Human Rights in EU Sustainable Finance

Abstract

In recent years, the European Union (EU) has adopted a broad range of sustainable finance-related legislation, including the Corporate Sustainability Due Diligence Directive (CSDDD), the Sustainable Finance Disclosures Regulation (SFDR), and the Corporate Sustainability Reporting Directive (CSRD). This legislation abounds with direct and indirect references to human rights and business and human rights (BHR) frameworks like the UN Guiding Principles on Business and Human Rights (UNGPs). They provide for BHR disclosure obligations and conduct obligations for investors and their portfolio entities. However, these references have largely been overlooked by both the BHR and financial law communities, leading to important gaps in how investors understand their BHR obligations and the efforts required to implement them.

This article makes two contributions to understanding the integration of human rights in EU sustainable finance. First, it conducts a review of the extensive human right provisions in EU sustainable finance-related legislation, including the CSDDD, SFDR, Taxonomy Regulation, and CSRD. It also examines their mobilization of established administrative and sanction mechanisms to monitor and enforce compliance. Second, it highlights important challenges arising from this integration, particularly concerning coherence and terminology.

Coherence challenges stem from conflicting interpretations between EU sustainable finance-related legislation, and between EU legislation and international human rights and BHR frameworks. Terminological challenges arise from different understandings of key concepts, such as ‘risk’, between the BHR and financial law communities. This article examines possible responses to these challenges.

I. INTRODUCTION

In recent years, the European Union (EU) has adopted a broad array of sustainable finance-related legislation such as the Sustainable Finance Disclosures Regulation (SFDR)¹ and the Corporate Sustainability Due Diligence Directive (CSDDD).² A lesser-known development is the broad integration of human rights into these instruments. Several provisions in EU sustainable finance-related legislation require alignment with key business and human rights (BHR) frameworks,³ including the UN Guiding Principles on Business and Human Rights (UNGPs) and the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises (OECD Guidelines).⁴ An important process in these frameworks is human rights due diligence (HRDD), which requires business to take various steps to ‘know’ and ‘show’ that they are respecting human rights in their global value chains.⁵ The process of HRDD has gained greater prominence with the recent adoption of the CSDDD. Despite these developments, the integration of human rights into EU sustainable finance has scarcely been examined, particularly in terms of its legalization and implementation.

This article makes two contributions to understanding the integration of human rights into EU sustainable finance. First, it conducts a comprehensive review of business and human rights provisions in EU sustainable finance-related legislation, highlighting this evolving legal landscape and identifying the resulting BHR obligations for investors and businesses. This overview demonstrates that human rights are widely integrated in EU legislation, marking a significant extension of human rights into positive law (sometimes called ‘hard law’) applicable to the private sector.⁶ This extension results from BHR provisions requiring alignment with non-binding international frameworks such as the UNGPs and the OECD Guidelines. These frameworks emphasize the responsibility of businesses and investors to respect human rights. As a result, this article underscores how EU sustainable finance-related legislation has substantially reinforced the legal infrastructure for investors and corporates to respect human rights—an observation that remains valid despite the limited inclusion of the financial sector in the CSDDD.⁷

With the exception of the CSDDD, these business and human rights provisions initially appear only as disclosure obligations: investors and/or corporates must produce disclosures that ‘demonstrate’ how they and/or their portfolio companies align with international frameworks such as the UNGPs or the OECD Guidelines. Yet, to be able to ‘demonstrate’ alignment with these international frameworks, and in particular with their HRDD process, investors or their portfolio entities have to implement, partly or wholly, the processes described in these frameworks, including HRDD. Thus, to be able to report on the existence of alignment with these international frameworks, in-scope entities would need to be in a position to demonstrate that their disclosures are substantiated by the actual conduct of some or all steps of HRDD.

Second, this article highlights important challenges associated with this wide integration of human rights in EU sustainable finance, particularly concerning coherence and terminology. Coherence challenges stem from conflicting interpretations of BHR provisions between EU legislation, and between this legislation and international human rights and BHR frameworks. This risk is amplified by the existing divide between the business and human rights and the financial law communities. Terminological challenges arise from diverging understandings of key concepts, such as ‘risks’ and ‘impacts’, between these communities. These different challenges can lead to an increase in legal uncertainty.

This article adopts a broad understanding of EU sustainable finance-related legislation, focusing on legislative developments following the EU’s 2018 Action Plan on Sustainable Finance (SFAP) and its update in 2021, along with related legislation that has important implications for investors and their portfolio entities.⁸ The SFAP, an integral part of the Capital Markets Union Action Plan⁹ and closely linked to the European Green Deal,¹⁰ sets the stage for several EU sustainable finance directives and regulations. This article examines four key EU pieces of legislation and, where relevant, their corresponding delegated regulations: (1) the Corporate Sustainability Due Diligence Directive (CSDDD); (2) the Sustainable Finance Disclosures Regulation (SFDR) and the SFDR Regulatory Technical Standards (SFDR RTS);¹¹ (3) the Taxonomy Regulation;¹² and (4) the Corporate Sustainability Reporting Directive (CSRD)¹³ and the European Sustainability Reporting Standards (ESRS).¹⁴ Each of these legal instruments, referred to in this article as ‘EU sustainable finance-related legislation’, includes references to human rights and/or to international business and human rights frameworks.

While other pieces of legislation under the SFAP exist, this article focuses on the four above-mentioned pieces of legislation which draw an important connection between EU sustainable finance and business and human rights. The SFDR and the Taxonomy are part of the SFAP. As for the CSRD (and the ESRS), they are considered building blocks for a sustainable financial system.¹⁵ Although not originally part of the 2018 SFAP, they have become integral to its overarching goals, and were considered in the update of the SFAP as a ‘prerequisite’ for some of its objectives.¹⁶ In particular, by improving corporate sustainability reporting, the CSRD and the ESRS can contribute to directing capital flows towards sustainable investments, offering investors a window into the respect of human rights by portfolio companies.¹⁷ Similarly, the CSDDD has important implications for the financial sector, although it is not part of the SFAP and only partially applies to the financial sector, as explained in this article. Notably, the CSDDD encompasses many investors’ portfolio companies, giving investors the opportunity to assess these companies’ HRDD practices, which can then inform their investments and engagement decisions.

The selected EU sustainable finance-related legislation have a broad scope, encompassing various entities, financial products, and economic activities. When considering the implications of these instruments for investors, this article primarily focuses on investment value chains and institutional investors, namely asset owners and asset managers. Also known as financial intermediaries, these investors include mutual funds, pension funds, general partners and limited partners, alternative investment funds, and sovereign wealth funds—each maintaining different relationships with retail clients and beneficiaries. Institutional investors can manage a variety of investment schemes across asset classes, including both actively managed assets and those passively managed, in particular funds passively tracking a market index. All of these investment vehicles can incorporate sustainability investment strategies.

In terms of methodology, this article reviews the occurrence of human rights provisions and related obligations within the selected EU sustainable finance-related legislation and their corresponding delegated regulation. References to human rights entail the mobilization of a rich ‘galaxy of norms’,¹⁸ including a vast network of international human rights treaties and public international law more generally. Accordingly, the review covers both explicit mentions of ‘human rights’ and implicit references through international frameworks that are relevant from a business and human rights perspective, such as the UNGPs, the OECD Guidelines, the fundamental Conventions referenced in the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work,¹⁹ and the UN Global Compact.²⁰ It is also important to note that while human rights are often viewed as social issues by the financial law community and beyond, they intersect with environmental and governance dimensions as well.

This article is divided into three further sections, followed by a conclusion. Section 2 provides an overview of the significant integration of human rights in EU sustainable finance-related legislation. It considers two key aspects that characterize this integration: the integration of human rights concepts and provisions, and the mobilization of well-established national administrative mechanisms in the financial sector to monitor whether private actors, including investors, are respecting these provisions. Section 3 details what this integration looks like for the CSDDD, CSRD, Taxonomy Regulation, and SFDR. It reviews the human rights provisions and concepts that are integrated in this legislation and the obligations they generate. In doing so, it demonstrates the extent to which human rights are integrated into positive law applicable to the private sector. Section 4 addresses the challenges associated with the implementation of these human rights-related obligations. It discusses coherence issues between EU sustainable finance-related legislation and, between EU legislation and international frameworks such as the UNGPs as well as human rights treaties. It also highlights terminological challenges that arise from diverging understandings of key concepts between the BHR and financial law communities. This section also considers responses to these challenges, particularly in relation to data, expertise, and guidance.

