Corporate governance – that is, the systems, principles and processes by which organisations are managed, directed and controlled – is one such topic at the moment, in this jurisdiction as in many others.
Amid the continuing climate emergency and the ongoing ‘culture wars’ spreading across the developed world, stakeholders’ demands of corporates are increasingly focused on more than just the bottom line. We want more, it seems, from companies than purely providing maximum returns for their investors. Corporates are expected, if not required, to profess a purpose beyond pure profit-making, and to conduct themselves according to a philosophy. In addition to profit-making, we want them to focus on their impact on the world around them in the broadest sense – to ‘pick a side’ – and we want this sense of purpose to flow through the entire organisation, from the top down.
Where public expectation leads, legislators soon follow: the regulatory confluence of the above concerns are perhaps most visible in the various legislative initiatives on ESG and sustainability which are taking shape around the world.
In Europe, there has been a recent focus on the environmental aspects and the European Green Deal is a vivid backdrop to much of the incoming legislation. As is evident from an analysis of the legislation, however, there is an equal awareness of and focus on the other aspects of ESG. Taking the EU’s flagship piece of legislation in this area, the Corporate Sustainability Reporting Directive (on which we have previously written;(the Reporting Directive) it is evident that going forward, companies will be expected to engage with and report on both social and environmental impacts, risks and opportunities of doing business. Of fundamental importance, this will be underpinned by requiring governance to be entwined with these goals.
This is evident both in how the Reporting Directive requires sustainability reports to be included in the directors’ report (and therefore signed off by the board) and also in the detailed standards against which companies will be required to report, the European Sustainability Reporting Standards, or ESRS. Again, we have written an advisory series on the ESRS. Significantly, not only do the ESRS contain a specific disclosure standard on governance matters (ESRS G1 which requires disclosures around a company’s administrative, supervisory and management bodies, and their role in overseeing an organisation’s approach to material sustainability matters, among other topics) but the architecture of the ESRS also requires each sustainability matter being reported to be subject to a governance analysis on policies, actions and targets (as well as around assessment of the materiality of what sustainability matters are sustainable), all of which will be described in sustainability reports.
But does the Reporting Directive significantly expand personal liability for boards of companies? On the whole, the answer here is probably that it does not (although it will be necessary to analyse impending domestic implementing legislation to be definitive on this point). The Reporting Directive requires companies to report on their existing behaviour rather than dictate what that behaviour should be. Yes, it requires action by reporting entities in preparing their reports (in collecting data internally and in sourcing and diligencing value chain information) but at the heart of the Reporting Directive is what can best be characterised as an information-gathering exercise with a twist. The twist is new standards of consistency and transparency to tackle greenwashing – and the twist is delivered through new reporting standards, double materiality and an external audit. This is intended to allow stakeholders to allocate capital more sustainably, thus influencing standards and behaviours in the long run, but it does not itself impose standards of conduct. We expect that failure to include compliant sustainability reports in directors’ reports will be subject to Irish company law provisions around the failure to prepare and publish accounts with appropriate reporting will sit alongside other failures in financial reporting. In a sense, this increases the breadth of information for which directors will be ultimately responsible, but does not amount to a new area of liability. It remains to be seen whether in the fullness of time, perceived or actual shortcomings in sustainability reporting enable investor suits.
By contrast, the proposed Corporate Sustainability Due Diligence Directive (the Due Diligence Directive), currently under trilogue negotiation among the institutions of the EU, may up the stakes for corporate leaders. The Due Diligence Directive will require companies to diligence their own operations and those of their established business relationships to identify, prevent, mitigate and account for adverse human rights and environmental impacts of their operations, and these matters will ultimately fall to be disclosed in organisations’ sustainability reports.
Significantly, obligations are due to be imposed directly on corporate leaders. Directors will be responsible for setting up and overseeing the implementation of the due diligence processes required by the directive, and for ensuring that an organisation’s business model and strategy are compatible with a transition to a sustainable economy. Further, if adopted in its originally proposed form, the Due Diligence Directive may even go so far as to insert a new fiduciary duty on directors explicitly to take into account the human rights and environmental impacts of their decisions when fulfilling their duties to act in best interests of their organisations (which may be an expansion of existing domestic company law in many jurisdictions). As we’ve noted before, these aspects of the Due Diligence Directive remain under discussion and may be subject to change. There are differences of opinion among the EU’s institutions on whether and to what extent the proposed directive should require explicit duties to be added to domestic company law. But what is clear is that the directive demonstrates a legislative intention to drive changes in corporate behaviour and to legally require that leaders take responsibility for overseeing and executing those changes.
This ESG lens on corporate governance comes at a time when the trading environment is becoming tougher for many companies, already putting directors under increased pressure to ensure the orderly conduct of business. The scope of the challenge is such that in-scope corporates already engaged in ensuring that data will be available for the preparation of compliant sustainability reports are turning their attention to interrogating value chain relationships for potential adverse human rights and environmental impacts to ensure their ability to meet these incoming requirements in a timely manner. Some in-scope businesses will inevitably have better existing systems and controls than others from which to begin (or continue) their sustainability reporting journey. For all business, the Reporting Directive and anticipated Due Diligence Directive now clearly make sustainability behaviours and reporting a Boardroom issue.