Upcoming Regulation on Sustainability Reporting and Human Rights Due Diligence in Switzerland

On 29 November 2020, the initiative on responsible enterprises failed. The initiative provided, among others, liability of Swiss enterprises for their subsidiaries abroad who have breached human rights or environmental standards. As a result, the parliament’s indirect counterproposal will likely enter into force (subject to a potential popular referendum). The indirect counterproposal provides for (i) non-financial reporting duties for larger publicly traded companies and prudentially supervised financial institutions as well as (ii) human rights due diligence requirements for enterprises processing or importing conflict minerals or enterprises having a reasonable suspicion of child labor. 

By Annette Weber (Reference: CapLaw-2021-19)

1) What happened until now?

In 2015, several civil society organizations initiated the so-called “Responsible Business Initiative”, which aimed to amend the Swiss Constitution. The popular initiative was submitted for voting on 29 November 2020 and was rejected. Although the majority of the Swiss people voted in favor, the majority of the cantons did not support the initiative, which would have been necessary for an amendment of the Swiss Constitution. The entry into force of the indirect counterproposal – while being very likely – is not certain due to pending appeals. Like any new statute, the indirect counterproposal may become subject to a popular referendum if so petitioned by 50,000 Swiss nationals or eight cantons within 100 days after the publication of the indirect counterproposal in the Federal Gazette. In such a referendum, if any, no majority of cantons would be needed anymore.

2) What obligations does the indirect counterproposal introduce?

The indirect counterproposal introduces two sets of duties: (i) non-financial reporting and (ii) mandatory human rights due diligence.

a) Non-financial reporting

The European Union published already in 2014 the so-called non-financial reporting directive (Directive 2014/95/EU), which applies to larger companies. The indirect counterproposal follows the EU approach by introducing a similar non-financial reporting duty.

i. Subject enterprises

The duty for non-financial reporting is applicable to companies of public interest with more than 500 full-time employees on average and either a balance sheet total of CHF 20 million or a turnover of CHF 40 million, in each case on a consolidated basis in two consecutive business years. Companies of public interest are (i) companies having (a) their equity securities listed on a stock exchange, (b) bonds outstanding or (c) contributing at least 20% of their assets or their turnover to the consolidated financial statements of a company falling under (b) or (c) and (ii) prudentially supervised financial institutions. In short, the non-financial reporting obligation applies only to larger Swiss companies and does not target small and medium-sized enterprises (SME).

Enterprises are exempted from the duty to produce a report on non-financial matters if they are controlled by an enterprise which is subject to the non-financial reporting obligation or which must prepare an equivalent report under foreign law. The exemption aims to avoid requiring companies to prepare several non-financial reports within a group of companies. 

ii. Content of the report

The report on non-financial matters includes primarily information on environmental issues, in particular CO2 goals, social issues, employee matters, compliance with human rights as well as the combat against corruption with a view to support the understanding of the enterprise’s business, its business development and position as well as the impact of the enterprise’s business on these matters. It also includes information on the enterprise’s business more generally. In particular, the report includes:

– a description of the business model;

– a description of the applied concepts of the enterprise’s business model, including the due diligence applied;

– a presentation of the implementation of the concepts and their effectiveness;

– a description of the main risks in connection with the described environmental and social issues as well as of the handling of the risks arising from the enterprise’s business and, if relevant and proportionate, of the business relationships, products or services; and 

– the main performance indicators relating to the enterprise’s business model.

If an enterprise does not have a concept regarding one or more of the above-mentioned points, this must be clearly stated and explained (comply or explain). The report must not only cover the subject enterprise, but also its controlled subsidiaries. The indirect counterproposal leaves great discretion to the enterprises in the implementation. In my view, it would have been desirable to include expressly a mandate to the Federal Council to determine details on the implementation in order to ensure a more uniform implementation and to give enterprises guidance on the level of detail.

