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Due diligence on sustainability: what it means for businesses and how can EU standards help them

 

This article is a review, editing and adaptation by Sustentia, based on the original written by Frank Bold, in the framework of the Alliance for corporate transparency (ACT), for publication in Spain. It is the sixth in a series of articles published with the aim of spreading the word about the importance of sustainability reporting., and the regulatory changes in this regard underway in the European Union to 2021. First outlined the political developments planned for 2021, included 10 key changes envisaged in the proposed reform of the EU Non-Financial Reporting Directive. The second focused on governance information (G of ESG). The third highlighted the role of EU standards in ensuring comparable and meaningful data, fill current gaps in legislation and ease the administrative burden on businesses. Fourth collected the key issues to be addressed by the EU climate reporting standard, reflecting on critical information regarding the climate transition: transition plan and governance, climate-related risks and opportunities. The fifth focused on the relevance of SMEs in this transformation, and in the need of clear supports so that they can face the challenge, all of them are available here.

The opinions included in this article do not necessarily represent the opinions of other members of the Alliance..

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The human rights and environmental impacts of the global value chains of European companies represent a significant business risk, and a challenge for fair competition. They are incompatible with the objectives of the European Green Deal and the EU Sustainable Finance agenda.

With these initiatives, the EU intends to redirect private and public funds to support the transformation towards a sustainable economy. However, business activities will not meet sustainability requirements if their value chains continue to be linked to impacts such as deforestation or forced or child labor.

The tool that can help companies overcome these challenges and access sustainable financing is the ” due diligence “.

Due diligence on human rights and the environment is a concept developed by the UN ago 10 years and supported by the OECD through robust implementation guidelines, whose objective is to help companies identify and address their impacts on people and the planet. Since then, has received the universal endorsement of the leaders in sustainability of companies and investors, of sustainability reporting frameworks and standards, governments and the EU itself, which is why it is increasingly important for companies.

The new one European Union Directive on Corporate Sustainability Reports (CSRD), currently in debate, will go a long way towards addressing the implementation challenge and meeting investors' need for information on the plans, actions and results of the companies. This clarity is also important for companies to avoid reputational risks and financial consequences..

The European Commission to propose new legislation on business due diligence in autumn. But meanwhile, CSRD and the development of accompanying sustainability standards will play an important role in contributing to due diligence by defining information disclosure elements that are related to.

Due diligence is important in determining what issues the company should address; CSRD will describe how the company should report on it.

In this regard, and with regard specifically to how to report, due diligence helps companies identify social issues (S) and environmental (E) important and the information they are expected to report on, beyond the most frequent KPIs on your performance in labor and environmental matters. These KPIs will be covered in our next article..

This article explains what human rights and environmental due diligence is, how companies can meaningfully report on it and what issues the forthcoming EU information regulations should clarify to help companies.

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Due diligence made easy

Due diligence describes the measures taken by a company to identify and act accordingly on the real and potential risks of its activity for people and the environment, not just in your own operations, but in your supply chain and in the services you use.

It is related to business risk management, but it is based on an understanding of the risks of activities to people and the environment.

It is based on a principle of proportionality: appropriate behavior depends on the severity of the impact, the company's involvement in it and its own ability to deal with it. Also, is guided by principles established in international standards such as the UN Guiding Principles on Business and Human Rights and the OECD Guidelines, in particular:

1. Due diligence complexity will vary based on company size, the risk of serious impacts on human rights and the nature and context of its operations.

2. Companies must identify and assess the actual and potential adverse impacts associated with their operations, products or services, including those produced by a commercial relationship (for example, the impacts that occur in supply chains).

3. The appropriate action depends on:

a) If the company causes or contributes to causing the impact (then you must stop doing it), or if it is only directly linked to the impact by a business relationship (then you should try to prevent or mitigate the impact).

b) The extent of your ability to influence to address the impact.

4. Businesses should monitor and report on the effectiveness of their response.

The OECD Guidelines on Due Diligence describe it in 6 etapas:

Fuente: OECD, Due diligence guide (the detailed explanation of the different stages can be read here).

If they are not exposed to high-risk supply chains, small businesses can easily conduct and report due diligence. They just have to show that they have evaluated their value chain and examining the typical risks of their sector.

