Sustainable and responsible corporate behaviour: unpacking the CSDDD

April 2023  |  FEATURE | BANKING & FINANCE

Financier Worldwide Magazine

April 2023 Issue

Corporates are under pressure from an array of stakeholders to improve their governance practices and frameworks. By adopting and promoting environmentally and socially responsible business practices, companies can take a long-term perspective that addresses adverse impacts on human rights, society, the environment and the climate.

A governance framework requires company directors and officers to properly integrate environmental, climate and social risks in their decision-making processes, as well as duly consider and address associated opportunities and impacts. These issues should form the basis for the organisation’s long-term strategy and business model, including financial and investment planning.

Improving sustainability – enter the CSDDD

The private sector will have a key role to play in achieving the goals set out by initiatives such as the European Green Deal, the UN’s Sustainable Development Goals and the Paris Climate Agreement, among others. To improve the sustainability credentials of companies throughout the European Union (EU), the European Commission (EC), in February 2022, adopted of a proposal for a directive on corporate sustainability due diligence.

The Committee on Legal Affairs (JURI) at the European parliament is set to publish amendments to the proposed Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937 (CSDDD), which will provide the basis for future negotiations between key stakeholders. Under the plan adopted by the EC, the CSDDD introduces an environmental and human rights due diligence duty for financial and non-financial companies within its scope.

The EU’s CSDDD is a broad-based reform that establishes a corporate due diligence duty for companies to identify, prevent, end or mitigate negative impacts of their operations on people and the environment. Its purpose is to “foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations” in companies’ activities and within their corporate governance structures. Its aim is to support the EU’s transition to a climate-neutral and green economy, as outlined in the European Green Deal and in alignment with the UN Sustainable Development Goals.

The directive aligns with the Human Rights Due Diligence (HRDD) process described in Pillar II of the UN Guiding Principles (UNGP) as well as Organisation for Economic Co-operation and Development (OECD) guidelines released in 2011 and 2018. Some European territories, such as France, the Netherlands, Germany and Norway, already have similar frameworks in place.

The European parliament and the EC will be asked to approve the plan. After the CSDDD is enacted, member states will have two years to incorporate it into their domestic legislation and provide the pertinent texts to the EC.

In tandem

One important aspect of the CSDDD is its ability to coexist and interact with other important pieces of legislation on ESG issues. Most notably, the CSDDD was introduced concurrently with the Corporate Sustainability Reporting Directive (CSRD), which will soon replace the Non-Financial Reporting Directive (NFRD). The CSRD establishes a network of reporting and disclosure requirements on a range of sustainability issues, from a company’s plan to ensure compliance with net-zero targets, to due diligence, to the role of the board and management in sustainability matters. The CSDDD aims to enhance the CSRD’s emphasis on disclosure obligations and associated accountability measures by demanding changes to national corporation laws.

The CSDDD and CSRD are designed to be applied in tandem by corporate entities. The CSRD serves as the major reporting vehicle by which companies will report their relevant sustainability activities, while the CSDDD outlines mandatory due diligence companies must implement regarding human rights and environmental impacts along their supply chains. The UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises are used as reference points by both directives.

Provisions and obligations

The CSDDD will apply to a company’s own operations, as well as its subsidiaries and supply chains, including direct and indirect business relationships. Companies in scope for the proposal include all EU limited liability companies with 500 or more employees and €150m or more in worldwide net turnover, and limited liability companies operating in defined high-impact sectors, including mining and extractives, agriculture and textiles, that have more than 250 employees and a net turnover of €40m or more worldwide.

The CSDDD proposes transition plan requirements for larger companies in scope, and would impose duties on directors of covered EU companies. The directive introduces duties for directors to set up and oversee the implementation of due diligence processes and integrate due diligence into official corporate strategy. As part of the duty to act in the best interest of the company, directors will now have to take into account the human rights, climate change and environmental impacts of business activities. The rules of directors’ duties will be enforced through existing member states’ laws on director obligations and violations thereof.

One of the most important features of the CSDDD is its corporate due diligence duty. The core elements of this duty are identifying, ending, preventing, mitigating and accounting for negative human rights and environmental impacts in a company’s operations, subsidiaries and value chain. In addition, certain large companies need to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5 degrees Celsius, in line with the Paris Agreement.

To comply with the CSDDD, companies must integrate due diligence into corporate policies, identify actual or potential adverse human rights and environmental impacts, prevent or mitigate potential impacts, bring to an end or minimise actual impacts, establish and maintain a complaints procedure, monitor the effectiveness of due diligence policies and measures, and publicly communicate on due diligence implementation.