III. THE SIGNIFICANT BUT OVERLOOKED INTEGRATION OF HUMAN RIGHTS INTO EU SUSTAINABLE FINANCE

This section considers the two key aspects that characterize the integration of human rights into EU sustainable finance-related legislation. The first aspect is the integration of human rights concepts and provisions that directly or indirectly require businesses to respect human rights, including references to BHR and international human rights frameworks (section 2.1). The second aspect is the mobilization of well-established national regulatory infrastructure in the financial sector to monitor the respect of BHR provisions by private actors, including investors, and ensure their enforcement (section 2.2). This section concludes by discussing the significance of this integration while also addressing its neglect within the BHR and financial law communities (section 2.3).

1. Integration through human rights provisions and concepts

A first aspect that characterizes the integration of human rights provisions in EU sustainable finance-related legislation are the references to key BHR and international human rights frameworks, such as the UNGPs and OECD Guidelines. These references, identified in greater detail in section 3, also incorporate HRDD, a process that originates in the UNGPs and requires that businesses identify, prevent, mitigate, and account for their adverse impacts on human rights.²¹

This integration of human rights marks a significant extension of the business responsibility to respect human rights into positive law. This responsibility was first developed in the UNGPs, a voluntary international framework. According to this framework, all businesses have a responsibility to respect human rights.²² Since investors are considered business enterprises, this responsibility also applies to them.²³ To fulfil this responsibility, businesses must have certain policies and processes in place, including HRDD. While the UNGPs reaffirmed the obligation of states to respect human rights under international human rights law,²⁴ they also introduced the notion that businesses have a responsibility to respect these rights. Although the UNGPs are a non-binding ‘soft law’²⁵ framework, their principles and related processes have increasingly become binding. In particular, this results from how they have been incorporated into positive law, both at the national level and at the EU level, as evidenced in EU sustainable finance-related legislation.

Table 1 shows the large volume of provisions referring to human rights-related international frameworks across the different pieces of EU sustainable finance-related legislation. When reading this table, it is essential to recognize that the OECD Guidelines are a key business and human rights framework as they include references to the responsibility of business to respect human rights and HRDD, in particular via a dedicated chapter on human rights that is aligned with the UNGPs.²⁶

This article argues that the references to alignment with these human rights-related international business and human rights frameworks in EU sustainable finance-related legislation have added significant normative force to the business responsibility to respect human rights and to HRDD. Initially outlined in the voluntary frameworks of the UNGPs and the OCDE Guidelines, key elements from these standards have been adaptated into binding legal obligations through their integration in EU legislation. Section 3 looks in greater detail at these references.

For example, the CSDDD is structured around the concept of due diligence as outlined in the UNGPs and OECD Guidelines. Similarly, in the SFDR RTS, on the basis of the concept of ‘principal adverse impacts on sustainability factors’ (PAIs), investors promoting certain sustainable products must, in their disclosures, demonstrate how their investee companies align with inter alia, the OECD Guidelines.²⁷ As noted earlier, the OECD Guidelines include conduct obligations such as HRDD. Additionally, the SFDR RTS mandate that investors demonstrate how products that promote sustainable investment align with both the OECD Guidelines and the UNGPs under the ‘do no significant harm’ (DNSH) concept.²⁸ The Taxonomy Regulation also requires a similar form of alignment for economic activities to be deemed taxonomy-aligned. Finally, the CSRD and the ESRS provide that the ‘materiality assessment of a negative impact is informed by the due diligence process’ as defined in the UNGPs and the OECD Guidelines.²⁹

However, as will be discussed in section 4, there is still some ambiguity regarding what constitutes sufficient demonstration of alignment with the UNGPs or the OECD Guidelines, especially for the purpose of implementing the SFDR and the Taxonomy Regulation. This is an area where further guidance is necessary and where implementation and enforcement action will bring greater clarity.

2. Integration through monitoring and enforcement processes

A second aspect that is characteristic of the integration of human rights provisions in EU sustainable finance-related legislation is the mobilization of monitoring and enforcement processes well established in financial law. Closely linked to the sanctions mechanisms provided in these legal instruments, these processes are also essential to the implementation of human rights-related obligations.

Much of EU sustainable finance-related legislation leverages the existing and well-established national regulatory infrastructure in the financial sector for monitoring and enforcement, including of its BHR provisions. The potential mobilization of this infrastructure is relatively unprecedented for BHR and international human rights frameworks, which as voluntary frameworks or public international law frameworks, have traditionally faced an important enforcement deficit.

For example, the SFDR and the Taxonomy Regulation provide that EU Member States shall ensure that competent authorities are designated to monitor the compliance with the requirements of these regulations.³⁰ Potential sanctions under financial law and general civil liability regimes could be applied under these legal instruments, which is a relatively novel development for human rights provisions. This monitoring and enforcement approach, however, hinges on competent authorities developing adequate expertise in human rights. As will be further discussed in section 3, these provisions have the potential to put investors at risk of a range of legal sanctions under the SFDR, Taxonomy Regulation, and CSRD. The large reclassifications of SFDR article 9 funds, which adhere to the most stringent sustainability standard compared to SFDR article 8 or 6 funds, indicate that investors may be wary of the increased regulatory scrutiny and the associated risks of facing claims of greenwashing or impact washing.³¹

As for the CSDDD, it lays out detailed requirements for the organization and competence of monitoring and enforcement authorities with respect to mandatory HRDD. EU Member States are required to designate one or more supervisory authorities to supervise the obligations outlined in the CSDDD once it is transposed into national law.³² These authorities have the power to investigate companies’ compliance with the obligations of the CSDDD and can impose a certain number of conduct requirements and penalties on companies.³³ The national regulatory infrastructure for the financial sector is also specifically addressed in the CSDDD, which provides that Member States ‘may designate the authorities for the supervision of regulated financial undertakings also as supervisory authorities for the purposes of this Directive’.³⁴ Additionally, the CSDDD establishes a ‘European Network of Supervisory Authorities’ (ESMA) to ensure ‘coordination and alignment of regulatory, investigative, sanctioning and supervisory practices of the supervisory authorities and, as appropriate, the sharing of information among them’.³⁵ The monitoring and enforcement power of the supervisory authorities under the CSDDD are also complemented by some civil liability rules provided in the CSDDD and to be implemented by domestic courts.³⁶ These different sanctions are further discussed in section 3.

The implications of this mobilization of monitoring and enforcement mechanisms will become clearer as more monitoring and enforcement actions are undertaken. ESMA has described this as a ‘gradual process’ attributing it to the ‘learning curve’ faced by national authorities. At these ‘initial stages’ the focus is more on supervisory interaction rather than strict enforcement,³⁷ in spite of calls from various stakeholders for more enforcement actions³⁸ and with national competent authorities undertaking more controls.³⁹

Moreover, there is a need for more detailed studies to assess the ramifications of these monitoring and sanction regimes on human rights. Specifically, it would be important to investigate how the largely disclosure-based obligations outlined in EU sustainable finance-related legislation are transformed when entities have to disclose on alignment with the conduct requirements of international frameworks like the UNGPs, including undertaking some or all steps of HRDD. These studies should also consider the interaction between the monitoring and sanction regimes in the CSDDD, SFDR, Taxonomy Regulation, and CSRD with other legislation such as the EU market abuse regulation and those aimed at preventing greenwashing.⁴⁰ At present, the absence of guidance on designing financial products that account for human rights, or adopting suitable methodologies for investors to respect human rights,⁴¹ leaves much to the discretion of investors, and raises additional questions as to how enforcement regimes could be operationalized in practice.

