“Sustainability” extends far beyond environmental concerns, encompassing a broader spectrum of issues, including human rights. Recognizing the pivotal role businesses can play in safeguarding the environment and championing these broader causes, sustainability has garnered significant interest from politicians, investors, consumers, and various stakeholders. The European Commission, through its proposed Corporate Sustainability Due Diligence Directive (CSDDD), has laid out a legislative framework designed to compel companies across diverse sectors, including financial services, to transparently showcase their commitment to environmental preservation and the protection of human rights.
The CSDDD Explained
The CSDDD establishes stringent mandates for companies, requiring them to proactively identify, cease, or alleviate actual and potential adverse impacts of their operations on the environment and human rights violations.
This directive extends its obligations beyond a company’s primary operations, encompassing its subsidiaries and entities throughout its value chain, including those with whom they maintain direct or indirect business relationships.
Companies would be tasked with formulating and executing “prevention action plans.” They would also be obligated to secure contractual commitments from their primary business partners, ensuring adherence to these plans and verifying compliance with them.
Who Would Be Affected?
The CSDDD proposal would encompass the following categories of companies:
Group One
The CSDDD proposal would encompass EU-based companies with over 500 employees and a net worldwide turnover exceeding EUR 150 million in the previous financial year.
Group Two
EU-based companies with over 250 employees and a net worldwide turnover exceeding EUR 40 million would also fall under the CSDDD’s scope. However, this applies provided that at least 50% of their turnover was generated within high-impact sectors. ‘High-impact’ sectors, as defined by the Commission, include textile manufacturing, various agricultural activities, and mineral resource extraction.
Group Three
Non-EU companies generating a net turnover of over EUR 150 million within the EU in the previous financial year would be subject to the CSDDD.
Group Four
Non-EU companies generating a net turnover of over EUR 40 million within the EU would also be included, but only if at least 50% of their global turnover is derived from high-impact sectors. Small and medium-sized enterprises (SMEs) would not fall directly under this framework. However, they may be indirectly influenced if they function as contractors or subcontractors to any companies mentioned above.
As part of its commitment to facilitate the EU’s transition to a more climate-neutral and environmentally conscious economy, the CSDDD would mandate certain companies (precisely, those in groups one and three mentioned above) to align their business models and strategies with the goals of the Paris Agreement.
Moreover, companies identifying climate change as a principal risk or impact of their operations would be required to incorporate emission reduction objectives into their business plans. Regarding human rights due diligence, the CSDDD would align itself with established international standards, including the UN’s Guiding Principles on Business and Human Rights, the OECD Guidelines for Multinational Enterprises, and the OECD Due Diligence Guidance for Responsible Business Conduct.
Enforcement Mechanisms
The envisioned directive would be administered at the Member State level, and two significant enforcement mechanisms will be of particular interest to companies falling within its scope:
Directors’ Duty of Care
Under the envisioned directive, the responsibility for supervising due diligence requirements would fall on the directors of EU companies. Notably, the proposed climate change requirements would influence their variable remuneration. Member States would thus revise their laws and regulations governing directors’ responsibilities, augmenting their existing fiduciary duties with considerations of “human rights, climate change, and environmental consequences.”
This facet of the proposal shares similarities with certain aspects of the UK’s Senior Managers and Certification Regime (SM&CR). Companies operating in the UK are already familiar with the individual accountability requirements set forth under the CSDDD. The Prudential Regulation Authority’s (PRA) supervisory statement (PDF 880 KB) (SS3/19) established the expectation for firms to designate responsibility for recognizing and managing the financial risks stemming from climate change to relevant Senior Management Functions (SMFs).
The EU’s elaboration of directors’ duties is still under negotiation. Nonetheless, the EU strives to institute senior-level responsibility akin to the SM&CR, either through supervisory enforcement measures or soft supervisory powers.
Civil Liability
Companies would incur liability for damages should they fail to adhere to their obligations to prevent, halt, or mitigate any potential adverse impacts. This includes situations where a failure subsequently leads to avoidable negative implications. Sustainability-related litigation is a growing concern for numerous companies, and the CSDDD could compound this legal burden.
Obligations for Companies
Scope of Business Relationships
The initial proposal by the Commission outlined that the CSDDD would encompass entities within its scope, along with all established business relationships within their “value chains.” This includes business relationships in activities related to goods’ production or service provision, both upstream and downstream in the supply chain. However, the Council’s proposal sought to narrow this obligation, limiting it to business partners within the “chain of activities.” Again, both upstream and downstream activities are encompassed, but downstream is restricted to business partners conducting activities for or on behalf of the company.
Parliament’s Position
Interestingly, the Parliament appears to align more closely with the Commission’s proposal regarding extending obligations to business relationships of the in-scope entity. However, they introduce the caveat that these relationships need not be “established” and emphasize the coverage of all activities in the “value chain.” Nonetheless, special regulations for the value chain of regulated financial undertakings are suggested.
Due Diligence Requirements
The proposed CSDDD obliges companies to assess their operations thoroughly and those of their business partners in their supply chains, specifically to identify potential adverse impacts on human and environmental rights. This new directive mandates firms modernizing their policies, procedures, and systems. It also necessitates a comprehensive review and potential amendment of existing contracts with parties in the supply chain.
