Due diligence obligations in finance: a partial inclusion, but still a priority

Last week, the EU struck a deal on a milestone directive which will require large companies to monitor human rights and environmental standards in their value chains. Banks and financial institutions ended up partially included in the deal, sparking controversy. Whether due diligence obligations will apply to financial services will be reviewed later. Until then, banks will have to implement concrete decarbonisation plans and ensure their internal operations comply with social and environmental standards. At the ABBL, we remain fully supportive of proportionate due diligence obligations on banking services and will keep promoting responsible business conduct in our sector via our dedicated working group and guidance documents.

Everyone loves a thriller. Those who closely followed the negotiations on the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) have had their share of twists and cliffhangers. Until last week, that is, when lawmakers struck a deal on the new law, which lays down ambitious rules for large firms to identify and address human rights and environmental impacts in their value chains. Previous legislative initiatives in the field of corporate sustainability were mostly about transparency. This time around, it’s about doing.

Few expected an outcome to the negotiations to be found before the end of the year on such a complex file. Some of its core elements remained major political issues until the last round of talks. One area of disagreement was whether to require banks and financial institutions to check if their corporate clients meet human-rights and environmental standards.

In-n-out

Whether to include finance in the text was a controversial topic from the get-go. Despite numerous calls from civil society and financial institutions alike, the political agreement scoped out financial services from the main obligations of the directive. But not permanently. A review clause added to the deal ensures the inclusion of financial activities will be re-evaluated at a later stage based on an impact assessment.

The reason for the controversy behind this exclusion seems clear: finance remains free to violate human rights and the environment. It is not that simple. According to the United Nations’ Guiding Principles on Business and Human Rights, companies can be connected to human rights impacts in one of three ways. They may cause an impact when their activities (i.e. their actions or omissions) alone are sufficient to result in harm. Firms may also contribute to an impact through their activities jointly alongside other parties. The third way would be for a company to have a business relationship with another party which has caused the impact, and which is directly linked to the company’s operations, products and services.

The UN’s Office of the High Commissioner for Human Rights acknowledged in an interpretation note that, in practice, human-rights impacts associated with a bank’s financial activities generally fall under the latter. It also noted that a direct link to an impact through a client relationship does not shift the responsibility from the client to the bank . A bank’s degree of involvement in a human rights impact will vary on a case-by-case basis on account of several factors, such as its initial knowledge, risk engagement, and client transparency. Ultimately, these factors will determine the adequacy of its due diligence processes.

Filling the gap

For banks which have portfolios made up of thousands of clients, conducting in-depth human rights due diligence across all business relationships is a daunting challenge. But if the responsibility for human rights impacts remains with the companies which actually caused them, doesn’t the CSDDD still fulfil its objectives? Yes, but only for large EU-based corporates and third-country firms operating in the EU single market which do fall in the scope of the law, as the European Central Bank (ECB) recently argued.

According to the banking regulator, the CSDDD would also fill a gap in the current sustainability rules banks have to follow. From a double-materiality perspective, the ECB’s arguments make sense. On the one hand, the prudential framework requires lenders to manage the financial risks posed by environmental and social factors. On the other hand, they should also consider the human-rights and environmental risks posed by their financing activities, i.e. the very objective of the proposed directive, closing the loop.

Some of the directive’s obligations will still apply to the financial sector. Banks with more than 500 employees will be required to monitor social and environmental impacts in the upstream part of their value chains. That is fairly limited, though, and will mostly cover areas such as procurement, outsourcing or their own workforce. They will also need to adopt and implement a decarbonisation plan in line with the climate objectives of the 2015 Paris Agreement.

The CSDDD remains a landmark achievement nonetheless. For most companies, human rights and environmental due diligence used to be a voluntary best practice framed by international guidelines set by the United Nations or the OECD. For large firms operating in the EU, it will become the new baseline.

What’s our take?

The ABBL supports the ambitious goals of the CSDDD. We have advocated for a proportionate inclusion of relevant financial activities under a risk-based approach since the beginning of the talks. Requiring due diligence on all conceivable financial services, in our view, is neither practical nor conducive to advancing the directives’ objective.

Banks are all but intermediaries. They have the most direct influence over the companies to which they provide loans and credit. This empowers them to demand assurances from their counterparties that they commit to responsible business conduct. Banks may also use their leverage to engage and collaborate with their financed counterparties to incentivise better and more transparent human rights and environmental practices.

We stay committed to promoting responsible business in our sector. That is why our ABBL code of conduct includes a specific commitment for our members to consider environmental and human rights aspects in their business strategy and decisions.

Supporting due diligence

Even though financial services ended up out of the scope of the CSDDD, we still encourage our members to commit to enhanced human rights monitoring. Joining the National Pact on Business and Human Rights, a local soft law initiative on corporate human rights due diligence, is one way to do so. Earlier this year, through our Corporate Sustainability Working Group, ABBL members had the opportunity to discuss this initiative in detail with policymakers and exchange best practices on human rights risk assessments.

The ABBL can do more. Our practical corporate social responsibility guide offers the perfect platform to share essential insights on human rights due diligence with our members and inspire best practices. In June, we initiated work to enhance our guide and develop new content, including dedicated factsheets on human rights due diligence in banking and climate transition targets. We aim to release our new guidance in Q1 of 2024.