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Corporate Sustainability Due Diligence Directive

Introduction

This briefing was prepared in November 2023. This regulation is subject to change.
The Corporate Sustainability Due Diligence Directive (CSDDD) is a European Union directive that mandates companies to conduct and report on due diligence regarding human rights and environmental impacts within their operations and supply chains (and / or ‘value chains’, subject to negotiation).

Objectives

  • Promote Sustainable Business Practices: Encourage companies to consider the environmental and social impacts of their operations and supply chains.
  • Accountability: Hold companies accountable for the impact of their activities on human rights and the environment.
  • Management of impacts: Ensure that businesses identify, prevent, mitigate, and account for potential and actual adverse impacts.

Scope

  • Applicable Entities: Targets large companies operating in the EU, including some non-EU companies with significant activity in the EU market. The exact size and turnover thresholds are part of the ongoing negotiations.
  • Sector Focus: While broad in scope, certain industries with higher risks of sustainability issues may be under more scrutiny.

Key Requirements

  • Due Diligence Obligations: Companies must establish and execute effective due diligence strategies and processes.
  • Preventing and Mitigating Risks: Actively working to avoid and lessen negative impacts.
  • Accountability: Regularly reporting on due diligence actions and their effectiveness.
  • Corporate Governance: Incorporating sustainability into corporate strategies and management structures.
  • Stakeholder Engagement: Involving relevant stakeholders, particularly affected communities, in the due diligence process.

Impact

  • Supply (and / or Value) Chain Transparency: As well as increased transparency in supply chains (much of which is covered by CSRD), requiring companies to be aware of (and disclose) their direct and indirect impacts, and take actions to prevent, mitigate and account for both actual and potential impacts.
  • Human Rights Protection: A focus on preventing human rights violations within business operations and supply chains.
  • Environmental Responsibility: Encouraging companies to consider and minimize their environmental footprint.

Challenges

Challenges and Controversies

  • Implementation: The practical application and enforcement of these rules can be challenging, especially in diverse and complex global supply chains.
  • Costs: Some businesses express concerns about increased costs and administrative burdens.

UN Guiding Principles

  • The CSDDD represents a significant step towards legally operationalising the principles outlined in the United Nations Guiding Principles on Business and Human Rights (UNGPs) and the OECD Guidelines for Multinational Enterprises (MNE Guidelines).
  • While the UNGPs and the OECD MNE Guidelines offer non-binding global standards for responsible business conduct, particularly in human rights and environmental stewardship, the CSDDD aims to translate these principles into enforceable legal obligations within the EU.
The United Nations Guiding Principles on Business and Human Rights (UNGPs) establish a framework for preventing and addressing human rights abuses linked to business activities, centred around three pillars: the state’s duty to protect human rights, the corporate responsibility to respect human rights, and the need for greater access to remedy for victims.

What Constitutes Effective Due Dilingence

In short, companies should:

1. Adopt a policy, 2. Identify impacts, 3. Prevent and mitigate direct and indirect impacts, actual and potential, 4. Remedy, 5. Report, and repeat.

Some of the processes involved may include:

  1. Governance and Policy Integration
  • Corporate Policy: Companies must adopt a policy statement outlining their commitment to respect human rights and the environment.
  • Integration into Corporate Governance: The due diligence process and findings must be integrated into the company’s governance and risk management.
  2. Identification of Actual and Potential Impacts
  • Scope: Companies are expected to identify actual and potential impacts on human rights and the environment in their own operations, their subsidiaries, and their value chain (which includes both suppliers and customers).
  • Continuous Process: The identification process should be continuous, acknowledging that risks can evolve over time.
  3. Preventing and Mitigating Impacts
  • Action Plans: Companies must develop and implement action plans to prevent or mitigate identified risks.
  • Integration into Business Decisions: The findings from the due diligence assessment should inform business decisions, including in their relationships with business partners.
  4. Remediation of Adverse Impacts
  • Consultation with Affected Groups: Companies should engage with potentially affected groups, local communities, and relevant stakeholders to understand the impacts of their activities.
  • Feedback Mechanisms: Establishing and maintaining a dialogue with stakeholders is key, including mechanisms for complaints or feedback regarding the company’s operations.
  • Addressing Harm: If a company identifies that it has caused or contributed to adverse impacts, it must provide for or cooperate in the remediation through legitimate processes.
5. Public Reporting
  • Transparency: Companies are required to publicly report on their due diligence processes, including the actions taken and the effectiveness of these measures.
  • Accessibility: This information should be accessible to the general public, ensuring transparency and accountability.
  • Ongoing Monitoring: Companies must regularly monitor the effectiveness of their due diligence measures and action plans.
  • Adaptation and Improvement: Based on this monitoring, companies should adapt and improve their strategies and actions over time.

