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Introduction of mandatory due diligence laws in the EU

In April 2020, the European Commissioner for Justice, Didier Reynders, announced a commitment to introduce mandatory due diligence legislation in the European Union (EU) by 2021. Following this, in March 2021, the European Parliament voted by a large majority to bring in new laws that would require EU companies to conduct human rights and environmental due diligence within their value chains. The term ‘value chain’ encompasses more entities than the term ‘supply chain’, including a company’s operations, direct and indirect business relations and investment chains. The proposed due diligence law is expected to target potential infringements of human rights; environmental impacts contributing to climate change; and good governance to prevent and mitigate the risk of corruption and bribery.  The Commissioner also announced that the legislation will be cross-sectoral and applicable to all businesses.

Currently in the EU, some companies monitor their supply chains for adverse impacts of their business practices, while others do not. In addition, access to justice and remedies for victims consist of non-judicial and voluntary schemes. The new legislation aims to resolve this issue by setting a legal standard. With the introduction of this legislation, companies are being asked to address the environmental and human rights impacts of their operations or face the imposition of sanctions for non-compliance. This signals a move towards an era of more responsible business practices and conduct, not only for corporates operating within the EU but also for corporates that do business with the EU globally.

What is due diligence?

The corporate responsibility to respect human rights through due diligence mechanisms is set out in the UN Guiding Principles on Business and Human Rights (UNGPs). The UNGPs were launched in 2011 to usher in a new era for business and human rights, calling on both states and corporates to respect their obligations to respect and protect human rights. This framework identifies due diligence as a means through which corporates can identify, prevent, mitigate and account for potential and actual adverse impacts arising from their business operations.

Corporate due diligence involves four components:

1. Identifying and assessing impacts

2. Integrating findings from impact assessments across relevant internal processes

3. Tracking the effectiveness of responses to address impacts

4. Externally communicating on how impacts are being addressed

The key aspects of due diligence are that it concerns risks to people, not risks to businesses, and that it is an ongoing process since risks change over time. The prevention of human rights and environmental violations in business operations and value chains are central to the mission of the UN Global Compact, as reflected in its Ten Principles for responsible business conduct.

What does this mean for Sri Lankan businesses which export to the EU?

By June 2021, it is expected that the European Commission will table due diligence legislation which will affect companies located outside the EU that operate on the EU market. This indicates that access to the EU market of 450 million consumers will be conditional upon complying with their standards for responsible business. This will incentivize companies to implement good practices that protect human rights and the environment.

The EU is Sri Lanka’s second-largest trading partner and its main export destination, with 31% of Sri Lanka exports going to the EU in 2015. Exports to the EU from Sri Lanka largely comprise of textiles and clothing, amounting to € 2.3 billion in 2019. Mandatory due diligence is a welcome step for businesses in Sri Lanka and other developing nations that have been used by companies in the EU to outsource their activities, by taking advantage of low wages, weak or underenforced labour legislation and lax environmental standards. The new EU legislation will target this vicious cycle and protect developing nations from the social and environmental risks linked to our current form of economic globalization.

However, for Sri Lankan businesses to retain their competitive advantage in the EU market, they will need to adhere to the required human rights and environmental standards. If not, companies with higher standards will be at an advantage, creating a trade barrier for Sri Lankan businesses. In this context, Sri Lankan businesses need to implement a due diligence mechanism for the company’s entire value chain, taking into consideration industry and country specific factors. Thus, as states demand more sustainable and responsible business practices, businesses in developing nations like Sri Lanka will have to incorporate due diligence into their processes if they are to retain a competitive edge in the EU market.