The Proposal for a Corporate Sustainability Due Diligence Directive: The view of the Board and Non-executive Director

Since the beginning of this century, also as a consequence of the 2007-2009 financial crisis, corporate governance has focused on topics of internal corporate governance such as composition of boards, qualification of board members, independence, diversity and remuneration. But there was a massive loss of trust in companies, their managers and directors (including NEDs), which also caused political concern.

This started a discussion about the necessity and success of detailed regulation and called for new approaches. In the UK, France and—to a lesser degree—Germany hard and soft law approaches to a more innovative way of dealing with the challenge of loss of trust were sought. The intent was to redefine corporations in the 21st Century as entities that benefit not only investors but society more widely through a purpose which is broader than just making profits. The role of values, cultures and law came into focus. The goal was to empower corporations to transform their purpose and their governance.

The UK amended its Corporate Governance Code (2018) with the goal to build trust in society as a whole, reenforcing, inter alia, stakeholder value. A project of the British Academy ‘The Future of the Corporation’ (2018-2021) had similar concerns and focused on purpose, policy and practice. The goal of the British Academy was for corporations to produce profitable solutions for the problems of people and planet while not profiting from creating problems.

France introduced its Loi Pacte (2019) which came with the introduction of a purpose and call for a raison d‘être for companies. Germany was slower and less courageous; only the German Corporate Governance Code introduced in 2020 the concept of purpose and societal responsibility. But the latest draft amendments to the Code as proposed by the Governmental Commission seek to include rather strong wording on sustainability.

This approach via the purpose/raison d‘être/societal responsibility opened the way to a wider definition of corporate governance, the best interest of companies and board role, but these approaches are too vague to provide for quick change. Corporate Governance was at risk of being guided by vague concepts with little guidance for boards, which have come under greater scrutiny along with increased risks of personal liability for directors.

At the same time ESG principles have become more detailed and more effectively enforced. Yet, that led rather to increased compliance than truly strengthened governance in practice.

Did those attempts at finding a new approach to Corporate Governance re-establish trust in companies and their managers and directors? I wonder.

Companies and boards had to deal, inter alia, with the numerous challenges arising from the public debate about loss of trust, the uncertainties as to what is (now) the best interest of the company, non-financial risk assessments no longer being sufficient any more, and operational risks having become  a big concern, in particular reputational risk.

Then came the big bang of the EU Green Deal assisted by younger generations standing up, eg, Greta Thunberg and Fridays for Future. And things became even more complicated for boards. I do not even want to start talking about the EU taxonomy and the question whether it can achieve the Paris climate goal of 1.5 degrees and not only net-zero which seemingly does not get us to saving our planet.

How were we to deal with the climate challenges at a time when due to the sanitary crisis and broken value chains the focus was on health, logistics, liquidity, liquidity, liquidity and sheer survival of the business?

And now comes the EU Proposal for a Directive on Corporate Sustainability Due Diligence. While in line with the developments in previous years, this is now the final move away from the general distinction between internal and external corporate governance: the outside-in perspective (looking at the internal governance of companies) needs now to be combined with the inside-out perspective (a totally new concept, taking into account and creating liability risks due to the external effects of companies’ activities). The inside-out perspective is necessary to cover the entire value chain but it still is a sea change for governance, board responsibilities and liability risk.

Boards have to take people and society, climate and the planet into account. The adverse impact of the company has to be assessed and  profitability may not always prevail. New learning and focus by boards is key.

The shift towards sustainable management has left the strategic level and is impacting the operational level on a day-by-day basis. Sustainability is becoming increasingly relevant to the performance indicators for corporate management (and also for remuneration). What companies need to realise is that ambitious sustainability goals require pragmatic and goal-oriented solutions rather than box-ticking.

The effort to establish sustainability expertise by means of an ESG/sustainability expert on the boards (as suggested by the EU Commission) is not to be advocated. On the one hand, boards have already built up know-how; on the other hand, the high goal of sustainability is one that concerns the board as a whole. Everyone has to contribute something to the topic from their own expertise.

The goal of a sustainable economy is widely considered to be the necessary way forward. However, many companies and their representatives worry that the leap is too ambitious, that the Proposal aims too high if only because fear of personal liability on the part of the board of directors and supervisory boards leads to too much internal procedure and compliance, instead of ambitiously and wholeheartedly seeing and embracing improved sustainability as a business opportunity.

How are we to balance the interests of the wider stakeholder groups, the people and the planet, with the interests of shareholders in profits and returns? How are we to avoid concerns of misappropriation of company funds and acting against the best interest of the company, the latter apparently having become a moving target?

Whatever the right answers to these questions are, new compliance management systems are an unavoidable tool for the verification of compliance with the new sustainability goals in the entire value chain (as suggested by the EU Commission). This is the only certain way to minimize liability concerns of boards and directors. The country-by-country approach rather than a group approach leads however to the risk of fragmentation of compliance management systems.

Let us hope that the discussions on this Proposal manage to alleviate the concerns of those who must act upon the new challenges. The aim must be to achieve the Commission’s political priority: ‘an economy that works for people.’ And we have not even started to look closely at social challenges, a social taxonomy, and their impact on companies and their governance.

To summarize, corporate governance research and practice are now connected to wider themes of responsible business, ESG, purpose and sustainability. The outward-in perspective has been reversed to an inside-out perspective, which represents a sea change in corporate governance. This has an enormous impact on the know-how requirements of board members and on their risk of liability. The call for an update of compliance-management systems by the EU Commission in the new Proposal for a Corporate Sustainability Due Diligence Directive of course makes sense. But all board members must update their know-how. It is not appropriate only to call in a sustainability expert (as suggested by the EU Commission). This is really the responsibility of the entire board. We need to strengthen the responsibility of the entire board and avoid the quasi-outsourcing of topics of such major and enduring relevance for companies to a single director. More work ahead!

This post is part of our series on ‘The Corporate Sustainability Due Diligence Directive Proposal’.

Daniela Weber-Rey is a business lawyer, a former board member and still Practitioner Member of ECGI and a (non-executive) board member of, among others, HSBC Trinkaus & Burkhardt and Fnac Darty.