The statute allows companies to prepare the report in accordance with national, European or international standards, but requires companies to publish all information required under the Swiss regime. Any additional information required under the new Swiss regulation, but not required to be disclosed under the applied international standard, must nevertheless be included in the reporting. Hence, companies that already prepare a report according to an internationally recognized standard may continue to apply such standard, but may need to prepare a supplement for any additional information required under the Swiss non-financial reporting duties that is not covered under the international standard.

iii. Approval and Publication

The report on non-financial matters must be approved and signed by the highest management body (typically, the board of directors) and requires the approval of the body responsible to approve the annual financial statements (typically, the shareholders meeting). In contrast to the financial statements, the report does not have to be audited or verified by an independent third party. Such requirement would have improved the quality and credibility of the reporting in my view. Further, the board of directors must ensure that the report will be published promptly after the approval by the shareholder meeting and remain accessible during a period of ten years. The report must be in English or one of the Swiss national languages.

The above listed duties should not be confused with the recently enacted provisions on transparency of commodity enterprises (cf. articles 964a – 964f of the Swiss Code of Obligations). These provisions encompass payments of at least CHF 100,000 to governments by enterprises which (i) are active in the field of the extraction of minerals, crude oil or crude gas or logging of timber in primary forests and (ii) are subject by law to the ordinary audit.

b) Human rights due diligence

The second prong of the indirect counterproposal encompasses due diligence duties related to human rights. Like the non-financial reporting, the human rights due diligence is not a novel Swiss concept. Several other legislations abroad, such as the EU regulation (see Regulation (EU) 2017/821) already provide for human rights due diligence duties.

i. Subject enterprises

The human rights due diligence is applicable to enterprises whose registered office, central administration (Hauptverwaltung) or principal place of business (Hauptniederlassung) is in Switzerland provided that they either import to or process in Switzerland tin, tantalum, wolfram, minerals with gold or metals coming from conflict or high-risk regions or offer products or services for which there is reasonable suspicion of child labor being involved in the production. The statute authorizes the Federal Council to define exemptions for low annual import volumes and for SME with low risk for child labor. The exemptions aim to avoid a disproportionate effort especially for SME to comply with the new regulations. Further, the Federal Council will decide under which circumstances companies are exempt if they publish a report prepared in accordance with internationally recognized standards, in particular the OECD guidelines for multinational enterprises. The provisions define neither the terms “child labor”, “conflict or high-risk regions” or “reasonable suspicion” nor do they task the Federal Council with defining these terms in the implementing ordinance. This is problematic in my view, as it will leave a number of enterprises with uncertainty.

ii. Human rights due diligence and reporting

A subject enterprise must introduce a management system which determines:

– the policy on supply chains for minerals and metals potentially originating from conflict and high-risk regions;

– the policy on supply chains for products and services, for which a reasonable suspicion of child labor exists;

– a system which traces the supply chain.

Further, enterprises must determine and assess the risks of harmful effects of their supply chains, prepare a risk management plan and adopt measures to minimize the identified risks. In addition, they must engage an independent expert who verifies the compliance regarding minerals and metals. Interestingly, the statute does not refer to an external control for child labor. In my view, it would have been desirable to require an external audit for the report on child labor as well because it is hard to find a justified reason for this distinction. The Federal Council will define these duties in more detail, whereby it will follow internationally recognized standards, in particular the OECD guidelines for multinational enterprises. 

