Today, the European Commission presents its long-awaited initiative on due diligence and directors’ duties. The new rules could have set a strong standard to lead companies in the EU on a path to climate neutrality and sustainable development. But important provisions in the proposal have been watered down. Without further clarification and strengthening of key provisions, the regulation will be ineffective in changing corporate behaviour.

“The introduction of mandatory due diligence rules is an important step towards curbing environmental damage or human rights violations in business operations,” says Maria van der Heide, Head of EU Policy at ShareAction.

“It is a real disappointment, however, that these rules only apply to large companies.* Human rights and environmental risks occur in operations and value chains of companies of all sizes. By excluding small and medium sized enterprises, which account for around 99 per cent of all EU companies, only a tiny percentage of the EU’s economy will have to identify and manage these risks to.”

Moreover, special exemptions are given to the financial industry, which will only need to execute simplified due diligence rules. The proposal deviates from international due diligence frameworks, that emphasise the need for all businesses to avoid and address negative impacts of their operations. Van der Heide adds: “The effectiveness of the due diligence system will be put at risk with this narrowed scope. The exemptions for the financial industry limit the positive impact that financial institutions can have by identifying and addressing risks to planet and people. It also sends a message to the financial sector that they don’t need to worry about these risks, when all the evidence points to the opposite.”

The recent call by more than 100 leading companies and investors for the inclusion of all businesses, including financial actors regardless of size, fell on deaf ears.

The directors’ duties part of the Directive has also been watered down significantly, compared to the Commission’s initial thinking. [1] Enhancing sustainability expertise in the board does not feature in the draft law for instance, and requirements for directors to engage with stakeholders have been weakened considerably.**

Nonetheless, the final package does include some positive measures. For example, it obliges companies to adopt a plan to ensure that their business model and strategy are compatible with the Paris Agreement, and to define emission reduction targets if climate change is considered a principal risk for the company. In addition, when companies set variable remuneration, this must be linked to transition and emission reduction objectives.

Van der Heide says: “Transition plans are an important step towards climate neutrality by 2050. Investors can use this information to determine how serious companies are about transitioning, and to redirect capital flows towards sustainable companies. Linking transition and emissions reduction plans to variable remuneration has the potential to put sustainability at the top of directors’ agendas. However, it is key that these rules are further clarified and strengthened to make sure that short-term financial considerations will not continue to override sustainability in directors’ decision-making.”

Other areas of concern in the proposal include the limited scope of civil liability, as well as the lack of clear criteria to consider climate risks, or requirements to set short-, medium- and long-term emission reduction targets.

This proposal will now be discussed in the European Parliament and Council.