3. Overlooked integration into positive law

The integration of human rights in EU sustainable finance-related legislation is a significant development, particularly with respect to HRDD obligations. The four pieces of legislation examined in this article show that this integration is extensive, both in terms of the range of entities and jurisdictions it encompasses. While similar developments have occurred in positive law, they have been limited in scope, and primarily confined to domestic legislation imposing HRDD obligations on certain businesses in a small number of countries,⁴² or to sector-specific EU legislation.⁴³

In contrast to the much-commented inclusion of BHR provisions in domestic laws applicable to businesses, there has been little attention to the integration of these provisions into EU sustainable finance-related legislation. The primary exception to this is the CSDDD and its earlier drafts, which have drawn significant commentary. As a result, although human rights provisions are integrated into EU sustainable finance-related legislation along with monitoring and enforcement mechanisms, this integration has been mostly overlooked, particularly concerning investors’ obligations.⁴⁴ This oversight stems primarily from the limited scrutiny of this legislation from a human rights perspective, despite the familiarity of the financial sector with the legalization of soft law principles.⁴⁵

The limited scrutiny of human rights integration into positive law applicable to investors can be attributed to infrequent interactions between the BHR community and the financial law community. This oversight is evident in scholarship on BHR and financial law where there is little cross-referencing between BHR⁴⁶ and financial law,⁴⁷ with a few exceptions.⁴⁸ This academic divide is mirrored in practice, where finance and BHR practitioners rarely interact, leading to compartmentalization and an absence of cross-over expertise. Indeed, these separate communities of academics and practitioners represent distinct networks of professionals with recognized expertise in a particular domain and a shared set of normative beliefs.⁴⁹ This lack of engagement is further reinforced by the traditional divide between private and public law. International human rights are predominantly associated with public law, particularly public international law, which is traditionally concerned with state obligations.

In its recent report titled ‘Investors, ESG, and Human Rights’, the UN Working Group on Transnational Corporations and Other Business Enterprise (UN Working Group on Business and Human Rights) highlighted the lack of focus on human rights in finance.⁵⁰ Further illustrating this situation, a small group of institutional investors recently publicized their challenge in obtaining human rights data from major environmental, social, and governance (ESG) data providers.⁵¹ Moreover, the absence of a human rights perspective in finance is further exacerbated by the prominent focus on environmental issues within discussions on EU sustainable finance, often sidelining human rights, and social issues more generally, as evidenced by the stalled progress on a social taxonomy.⁵² Yet some stakeholders⁵³ and international organizations⁵⁴ have begun to actively engage with these issues, and areas like development finance and project financing are well on their way to bridge this gap.⁵⁵ This article also contributes to this endeavour, in particular with the next section, which maps in more detail the integration of human rights provisions and concepts across four key pieces of EU sustainable finance-related legislation.

III. A REVIEW OF THE INTEGRATION OF HUMAN RIGHTS IN EU SUSTAINABLE FINANCE-RELATED LEGISLATION

Having observed general trends around the integration of BHR provisions into EU sustainable finance, this section examines these provisions in greater detail across four pieces of legislation and their delegated regulations. First, the CSDDD, which establishes a regime of mandatory HRDD with significant implications for both corporates and investors (section 3.1). Second, the SFDR and the SFDR RTS, which supports the identification of financial products with sustainability characteristics or objectives, emphasizing human rights-related concepts such as ‘sustainability risks’, ‘principal adverse impacts’ (PAIs), and ‘do no significant harm’ (DNSH) (section 3.2). Third, the Taxonomy Regulation, which assists to define what is sustainability in terms of environmental issues, while also integrating the human rights-related concept of ‘minimum safeguards’ (section 3.3). Finally, the CSRD and the ESRS, which help identify the sustainability of business activities through disclosure, focusing on the concepts of ‘sustainability matters’ and ‘impact materiality’ (section 3.4). As an introduction to this discussion, Fig. 1 provides an overview of human rights-related concepts across these four pieces of legislation, as well as their direct or indirect references to HRDD.

1. The corporate sustainability due diligence directive (CSDDD)

a. General provisions (i.e. scope, obligation, sanctions)

The CSDDD is the first regional mandatory HRDD legislation. Its aim is to ensure that businesses contribute to sustainable development and the sustainability transition of economies and societies, through human rights and environmental due diligence.⁵⁶ The CSDDD applies to large EU businesses⁵⁷ with over 1000 employees and a net worldwide annual turnover exceeding €450 million. It also applies to non-EU businesses generating at least annual turnover of €450 million in the EU.⁵⁸ Approximately 6000 EU businesses and 900 non-EU businesses meet these criteria, though many financial actors are likely excluded due to the high threshold.⁵⁹ There is a phased implementation period to the CSDDD, with smaller companies facing later compliance deadlines.⁶⁰

The CSDDD provides for a process of HRDD that is closely aligned with the UNGPs and the OECD Guidelines, with some exceptions.⁶¹ Businesses are required to conduct due diligence with respect to their adverse human rights and environmental impacts. Specifically, the concept of ‘adverse human rights impact’ is defined as impacts resulting from the abuse of certain human rights that are tailored for corporate conduct,⁶² and with respect to human rights enshrined in listed international frameworks.⁶³

The HRDD process outlined in the CSDDD extends to a businesses’ own operations, its subsidiaries, and its business partners in its ‘chain of activities’. This chain encompasses the activities of upstream business partners related to the products and services of the business, as well as those of downstream business partners involved in distribution, transport, and storage of products, provided these activities are conducted for the business or on its behalf.⁶⁴ This perimeter has a more limited scope than the one found in the UNGPs and the OECD Guidelines, which encompasses the entire global value chain of a business.

The process of HRDD in the CSDDD reflects the steps outlined in the UNGPs. Businesses are required to identify and assess both actual and potential adverse human rights impacts within their operations and chain of activities. They must also take appropriate actions to prevent, mitigate, end, and remedy these impacts. Additionally, businesses are required to integrate due diligence into their policies; establish and maintain a notification and complaints procedure; periodically monitor the effectiveness of their due diligence policy and measures; and publicly communicate on their due diligence practices.⁶⁵

Businesses must also take ‘appropriate measures’ as part of their HRDD process. These measures are defined as actions ‘capable of achieving the objectives of due diligence by effectively addressing adverse impacts in a manner commensurate to the degree of severity and the likelihood of the adverse impact’.⁶⁶ Such measures might include improvements to the business’s ‘own business plan, overall strategies and operations, including purchasing practices, design and distribution practices’.⁶⁷ In its assessment of the appropriate measures to prevent or end adverse impacts, business must consider the nature of their involvement with these impacts. This includes determining whether an impact is caused by the company alone, jointly with a subsidiary or business partner, or solely by a business partner over which the company has influence.⁶⁸ This approach mirrors the levels of involvement outlined in the UNGPs: causing, contributing to, or directly linked to adverse impacts through business relationships.

The CSDDD also includes a specific obligation for business to consult with stakeholders as part of their due diligence process.⁶⁹ Stakeholders encompass a broad group that includes employees, employees of subsidiaries, trade unions and workers’ representatives, consumers and other affected individuals, groups, and communities, together with national human rights and environmental institutions.⁷⁰

In terms of enforcement, as already mentioned in the previous section, the CSDDD mandates that EU Member States designate an authority responsible for supervising and enforcing its obligations.⁷¹ These authorities are empowered to require businesses to implement remedial actions; order the cessation of infringements and prevent future violations; implement interim measures; and impose penalties. Specifically, the penalties can include maximum fines of not less than 5 per cent of a business’s net worldwide annual turnover.⁷² Additionally, the CSDDD relies on civil liability, requiring Member States to ensure that victims can seek civil remedies against businesses. Member States have to ensure that victims can seek civil remedies against businesses on the basis of breaches of their human rights resulting from a business’s intentional or negligent failure to prevent or end an adverse impact with appropriate measures.⁷³

b. The partial inclusion of the financial sector

The inclusion of the financial sector in the CSDDD has been the source of much debate.⁷⁴ The text finally adopted narrows the scope of ‘chain of activities’ for ‘regulated financial undertakings’ by limiting their due diligence obligations to their own operations, those of their subsidiaries, and only the upstream of their chain of activities. Downstream activities are explicitly excluded in these terms: ‘[f]or regulated financial undertakings, the definition of the term “chain of activities” should not include downstream business partners that receive their services and products’. However, no such limit exists in the Taxonomy Regulation, SFDR, and CSRD and as a result, rather than bringing more coherence with respect to HRDD, the CSDDD has brought an added degree of complexity.⁷⁵

Yet distinguishing between upstream and downstream activities in the financial sector is far from straightforward. Indeed, some view this choice of terminology as unfortunate and ill-suited to the financial sector.⁷⁶ While excluding downstream activities appears to set aside scenarios such as corporate lending, it remains unclear how the relationship between asset managers and asset owners or the relationship between them, their products and asset classes would be captured in the CSDDD. For example, if an asset owner is considered as a client of an asset manager, this would suggest that the asset manager’s due diligence obligations do not extend to the activities of the asset owner. However, given that the operations of an asset manager depend on funding by asset owners, could one argue that an asset owner falls within the upstream of the asset manager’s activities? Alternatively, should asset owners view their asset managers as part of their own upstream activities because they manage assets which could be part of products asset owners offer to their beneficiaries? Additionally, questions arise about how this interacts with other EU human rights provisions and legislation affecting financial investors and their products, as discussed in section IV.

