How the EU aims to enforce sustainability goals beyond its borders

No supercharged words have been spared when describing the EU Green Deal – a set of policies that the European Commission announced at the end of 2019. This “new growth strategy” aspires to make Europe the first climate neutral continent by 2050 and decouple its economic growth from the extensive use of natural resources. It has been described as “the most advanced experiment in the world; a real industrial revolution, which will touch every aspect of our economic systems and affect the way we live and relate to the environment”¹, and “the most important initiative in a generation”², which “is going to dominate the legislative and regulatory calendar for years.^”3

Perhaps the Green Deal’s greatest quantum leap does not pertain to the domestic goals, but rather to how the EU intends to correct market failures and environmental externalities that take place beyond its borders. The most prominent example of this extraterritorial outreach is the carbon border adjustment mechanism (CBAM) with which the EU is planning to put a price on greenhouse gases emissions embedded in the products imported to the bloc.

The CBAM proposal divided industries and governments worldwide. Most respondents who took part in the public consultations conducted by the European Commission in the late 2020 expressed their belief that carbon leakage is a real issue and that the CBAM can not only mitigate it but also foster consumption of low-carbon products in Europe and stimulate the deployment of low-carbon technologies and ambitious climate policies in third countries⁴. Most of the EU trading partners, however, offered CBAM a rather frosty reception or even voiced outright resistance⁵.

As CBAM lies at the intersection of climate and trade, it is already triggering scrutiny from the perspective of the World Trade Organization (WTO) regulations.  While the details around CBAM design are not yet clear and therefore nothing conclusive can be said before the draft law is released the prevailing views seem to be that ensuring compliance will be challenging but feasible.

Furthermore, the rules governing international trade might also undergo some evolution to allow for CBAM-like measures and even make broader environmental border adjustments possible. The WTO has launched Committee on Trade and Environment and the organization’s new Director-General, Dr Ngozi Okonjo-Iweala, is expected to lead the way towards a better integration of climate objectives and free trade. The European Commission put WTO’s reform at the heart of its recently released New Trade Strategy, advocating for a set of changes focusing on sustainable development and mainstreaming sustainability in the work of the Organization.

While most eyes of the international community are on CBAM some other measures that the EU is contemplating might be from that perspective even more consequential. As an example, under the proposed mandatory due diligence the EU intends to assume the authority to hold companies to account for adverse impacts that the activities in their global supply chains are causing to the environment or human rights.

Such legislation, according to the European Parliament that recently passed its draft in a landslide vote, would create a level playing field among all companies operating on the EU market.  Bringing legal clarity, and establishing effective enforcement and sanction mechanisms, while improving access to remedy for those affected by establishing civil and legal liability for companies.

The new rules would oblige companies to identify, address and remedy those areas of their value chain (which would include all operations, direct or indirect business relations and investment chains) that could or do infringe on human rights, the environment and good governance. The rights of victims or stakeholders in third countries would be protected through giving them standing to bring claims before the EU courts. 

With fines expected to be comparable to those imposed for violations of competition and data protection laws the companies that operate in or trade with the EU might face financial exposure for up to 10% of their global turnover. Other sanctions mentioned in the draft law include suspension of operations and seizure of commodities.

Another proposal that sparked a lot of controversy and will affect cross-border corporate strategies relates to sustainable corporate governance. The EU is exploring board accountability options where directors would be required to integrate sustainability considerations into the decision-making process as part of their duty of care.  Furthermore, the Commission considers different approaches to aligning directors’ remuneration with a longer-term perspective, including attention to sustainability risks and opportunities and establishment of corporate sustainability metrics and KPIs.

Another initiative with an extraterritorial outreach is the Methane Strategy. This proposal envisages a series of measures aimed at reduction of methane emissions that occurred in and outside of the EU in relation to fossil fuels used by the Member States. While the European Union is the world’s largest importer of natural gas the majority of associated emissions are generated outside of its borders. The Commission therefore believes that the EU can play an important role in ensuring worldwide reductions of methane emissions by supporting or requiring actions by its trading partners.

Several other initiatives under the Green Deal also have a considerable international dimension.  Biodiversity and Forest Strategies propose measures to support deforestation related to imported agricultural products, while the Industrial Strategy and Circular Economy Action Plan aim to promote resource efficiency and waste reduction in the EU and on a global scale. In practice this  will require the EU to develop sustainability standards for products sourced from the third countries.

Lastly, the EU has the ambition to spearhead international climate diplomacy. The EU Green Deal stipulates that adherence to the Paris Agreement will be proposed as “an essential element for all future comprehensive trade agreements” and notes that “the EU’s most recent agreements all include a binding commitment of the Parties to ratify and effectively implement the Paris Agreement”.

The picture that emerges from the above is that the Europe’s Green Deal will make a significant mark on the way businesses conduct their global operations. The EU is taking on a mission to improve global sustainability via a suite of regulatory tools ranging from support and encouragement through monitoring of foreign activities, imposing binding standards and border adjustments to penalties and sanctions.

While such measures might trigger scrutiny under the WTO rules, especially under the Technical Barriers to Trade Agreement, in their absence the EU might face credibility challenges if the Green Deal delivers on its promises domestically but raises questions about potential offshoring of environmental impacts.  Such concerns might soon be shared among all the nations who aspire to lead the transition to climate neutrality and sustainable development. Therefore, the world of international trade seems to be inevitably trending towards greater consideration given to environmental safeguards.

As businesses prepare to operate in this new environment, they should consider taking the following steps:

First, be sure to closely follow policy developments and influx of new regulations coming from the EU that will have impact on global operations. They should also consider participating in public consultations that the EU is conducting regarding most of these new policies

Next, businesses should quantify the impact of the new policies on business (applies to CBAM) and other financial instruments. And, they should start thinking through a compliance strategy regarding corporate governance, supply chain accountability and other standard-setting regulations.