Managing Contracts Good First Step Under EU’s New Sustainability Directive

According to the Thomson Reuters Institute’s recent 2023 State of the Corporate Law Department report, the frequency and complexity of regulatory change is the most-cited risk on the horizon for in-house legal teams, and ESG issues represent one of the most complex areas in today’s variable global regulatory landscape.

Until companies begin reporting under the CSRD, the current rules, introduced in 2014 under the non-financial reporting directive, remain in force for about 11,700 companies across the EU.

The CSRD aims to modernize and enhance disclosure requirements regarding social and envi­ron­men­tal factors, broadly in line with the U.N. sustainable development goals, to be achieved by 2030. It expands the scope of reporting requirements to include about 50,000 companies, which range from large enterprise organizations to listed small- and medium-sized enter­prises, as well as large operations of businesses established outside the EU. 

With a granular set of reporting standards exceeding a staggering 1,000 reportable data points, the CSRD effectively brings sustai­nability reporting in line with financial re­por­ting for the first time.

Undoubtedly, the CSRD represents a significant leap in tackling climate change and addressing va­ri­ous sustainability challenges, and companies covered by the first wave of regulations are already heavily engaged in preparing their first reports. For companies covered by the second or third reporting waves, prepa­ra­tions are rapidly moving to the top of their list of priorities.

Following the paper trail 

Many of the required disclosures implicate contract documents and their contents. Since contracts contain commitments to take (or not take) specific actions, they are used to codify agreements related to ESG and are also the basis for tracking (and ultimately ensuring) compliance with these commit­ments.

An essential aspect of the CSRD involves the application of a dual materiality assessment. This as­sess­ment serves to identify the effects of a company’s operations on ESG factors, as well as the influence of these same ESG factors on the company itself. Upon conducting this assessment, companies are required to perform a gap analysis, which helps identify areas where exis­ting data collection processes fail to cover the necessary sustainability information.

The task of conducting those assessments and implementing the CSRD is daunting and relies on many internal stakeholders, more often than not legal and procurement teams, as it requires changes to contracts, systems and opera­tio­nal metho­do­logy. However, by using the right tools and resources, such as contract lifecycle management, companies can not only ensure compliance with the CSRD but also gain a clear advantage over their competitors as they demonstrate their commitment to sustainability.

The directive intends to push organizations to integrate sustainability considerations into their supplier management processes in several ways:

• Contractually ensure access to detailed sustainability information from suppliers, such as car­bon emis­sions, social impact and resource usage.
• Perform a thorough due diligence on supply chain contractual frameworks to identify po­ten­tial risks related to human rights, environmental issues or other sustainability concerns.
• Establish robust supplier performance evaluation schemes to incorporate sustainability per­formance as a criterion in evaluating and selecting suppliers. Companies may in this regard have to establish specific sustainability metrics or standards that suppliers must meet to be considered for partnerships.

Organizations will need to verify that their contracts accu­rately reflect the sustainability claims and commitments they make. This means that contracts should align performance targets, as well as mechanisms for governance, auditing and remediation or termination. This will likely include intro­du­cing clauses or provisions into contract templates and amending existing contracts.

Accusations or perceptions of greenwashing by consumers and regulators is a specific concern that will drive companies to enhance their due diligence proces­ses to verify the sustainability claims made by suppliers, partners or contractors as they onboard new relationships and then monitor their performance periodically.

If contracts with customers and suppliers don’t keep up with all the above changes, firms face compe­titive disadvantage as well as regulatory and financial risk. Effective contract management enables in-house legal, sales and procurement teams to understand who is compliant, who is liable and who is meant to do what, when and at what cost. Having that sort of information at your fingertips is invaluable.

Whether they are dealing with CSRD (ESG), Schrems II (data privacy) or the new Digital Operational Resilience Act (financial services), a robust contract lifecycle management system provides a full audit trail, precise controls and automatic noti­fi­cations across all agreements.