Furthermore, several financial actors will fall within the perimeter of the due diligence processes of large businesses required by the CSDDD, as they are integral to the ‘chain of activities’ of these businesses, upstream or downstream. Consequently, they could be required to conduct due diligence through contractual assurances. It is also important to note that the CSDDD expressly excludes alternative investment funds (eg, AIFs) and undertakings for collective investments (eg, UCITS) from its scope.⁷⁷

Despite these limitations and interrogations, it is noteworthy that recital 51 of the CSDDD references the OECD Guidelines, stating that they ‘provide indications of the types of measures that are appropriate and effective for financial undertakings to take in due diligence processes’.⁷⁸ According to recital 51, these financial undertakings are also expected to ‘consider adverse impacts and to use their “leverage” to influence companies’, including through the exercise of shareholders’ rights.⁷⁹ This reference can be interpretated as a reminder that the OCDE Guidelines, along with the UNGPs, apply to all businesses, including investors, who are thus required to conduct HRDD across their entire value chain. Furthermore, article 36 of the CSDDD specifies that within two years of its entry into force, the Commission will report on the necessity for additional due obligations that would be ‘tailored to’ regulated undertakings and financial services.

2. The sustainable finance disclosure regulation (SFDR) and regulatory technical standards (RTS)

The SFDR aims to further a shift to ‘sustainable investment’⁸⁰ through a standardized framework for sustainability disclosure. It lays down harmonized sustainability-related disclosure rules for financial market participants (FMPs) such as asset managers and asset owners,⁸¹ and financial advisers such as investment advisers (investment firms and credit institutions) and insurance advisers (insurance intermediaries and insurance firms).⁸² Harmonized rules are set out with respect to pre-contractual and periodic disclosures,⁸³ and apply to entities within the scope of the SFDR as well as at the level of financial products,⁸⁴ including whether they promote or have as an objective sustainable investment.⁸⁵ Disclosure requirements vary according to the sustainability strategy of a given product. National supervisory authorities monitor the compliance of FMPs and advisers with the requirements of the SFDR.⁸⁶ The SFDR RTS, which is the delegated regulation designed to support the implementation of the SFDR, elaborates on the disclosure requirements of the SFDR.

a. ‘Sustainability risks’ include human rights

The SFDR requires that FMPs and financial advisers disclose how they integrate ‘sustainability risks’ in their investment decision-making processes and advisory services, or explain why they do not do so.⁸⁷ A sustainability risk is defined as ‘an environmental, social or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment’.⁸⁸ FMPs and financial advisers, after explaining how they integrate sustainability risks at the entity level, must assess how these risks could adversely affect the value of the products they make available or advise on.⁸⁹ Yet as already alluded to in section 2 and as evidenced in the aforementioned provisions, the SFDR’s approach to ‘sustainability risks’ relies on an understanding of risks that is limited to the risks to an investor’s risk-adjusted return, rather than risks to the environment and to rights-holders.

The definition of ‘sustainability risks’ is not assimilated to environmental risk alone and expressly includes social and governance issues. Although this definition of ‘sustainability risks’ does not include any direct reference to negative human rights impacts,⁹⁰ negative human rights impacts could constitute a ‘social event or condition’, or be intersected with an ‘environmental’ or ‘governance’ condition. These intersecting events or conditions have the potential to generate legal, financial, operational, and reputational damage at the investee and investor level, which can then subsequently affect the value of an investment.

Two examples can help highlight how potential human rights impacts on people could be considered as a ‘social event or condition’ or an ‘environmental or governance condition’, and thus lead to a ‘sustainability risk’ as defined in the SFDR. First, social events or conditions related to negative human rights impacts, including on workers, local communities, users, and various other stakeholders can cause a negative impact on the value of an investment. For instance, large-scale projects like mining, agriculture, or infrastructure development can result in the displacement of local communities, infringing on their rights to housing, livelihoods, and cultural heritage,⁹¹ which can lead to legal challenges, community opposition, and reputational damage.⁹² Second, negative human rights events or conditions can also intersect with governance and environmental events and conditions. For instance, impacts on biodiversity can affect the right to livelihood of communities; the effects of climate change can affect the rights of individual to live in a clean and healthy environment;⁹³ and the absence of parity across businesses can be connected to gender equality and non-discrimination⁹⁴ adversely impacting human rights.

b. ‘Adverse sustainability impacts’ and ‘principal adverse impacts’ include negative impacts on human rights

The SFDR also requires that FMPs (including their products), and financial advisers, assess whether and how they consider ‘principal adverse impacts of investment decisions on sustainability factors’ (PAIs), also known as ‘adverse sustainability factors’. Sustainability factors are defined in article 2(24) of the SFDR, and explicitly encompass human rights. They include ‘environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters’. These ‘adverse sustainability impacts’ are considered from an ‘impact materiality’ standpoint, meaning that they are concerned with the impacts of FMPs on sustainability factors including human rights.

The SFDR requires that FMPs disclose at both entity and product level whether and how they consider PAIs. FMPs with more than 500 employees must consider PAIs, and those below this threshold must either comply with this requirement or explain why they do not.⁹⁵ Additionally, FMPs must provide reasons if their financial products do not consider such impacts.⁹⁶

The SFDR RTS detail PAIs by reference to a combination of mandatory and voluntary quantitative and qualitative indicators and metrics (see Table 2).⁹⁷ Among these, several indicators and metrics address human rights issues. In particular, two mandatory indicators focus on the share of investee companies involved in violations or lacking adequate processes and mechanisms to monitor compliance with the UN Global Compact principles and the OECD Guidelines.⁹⁸ In addition, seven voluntary indicators directly reference human rights, with one indicator specifically requiring alignment with the UNGPs and the OECD Guidelines.⁹⁹ This method of integrating human rights into PAIs by requiring alignment with international BHR frameworks generally, rather than identifying specific human rights issues, helps avoid selective adherence or focus on certain human rights over others. Nevertheless, the SFDR RTS does not define the terms ‘violations’ and ‘adequate processes’ within these indicators, leaving them open-ended. This lack of specificity can create uncertainty about what exactly is required for compliance with these provisions.¹⁰⁰

When FMPs do consider human rights (via PAIs), or are required to do so (for those with more than 500 employees), their reporting obligations increase significantly. They must provide detailed insights into how their investment decisions affect human rights and the due diligence processes they have implemented to assess and manage these impacts, taking into account ‘their size, the nature and scale of their activities and the types of financial products they make available’.¹⁰¹ These disclosures encompass a detailed explanation of the methods used for identifying and prioritizing impacts and indicators, along with a description of the strategies and actions undertaken in relation to such impacts, including in relation to their engagement policies and adherence with ‘responsible business conduct codes and internationally recognised standards for due diligence and reporting’.¹⁰² In addition, at a product level, FMPs must provide clear explanations of how their financial products consider PAIs on human rights,¹⁰³ though they retain considerable discretion in determining what actions they take with respect to these impacts.¹⁰⁴

Financial advisers, at the entity level, face obligations that are less demanding compared to FMPs. They have to disclose whether they consider PAIs in their investment or insurance advice, and if not, explain why and indicate whether they plan to consider them in the future.¹⁰⁵

c. ‘Do no significant harm’ (DNSH) and the need to align with human rights

Financial products covered under article 9 that have a defined ‘sustainable investment’ objective are subject to additional disclosure requirements.¹⁰⁶ According to article 2(17) of the SFDR, sustainable investments should not only address environmental and social objectives but also adhere to the ‘do no significant harm’ (DNSH) concept as defined in the SFDR with respect to these objectives. This DNSH differs from the one used in the Taxonomy Regulation, as will be discussed later. At first glance, it may seem similar to the ‘doing no harm’ concept in business and human rights.¹⁰⁷ This later concept implies that businesses should not harm human rights even if they are simultaneously ‘doing good’ by supporting other rights. However, unlike the SFDR’s DNSH principle, this concept is not limited to ‘significant harm’. Accordingly, further clarification is needed to define what constitutes, in the context of the DNSH principle, ‘significant’ harm and in relation to whom (investors, investees, or right-holders) such harm should be considered.