The greater a company's involvement in high-risk supply chains and operations and the greater its leverage on them, The more detailed information you provide should be to demonstrate that you have acted with due diligence. In case the company itself causes or contributes to the impact, you must take strong action to end it.

For example, following OECD guidance and EU rules already agreed for investors, banks and insurers, financial market agents are examining their support for mining or agro-industrial projects for their possible involvement in the violation of land rights, access to water or deforestation.

The OECD Watch Complaints Database contains examples showing that the financing of projects with negative impacts on the environment and human rights makes a direct contribution to these impacts. Leading companies in the textile sector are also analyzing the impact of their purchasing policies and practices on the working conditions of their suppliers in Southeast Asia..

The violations Human rights or environmental rights are often associated with big business and flagrant cases. But due diligence affects every business and can arise from everyday issues., like harassment in the workplace, the misuse of the company's products or services for unwanted purposes, the right to express oneself or practice the faith, unfair purchasing practices or privacy management of personal data.

However, impacts on the supply chain are often beyond the direct control of the company. In these cases, the key consideration is what possible actions would maximize positive changes and outcomes for people or the environment and if the company has done all it could do about it.

Regarding the publication of information, companies must be able to demonstrate who are aware of the risks and impacts they have or could have on human rights and the environment in their value chains, that they are not contributing to any of those impacts through their own actions and policies, and that they are doing all they can to maximize positive changes and outcomes regarding the impacts to which they are linked, but over those who have no control.

Caso Shell: a breakthrough for mandatory due diligence and corporate responsibility

The sentence handed down in May 2021 in the climate damage case presented by Milieudefense in 2019 contra Royal Dutch Shell (Shell) has been rated, justly, of historic: Shell must reduce its CO2 emissions by 45% grandson to 2030 (in comparison with 2019) regardless of the actions or policies of the Dutch government. But the sentence is historical also for other reasons: the court based its verdict largely on two rules of soft law or "soft law": the United Nations Guiding Principles on Business and Human Rights (UNGP) and the OECD Guidelines for Multinational Enterprises (OECD Guidelines). Also, affirms that companies have an individual responsibility in the fight against climate change throughout their value chains, and very clearly links climate change with human rights. This means that the judgment is likely to play an important role in materializing mandatory due diligence legislation..

Fuente: Centre for Research on Multinational Corporations (SOMO)

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Good for business

The main objective of due diligence is to prevent and mitigate impacts on affected people and the environment, in particular those of a systemic nature.

Generally, we can say that companies do not violate human rights or environmental standards on purpose. Due diligence enables companies to adequately assess relevant ESG risks and impacts that they would like to avoid knowing about., and what if they are not managed, sooner or later can lead to regulatory pressures, of investors, public or legal, against the company. In a similar way, companies and investors are already required to assess and report on the risks to their business arising from sustainability factors in their sustainability reports. This cannot be done if it is not clarified in which cases the company and its supply chain can have adverse impacts on people and the planet..

According to Gonzalo Gómez Retuerto, CEO of BME Renta Fija and MARF, “The political and economic priorities defined both globally, European and Spanish, demand from companies a greater commitment to sustainability and this will require greater environmental requirements, social and governance, which must also undertake and finance smaller companies ".

For example: “The economic value of clothing and textile companies is closely related to the reputation of their brands, giving investors a strong financial stake in supply chain visibility and human rights due diligence”, according to Eckhard Plinke, Lead ESG Analyst at Vontobel Asset Management (150.190 million dollars in assets under management).

In more general terms, due diligence is becoming the norm in business-to-business relationships in sectors dependent on global value chains. The ability of companies to demonstrate to their buyers that they have a strong due diligence system in place will become an increasingly important asset., that will help companies retain their business partners and grow.

“Investors are increasingly realizing that ESG issues are intersectional. We can't just focus on the weather, but we also have to examine the transparency of the supply chain. We won't make the necessary progress on climate if we don't address supply chains and due diligence”, describe Kate Monahan, Trillium Asset Management Shareholder Defense Director.

Also, paying attention to human rights and due diligence brings opportunities for companies. The Shift organization outlined concrete examples of how companies have used this approach to evolve their business “15 cases of how companies are driving their contributions to the Sustainable Development Goals by putting people first”.

