Background and conceptual definition
In 2014, for certain companies, the EU first introduced CSR (corporate social responsibility) guidelines in the field of reporting under commercial law. The aim has been to provide greater transparency about the environmental and social aspects of companies in the EU by, among other things, expanding reporting requirements in the management report. The Non-financial Reporting Directive (NFRD), which has to be applied now already, has been tightened further under the Corporate Sustainability Reporting Directive (CSRD) that is now supposed to be transposed into national law by 6.7.2024.
The environmental, social and governance (ESG) elements can be defined as follows within the scope of a business strategy.
(1) E = Environmental (protection of the natural environment) – In this regard, it is possible to turn to Art. 9 of the Taxonomy Regulation where six environmental objectives have been defined:
- climate change mitigation,
- climate change adaptation,
- the sustainable use and protection of water and marine resources,
- the transition to a circular economy,
- pollution prevention and control,
- and the protection and restoration of biodiversity and ecosystems.
In Germany, the objective that has been set out in the Federal Climate Change Act (Bundes-Klimaschutzgesetz, KSG) is to provide protection from the effects of worldwide climate change by ensuring achievement of the national climate targets and compliance with the European targets. However, there is an absence of clear guidelines as to how these targets can be achieved.
(2) S = Social (social elements) – Employment law, in particular, covers a large area of the social responsibility of companies since its purpose is the protection of the employee as the weaker contractual party and the protection of specific human rights. It covers various subject areas, such as, notably working conditions, human rights, diversity and inclusion.
(3) G = Governance (responsibilities of business leaders) – This includes, for example, management and monitoring processes to ensure compliance with legal provisions and disclosure requirements as well as the aspects of management remuneration and the implementation of a sustainability strategy.
An overview of the legal framework
The EU Commission’s strategy for enforcing ESG requirements involves the use of a mix of different instruments:
- mandatory legal requirements, in particular, on the basis of EU directives and regulations that, in some cases, will have to be transposed into national law.
- ‘Soft law’, thus requirements that have no binding force, for example, in the form of ‘expectations’ and ‘recommendations’.
- Other soft control mechanisms, such as, those for the development of best practices.
In terms of the requirements under employment law, the international labour standards (ILS) drawn up by the International Labour Organisation (ILO) that form part of United Nations Law constitute the core international standards. Five basic principles determine the ILO’s identity and actions:
- the freedom of association and the right of collective bargaining,
- the elimination of forced labour,
- the abolition of child labour,
- the ban on discrimination in respect of employment and occupation,
- and occupational health and safety.
In the national context, the international standards (such as, occupational health and safety, ban on child labour and co-determination) are implemented into national law and their criteria are also taken into account in national case law (for example, the enforcement of equal pay). The standards are used internationally, for example, in the ethics codes of corporate groups or businesses and in international framework agreements under civil law in the sense of voluntary commitments.
Instruments for implementation in a company
Supply chain due diligence requirements
The purpose of the Act on Corporate Due Diligence Obligations in Supply Chains (Lieferkettensorgfaltspflichtengesetz, LkSG), which came into force on 1.1.2023, is to improve the international human rights situation. This legislation provides binding requirements for large companies in respect of organising their supply chains in a responsible way. To begin with, it applies to all companies with, ordinarily, at least 3,000 employees in Germany (from 2024: 1,000 employees). Companies of this size based in Germany will be required to perform a review of their global supply chains with respect to human rights and environmental risks. The ‘supply chain’ in this case includes all the company’s products and services.
The companies concerned are required to set up control mechanisms within the supply chain, in particular, with respect to compliance with international standards (this with reference to the numerous ILO Conventions). The controls should cover not just the actions of the company itself but also those of its direct and indirect suppliers.
The companies have to prove that they complied with the legally defined due diligence requirements. These include, in particular,
- an effective risk management system,
- a human rights strategy,
- in-house responsibility for the monitoring of risk management (for example: a position for an official representative for human rights and complaints),
- appropriate and effective preventative measures (among others, a complaints procedure).
Please note: Complaints procedures in accordance with the LkSG can or should be aligned with the reporting systems based on the German Whistleblower Protection Act (‘Whistleblower Systems’).
Those affected by human rights violations within the supply chain may, for example, authorise German trade unions to sue.