The SFDR RTS provide a detailed framework for understanding and applying the DNSH. According to the SFDR RTS, article 9 funds need to include detailed descriptions demonstrating how their investments are ‘aligned with the OECD Guidelines for Multinational Enterprises and the UN Guiding Principles on Business and Human Rights, including the principles and rights set out in the eight fundamental conventions identified in the Declaration of the International Labour Organization on Fundamental Principles and Rights at Work and the International Bill of Human Rights’.¹⁰⁸ In addition, the RTS require an explanation of how these investments take into account the mandatory and voluntary PAI indicators and metrics found in the SFDR RTS.¹⁰⁹

The inclusion of the OECD Guidelines and the UNGPs in the SFDR RTS is a noteworthy development from a human rights perspective. The OECD Guidelines and the UNGPs both underscore the critical importance for businesses to have policies and processes in place to respect human rights, including HRDD as a means to ensure respect for human rights.¹¹⁰ The inclusion of the OECD Guidelines and the UNGPs in the SFDR RTS embeds the HRDD process within both the DNSH concepts and the PAIs. In particular, this inclusion means that article 9 funds, to ensure that they adhere to the DNSH concept, must demonstrate how their investments are aligned with the OECD Guidelines and UNGPs. Demonstrating this alignment requires deploying the processes provided in these frameworks including HRDD.

3. The EU taxonomy regulation

The Taxonomy Regulation establishes a standardized framework for classifying or labelling environmentally sustainable economic activities and provides for associated reporting obligations.¹¹¹ The Regulation extends beyond FMPs subject to the SFDR to include large ‘public interest entities’, including companies listed on a EU-regulated market with more than 500 employees, credit institutions, insurance undertakings, and other companies designated by Member States as public interest entities.¹¹² To be taxonomy-aligned, an economic activity must (1) contribute to one of the environmental objectives; (2) do no significant harm to any other of these objectives; and (3) meet minimum safeguards.

Human rights are integrated in the Taxonomy Regulation through the interlinked concepts of ‘minimum safeguards’ as defined in article 18 of the Taxonomy Regulation. According to article 3(c) of the Taxonomy Regulation, an economic activity qualifies as environmentally sustainable if, amongst others, it is carried out in compliance with ‘minimum safeguards’.¹¹³ Article 18 of the Taxonomy Regulation clarifies what are minimum safeguards, highlighting two key components: (1) the need for procedures to ensure alignment with several human rights-related frameworks; and (2) the need for these procedures to be aligned with the concept of ‘do no significant harm’ (DNSH) found in the SFDR. While the primary focus of the taxonomy is on the activity level, compliance with minimum safeguards is to be evaluated at the entity level, meaning at the level of investee companies.¹¹⁴

The first component of the minimum safeguards refers to the need for procedures to ensure alignment with several human rights and business and human rights frameworks. Specifically, the Taxonomy Regulation provides that in-scope entities must implement procedures to ensure their economic activities align with the OECD Guidelines and the UNGPs. They must also align with the eight fundamental conventions identified in the Declaration of the International Labour Organization on Fundamental Principles and Rights at Work along with the International Bill of Human Rights.¹¹⁵ The second component emphasizes the necessity of adhering to the ‘do no significant harm’ principle from the SFDR as part of the implementation process for the aforementioned international human rights-related frameworks.¹¹⁶

The Taxonomy Regulation also includes another, yet distinct, concept of ‘do not significant harm’ that is unrelated to human rights and that is not examined in this article. Under that concept, to qualify as environmentally sustainable, economic activities must also ‘do no significant harm’ to any of the Taxonomy Regulation’s six environmental objectives.¹¹⁷ This requirement is distinct from the requirement of ‘do not significant harm’ of the minimum safeguards. The coexistence of two ‘do no significant harm’ concepts within the Taxonomy Regulation, each with a different scope yet with the same name, can lead to confusion.

In the context of minimum safeguards, entities must demonstrate compliance with the ‘do no significant harm’ concept as outlined in the SFDR.¹¹⁸ This entails two key requirements. First, entities must detail the alignment of their economic activities with key international human rights-related frameworks. Second, they must illustrate how they consider the mandatory and voluntary PAI indicators and metrics in the SFDR RTS.¹¹⁹ These indicators and metrics require that investee companies align with the OECD Guidelines¹²⁰ and, on a voluntary basis, the UNGPs.¹²¹

The requirement for an economic activity to align with the OECD Guidelines in the Taxonomy Regulation mirrors the approach taken by the SFDR. Alignment with the OECD Guidelines requires that entities, to respect human rights, engage in the process of HRDD, as outlined in these frameworks.¹²² As explained in the Final Report on Minimum Safeguards by the EU Platform on Sustainable Finance, ‘[human rights d]ue diligence processes are at the heart of MS [minimum safeguards]’.¹²³ By requiring HRDD as a criterion for defining minimum safeguards, both the Taxonomy Regulation and the SFDR highlight the role of investee companies in actively engaging in the identification, prevention, mitigation, and accountability for their negative human rights impacts. The complexities of implementing this process in sustainable finance are further elaborated in section 4.

The Taxonomy Regulation emphasizes the necessity for Member States to adopt measures and penalties that are ‘effective, proportionate and dissuasive’.¹²⁴ In Luxembourg, the most important fund centre in the EU, specific administrative sanctioning powers are given to the Commission de Surveillance du Secteur Financier (CSSF) and the Commissariat aux Assurances (CAA) in case of non-compliance with the SFDR and Taxonomy Regulation.¹²⁵ In addition to their investigative and supervisory powers, the CSSF and CAA also possess sanctioning powers. In case of breaches of the SFDR or the Taxonomy, they can issue a public statement specifying the identity of the person responsible and the nature of the violation; impose temporary prohibition of a person exercising managerial functions or of any natural person responsible for such a violation from exercising managerial functions; or levy administrative fines of between €250 and €250,000.¹²⁶ Given their sanctioning powers with respect of the SFDR and Taxonomy Regulation, the CSSF and CAA must also ensure the enforcement of human rights provisions integrated in these regulations. However, determining what constitutes ‘effective, proportionate and dissuasive’ measures and penalties in this context remains to be seen.

4. The corporate sustainability reporting directive (CSRD) and the European sustainability reporting standards (ESRS)

The CSRD is built around the need for clear reporting on sustainability information to facilitate access to financial capital amidst a growing offer of sustainable financial products,¹²⁷ and in view of the increasing demand for corporate sustainability information from investors.¹²⁸ The CSRD did not emerge in a vacuum; it notably amends Directive 2013/34/EU on the annual financial statements, consolidated financial statements and related reports¹²⁹ which itself was previously amended by the directive on non-financial reporting from 2014.¹³⁰ The Directive 2014/95/EU already required a certain number of companies to disclose information on human rights. It was also against the background of this Directive that the notion of double materiality was developed.¹³¹ The CSRD provides a more granular and systematic integration of human rights into the reporting of in-scope entities, which should increase the information available to the public, and investors in particular, on the respect of human rights in portfolio entities.

The CSRD mandates large companies, publicly listed small and medium-sized enterprises (SMEs), and parent companies of large groups (known as ‘undertakings’ in the CSRD) to report comprehensively on their ‘material impacts, risks and opportunities in relation to environmental, social, and governance sustainability matters’.¹³² A delegated regulation, the ESRS, is designed to specify the sustainability information that entities have to disclose in accordance with the CSRD. The ESRS is divided into three main categories: (1) cross-cutting standards; (2) topical standards, covering environmental, social and governance standards; and (3) sector-specific standards (yet to be developed).¹³³

First, the CSRD and ESRS integrate human rights through the concepts of ‘sustainability matters’ and ‘impact materiality’. They define ‘sustainability matters’ as encompassing ‘environmental, social and human rights, and governance factors’.¹³⁴ The ESRS explicitly includes human rights as part of ‘sustainability matters’.¹³⁵ Within the ESRS, sustainability matters are further detailed under various topical standards, many of which explicitly address human rights issues. These include S1 Own Workforce, S2 Workers in the Value Chain, S3 Affected communities, S4 Consumers and End-Users. Each standard focuses on different aspects of how businesses impact, and are impacted by, these groups of stakeholders. When preparing disclosures in line with the ESRS, in-scope businesses are required to consider both the material impacts that they can have on human rights and the material risks that human rights issues can pose to their business. As detailed previously, this dual focus is encapsulated in the concept of double materiality.