Rosa Soto, Sustainability Manager at ACCIONA Energy, think that for a multinational this new context of regulatory advances in ESG management, and specifically regarding due diligence, they are an opportunity. This, not just because it is relevant to investors and others stakeholders, but also because it gives companies much clearer instructions and guidelines to manage adequately in the case of countries that do not have robust legislation, or in which these aspects are not considered binding; makes it easier to equalize the gaps between different geographies to have a single execution model for all operations in all countries. “More than a peso, it is an opportunity to channel our results and our way of doing things., and we believe that without a doubt this will be transformed into a competitive advantage for a business model that is sustainable and regenerative. In this case, more is better ".

However, the results of the 2020 Corporate Human Rights Benchmark show that too many companies still fail to meet human rights due diligence expectations and that negative impacts are felt primarily outside company headquarters, in developing countries. Of them 229 companies evaluated, 104 had at least one accusation of serious impact on human rights in 2020.

One of the main negative environmental impacts is deforestation. In total, the planet loses about five million hectares of forest every year. Almost all of it occurs in the tropics. The 14% of deforestation is driven by consumers in the world's richest countries, that import beef, vegetable oils, cacao, coffee and paper that have been produced on deforested land. An example of a lack of due diligence leading to extensive deforestation, could be the case described by Global Witness showing how deforestation of the Amazon is linked to global beef supply chains supported by EU and US banks.

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The right answer for Europe

At this time, momentum for due diligence legislation is high. Francia, Norway and Germany have recently adopted legislation that makes companies legally responsible for acting with due diligence., in reaction to prominent cases of massive damage, like the accident of the Rana Plaza textile factory fire, the collapse of the Belo Monte dam and the increasing speed of the deforestation linked to agricultural products. This has also led the European Commission to start preparing a proposal to harmonize the EU legal framework., with the European Parliament voting overwhelmingly in favor of this initiative.

“The new rules will give victims a legal right to access help and request reparations., and will guarantee equity, a level playing field and legal clarity for all companies, workers and consumers”, said the MEP and rapporteur Lara Wolters (S&D, NL).

For his part, Adela Diaz, Director of the Human Rights Office of the Government of Spain, announced that Spain welcomes the announcement of the due diligence regulation made by Commissioner Reynders from the DG of Justice of the European Commission. It considers that it will be an instrument of internal and external coherence of the policies of the European Union, and that a regulation at this level can facilitate reference and benefits for companies in the EU. In the first semester of 2021 In Spain, two strategic documents have been developed that include the Government's commitment to due diligence in human rights and its recognition as a management instrument. One is the Foreign Action Strategy 2021-2024, which is committed to "the active involvement of the private sector in the defense and promotion of human rights and compliance with the principle of due diligence". Another is the Sustainable Development Strategy 2030 , incorporating the development of a Due Diligence Law as a priority for action.

Environmental and human rights due diligence also plays an important role in the more advanced European and global movements towards what has been termed a sustainable financial system.. The EU is implementing a comprehensive sustainable financing strategy to mobilize more than 1 billion euros of public and private investment in support of sustainable activities in order to meet the objectives set in the European Green Deal. Legislation that specifies criteria for financial activities and products to be considered sustainable (the EU Sustainability Taxonomy and the Sustainable Finance Disclosure Regulation), requires financial activities and products marketed as such to be supported by due diligence. This has been established as a necessary safeguard to avoid the risks of adverse impacts simply being passed through to supply chains.. The principle of due diligence will also be reflected in the development of EU green bonds and social bonds..

Due to its proportional nature, reporting due diligence seems easy at first, but clear reporting standards are what will make it easier for companies in practice. Today, although most companies are willing to report on their commitments and high-level policies, only the 20% provide information on the actual due diligence process, and less than the 4% provides relevant and key performance indicators on your progress.

For more details, see the full database of research results on 1000 companies carried out by the Alliance for Business Transparency.

In the case of the companies analyzed in Spain in this research, “The reports focus on presenting general policies and commitments (80-90% for key issues such as climate, human rights and the fight against corruption), but no concrete goals, policy results with respect to these objectives and specific information on risks and impacts (20% on average)”, According to the results presented by Juanjo Cordero, partner of Sustentia.

