainable value creation rather than short-term benefits.
The challenges to businesses of COVID as well as the increasing extreme climate events has reinforced the concern that businesses must be more resilient to be sustainable. The Commission’s research into sustainable corporate governance (culminating in its July 2020 Corporate Governance study) argues that “...many companies still focus too much on short term financial performance compared to their long-term development and sustainability aspects …”
Initially included as one of the ten key actions in the Action Plan (fostering sustainable corporate governance and attenuating short-termism in capital markets), the focus on sustainable corporate governance has been included in a number of subsequent initiatives, including:
- the European Green deal, launched in 2019;
- the post COVID Next Generation EU recovery plan; and
- the Renewed Strategy on Financing Sustainable Growth.
In addition, corporate governance and accountability are central to other initiatives such as the ongoing review of the Non-Financial Reporting Directive, the EU Taxonomy, the Sustainable Finance Disclosure Regulation, and related changes to the UCITS and AIFMD regimes.
Highlights of the Consultation
The Consultation comprises 26 questions which fall largely into two categories corresponding to studies conducted by the Commission: one on due diligence requirements through the supply chain and the other on directors duties and sustainable corporate governance.
The Consultation is a first step towards EU policy intervention, which would align with the general direction of travel on sustainability issues.
The key highlights of the Consultation are:
- Clarifying and strengthening directors’ duties of care. The Consultation invites feedback on the need to define more clearly duties of care which directors owe and the sanctions for non-compliance. The Consultation postulates that the lack of clarity contributes to “…a narrow interpretation of the duty of care as requiring a focus predominantly on shareholders financial interests”. Importantly as we emerge (slowly) from COVID 19, directors will have to consider how and over what time they manage their businesses back to financial health and potentially taking account of (amongst others) the interests of employees, environmental and social issues and not merely the short term consequences for shareholders.
- Remuneration of directors. The Commission invites input on different approaches to aligning directors’ remuneration with a longer-term perspective, including integrating sustainability risks and opportunities in their business strategies, and the establishment of sustainability metrics. This is consistent with the approach undertaken by the Sustainable Finance Disclosure Regulation, the Renewed Sustainable Finance Strategy, and the European Central Bank’s draft guidance from May 2020
- Sustainability expertise on boards. A key problem with embedding sustainability issues at board level is considered to be a lack of expertise. The Commission seeks input on what steps boards might take to demonstrate their expertise on sustainability issues including regular assessments of competence and requirements to have a specific proportion of the board with relevant background and expertise in sustainability issues.
- Supply chain due diligence. The need to consider due diligence in the supply chain forms part of Action 10 of the Action Plan and is also addressed within the Renewed Sustainable Finance Strategy. The Consultation invites input on issues that should be addressed in supply chain due diligence, including the introduction of adequate processes to prevent, mitigate and account for human rights and environmental impacts in companies’ operations and supply chains. The Consultation also considers whether there should be an enforcement procedure or wider liability.
It is noteworthy that some of the questions in the Consultation on directors duties are in line with the obligation on directors to identify crises at an early stage, which has now been implemented in all European countries via the Restructuring Directive. The question for directors is whether they are properly positioned to identify dangers (from the supply chain, from environmental risks, from human rights violations, etc.) in good time in order to avert any disadvantages that may result and any crises that may follow.
The Consultation is the forerunner to legislative change and whilst the UK will not be subject to any EU legislation, it is likely that it will face pressure to pass domestic legislation similar to any proposed EU law given the broader trend towards mandatory reporting on standards on environmental, social and governance concerns.
How can we help you?
We have a team of sustainable finance and regulatory experts, energy and corporate partners who can help you to make sense of the myriad legislative change in this area, and its impact on your business, in the UK and across Europe. We can help you to identify where there may be gaps in your systems, processes and disclosures which you will need to rectify under upcoming regulation.