Primer: Corporate Sustainability Due Diligence Directive
The EU’s proposed Corporate Sustainability Due Diligence Directive (CSDDD) aims to endorse greater corporate responsibility, improve sustainability due diligence standards, corporate governance of human rights and aid stakeholder’s rights to access remedies.
It will target current and potential adverse human rights and sustainability risks by setting out obligations for companies and their subsidiaries. Requirements could also affect any entities with whom the company has a corporate relationship.
Giorgio Botta, manager of sustainable finance at AFME (Association for Financial Markets in Europe) said: “We support the objectives of the CSDDD in enhancing due diligence practices, ensuring that companies put in place the processes and means to identify, prevent, and mitigate human rights abuses and environmental harm across their value chains.”
See also: Concerns continue to loom over SFDR
The precise details have not yet been ironed out, because the proposed law is still in the EU’s legislative process. So far, there have been some important differences of position between the Commission, Council, and Parliament.
However, the Parliament is due to adopt its final position in May 2023 and it is expected that a final text will be agreed between the three institutions later in 2023.
What’s different about the CSDDD?
As opposed to current EU and member state legislation regarding human rights and sustainability due diligence, the CSDDD provides a comprehensive set of personal requirements with a broader scope. As a result, it will have a greater influence on non-EU firms exporting goods throughout the EU or those linked to those within the EU.
“Typically, ESG-related obligations have targeted reporting but CSDDD is different because it goes beyond what companies say about their ESG performance in their reporting, to what they actually do about ESG in their everyday business operations,” said Nic Lockhart, an international trade lawyer at Sidley Austin.
What is the significance for financial service providers?
On January 24, the ECON Committee voted to widen the scope of the draft directive, deviating from the original plans of the European Commission and the Council of the European Union.
The committees have since decided the CSDDD will include:
● Financial services sector and smaller companies; and
● The financial services sector will not be assigned “high risk” status, meaning those within the sector will not be required to report on their sustainability engagement policies.
“The ECON Committee’s vote marked an important step for the file as it included a call to expand mandatory due diligence also to the financial sector,” said Frederik Hafen, environmental democracy policy officer at the European Environmental Bureau. “The vote is a strong indicator that the Parliament is moving to improve upon the Commission’s proposal and the disappointingly weak Council position.”
However, the consequences of the vote could also pose serious challenges for financial institutions.
See also: Swiss ESG regulation for funds
What are the due diligence challenges for financial firms?
Some sources believe that the proposed scope of the value chain for financial institutions’ due diligence requirements does not consider:
● the nature of the financial services provided by banks;
● the exorbitant number of counterparties which would be captured, nor;
● the tools that banks have to influence their clients’ behavior.
“The downstream value chain of financial institutions can be made up of many thousands of companies and counterparts, operating across different sectors and jurisdictions, as recipients of a broad range of products and services where the indirect links with companies’ impacts on the environment and human rights are more or less relevant,” said Botta.
Under the CSDDD, due diligence provisions will encompass:
● Recipients of any kind of financial service, including custody and clearing;
● Essential services; and
● Trading and derivatives activities.
According to Botta the consequences of such may result in financial institutions’ inability to establish the necessary, ongoing, direct business relationship and exchange of information with the recipients of such services – and therefore cannot effectively influence their behavior.
However, the Council has also proposed to soften the impact for financial services providers – they wouldn’t need to terminate an existing relationship if a client’s ESG performance is not up to standard. The Parliament, though, does not seem to be heading in the same direction.
Alternatively, Florian Drinhausen, partner at Ashurst, believes that the CSDDD will be more impactful for non-financial institutions than for financial institutions.
“Financial services are already subject to extensive governance requirements and regulatory expectations. Given the level of sophistication on the governance systems, policy systems and due diligence requirements and financial institutions, I would expect that they will cope very well, in theory, with additional requirements,” he said.
Dipika Keen, head of knowledge for the business transactions group at Osborne Clarke said: “If the finance sector was included, this would go a long way towards achieving the aims of the directive to foster sustainable and responsible corporate behavior throughout global value chains by requiring them to identify and, where necessary, prevent, end or mitigate adverse impacts of their activities on human rights and on the environment.”
Currently, the Council is in agreement with the Commission not to impose due diligence obligations on investors as a result of the entities they invest in.
Having said that, early signs suggest that the EU Parliament will push for a more expansive approach, said Sidley Austin’s Lockhart. “In any event, investors will need to be aware that companies in which they invest in may soon carry significant legal risks vis-à-vis their own supply chains (even if the obligations do not attach to the investors themselves),” he continued .
What’s the scope of the obligations?
Under article 2, the CSDD will apply to both EU and non-EU companies based on their revenue and number of employers.
“The Council is pushing for higher thresholds that would limit the scope of the law, but Parliament seems to be heading in the opposite direction, with lower thresholds that would expand coverage,” said Lockhart.
Companies subject to the directive will be expected to: identify, prevent, end, mitigate, and account for potential adverse impacts on human rights and the environment – such as forced labor, inadequate workplace health and safety, greenhouse gas emissions, biodiversity loss, and waste disposal.
Article 4 of the directive instructs companies to carry out human rights and sustainability due diligence by conducting the following:
● integrate due diligence into their company policies and have in place a due diligence policy;
● identify actual or potential adverse human rights and environmental impacts;
● prevent or mitigate potential impacts;
● bring to an end or minimize actual impacts;
● establish and maintain a complaints procedure;
● monitor the effectiveness of the due diligence policy and measures; and
● publicly communicate what they are doing on due diligence.
Some sources believe that unlike many existing directives, the CSDDD is more robust in tackling all aspects of ESG.
“ESG is wider than climate,” said Drinhausen. “There are a lot of issues that the EU has sidelined at the moment because climate is such a dominant topic. However, other ESG components will also become more important in the long term as opposed to now where most regulations concentrate on carbon neutral policies.”
Alternatively, Frederik Hafen noted: “The proposed article 15 on combating climate change is too weak and incoherent with the definition of environmental adverse impacts (article 3).”
“The CSDD directive must not leave any legal ambiguity concerning environmental and climate change due diligence and must make it clear that failures to implement climate change obligations result in civil liability. This goes hand in hand with the need for effective procedures of redress for victims and the reversal of the burden of proof. Due diligence is needed now more than ever and is part of the solution to a sustainable economy that works for people – not against us,” he continued.
The regime is also significant because company directors could see their pay based on ESG performance, and they could face civil liability for a failure to meet the obligations.
In any case, despite controversies, the EU continues to be at the global forefront of ESG regulation and sustainability disclosures.
“The current UK government has already stated that it will not be bringing in something similar to CSDDD,” said Osborne Clarke’s Keen. “In Asia, while there are some requirements for ESG/sustainability disclosures and these are being strengthened, they are not as far reaching/all-encompassing as the CSDDD. There are piecemeal laws in the US. However, it lacks a broader federal supply chain due diligence law.”