Contractual Provisions
Companies must draft new contractual provisions for inclusion in fresh contracts with suppliers and third parties. These provisions might encompass rights to request information to fulfill CSDDD disclosures, remedies in cases where information is not disclosed, and contractual guarantees of compliance with a specific code of conduct.
Directors’ Duties
The CSDDD might also impose a broader duty of care on directors, compelling them to act in the best interest of their companies. Directors could be required to integrate corporate strategy and oversee its implementation. Additionally, the directive might establish a potential link between directors’ remuneration and contributions to their company’s business strategy, long-term interests, and sustainability.
Size and Sector-specific Obligations
The new due diligence regulations will apply to companies with significant size and economic strength, especially those operating in high-impact sectors like textiles, agriculture, and mineral extraction. While SMEs are not directly subject to obligations in the proposal, accompanying measures will support SMEs that might be indirectly affected.
Costs and Transition
To align with these new regulations, companies may incur costs related to establishing and operating due diligence processes and procedures. Businesses might also face additional transition costs from necessary investments to adapt their operations and value chains to address potential adverse impacts.
Consequences of Noncompliance
Regulatory Penalties
Noncompliance with the EU CSDD entails significant consequences. A designated regulatory authority, as appointed by the EU Member States, possesses the power to levy sanctions against non-compliant companies. These sanctions can encompass fines and compliance orders.
Compensation for Damages
Individuals or entities adversely affected by noncompliance with CSDD obligations retain the right to seek compensation for damages. Companies that fail to adhere to the CSDD face a multi-faceted fallout. Primarily, they are susceptible to fines and legal actions that have the potential to tarnish their reputation, subsequently impacting their future business prospects.
Additional Reporting Obligations
Non-compliant companies may also be obligated to furnish additional reports, and in cases where proactive compliance with the CSDD could have forestalled damages, civil liability may come into play.
Impact of the EU CSDD on Non-EU Organizations
While the EU CSDD originates from the EU, its influence is poised to extend globally, affecting any organisation operating within the EU’s jurisdiction.
Criteria for Inclusion
As previously mentioned, non-EU countries are subject to the proposed EU due diligence directive if they satisfy specific criteria, including conducting a substantial volume of business in the EU or engaging in revenue-generating activities within designated high-risk sectors. Entities meeting these criteria must promptly adhere to EU due diligence regulations.
Additional Requirements
For instance, third-country organisations falling within the directive’s scope must appoint an authorised representative based within the EU. This authorised representative would serve as the contact point for the competent Member State authority. The authorised representative must be established or domiciled in the EU, in one of the Member States where the non-EU company in question operates.
Global Implications
Even if an organisation does not fall within the purview of the EU CSDD, mounting pressure to align operations and supply chains with ESG (Environmental, Social, and Governance) objectives is expected to foster similar legislative initiatives in various jurisdictions. Thus, proactively assessing and enhancing supply chain practices, alongside compliance with human rights and environmental standards, represents a prudent strategic move.
Benefits for Companies
Companies operating within the EU market stand to gain several significant advantages from the EU CSDD:
Standardised Rules
A set of consistent and transparent rules for corporate sustainability due diligence will be established across the EU for the first time. This eliminates the risk of legal fragmentation, harmonizing regulations, and promoting uniformity in compliance. Previously, EU countries had their own, often varying, laws addressing human and environmental rights violations in supply chains.
Meeting Consumer Expectations
As consumer consciousness about ethical and environmentally sustainable production grows, the CSDDD assists companies in meeting these expectations. It aligns their practices with consumer preferences, increasing the appeal of their products as they are perceived as ethically and environmentally responsible.
Investor Confidence
Investors increasingly seek companies with robust value chain standards and transparent operations. The CSDDD provides a framework for companies to demonstrate these qualities, enhancing investor confidence and potentially attracting more significant investment.
Enhanced Awareness
The directive mandates a comprehensive review of operations and supply chains. This heightened awareness enables companies to identify and address adverse impacts, fostering improved sustainability practices.
Resilience and Returns
The EU asserts that companies incorporating sustainability factors into their policies tend to generate higher returns and exhibit greater resilience during major disruptive events, such as the COVID-19 pandemic. The CSDDD encourages the integration of sustainability into corporate strategies, potentially enhancing both financial performance and stability.
Summing it Up
The EU Corporate Sustainability Due Diligence Directive (CSDDD) transcends the traditional concept of sustainability, embracing a holistic approach that encompasses environmental concerns and vital human rights considerations. The recognition of businesses as pivotal actors in ecological protection and broader societal welfare has attracted the attention of politicians, investors, consumers, and stakeholders alike. The CSDDD heralds a transformative era in corporate sustainability, prompting companies to navigate the intricate intersection of environmental stewardship and human rights protection.
Beyond obligations, it promises enhanced resilience, consumer appeal, and investor trust. As the world collectively moves towards a more sustainable future, embracing the principles embedded in the CSDDD is not merely a legal requirement but also a strategic imperative for companies aspiring to thrive in a changing landscape.