Second, the process of HRDD described in the UNGPs and OECD Guidelines is central for businesses¹³⁶ conducting their materiality assessment. To determine the specific information that needs to be disclosed, businesses must perform a materiality assessment. This assessment is key to identifying the material impacts, risks, and opportunities associated with sustainability matters.¹³⁷ To assess what material impacts, risks and opportunities to disclose, businesses are informed by the outcome of what the ESRS call a ‘sustainability due diligence’ process.¹³⁸ This process is defined in the ESRS by explicit reference to the UNGPs and OECD Guidelines.¹³⁹

The ESRS draw heavily on the UNGPs and the OECD Guidelines reflecting similar steps in the HRDD process.¹⁴⁰ According to the ESRS, these steps include embedding HRDD in governance, strategy, and business models;¹⁴¹ engaging with affected stakeholders;¹⁴² identifying and assessing negative impacts on people and the environment;¹⁴³ taking action to address negative impacts on people and the environment;¹⁴⁴ and tracking the effectiveness of these efforts.¹⁴⁵ Furthermore, similar to the UNGPs, the scope of sustainability due diligence extends to negative impacts on the environment and people connected not only to the undertaking’s own operations but also its upstream and downstream value chains.¹⁴⁶ This comprises impacts through its products or services and business relationships.¹⁴⁷ The ESRS acknowledge the challenge in gathering this information, especially when businesses lack control over the activities of their value chain and business relationships.¹⁴⁸ They also rely on concepts from the UNGPs such as ‘severity’, which requires entities to evaluate the materiality of an impact based on its scale, scope, and irremediable character,¹⁴⁹ and the concept of addressing impacts that are ‘directly linked’ to a company’s operations.¹⁵⁰

However, the ESRS diverge significantly from the UNGPs and the OECD Guidelines in two critical aspects. Whereas the UNGPs’ HRDD process typically encompasses actions to identify, prevent, mitigate, and remedy negative human rights impacts, the ESRS sustainability due diligence process focuses more narrowly on identifying and gathering information for disclosure purposes. Indeed, the ESRS expressly do not include an obligation of conduct,¹⁵¹ meaning that they do not require businesses to prevent, mitigate, and remedy the negative human rights impacts they will have identified for the purpose of disclosure.¹⁵² In addition, while the ESRS apply due diligence to issues wider than just human rights, aligning more consistently with the OECD Responsible Business Conduct Guidelines, this approach differs from the UNGPs, which focus exclusively on human rights. Despite the absence of an explicit conduct requirement as a response to identified impacts, the ESRS still require that businesses generally disclose what due diligence process they have in place and their policies to prevent, mitigate, and remedy their negative human rights impacts.¹⁵³ This sort of disclosure, however, is only the first step of HRDD, and business and human rights scholars have highlighted the need for more research on ‘corresponding systemic change to corporate practices that would prevent harms occurring in the first place’.¹⁵⁴

Accordingly, the approach to ‘sustainability due diligence’ found in the ESRS can be described as ‘partial’ HRDD. While it is a form of HRDD as it draws heavily on the UNGPs and the OECD Guidelines and includes some of its essential steps (in particular reporting, which is the final step of HRDD), it is classified as ‘partial’ HRDD because it lacks a conduct obligation regarding the impacts that have been identified, a requirement in both the UNGPs and the OECD Guidelines (and CSDDD for in-scope entities).

In terms of enforcement, the CSRD notably provides that Member States must ‘ensure that the members of the administrative, management and supervisory bodies of an undertaking have collective responsibility’ for sustainability reporting.¹⁵⁵ France has become the first country to transpose the CSRD into its national law.¹⁵⁶ Under this transposition, the sustainability information disclosed under the CSRD is subject to the general civil liability regime that applies to companies as well as company directors. This regime provides that directors and chief executive officers are liable individually or jointly and severally for breaches of statutory or regulatory provisions, the company’s bylaws, and misconduct in their management.¹⁵⁷ This transposition also provides for criminal sanctions in cases such as the failure of appointing an auditor or for obstructing audits.¹⁵⁸

The integration of human rights provisions and concepts across the CSDDD, the Taxonomy Regulation, the SFDR, and the CSRD legislation and delegated regulations is significant, as this section has demonstrated. However, when considering the implementation of these different pieces of legislation, challenges arise. These challenges are considered in section 4, together with possible responses.

IV. THE CHALLENGES OF INTEGRATING HUMAN RIGHTS IN EU SUSTAINABLE FINANCE

This section identifies two sets of challenges with integrating human rights in EU sustainable finance. First, coherence challenges which can lead to conflicting interpretations of business and human rights provisions between EU legislation, and between EU legislation and BHR and international human rights frameworks (section 4.1). Some of the coherence issues with these provisions have already been noted,¹⁵⁹ but challenges persist, especially with the process of HRDD. Second, diverging understandings of certain key concepts between the BHR and financial law communities reveal important terminological challenges (section 4.2). Concepts such as ‘risks’ and ‘impacts’ found in BHR differ from their traditional meaning in the financial sector. Responses to these challenges include bringing more human rights expertise to the financial sector, and access to guidance and data on human rights that are aligned with the UNGPs (section 4.3).¹⁶⁰

1. Coherence challenges related to human rights provisions and human rights due diligence (HRDD)

Coherence challenges generally relate to differences between EU sustainable finance-related legislation, and between EU legislation and BHR and human rights frameworks. As noted earlier, little attention has been given to human rights in EU sustainable finance by both the BHR community and the financial community. This lack of attention raises the risk of these coherence challenges.

Coherence challenges between EU legislation arise due to differences in human rights-related obligations, scope, and perimeter across the pieces of legislation detailed in previous sections.

A striking example of these differences is the HRDD process. As noted earlier, the CSRD provides for what can be called ‘partial’ HRDD. While closely aligned with the HRDD process in the UNGPs and the OECD Guidelines, ‘partial’ HRDD under the CSRD only requires in-scope entities to identify and disclose negative human rights impacts, not to address, prevent, or remedy them.¹⁶¹ Conversely, HRDD in the CSDDD requires entities not only to identify negative human rights impacts, but also to address, prevent, or remedy these impacts; it can be considered similarly under concepts such as the DNSH in the SFDR and the minimum safeguards in the Taxonomy Regulation. In terms of scope, the CSDDD, SFDR, the Taxonomy Regulation, and the CSRD each apply to different entities and, where applicable, to different financial products. For instance, in the SFDR, only SFDR article 9 funds have to ensure alignment with, inter alia, the UNGPs and the OECD Guidelines in accordance with the DNSH concept. Yet under the CSRD, a broad group of entities, including banks and other large asset managers, have to conduct ‘partial’ HRDD to identify their disclosure obligations. In terms of perimeter, the CSDDD limits HRDD to the upstream of investments activities. No such limit exists in the Taxonomy Regulation, SFDR, and CSRD.

Coherence challenges between EU legislation and BHR and international human rights frameworks arise when international human rights law is interpreted by different specialist legal regimes (ie BHR or financial law), each focusing on specific subject matters. The decentralized nature of international human rights law, as a component of international law, presents unique concerns. International human rights law, as a component of international law, is without a central authority to govern all of its aspects, interpret and enforce its rules, or an accepted hierarchy of laws. In this context, specialist legal regimes such as BHR or financial law can develop their own principles and practices when interpreting international human rights law, and without coordination this can lead to conflicts between rules, contradictory institutional practices, and a lack of legal coherence.¹⁶² Thus, the need to resolve interpretive conflicts between these regimes is pressing.