Compliance with the CSDDD, when it does come into force, will require companies to adopt environmental and human rights due diligence into every entity in their organisation, and their supply chain, as well as showcase their actions to their stakeholders. This process will, of course, take time, but the CSDDD presents at the very least a starting point. It should also provide companies with additional insight into their value chain risks.

Penalties, liabilities and enforcement

When transposing the CSDDD into national law, EU member states must lay down the rules on penalties to be imposed when companies fail to meet their due diligence obligations. According to the directive, sanctions could include orders to cease certain actions, fines based on the company’s turnover, or interim measures. When deciding on sanctions, supervisory authorities must consider a company’s efforts to comply with any remedial action, any investments it has made, and its cooperation with other entities to address adverse impacts in value chains.

There are also civil liability implications. Under the CSDDD, member states will ensure that victims receive compensation for damage resulting from failure to comply with the obligations of the new proposals. The rules on directors’ duties are enforced through existing member states’ laws, as the directive does not include an additional enforcement regime in the event directors fail to meet their requirements.

The rules on corporate sustainability due diligence will be enforced through administrative supervision by member states’ designated authorities, which will be authorised to supervise and impose “effective, proportionate and dissuasive sanctions”, including fines and compliance orders. Regarding civil liability, member states will be tasked with ensuring victims are eligible for compensation for damages resulting from violations.

The rules on corporate sustainability due diligence will be enforced on both a national and EU level. Member states will designate one or more authorities to supervise and impose effective, proportionate and dissuasive sanctions, including fines and compliance orders, once the directive has been transposed into domestic law. The EC will publish a list of the competent authorities.

The various national supervisory authorities will have broad powers to verify compliance with the directive. They are also required to share with each other relevant information and provide mutual assistance in carrying out their supervisory work. At the EU level, the EC will establish a European network of supervisory authorities, which will be composed of representatives of national supervisory authorities and of the EC, to facilitate the cooperation of authorities and to coordinate investigations, sanctions and supervisory practices.

Benefits and drawbacks

According to the EC, the CSDDD offers significant benefits for citizens, companies and developing countries.

For citizens, the CSDDD is intended to provide better protection of human rights, including labour rights, a healthier environment for present and future generations, increased trust in businesses, greater transparency enabling informed choices, and better access to justice for victims.

For companies, the directive aims to provide a harmonised legal framework in the EU, creating legal certainty and a level playing field, greater customer trust and employee commitment, increased awareness of companies’ negative environmental and human rights impacts, better risk management and adaptability, increased attractiveness for talent, sustainability-oriented investors and public procurers, more attention on innovation, and better access to finance.

For developing countries, the directive offers better protection of human rights and the environment, increased stakeholder awareness of key sustainability issues, wider sustainable investment, improved sustainability-related practices, increased take-up of international standards, and improved living conditions for people.

While the CSDDD has been welcomed in many circles, there are, understandably, critics of its expected impact.

There are suggestions the CSDDD may lead to disengagement and asset partitioning, for example. When subsidiaries or third parties act improperly, it is not a given that the entities ultimately responsible for their actions under the CSDDD will engage and improve the conduct of these parties; instead, it may be easier and cheaper for companies to simply find other suppliers or divest their subsidiaries.

In addition, under the terms of the CSDDD, companies will have to bear the cost of establishing and deploying the required due diligence procedures, as well as transition costs which may include expenditures and investments toward changing a company’s operations and value chain to comply with the due diligence obligation, where needed. Furthermore, the CSDDD allocates the financial burden only to enterprises in scope. When two or more market players in the same value chain are all in scope of the directive, it is unclear which company should bear the financial consequences.

The directive may also have anti-competitive effects, as the costs of compliance may distort competition. Out-of-scope companies with only limited operations in the European market could be at a significant advantage in non-EU markets.

To address these issues, the EC could amend the CSDDD or utilise other methods, such as existing antitrust policies or taxation measures, to redistribute the financial burden placed on in-scope enterprises.

Effective tool?

Once it enters into force, the CSDDD could be an effective tool in helping companies within the EU to achieve societal good in the face of shifting stakeholder expectations and greater ESG demands.

As the CSDDD has not yet come into force, there is still time for companies to prepare for its arrival. Companies with a net turnover in the EU of at least €40m should identify whether they are within scope and what steps the business will need to undertake to ensure compliance. Though it may be premature to begin implementing compliance measures specifically in response to the CSDDD, companies should continue to develop or enhance policies, procedures and programmes to address adverse human rights and environmental impacts.

Businesses have a key role to play in creating a sustainable and fair economy, and the CSDDD aims to usher them toward this goal over the coming years.

© Financier Worldwide

BY

Richard Summerfield