Following last month’s vote by the EU’s Legal Affairs Committee to approve a draft law to require companies to conduct environmental and human rights due diligence in their supply chains, the EU parliament adopted the legislative report.
Why the New Requirements?
Among the goals of the legislative initiative is to level the playing field for companies that are voluntarily conducting due diligence in these areas, and to establish fines and penalties against those who flout the rules. According to reports, the EU Commission is expected to publish a binding due diligence directive for all companies in the market by June.
The proposed legislation will impact companies across the globe and in all industries, either directly if a company has EU operations, or indirectly if companies in their supply chains are subject to the legislation.
The proposed legislation has enjoyed broad support, including from the Investor Alliance for Human Rights, which has noted that:
Investment portfolios comprised of companies showing greater responsibility have outperformed and proved more resilient during the pandemic. Nevertheless, the irresponsible practice of squeezing profits and returns out of suppliers or investments while externalizing social and environmental costs remains endemic in the broader market. In the worst case this even goes unnoticed in ESG ratings. Responsible investors therefore have much to gain from mandatory due diligence legislation: it would substantively complement their own leverage with companies to drive change, as well as reducing (short-term) competitive disadvantages they might still face under current unsustainable market and investment conditions. Put simply, mandatory human rights due diligence makes good business sense for companies, investors, and governments alike. This type of regulation increases the robustness of corporate risk management processes, helps investors achieve higher risk-adjusted returns, and contributes to economic growth. Positive performance on human rights and proactive management of risks to people can attract investment and procurement opportunities for both companies and governments.
Ethical Companies Ahead of the Curve
Our data supports that organizations that invest in ethics are themselves good investments. We have noted over the last several years a trend—even in the absence of mandatory legislation, where leading companies have begun to take a more holistic approach to third party management, expanding their focus from “core” compliance issues like fraud, corruption and money laundering to include a broader set of risk factors, including human rights, labor conditions, and environmental sustainability.
Each year for the last 15 years, Ethisphere has honored companies who meet a rigorous set of ethics and compliance standards. Ethisphere’s 2021 Ethics Index, comprising this year’s publicly traded company recipients of the World’s Most Ethical Companies® designation, outperformed a comparable index of large cap companies by 7.1 percentage points over the past five calendar years. What we refer to as the “Ethics Premium” has remained consistent over the years that we have been tracking the equity performance of honorees.
Among this year’s honorees, more than 80 percent regularly perform human rights due diligence, and 77 percent evaluate the environmental performance of supply chain members. When asked whether they include requirements related to environmental performance and human rights in their third party codes—a key mechanism for cascading requirements through the supply chain—more than 92 percent reported including human rights and roughly 90 percent environmental performance.
Preparing Your Company
Companies who have not already put human rights and environmental requirements into their third party agreements and codes should begin preparations to do so once these new regulations are published in June. They should also begin planning for what due diligence will look like, and if they need to either hire more staff or find an outside partner for that task. The draft directive included the requirement for risk-based due diligence on all supply chain partners, an annual review of the process and grievance and remediation mechanisms for actual or potential adverse human rights and environmental impacts.
You must of course ensure that your own program checks all of the necessary boxes once the new regulations are finalized. As the quote from the Investor Alliance for Human Rights makes clear, there is an investor relations component to this work as well—make sure that your IR team is well-prepared to answer any questions they may get, or even to highlight the quality of your programs as material proof of your organization’s soundness as an ESG-oriented, risk-resilient investment.
Later this spring, we will be releasing further insights from the World’s Most Ethical Companies data on these critical issues, so if you are tracking the efforts to increase the capabilities of value chain companies, be sure to stay tuned.
About the Expert:
Leslie Benton is a Vice President at Ethisphere, where she engages with global companies on assessing and benchmarking anti-corruption programs and building capabilities across organizations and with third parties. Additionally, she leads the anti-corruption initiatives at the Center for Responsible Enterprise And Trade (CREATe.org); and is one of the ISO 37001 Anti-Bribery Management Systems Standard drafters as a member of the U.S. Technical Advisory Group to the ISO committee developing ISO 37001.
