UPDATES ON ESG FACTORS: CORPORATE SUSTAINABILITY DUE DILIGENCE DIRECTIVE (CS3D) NOW ADOPTED

May 29, 2024

BLOG

The CSDDD requiring human rights and environmental due diligence has been adopted in the European Parliament.

On April 24^th, the European Parliament approved the Corporate Sustainability Due Diligence Directive (CS3D or CSDDD), which will require companies operating in the EU to monitor their supply chains for the risk of human and/or environmental rights violations. The new rules will also deal with remediation of any such violations, require reporting on the due diligence findings and mandate Paris-aligned transition plans (but do not require them to be linked to remuneration).

Officially known as the Corporate Sustainability Due Diligence Directive, the groundbreaking legislation will mandate that a significant portion of European companies accept responsibility for social and environmental concerns throughout their entire supply chain. Back in 2020, all 27 member states of the EU agreed to create such regulation.

Many European businesses, which are on the front lines of implementing the CCSDDD, had already started preparing for the regulations.

To comply with the rules, companies must exercise human rights and environmental due diligence in relation to their own operations, those of their subsidiaries, and their direct and indirect business partners throughout their chains of activities. This applies regardless of whether impacts occur within or outside the European Union. However, product disposal and indirect downstream business partners have been removed from the scope of application.

The CSDDD is part of a wider EU Green Deal, including other emerging ESG-related regulations, including the Corporate Sustainability Reporting Directive (CSRD), the EU Deforestation Regulation (EUDR), and the EU Taxonomy Regulation, aimed at promoting responsible business practices for companies operating in the EU.

Scope

Companies in scope are large companies with over 1 000 employees and an annual turnover of over 450 EUR million.

Financial sector

The financial sector will only have to apply the CSDDD in relation to their own operations and upstream supply chains. Firms in the financial sector will also have to adopt a plan ensuring their business model complies with the Paris Agreement.

Adaptation scheme

The CSDDD includes an adaption scheme for in-scope companies (which applies from the moment the CSDDD entries into force), which is as follows:

Companies with more than 5000 employees and 1500 million turnover in the previous two consecutive financial years will have 3 years to comply with the CSDDD;
Companies with more than 3000 employees and 900 million turnover in the previous two consecutive financial years will have 4 years to comply with the CSDDD; and
Companies with more than 1000 employees and 450 million turnover in the previous two consecutive financial years will have 5 years to comply with the CSDDD.

Further, also falling under the Directive’s purview are:

Non-EU companies operating within the EU and meeting the turnover threshold of EUR 450 million (generated within the EU); and
Companies that have a franchising or licensing agreement with a third-party company in the EU in return for royalties exceeding EUR 22,5 million, provided their worldwide net turnover also exceeds EUR 80 million.

The due diligence obligations set out under the CS3D follow the six steps as defined by the OECD Due Diligence Guidelines for Responsible Business Conduct:

Integrating due diligence into policies and management systems
Identifying and addressing adverse human rights and environmental impacts
Preventing, ceasing or minimizing actual and potential adverse human rights impacts
Monitoring and assessing the effectiveness of measures
Communicating
Providing remediation

Indirectly, smaller companies operating in the value chains of covered companies across the globe will be affected as a result of contractual requirements imposed on them by covered companies (so called “trickle-down effect”).

Other noteworthy amendments include:

Downstream: A revised definition of downstream chain activities omits the inclusion of “indirect business relations,” now referencing solely “business partners which perform business operations related to the operations, products or services of the company.”
High-risk sectors: The compromise text does not lower the general thresholds for companies in high-risk sectors (e.g., textiles, agriculture, extraction of minerals), but notes that these sectors could be incorporated at a later stage.
Climate transition plans: The requirement for certain large enterprises to formulate and implement a climate transition plan aligned with the Paris Agreement has been rescinded and is deemed to be fulfilled under the reporting for Corporate Sustainability Reporting Directive.

What human rights and environmental impacts are covered?

For due diligence, the CSDDD aligns with the main international human rights and environmental law standards. However, it only covers those rights and prohibitions specifically listed in the Annex to the proposal as well as any human rights risks that are foreseeable. The list includes a range of labour rights, the prohibition of interference with freedom of thought, conscience and religion, and the right to freedom of association, assembly, the rights to organise and collective bargaining. Although freedom of expression is not explicitly listed, it would presumably still fall within the scope of due diligence of any media organization given its operational context.

The list also includes certain violations of international environmental law concerning, for instance, the handling, collection, storage and disposal of waste, or the use of biological resources that could have adverse impacts on biodiversity. Companies with more than 500 employees and at least EUR 150m turnover will also have to ensure that their business model and strategy are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5 °C in line with the Paris Agreement. Companies that have or should have identified climate as a principal risk for or a principal impact of their operations, should include emissions reduction objectives in their plan.

Note that the CSDDD does not cover the entire range of sustainability or ESG (Environmental Social Governance) standards. The latter include, for instance, considerations of diversity and inclusion or anti-corruption, but would not be covered by the CSDDD.

How will the new rules be enforced?

The CSDDD will be enforced at Member State-level. The Commission proposes three enforcement mechanisms: administrative supervision and sanctions, civil liability, and financial incentives.

Administrative supervision and sanctions: Member States would designate an authority to supervise and impose administrative sanctions, including fines and compliance orders. At the European level, the Commission will set up a European Network of Supervisory Authorities that will bring together representatives of the national authorities to ensure a coordinated approach. Natural and legal persons would be entitled to submit “substantiated concerns” to any supervisory authority alleging that a company is failing to comply.

Civil liability: Member States will ensure that victims have access to compensation for damages resulting from the companies’ failure to comply with their due diligence obligations.

Financial incentives: Implementation of the emission reduction plans will be embedded in the financial incentives of directors of EU companies by linking their variable remuneration to their contribution to fulfilling these plans.

Part of the CSDDD would be enforced through existing Member States’ laws. For instance, the CSDDD does not foresee an additional enforcement regime in case directors do not comply with their obligations under this directive. However, Member States would have to amend their laws and regulations on directors’ duties, adding consideration of human rights, climate change and environmental consequences to their existing fiduciary duties. This will have various implications under domestic company law. For instance, shareholders may be able to sue directors who violate this fiduciary duty. The CSDDD may even add to the risk of sustainability-related strategic litigation, which has become a growing concern for companies.

Next steps

The directive now also needs to be formally endorsed by the Council, signed and published in the EU Official Journal. It will enter into force twenty days later. Member states will have two years to transpose the new rules into their national laws.

The new rules (except for the communication obligations) will apply gradually to EU companies (and non-EU companies reaching the same turnover thresholds in the EU):

From 2027 to companies with over 5000 employees and worldwide turnover higher than 1500 million euro;
From 2028 to firms with over 3000 employees and a 900 million euro worldwide turnover;
From 2029 to all the remaining companies within the scope of the directive (including those over 1000 employees and worldwide turnover higher than 450 million euro).