Corporate due diligence and corporate accountability European added value assessment STUDY EPRS | European Parliamentary Research Service Author: Cecilia Navarra European Added Value Unit PE 654.191 – October 2020 EN Corporate due diligence and corporate accountability European added value assessment There is evidence of human rights violations and negative environmental impacts related to business activities, including of EU companies. Several actions have been taken at both international and EU level to promote responsible business conduct and to prevent such violations. While being important steps forward, these initiatives suffer from several limitations, as they are either voluntary, sector-specific, or limited to reporting obligations. The EU is committed to upholding human rights and environmental protection, and has the competence to harmonise national company law to ensure the proper functioning of the single market. This study analyses the European added value of a potential measure requiring companies to carry out due diligence on possible social and environmental risks in their operations and supply chains. It analyses why action should be taken at the EU level and points to its potential impacts from the perspective of both EU companies and society at large. EPRS | European Parliamentary Research Service AUTHORS Cecilia Navarra, European Added Value Unit, DG EPRS. This paper has been drawn up by the European Added Value Unit of the Directorate for Impact Assessment and European Added Value, within the Directorate-General for Parliamentary Research Services (EPRS) of the Secretariat of the European Parliament. The annexed company-level analysis of the estimated economic impact of environmental, social and governance due diligence and corporate accountability for EU companies has been written by Stefania Camoletto, Maria Jose Montes-Sancho and Erica Santini at the request of the European Added Value Unit (EPRS). To contact the authors, please email: [email protected] ADMINISTRATORS RESPONSIBLE Cecilia Navarra, European Added Value Unit, DG EPRS To contact the publisher, please email: [email protected] LINGUISTIC VERSIONS Original: EN Manuscript completed in October 2020. DISCLAIMER AND COPYRIGHT This document is prepared for, and addressed to, the Members and staff of the European Parliament as background material to assist them in their parliamentary work. The content of the document is the sole responsibility of its author(s) and any opinions expressed herein should not be taken to represent an official position of the Parliament. Reproduction and translation for non-commercial purposes are authorised, provided the source is acknowledged and the European Parliament is given prior notice and sent a copy. Brussels © European Union, 2020. PE 654.191 ISBN: 978-92-846-7182-3 DOI: 10.2861/594198 CAT: QA-02-20-823-EN-N [email protected] http://www.eprs.ep.parl.union.eu (intranet) http://www.europarl.europa.eu/thinktank (internet) http://epthinktank.eu (blog) Corporate due diligence and corporate accountability Executive summary European added value assessments (EAVAs) provide support in the form of research-based evidence to European Parliament reports on legislative-initiative proposals drafted under Article 225 TFEU. This EAVA accompanies the legislative-initiative report of the European Parliament’s Committee on Legal Affairs (JURI) on Corporate due diligence and corporate accountability (2020/2129(INL)). EAVAs try to explore the potential impact of an EU action in a certain field, by analysing the gaps existing in the status quo and identifying the potential European added value of the proposed intervention. One of the points of departure in the debate around the need for companies to apply due diligence with respect to human rights violations and negative environmental impacts is the increased business internationalisation and integration in global value chains. Companies’ activities can have social and environmental impacts in the regions where they themselves or other actors in their value chain operate, which are sometimes far from the country in which the company is registered. There is evidence of violations of fundamental rights related to business activity; as an example, in 2017, the International Labour Organization (ILO) reported 24.9 million people were victims of forced labour, of whom 16 million were in the private economy, in sectors such as manufacturing, construction, agriculture and domestic work. Research also shows adverse environmental impacts: 62 % of tropical forest loss is due to agricultural exploitation for commodity production, and 24 % is due to illegal agro-conversion for export markets. In the light of these negative impacts, some major initiatives at the international level, such as the United Nations Guiding Principles on Business and Human Rights, have been taken to promote responsible business conduct and to prevent businesses' violations of human rights. These initiatives are important steps towards addressing negative impacts related to business activities, and they recommend the adoption of due diligence as a way to implement responsible business conduct. They are nevertheless voluntary measures and their uptake by companies appears limited. The UN working group on business and human rights itself points to the low prevalence of practices that reflect the UN Guiding Principles. There is a growing consensus that the approaches applied, which are largely voluntary, suffer from limitations. The EU is committed to protecting human rights and the environment, and has assumed a number of international obligations in this respect. At the EU level, a number of initiatives –such as the Non-Financial Reporting Directive, the Timber Regulation and the Conflict Minerals Regulation – have been put in place to address the negative impacts of business activities. Still, these important steps remain focused on specific sectors, or are limited to reporting requirements. There is evidence of a limited uptake of due diligence practices among EU businesses. A 2020 study commissioned by the European Commission's Directorate-General for Justice and Consumers (DG JUST) finds that just a little over a third of business respondents indicated that their companies undertake due diligence accounting for a broad range of impacts on human rights and the environment. Relatedly, there appear to be gaps in the effective access to remedy for victims, which is a right enshrined in the Charter of Fundamental Rights of the European Union. Most research and business surveys underline the reduced legal certainty as regards the duties of companies due to the absence of a common legal approach at the EU level. Against this background, the need for a level playing field is mounting, since companies that are more proactive in social and environmental fields risk being exposed to a number of disadvantages. I EPRS | European Parliamentary Research Service This EAVA focuses on a potential measure that requires companies to carry out due diligence to identify, prevent, mitigate and account for actual or potential human rights violations and negative environmental impacts in their operations and supply chain. This is assessed against the current situation, where some but not all EU Member States have adopted laws in this regard, and where international voluntary guidelines already exist. Overall, the European added value of such a potential measure appears significant, even if it is not possible to quantify each and every one of its components. The present study suggests that potential mandatory measures would increase compliance with standards such as the OECD Guidelines and the UN Guiding Principles. According to the European Union Agency for Fundamental Rights, effective due diligence practices can also help to strengthen victims' access to remedy. The impact can be substantial, depending on the quality of enforcement and on how the legal aspects are designed. Action at the EU level would allow to harmonise the rules within the single market and thereby ensure its good functioning and the creation of a level playing field favouring fair competition. Legal certainty is expected to increase substantially, since EU-level due diligence requirements could address the concern raised by many businesses on the lack of clarity regarding their duties. A specially designed law-based standard would support current good practices and give companies greater leverage over their suppliers. From a company perspective, mandatory due diligence involves implementation costs and has an impact on economic performance. According to the literature, these costs, while significant in some cases, are expected to be moderate as compared to company revenues. They will nevertheless be contingent on the type of company and especially its size. The impact of environmental, social and governance accountability practices on company outcomes is usually considered positive in most literature thanks to: reduced risks, improved stakeholder relationships, lower costs resulting from conflicts, improved transparency and knowledge of the value chain, increased reputation and greater incentives to innovate. The present study confirms these findings. Analysing a sample of EU companies, it indeed finds a positive correlation between the extent to which companies implement environmental and social policies and their economic performance (with a focus on profitability). Interestingly, this correlation is stronger