The highest management body (typically, the board of directors) must produce a report about its compliance with the due diligence obligations on an annual basis. Enterprises which offer products or services from enterprises which already produced a report for these products or services (for example, resellers) are not required to publish a report. The report must be published electronically within six months after the end of the financial year and be accessible for at least ten years. The report must be in English or one of the Swiss national languages. 

c) Sanctions

The reporting of false information or the failure to report on non-financial matters or in connection with the reporting on human rights due diligence is subject to a fine of up to CHF 100,000 and in case of negligence up to CHF 50,000. The same sanctions face those persons who do not comply with the duties on storage and documentation of said reports. Based on the principle of nulla poena sine lege and absent any clear guidance from the Federal Council, enterprises which do not adhere to the obligations of the human rights due diligence because it is debatable whether or not they fall within the scope of application at all should not be sanctioned. Further, it is worth to note that the enterprise itself cannot be subject to the above-mentioned sanctions because the sanctions are misdemeanor (Übertretung) for which Swiss criminal law does not foresee corporate liability (see art. 105 para. 1 in conjunction with art. 102 of the Swiss Penal Code). I therefore expect that the provision will only be enforced in obvious cases of non-compliance, which will hopefully remain rare.

As the indirect counterproposal introduces new duties for the board of directors and the management, any failure to comply with the new obligations may give rise to claims against members of the board of directors and management (cf. art. 754 of the Swiss Code of Obligations). It might be difficult, however, to establish a damage as for example the non-publication of a report does typically not lead to any damage. Nevertheless, this liability exposure will require boards of directors and the executive bodies to properly allocate resources to comply with the new obligations, to implement and effectively oversee them.

3) Outlook

Before the indirect counterproposal becomes binding law, it first needs to be published in the Federal Gazette and is subject to a referendum if petitioned by the above-mentioned 50,000 Swiss nationals or eight cantons within a period of 100 days. Further, the Federal Council will need to draft an implementing ordinance. The timing of the publication of the indirect counterproposal in the Federal Gazette and any further implementation steps are not yet known due to pending appeals. Although in my view unlikely, it is possible that the provisions on the non-financial reporting will enter into force earlier than the provisions on the human rights due diligence as the latter require an implementation ordinance. Further, the implementation ordinance will likely go through a consultation process.

Once the indirect counterproposal has entered into force, transitional periods will apply according to which the statute will apply the first time to the financial year that will start one year after the entry into force of the statute. The earliest adoption date is in 2021 in which case enterprises have to apply the provisions the first time in 2022 and report the first time in 2023 covering the financial year 2022. Currently, it seems rather unlikely that the statute will enter into force this year.

Despite the uncertainty when the statute will come into force, it is advisable for enterprises to start verifying now what steps will be required and to work out a roadmap for the implementation as the implementation, in particular the human rights due diligence, might be complex and will take some time. Enterprises will need to implement adequate internal processes and controls in order to ensure compliance and, if applicable, involve business partners along the supply chain. Although the implementing ordinance is not yet available, international standards such as the OECD guidelines for multinational enterprises may provide helpful guidance.

The EU is currently assessing whether it should propose a revision of the non-financial reporting directive. A consultation regarding the potential revision of the directive with several stakeholders showed problems for preparers and readers in relation to the quality and the scope of information to be disclosed in non-financial reports. In particular, users claim a lack of comparability between different reports and the relevance of information provided. If the EU amends the non-financial directive, Switzerland risks that its regime on non-financial reporting will be regarded as outdated. Further, the Trustees of the IFRS Foundation published recently a consultation paper on sustainability reporting in the context of assessing the need for sustainability reporting under IFRS. Although the consultation process is still in an early stage, the initial feedback showed a need for uniform reporting. If IFRS will adopt sustainability reporting rules, Swiss subject enterprises reporting under IFRS will need to adhere to two different sets of rules (which are hopefully aligned). As the regulatory landscape is constantly changing, it would have been more advisable to delegate the content and implementation of the non-financial reporting duty to the Federal Council. This would have enabled Switzerland to be at the forefront of international developments.

Switzerland follows international trends and regulation for the non-financial reporting and the human rights due diligence. This is a prudent approach given that many multinational enterprises will have to adhere to different regulation. For non-financial reporting, however, Switzerland risks falling behind the EU and international organizations as they move towards higher disclosure standards.

Annette Weber (annette.weber@advestra.ch)