Including The Finanicial Sector

This is the one of the most controversial parts of the Directive.

Arguments for Including the Financial Sector

  • Amplified Impact: The financial sector has a substantial influence on the economy and can significantly impact social and environmental outcomes through its investment and lending decisions.

  • Consistency Across and Within Sectors: Including the financial sector would ensure a level playing field and consistency in sustainability expectations across different industries (due diligence is already referred to in SFDR, AIFMD, and UCITS).

  • Risk Management: Embedding due diligence processes in the financial sector can lead to better risk management, which can have significant financial implications.

  • Promoting Sustainable Investment: The inclusion could accelerate the shift towards sustainable investments, as financial institutions would need to consider the social and environmental impact of their portfolios.

  • Global Leadership: The EU’s inclusion of the financial sector could set a precedent, encouraging other regions to follow suit, leading to a more comprehensive global approach to sustainability.

Arguments Against Including the Financial Sector

  • Complexity of Assessing Impact: Measuring and managing the indirect impact of financial institutions (through their investments and lending) is complex and may be challenging to implement effectively.

  • Overlap with Existing Regulations: The financial sector is already subject to numerous regulations, including those related to sustainability and ESG factors. Additional regulations may lead to overlap (although the trialogue negotiations are taking steps to address this).

  • Potential for Reduced Investment:  There’s a concern that stringent due diligence requirements might lead to financial institutions becoming risk- averse, potentially reducing investment in developing countries or in sectors deemed to be high-risk.

  • Cost and Resource Implications: Implementing comprehensive due diligence processes can be resource- intensive and costly.

  • Effectiveness of Influence: There’s a debate over how much influence financial institutions can realistically exert over the operations of the entities they invest in or lend to, especially in the case of minority stakes.

Positioning

The PRI has consistently advocated for the inclusion of the financial sector in the CSDDD, arguing that it is essential to ensure that the directive is effective in promoting responsible investment practices.

In its most recent position paper on the CSDDD, published in March 2023, the PRI stated that “while significant improvements are needed”, CSDDD “offers an important opportunity to create a harmonised framework to ensure that economic activities tied to the EU single market are conducted in a responsible manner.”

The PRI made a number of recommendations, including:

  • Support ECON amendment that divestment must be considered as a last resort.

  • Focus on harmonisation across the EU sustainable finance framework in the upcoming revision of SRD II and potential review of the SFDR.

  • Introduce level 3 legislation which clarifies what an “acceptable level” of due diligence is for different investor types, asset classes and strategies.

A range of groups have argued against the financial sector’s inclusion.

The IIGCC advocates for a tailored approach for investor due diligence within the CSDDD framework. While they support the overall goals of the CSDDD and encourage ambitious action on climate change, they believe the specific requirements for the financial sector should be adapted to reflect the unique nature of their activities and existing regulations.

Their position paper from February 2023 highlights several key points:

  • Financial due diligence inherently differs from corporate due diligence: The nature of financial services and their impact on sustainability require a different approach compared to companies directly involved in production and operations.

  • Avoiding duplication and complexity: The CSDDD should be designed to avoid overlapping with existing regulations and create unnecessary burdens for the financial sector.

In its response, BlackRock said, “we do believe a distinction needs to be made between the financial sector approach (especially as it relates to asset management) and all other sectors covered by the proposed Directive”.

 

CSDDD, CSRD, SFDR AND Taxonomy

CSDDD is focused on due diligence  relating to human rights and  environmental impacts within a  company’s value chain.

Scope of Reporting:

  • CSDDD requires specific information on how due diligence is conducted, stakeholder engagement, and grievance mechanisms.

  • CSRD covers a wider range of sustainability topics and is more comprehensive in terms of the overall sustainability performance of the company.

Corporate Sustainability Reporting  Directive (CSRD)

  • Function: Expands the sustainability reporting requirements for companies, focusing on environmental and social impacts.

EU Taxonomy

  • Function: A classification system that defines environmentally sustainable economic activities.

Sustainable Finance Disclosure  Regulation (SFDR)

  • Function: Requires financial market participants to disclose how they integrate sustainability risks and impacts in their investment decisions.

Linkages from SFDR to:

  • CSDDD: Information from companies about their due diligence practices (CSDDD) can inform SFDR disclosures.

  • CSRD: Relies on corporate sustainability data reported under CSRD for accurate investment disclosures.

Linkages from EU Taxonomy to:

  • CSRD: Companies must report on how their activities align with the Taxonomy, as part of their sustainability reporting under CSRD.

  • CSDDD: Indirect link.

Next Steps

The next trialogue (negotiation between the European Council, Parliament and Commission) is scheduled for 22 November.

Some commentators expect the financial sector to be excluded  subject to a review clause.

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