Admittedly, specialized legal regimes can offer opportunities by facilitating the development of legal norms specifically tailored to complex issues,¹⁶³ such as aligning international human rights with sustainable finance. However, they also present significant risks. They can lead to fragmentation that generates contradictory interpretations ultimately creating complexity, uncertainty, and inefficiency.¹⁶⁴ Indeed, when interpretations put forward in financial law conflict with those long put forward in the context of BHR and human rights frameworks, this can generate uncertainty as to which interpretations should prevail in the absence of a central authority to interpret international human rights law.

For example, the issue of how financial actors interpret international human rights treaties such as the International Covenant on Economic, Social and Cultural Rights (ICESCR) or the International Covenant on Civil and Political Rights (ICCPR) in their efforts to align with the UNGPs can raise conflicts. States that have ratified international human rights treaties have long been subject to human rights obligations that have been extensively interpreted by UN human rights treaty bodies and international judicial bodies. When financial actors interpret international human rights treaties while not being attuned to the existing interpretations produced by these authoritative bodies, their interpretations may not align, or may even conflict, with those long-established by these bodies, leading to legal uncertainty. This can generate inconsistencies in the application and understanding of international human rights treaties globally.

Furthermore, conflicting interpretations might arise regarding how financial entities’ involvement in negative human rights impacts are interpreted and their relative consequences. According to the UNGPs, HRDD should help inform whether a business causes a negative human rights impact, or whether it contributes to such an impact, or whether the impact is directly linked to its operations, products, or services as a result of its business relationships.¹⁶⁵ Depending on the level of involvement, the response required from the business will vary, including the extent to which it has to provide remedies or use its leverage.¹⁶⁶ The qualification of the financial sector’s level of involvement under the UNGPs, depending also on asset classes, has been the source of much controversy.¹⁶⁷ Yet, without adequate guidance and interaction between the BHR and financial law community, the levels of involvement of the financial sector in adverse human rights impacts risks not being uniformly interpreted between EU sustainable finance-related legislation and BHR and human rights frameworks. These divergences come in addition to the very understanding given to ‘adverse impact’ that could be interpreted differently and more restrictively than in the UNGPs across EU legislation, bringing further uncertainty as to the appreciation of civil liability by domestic courts.¹⁶⁸

The potential for conflicting interpretations could be addressed using the principle of lex specialis, a recognized method of interpretation in both international and domestic law designed to resolve such conflicts. This principle dictates that priority should be given to the more specific norm.¹⁶⁹ But in the context of BHR and financial law, questions arise as to which legal instrument is the most specific and thus qualifies as the lex specialis. For example, should the lex specialis be the special regime applicable to the financial sector (eg SFDR), or human rights and BHR frameworks (eg UNGPs or ICESCR)?¹⁷⁰ An effective means to anticipate and manage these challenges involves enhancing coordination and fostering dialogue between BHR and financial law to ensure the coherence of interpretations.¹⁷¹

2. Terminological and conceptual challenges related to the interplay of impact and risk

a. Examples of terminological and conceptual challenges

As already alluded to in section 2, there are few interactions between the BHR and the financial law communities. This absence is mirrored in the little intersection seen to date between financial and BHR concepts. Accordingly, the integration of human rights into positive law applicable to the private sector, in particular to investors, brings terminological challenges. This integration can lead to confusion and misunderstandings since terms like ‘impacts’ and ‘risks’, as well as associated processes such as ‘due diligence’, often carry different meanings and implications in the financial sector compared to BHR.¹⁷²

In the field of BHR, the UNGPs and the OECD Guidelines require investors and investees to assess how their investments and broader activities, as well as those of their business relationships, have actual or potential ‘impacts’ on people. In these contexts, such impacts are referred to as a ‘human rights risk’¹⁷³ or ‘RBC risk’ in the OECD Guidance for Institutional Investors.¹⁷⁴ Conversely, in the financial sector, investors generally focus on ‘risks’ that affect ‘risk-adjusted returns’, where the relevant risks are those that impact investors’ portfolio and not those that impact rights-holders.

The divergence in the usage of similar terms extends beyond ‘risks’. For investors, ‘impacts’ and ‘contribution’ often carry positive connotations, generally linked to positive impacts or contributions towards the SDGs.¹⁷⁵ In contrast, the UNGPs use both terms with a focus on negative (ie adverse) human rights impacts, with the notion of ‘contribution’ to an impact entailing both a specific type of involvement in an impact and a specific response from an investor as per the UNGPs. Terms like ‘leverage’ and ‘due diligence’ are also understood differently.¹⁷⁶ For instance, due diligence in the financial sector refers to a process generally intended to identify risks to return rather than impact on rights-holders. It is also generally a process conducted only at the initial stage of an investment rather than an ongoing process.

The discrepancy in meanings between the terms used in the BHR context and those used in the financial sector goes beyond mere terminology; it underscores a fundamental divergence in approach. This divergence stems from the traditional investor focus on risk-adjusted returns, a priority embedded in practice, various national laws, and interpretations of fiduciary duties,¹⁷⁷ in contrast to the risk to people approach of the UNGPs and the OECD Guidelines. Significantly, the notion of ‘sustainability risks’ defined in the SFDR is limited to the risk-adjusted return of investors and does not extend to risks to rights-holders as understood in the UNGPs.

The use of the same terms with different meanings within the BHR community and within the financial sector could generate significant confusion among investors and other stakeholders, in terms of expectations and investors’ implementation of human rights provisions.¹⁷⁸ This situation could lead to the concept of ‘risks’ under the UNGPs, which refers to risks to people, being misinterpreted by the financial sector as referring to risks to the risk-adjusted returns of investors. This possible confusion could then lead to an interpretation opposite to what the UNGPs intended.

This situation is exacerbated by the scarcity of individuals with cross-over expertise in both financial law and business and human rights or, at least, who are conversant in both the language of finance and BHR. As noted earlier, this gap in expertise contributes to explaining the reasons why the BHR community has given little attention to EU sustainable finance. The complex infrastructure of financial markets, along with the diverse actors and products involved, further complicates engagement. Nevertheless, the concept of double materiality that is now widely adopted across EU sustainable finance-related legislation could help harmonize the understanding of risk and impact across these different communities with regard to its applicability to human rights.

b. Clarification through double materiality

EU legislation has now brought together these different understanding of risks and impacts and established a clear distinction: ‘risks’ is understood as risk to business and investors while ‘impact’ is understood as risk to rights-holders (i.e.people and/or planet). These different understanding of risks and impacts are captured in the EU by the overarching term of ‘double materiality’.¹⁷⁹ Many investors, traditionally focused solely on the financial implications of risks and opportunities for their investments, may find this broader ‘impact’ lens challenging. Yet this lens is aligned with the UNGPs’ emphasis on ‘impact to rights-holders. Indeed, the ESRS, which detail double materiality and its requirements, heavily draw on the terminology and concepts of the UNGPs.

Both sides of ‘double materiality’ can interrelate on occasions: human rights issues can generate material impacts, risks, and opportunities. Taking poor labour standards in the textile industry as an example, issues such as unfair wages,¹⁸⁰ unsafe working environments, and the use of child or forced labour,¹⁸¹ not only have negative human rights impacts but can also result in substantial financial and reputational harm to businesses. In this scenario, there are material impacts on human rights, such as the right to just and favourable remuneration,¹⁸² and related material risks to the business, including potential sanctions under various legislation related to mandatory HRDD, reputational harm, and possible loss of access to some capital streams.

In addition, there is growing acknowledgment, including amongst investors, that impacts not currently deemed financially material may become so over longer time horizons.¹⁸³ This shift in materiality can result from the adoption of human rights legislation (resulting in legal risks), increased reputational risks, or evolving preferences from beneficiaries and clients. More generally, it can also result from broader systemic issues related to human rights such as inequalities, climate change, or biodiversity loss. These can have profound implications on society and the economy, potentially impacting companies and investors’ portfolio. Nevertheless, scenarios also exist where human rights impacts may not interrelate and be deemed financially material by an organization and its investors, regardless of time horizons. These impacts, however, would be accounted for under an impact materiality approach based on the UNGPs, OECD Guidelines, and on EU sustainable legislation.

Accordingly, incorporating impact materiality into investment decisions requires a significant shift in approach for investors, as they need to learn the language and approach outlined in the UNGPs and OECD Guidelines. With limited cross-over expertise between the BHR and financial law communities, it may take time for investors, corporates, and their lawyers to fully grasp all these terminological nuances, a process that has also been documented for the Vigilance Law in France.¹⁸⁴

These terminological and conceptual challenges underscore the importance of capacity building across all levels of investors, from analysts to the C-Suite and board members. Moreover, it is essential that a larger ecosystem of actors, including commercial data providers, proxy advisers, and other ESG service providers, also incorporate impact materiality into their methodologies and approaches.