Please note: In reality, the LkSG could affect not just the companies with, ordinarily, at least 3,000 employees (from 2024: 1,000), but also SMEs with (considerably) less than 1,000 employees. This is because if they are suppliers to one of the companies that fall within the scope of application of the legislation and they are contractually obliged by this company to comply with the due diligence requirements then, effectively, they have to meet these obligations, too.
The transposition of the CSR Directive resulted in the companies concerned having to add a non-financial statement to their reporting. In terms of content, the statement needs to include, among other things, ‘employee matters’. According to the legislation, these could relate to the following points:
- the measures that have been taken to ensure gender equality,
- the working conditions,
- the implementation of the basic conventions of the International Labour Organisation,
- the respect for the rights of employees to be informed and consulted,
- social dialogue,
- the respect for the rights of the trade unions, occupational health and
- safety at work.
Please note: The EU Commission has adopted twelve European Sustainability Reporting Standards (ESRS) with a view to harmonising the reporting. Disclosure requirements specific to employment law have been set out in ESRS S1. On this topic, please see also the following article as well as the three-part series of articles on sustainability reporting in the SME sector, which were published in 2022 (beginning with Part I).
Irrespective of the legal requirements (‘hard law’) – it can indeed be expected that they will be expanded in the future, in particular, at the EU level – an individual company has at its disposal a range of measures that can play a role within the scope of an ESG strategy depending on the size of the company, its sector, etc. Such measures could be, for example, the following (not an exhaustive list):
(1) Introduction of a Code of Conduct – A Code of Conduct can be drawn up on the part of management – as early as possible – in order to document desirable employee behaviour and to increase acceptance by the staff and the works council, if there is one.
(2) Employee surveys and collection of employee data – Employers can use (voluntary) employee surveys with respect to, for example, the social aspects in the company as the starting point for their strategies. Furthermore, employers could also be interested in collecting data, for example, with a view to analysing a company’s own CO2 consumption. Ultimately, there could also be an interest in gathering employee mobility data in order to meet the requirements of non-financial reporting (see also the next measure (3)).
Please note: Aspects of data protection law are especially relevant in the context of the aforementioned measures. Whether or not data processing for such purposes is ultimately justified is a normative question that, as far as we can tell, has as yet not been decided. In addition, issues concerning regulations applicable to co-determination, in particular, play an important role.
(3) Steering employee mobility – Including the employee mobility sphere within the scope of an ESG company strategy is an obvious choice. This is because, to begin with, employee mobility plays an important role for the climate protection aspect (avoidance of greenhouse gas emissions). Depending on the type of company, various measures could be considered, such as, for example:
- concepts for flexibility about where people work (avoidance of journeys to work), for instance, by introducing a desk sharing workplace concept;
- encouraging the use of public transport, including via short-distance public transport season tickets for employees,
- and offers for the use of company bicycles.
In doing so, legal aspects have to be taken into account, such as, compliance with data protection regulations, safeguarding the co-determination rights of the works council/employee representative body and occupational health and safety aspects (working from home). Moreover, it is important to consider the (payroll) tax implications of the benefits provided by employers. Appropriate company policies (for example, on travel costs, or the use of a company car) have to be drawn up while taking particular account of the principle of equal treatment under employment law.
(4) Switching to sustainable resources – A climate change mitigation measure that could be considered is switching to sustainable operating resources in all the business divisions right down to changing the production goods or products. Here, depending on the implementation, different legal requirements will be relevant. If a restructuring of the company is under discussion then, from an employment law perspective, it would be advisable to involve the works council early on.
(5) Fostering inclusion, diversity and equality of opportunity – Measures in this respect could be taken to achieve the following goals:
- gender equality and, in particular, equal pay for work of equal value,
- boosting training and continuing education,
- employment and inclusion of persons with disabilities,
- curbing violence and harassment at work,
- strengthening diversity in the company.
Conclusion: The implementation of the transformation processes described above will be in the interests of a company. This is because it can be assumed that, in the future, the reporting requirements will be expanded and uniform standards will have to be followed. Moreover, companies that do not adapt their processes to the new requirements will have to put up with the drawbacks. In any event, in the future, an increase in requests for information from companies in the supply chain that are subject to the reporting obligation or inquiries from investors can be expected.