Theo Jaekel, expert in Corporate Responsibility of the telecommunications company Ericsson, is very clear in its support for EU plans to introduce mandatory due diligence requirements and standards regarding sustainability reporting. “Today, we have an obligation to disclose certain information on due diligence, but there is no clear harmonization on what that information should include. We consider that mandatory human rights due diligence requirements are part of the information that companies must report within the framework of the CSRD. Sustainability standards should clarify how companies should report”.

From the United Nations Global Compact Spain, support "firmly the obligation to carry out due diligence processes in matters of human rights", as Cristina Sánchez highlights, your Executive Director, who also comments that of more than 1900 Spanish companies surveyed, "only a 8% of these affirm to evaluate their impacts on human rights within their business activity, a very small percentage that, according to our report Communicating progress 2020: a call to sustainable action and business reporting, increases only up to 10% among the companies adhered to the Global Compact in Spain.

The lack of clear rules carries a risk of greenwashing and disadvantages companies whose business models are not intrinsically related to systemic environmental and human rights issues, particularly low risk SMEs, as well as responsible companies that apply due diligence. No clear transparency rules, for investors, banks and insurers it is difficult to distinguish between these companies and, Consequently, apply widely divergent approaches and indicators.

At the same time, international investors are convinced of the arguments for mandatory human rights and environmental due diligence. Last april, 105 investors, which represent 5 trillion dollars in assets under management, they signed a statement in which governments were asked to develop, apply and enforce mandatory due diligence requirements for companies. “When there are risks to people and the planet, there are material risks for companies and investors, including reputational damage, financial losses and legal liabilities. Investors welcome clear and consistent rules for companies to report their most prominent risks and how they manage them, as a means of supporting sustainable investment practices”, explica Rebecca DeWinter-Schmitt, Associate Director of Programs of the Investors Alliance for Human Rights.

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What can policy makers do to ensure that the Corporate Sustainability Reporting Directive provides clarity and certainty?

Increased obligations of financial agents increases pressure on companies to publish information on their due diligence. To deal with the lack of clarity, in the new directive on corporate sustainability reporting (CSRD) the European Commission proposes to develop and adopt, along with this, a standard on how companies must report on their due diligence, its main adverse impacts and its actions.

To overcome the challenges faced by companies and investors in this area, it should specify the following key elements of the due diligence information:

  1. How to report on the identification and assessment of impacts, in such a way that it is taken into account that the exposure of companies to the risks of such impacts is highly variable.
  2. What should be described about the identified impacts, in relation to the business context and the relationships involved in the impact, the people affected and the relationship with them.
  3. Criteria for reporting on the effects of policies and actions of the company on the impacts.
  4. Sector specifications for environmental and human rights issues and KPIs, that companies should evaluate and report, to center, simplify and better standardize information (for example, high-risk commodities in the food and beverage industry; working conditions in the supply chain in the garment sector, privacy of end users and consumers in the ICT sector, contamination and access to water by communities in the extractive industries sector).
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Conclution

Due diligence on the environment and human rights is reaching companies of all sizes and structures. Despite the fact that the headlines tend to focus on major catastrophes or scandals associated with a few multinational companies, all companies can unintentionally have adverse impacts on people and the planet in their value chains. Due diligence is the tool that turns what “unknown” in “known”, and guides the company on what it can reasonably do about it.

In this article we have shown that the measures that are evolving in Europe and internationally to demand due diligence on the environment and human rights can and will benefit companies.. They are necessary to manage risks, support fair competition, define the contours of the “best efforts” what companies can do in a specific situation, and prevent business partners or regulatory authorities from taking negative action against the company itself.

We have highlighted how the current debate on an EU Directive on corporate sustainability reporting is critical to ensuring adequate disclosure requirements for company due diligence., and should be complementary to the European Commission's own initiative on mandatory due diligence. We have also identified the ways in which the European Sustainability Information Standards, accompanying the Directive, can help due diligence. These can be the tool that helps companies understand how they can identify potential risks and adverse impacts., which sectors could be chosen for more specific standards, and how the company's own actions in response to risks can be assessed and then reported.

With a widely accepted due diligence framework, responsibility for environmental and human rights damages cannot be attributed to the company in an unfounded manner, Rather, it will allow all companies to understand and take adequate responsibility for the social and environmental impacts of their business..

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