3. Responding to these challenges: data, guidance, and expertise

a. Data

For investors to fulfil their responsibility to respect human rights, they first must have access to different categories of decision-useful data.¹⁸⁵ While there is already some data available to inform investors about investees’ respect for human rights,¹⁸⁶ including through EU initiatives such as the ESRS, the challenges of data availability, granularity, comparability, and standardization remain significant to date.

Amongst the challenges, the data currently available at the investee level may not be indicative of the quality of HRDD processes implemented both at the investee and portfolio levels.¹⁸⁷ Data may also lack contextualization, which is particularly important when investing across various jurisdictions with varying levels of protection and enforcement of rights. The qualitative nature of human rights data can also be a challenge for investors used to interacting with quantitative data, especially when looking at data related to climate change. More generally, the very possibility and challenge of quantifying and measuring human rights impacts, alongside questions about the applicability of this to businesses and investors, has been a subject of long-standing debate.¹⁸⁸.

Besides, investors, with some exceptions,¹⁸⁹ primarily rely on third-party data from commercial data providers to inform themselves about sustainability issues prior to making investment decisions and throughout the lifecycle of the investments. The limitations of relying on these commercial data providers are well known, and also extend to human rights, including issues related to their business models, the use of diverging methodologies and results.¹⁹⁰

The upcoming EU regulation on ESG rating activities¹⁹¹ should help increase the transparency of methodologies used. This transparency combined with the ESRS could result in improving the quality and quantity of data on human rights used in ESG ratings. In combination with these legislative changes, some investors have also started engaging with commercial data providers and proxy advisers to improve the availability and quality of human-rights related data to foster alignment with the UNGPs in particular with HRDD.¹⁹² That said, in addition to having access to data, investors also require clear guidance on how to utilize this data effectively within their decision-making processes.

b. Guidance and expertise

EU sustainable finance-related legislation, while facilitating disclosure, provides limited guidance on the processes and strategies that investors could adopt to respect human rights,¹⁹³ including across different asset classes. This gap mirrors the little guidance available under the UNGPs and OECD Guidelines on how different types of investors can fulfil their responsibility to respect human rights.¹⁹⁴ While this appears to grant investors flexibility in implementing appropriate processes and strategies, it also raises questions as to how these obligations should be fulfilled while anticipating coherence risks and what constitutes necessary baselines.

In addition, due to the limited guidance currently available, the considerable discretion afforded to investors, and the absence of uniform supervisory practices across different regulations, initial variations in how these regulations are supervised and enforced are likely.¹⁹⁵ These variations are exacerbated by the fact that many regulators themselves have limited experience with human rights issues, as sustainability issues have traditionally been addressed outside of financial regulation.¹⁹⁶ They are further exacerbated by the differences in human rights-related obligations, scope, and perimeter across EU legislation.

Accordingly, the effective implementation of human rights provisions in EU sustainable finance-related legislation will require a broader range of stakeholders to become more familiar with these provisions and their differences, and to actively engage in their implementation. This includes auditors, data providers, and civil society organizations, all of whom play critical roles in monitoring, reporting, and advocating for adherence to these provisions.

To address these challenges, several types of guidance could be developed. For investors, guidance should be directed to their analysts, C-Suite, and board members, and could encompass trainings, peer learning, and written guidance on specific themes and specific asset classes, offered by regional or national policy makers and various stakeholders. For investees, guidance and awareness raising would support investees’ understanding of the soft law and hard law requirements of human rights provisions applicable to them and also to investors, and possible action they can undertake.¹⁹⁷ Investors would also be able to rely on such guidance to support their stewardship efforts with investees.

Finally, guidance is also needed for service providers, such as commercial data providers, proxy agencies, lawyers, and accountants. Such guidance would support a market infrastructure that is aligned with business and human rights, its language, approach, and ultimately, its processes and expected outcomes. The CSDDD is putting in place a rich infrastructure to provide guidance for companies of various sizes. As for the CSRD, EFRAG has already started issuing guidance to facilitate the implementation of the ESRS.¹⁹⁸ But questions remain as to which other entities should (and have the legitimacy to) be developing such guidance.

Focusing more specifically on what guidance for investors might entail, it could provide clear strategies for accounting for human rights impacts in their ‘ESG approaches’.¹⁹⁹ Traditionally, these strategies have largely focused on enhancing investors’ risk-adjusted return rather than impact on people and the environment. Nevertheless, they could be adapted to take into account human rights impacts beyond those associated with financial risks and opportunities.²⁰⁰ In practice, three main strategies could be considered by investors when taking action on human rights, including in response to risks identified under the HRDD process: (1) capital allocation and investment decisions; (2) stewardship of investees; and (3) larger stakeholder engagement.²⁰¹ An overview of these strategies is provided below.

First, investors can incorporate human rights impacts into their investment criteria, prioritizing portfolio entities that maintain or improve human rights standards, or excluding those that fail to meet these standards. Second, investors can use their influence to encourage better human rights practices among their portfolio entities through dialogue and voting, including through collective stewardship initiatives on human rights that have been increasing.²⁰²

On voting, more specifically, social-related shareholder proposals have been a rising trend over the past years,²⁰³ including on human rights topics such as requesting human rights policy, due diligence, and free prior and informed consent. However, the number of these resolutions fluctuates over years, depending on topics, geography, and sectors, as well as the support of investors for these proposals and the number of them which have been passed.²⁰⁴ In that regard, it is worth noting that European asset managers supported more resolutions, indicating that the ‘relative strength of the regulatory environment in Europe suggests that regulation has had a positive impact on voting performance from managers in the region’.²⁰⁵ For passive funds, the conduct of stewardship can be more challenging.²⁰⁶ Yet, large index funds in particular hold promise as a result of their size,²⁰⁷ while stewardship could be more easily conducted for actively managed funds, although the question of its costs and generated outcome are key.²⁰⁸

Third, engaging with a broader array of stakeholders, including policy makers, proxy advisers and commercial data and index providers, civil society organizations, and right-holders can help investors gain a more comprehensive understanding of human rights impacts.

HRDD, remediation, and policy processes as prescribed by the UNGPs can be found across the three strategies described above.²⁰⁹ Similarly, the concept of leverage, a key element of the UNGPs that refers to ‘the ability of a business enterprise to effect change in the wrongful practices of another party that is causing or contributing to an adverse human rights impacts’,²¹⁰ also pervades these approaches, particularly with respect to stewardship. However, the actual implementation of these processes and strategies by investors is likely to vary significantly. This variability could be attributed to several factors, including the type of investors, their investment strategies (whether they are active or passive), and the asset classes they manage.

V. CONCLUSION

This article has demonstrated the significant integration of human rights into key pieces of EU sustainable finance-related legislation through references to international human rights and BHR frameworks such as the UNGPs and the OECD Guidelines. Notably, this integration encompasses not only human rights-related disclosure requirements but also, in certain instances, conduct obligations for investors and their portfolio companies. Furthermore, this integration is supported by the mobilization of established national regulatory infrastructure within the financial sector, which are employed to monitor and enforce business and human rights provisions in the CSDDD, SFDR, Taxonomy Regulation, and CSRD. Together, these developments mark a significant extension of human rights into positive law applicable to the private sector. Yet, they have received little attention from the BHR community and the financial sector.

This article has also highlighted several challenges stemming from this unexamined integration, particularly coherence issues in the interpretation of human rights provisions between EU sustainable finance-related legislation, and between EU legislation and international human rights and BHR frameworks. Additional challenges arise from diverging understandings of key concepts between the BHR and the financial law communities. These challenges underscore a gap in investors’ preparedness and expertise regarding human rights and the efforts required to implement BHR provisions in EU sustainable finance-related legislation.

In light of these developments and challenges, this article contends that there is a critical need for infrastructure to support the multiplicity of actors in the financial sector who, in the coming years, will be interpreting and implementing human rights, including processes such as HRDD. An important step in addressing this need is the provision of relevant interpretive guidance across asset classes, alongside decision-useful human rights data.

Footnotes

Author notes