ESG and employment law

EU requirements

The new EU directives “Corporate Sustainability Reporting Directive”  (CSRD) and ESRS

In November 2022, the EU Parliament adopted a new directive on sustainability reporting (Corporate Sustainability Reporting Directive –CSRD). The directive came into force in January 2023. It requires companies to disclose information on how sustainability affects their business results, position and performance and impacts people and environment. 

On 31 July 2023, the European Commission published the first draft of the “European Sustainability Reporting Standards” (ESRS), which will become applicable on 1 January 2024. The European Sustainability Reporting Standards define the specific contents that will be developed by the European Financial Reporting Advisory Group (EFRAG) on behalf of the European Commission. Basically, this means: while the CSRD determines if reporting is required, the ESRS determines what is to be reported with the aim to provide for transparency as regards a company’s sustainability

From an employment law perspective, it is particularly interesting that under the CSRD companies are obliged to report on their diversity concept and provide specific details on the composition of their management. In the ESRS, employment law is reflected primarily in ESRS S1 and S2, which deal with social topics and according to which information on a company’s own workforce and on the workforce in the value chain is to be disclosed. In accordance with Recital 49 of the CSRD, sustainability reporting should cover working conditions, gender equality and the company’s impact on human health and human rights (in particular, in relation to forced labour). 

In terms of contents, the “principle of double materiality” is of particular importance, according to which, on the one hand, the effects of the company on the environment and, on the other hand, the effects of the environment on the company shall be taken into account. Under this principle, a sustainability-related topic is regarded as material and reportable if 

• it relates to a significant actual or potential impact of the company on people or society (“impact materiality”); or
• it has, or may have, a significant financial impact on the company in the short, medium or long term (“financial materiality”).

If a company comes to the conclusion that a standard is not material or reportable, disclosures can be made, but are not required.

This does, however, not apply to the general disclosure requirements pursuant to ESRS 2, with respect to which a materiality assessment is not permitted.

Remuneration structures

1. Supply Chain Act obliges employers to pay appropriate remuneration

The Act on Corporate Due Diligence Obligations in Supply Chains (Lieferkettensorgfaltspflichtengesetz – LkSG or Supply Chain Act) has been in force since 1 January 2023. It applies to companies in Germany above a certain size (1 January 2023: more than 3,000 employees; 1 January 2024: more than 1,000 employees), irrespective of their legal form. The Supply Chain Act aims to improve the international human rights situation by obliging companies to comply with human rights and environmental standards along the entire supply chain. It does not impose any abstract, general obligations to act in order to incorporate sustainability concerns but takes into account those concerns that arise from the international conventions listed in the Annex. Pursuant to section 2 para. 5 LkSG, the term supply chain refers to all of a company’s products and services and includes all activities of a company in Germany and abroad that are necessary to manufacture the relevant product or provide the relevant service. It comprises the company’s activities in its own business area as well as any activities of direct and indirect suppliers. 

As part of their duties of care, companies are to establish a risk management system in accordance with section 3 LkSG and perform regular risk analyses to prevent human rights and environmental risks. In addition, remedial action is to be taken and an internal complaints procedure is to be established. Companies have to document the fulfilment of their duties of care.  

In an employment law context, this means, in particular: companies and their business partners along the supply chain are obliged to pay appropriate wages, which shall be at least equal to the applicable statutory minimum wage at the place of employment. Moreover, the Supply Chain Act provides for equal treatment. In particular, no one may be paid less because of their gender.

Pursuant to section 24 para. 3 LkSG, non-compliance with the requirements imposed by the Supply Chain Act by a company or its business partners along the supply chain may be punished as an administrative offence with a fine of up to EUR 500,000.00.

2. Listed companies must ensure sustainable remuneration

The implementation of sustainable remuneration policies for directors is seen as a key element of ESG. According to the current legal situation, listed companies are not obliged to take account of environmental and social aspects when determining variable remuneration. Also at EU level, an amendment of the relevant Shareholder Rights Directive is not considered necessary. Insofar as, pursuant to section 87 para. 1 sentence 2 German Stock Corporation Act (Aktiengesetz – AktG) (ARUG II – Act on the Second Shareholders’ Rights Directive), the remuneration structure of management board members is to be geared towards the sustainable and long-term development of the company, sustainability is currently regarded as a purely temporal component in this context. According thereto, variable remuneration components must be subject to a multi-year assessment basis. 

Nonetheless, institutional investors are exerting increasing pressure on companies to set up remuneration systems aimed at integrating environmental and social aspects more closely into their business strategy and operational implementation. Furthermore, unlisted companies are also increasingly reflecting elements of their ESG strategy in their remuneration regimes.

Co-determination

The works council plays an important role as regards ESG matters.

A sustainable corporate policy does not only depend on corporate co-determination (unternehmerische Mitbestimmung) but also on operational co-determination (betriebliche Mitbestimmung). If the planned ESG strategy leads to a change in operations within the meaning of section 111 German Works Constitution Act (Betriebsverfassungsgesetz – BetrVG), the works council is to be involved. Pursuant to section 111 sentence 1 BetrVG, an operational change (Betriebsänderung) occurs, for example, when fundamental changes to the business organisation, the purpose of the business or the operational facilities or other planned measures are expected to entail significant disadvantages for the workforce or a significant part of it. In case of ESG-driven restructurings, an operational change may, for example, occur if a company aims at achieving more sustainable production in terms of avoiding waste or reducing CO2 emissions.

In addition to the right of co-determination in the event of a potential operational change, the works council has other original co-determination rights it can assert when certain measures are implemented. With regard to ESG, for example, the works council is responsible pursuant to section 80 para. 1 no. 9 in conjunction with section 89 BetrVG to promote occupational health and safety and environmental protection measures. Furthermore, the works council has a right of co-determination with regard to sustainable remuneration systems and measures for the organisation of remote working in accordance with section 87 para. 1 no. 10, 14 BetrVG. Whether these or other participation rights exist when implementing ESG concepts should be examined in the individual case.