German multinationals urged to up ESG game in China

There are currently no mandatory ESG reporting and governance guidelines in China but a leading Beijing-based law firm advising German-speaking businesses active in the country has warned that regulation is coming and, as ever, it’s best to act now rather than regret later. Also, as Rainer Burkardt, founder and managing director of Burkardt & Partner, and colleague Ondrej Zapleta explain in a recent note, the European Union has finally passed the Corporate Sustainability & Due Diligence Directive (CSDDD) that means such companies will be subject to these ESG requirements anyway. Regardless of EU supply chain requirements, European firms active in China and Chinese firms will see the first formal ESG rules come into force with the arrival of the revised Company Law that goes live on 1 July. Burkardt explains that, while not specifically labelled as ESG requirements, Chinese firms already have to comply with general stipulations on ESG on a national law level. Examples include the Environmental Protection Law, which requires companies to prioritise environmental protection and prevent pollution; the Labour Law, which obligates companies to develop and improve their labour systems to ensure legality and equality in their organisations; and, the Consumer Protection Law and the Advertising Law, which penalises greenwashing. “More recently, ESG has been included in the Company Law, effective July 1, 2024. According to the law, companies shall consider the interests of their employees, consumers, and other stakeholders, as well as environmental protection, and assume social responsibility,” said Burkardt. The new Company Law also stipulates that companies should be encouraged to publish social responsibility reports. Burkardt explained that currently China has no “proper legal framework” for ESG disclosure and an ESG reporting obligation only applies to certain industries, including financial and insurance institutions and listed companies. “For non-listed companies, ESG disclosure is basically voluntary and encouraged through green investment and other market-based forces. However, there are mandatory information disclosure requirements on environmental performance for certain companies,” he said. But the lawyer, who has been active in China for 16 years now, said that, based on the recent developments in ESG, it is expected that China will continue emphasising sustainability and ESG compliance in the future. “The ESG regulatory requirements will become more standardised and mandatory. Consequently, companies operating in China and their management will face more obligations and increased ESG compliance risks. Non-compliance may result in penalties, reputational damage, and even the withdrawal of their business licence,” warned Burkardt. As with all matters risk management, the key is to get ahead of the game and actually view ESG as a positive strategic asset rather than merely a tick-box and compliance matter, advised the lawyer. “ESG compliance efforts, as a part of a company’s compliance system, may help companies to better understand their ESG performance and support the timely detection of potential risks. Companies that proactively integrate non-mandatory ESG principles into their operations are more likely to stay ahead of regulatory changes and minimise risks,” said Burkardt. “The demonstrable addressing of grievances within the company also generally improves the company’s social credit rating,” he added. Burkardt further explained that, under the EU’s draft CSDDD, companies have due diligence obligations and shall seek the necessary contractual assurances from their business partners and other entities in their global value chain to assure ESG compliance. “The CSDD Directive will not only affect the companies falling within the CSDD Directive’s scope, but also, indirectly, companies in their global value chains, including companies in China,” he said. “Whether due to the obligation under the CSDD Directive or on a voluntary basis, ESG contractual obligations will often be passed through the value chain from European OEMs via contractual cascading downstream to the raw material supplier, as the final chain link. The violation of ESG contract clauses may lead to contract disputes and substantial damage claims,” added Burkardt. Besides legal and contractual compliance, investors and consumers are also significant drivers of companies’ ESG efforts, pointed out the Chinese legal expert. He said that, as consumers in China become more conscious of the environmental and social impact of their purchasing decisions, companies that demonstrate a commitment to ESG values can build trust, enhance brand loyalty, and gain a competitive edge in the market. Furthermore, companies with positive ESG performance may enjoy an accelerated process for authority approvals and enhance their access to capital as banks consider ESG performance as a criterion when granting bank loans, added Burkardt. “ESG compliance is – and will become – more important for successful business operations in China. By proactively embracing ESG best practices, companies can comply with regulatory requirements and gain a competitive advantage, enhance brand value, and improve access to capital,” said Burkardt. “This also includes ensuring contractual ESG compliance through the supply chains by assessing contracts with business partners, including general terms, conditions and code of conduct to identify potential ESG risks,” he continued. “For that purpose, it is recommended to establish a contract management system. As the implementation of ESG compliance is a long-term process, we advise companies to start with their ESG implementation as soon as possible,” concluded Burkardt.

German multinationals urged to up ESG game in China

Long reach of CSDDD adds to risk for European firms

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