December 2023, the European Union Parliament and European Council (heads of state or government of the EU member states) negotiators have reached an agreement on a new directive for corporate sustainability due diligence (the “Directive”). Although the Directive does not apply in Malaysia, it has significant implications for Malaysian companies:
What are the key features of the Directive
The Directive requires companies to integrate human rights and environmental considerations into their management systems and in principle applies throughout the value chain, from raw materials all the way through the end customer. Furthermore, the Directive mandates companies, including those in the financial sector, to address issues such as child labour, slavery, pollution, deforestation, and more. Businesses must incorporate “due diligence
” into their policies and risk-management systems, detailing their approach, processes, and code of conduct. The European Union relies on the OECD Due Diligence Guidance for Responsible Business Conduct
Who is affected
The future legislation will apply to EU companies with:
It is estimated that as of the end of 2023, approximately 13,000 EU businesses meet these criteria.
Furthermore, the Directive will also apply to foreign – and thus including Malaysian – companies which non-EU companies with more than EUR 300 million net revenue generated in the EU. It is estimated that 4,000 international companies will thus be affected.
What impact does the Directive have on EU companies
Companies are obligated to identify, assess, prevent, and remedy negative impacts throughout their supply chain and engage with affected parties. Additionally, EU countries will appoint supervisory authorities to monitor compliance and enforce penalties, including fines of up to 5% of net worldwide turnover.
There is also a civil liability regime: affected parties, such as individuals or communities impacted by a company’s activities, can file civil lawsuits against the company to claim compensation for the harm suffered. As such, if an EU company – both directly or indirectly – purchased from a company that relies on forced labour, the affected individual(s), although they are not employed by the EU company, could directly start civil action against that company.
What does this mean for Malaysian companies
The European Union is one of Malaysia’s most important trade partners and Malaysian companies export a lot of goods to the European Union. Overall, trade with the European Union accounts for approximately 10% of all of Malaysia’s trade. To the extent that there is trade between a Malaysian and an EU company affected by the Directive, the EU company would want to make sure that its Malaysian supplier meets all relevant environmental and human rights standards.
However, the implications go far beyond direct trade: as the Directive will have an impact both on direct and indirect procurement, as long as Malaysian companies are somehow involved in the supply chain of an EU company affected by the Directive, that EU company will want to ensure that its entire supply chain is free from environmental and human rights issues. Therefore, all companies involved in the supply chain will – one way or another – be able to show that they have no such issues.
This could be quite difficult for many Malaysian companies. Both environmental and human rights-related matters are an issue in Malaysia. Especially the heavy reliance on foreign workers, including security guards, which almost every entity relies upon, is highly problematic because it is rampant with forced labour: commission fees up to a multiple of foreign worker’s monthly salary, as well as movement restrictions and the seizure of passports upon arrival in Malaysia are all indicators of modern slavery according to international standards. Yet, we regularly see them here.
Once EU companies will have to apply the Directive, they will very likely want to see assurances or even specific actions from Malaysian companies that these practices no longer happen. For those heavily relying on foreign workers, this could in some ways completely change the way they are doing business today.
If the EU companies are not convinced by the assurances/actions, they will simply not involve Malaysian companies in supply chains any longer. With the civil liability and the fine of up to 5% of global annual turnover – which could be billions of Ringgit for large companies – the risks are simply too great.
Since the negotiations on the Directive have reached the finishing line, the Legal Affairs Committee, the Council and the European Parliament will need to formally approve it. After adoption, which is expected to happen very soon, the Directive will become law. EU countries then have two years to pass implementing legislation in their own countries.
However, Malaysian companies should remember that EU companies will hardly wait for two years before they implement the Directive. It must be expected that EU companies will apply the Directive from sometime in 2024 onwards as they usually do not wait until the very last minute before applying it. The clock is ticking for Malaysian companies which are not ESG-compliant…
For further information on this topic please contact Prof. Dr. Harald Sippel, Head of Skrine’s European Desk of Skrine.