CSDD: A Game-Changer for Responsible Business Practices (2/4)

Published on 03/07/2023

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Over the past few decades, there has been increasing recognition of the role that businesses play in shaping social and environmental outcomes, and the need for them to operate in a way that is sustainable and responsible. As the second article of the series focusing on the EU sustainable regulatory ecosystem, we will cover the Corporate Sustainable Due Diligence (CSDD) directive (also known as CS3D). The CSDD directive, which is still at the proposal phase, will be key in the EU strategic plan, the green deal. We will see how this directive differs from, and complement the CSRD (refresh your mind on the CSRD here).

The objectives of the CSDD

The CSDD directive aims to establish a framework for companies to identify, prevent, mitigate and account for the adverse impacts of their operations and business relationships on human rights, the environment and good governance. Its main objectives are:

Promoting sustainable corporate governance, with a common approach across the EU
Protecting human rights, by requiring companies to detect and prevent human rights abuses in their operations and value chains.
Protecting the environment, by identifying and preventing environmental harms caused by their operations and value chains.
Enhancing transparency and accountability, by requiring companies to report on their sustainability performance, including their sustainability due diligence processes and the measures they have taken to address sustainability risks and impacts.

These objectives are leading to positive impacts, benefiting to the citizens, companies, and investors from the EU, but also in all (developing) countries that are part of an EU company’s value chain. These two directives are meant to be applied in tandem.

Context

There has been an emergence of sustainability reporting frameworks & standards and certification schemes, with in parallel, increasing expectations from stakeholders for companies to demonstrate their commitment to sustainability. However, voluntary initiatives alone will not be able to address the scale of the sustainability challenges. There is a need for stronger regulation to ensure that companies are held accountable and to create a level playing field for responsible business practices.

Scheme of the EU sustainable ecosystem for companies:

EU’s directives, regulations and plans related to the CSDD:

The Corporate Sustainability Reporting Directive (CSRD) that builds on the Non-Financial Reporting Directive (NFRD): requires companies to disclose Non-Financial information on Environmental, Social, and Governance (ESG) topics.
EU taxonomy (Article 3/4): EU’s complete definition and categorization of sustainable activities
EU green Deal (Article 4/4) : EU’s strategic plan to make the EU’s economy sustainable and carbon-neutral by 2050

Sustainable finance directives complemented by the CSDD directive:

Shareholder Rights Directive II (SRD II): institutional investors and asset managers have to disclose their policies on engagement with investee companies on ESG matters
Sustainable Finance Disclosure Regulation (SFDR): it requires financial market participants and advisors to disclose information on how ESG factors are integrated into their investment decision-making processes.

The CSDD directive plays an important role in the EU sustainability landscape by requiring companies to identify, prevent, and mitigate their ESG risks and impacts as part of their due diligence processes.

To whom applies the CSDD directive

The directive applies to all large companies operating in the EU, as well as to certain non-EU companies that provide goods or services to the EU market.

The Directive also applies to certain public sector entities, including state-owned enterprises that meet the same size criteria.

For the group 2, the rules will start to apply two years later than for group 1. It is worth noting that the Directive is currently being negotiated by the EU institutions and is not yet final. Once adopted, EU member states will have two years to transpose the Directive into their national laws.

The requirements and impacts rising from the CSDD directive

The corporate due diligence duty

The core of the directive is to push companies to proactively identify, bring to an end, prevent, mitigate and account for negative human rights and environmental impacts in the company’s own operations, its subsidiaries and its value chains. In addition, group1 (cf. previous section) companies will have to provide a plan to ensure that their business strategy is compatible with limiting global warming to 1.5°C in line with the Paris Agreement.

Stakeholders’ dialogues

The CSDD directive will also require companies to engage with stakeholders, including workers, local communities, and civil society organizations, as part of their due diligence process. This intends to ensure that companies are taking into account the perspectives of those who may be affected by their operations and value chains and to facilitate dialogue and collaboration with stakeholders.

Duties for the directors

The CSDD directive introduces the duties for the directors, that will be considered as accountable for setting up overseeing the implementation of the due diligence processes and integrating it into the corporate strategy.

Administrative supervision & civil liability

To supervise the correct application of the directive, each of the EU member states will designate an authority. This entity will be entitled to supervise and impose effective, proportionate and dissuasive sanctions, including fines and compliance orders. A European Network of Supervisory Authorities will be created at the European level to ensure a coordinated approach across the states.

Member states will have to ensure that victims get compensation for damages resulting from the failure to comply with the obligations of the proposed directive.

Criticism

While the Corporate Sustainable Due Diligence (CSD) directive has been widely welcomed as a step towards promoting corporate sustainability, it has also faced some criticism from various stakeholders.

Lack of clarity and guidance on how companies should carry out due diligence and what standards they should follow. This could lead to inconsistency and confusion among companies, and make it difficult for them to comply with the directive.
Burden on SMEs, with disproportionate obligations for SMEs, which may not have the resources or expertise to carry out comprehensive due diligence. This could lead to increased costs and administrative burden for SMEs, which could hinder their ability to compete with larger companies.
Limited scope, as it only covers human rights, environmental, and governance impacts. Some have called for the directive to be expanded to include other sustainability issues, such as social impacts and climate change
Lack of enforcement mechanisms in the CSD directive. People argue that without strong enforcement measures, companies may not take the due diligence process seriously and may fail to disclose relevant information.
Risk of greenwashing, where companies present a false impression of their sustainability performance to stakeholders. This could happen if companies prioritize meeting the requirements of the directive over actually addressing sustainability risks and impacts.

Next steps

The commission published the proposal for the CSDD directive in February 2022. It is now awaiting approval from the European Parliament and Council. Once approved by both institutions, member states will have two years to transpose the directive into national laws.

Given the timeline and its deep links with the CSRD, the CSDD directive should come around 2025-2026; however, this cannot be confirmed before the proposal is adopted.

Conclusion

Now that the EU launches a series of CSR frameworks, official definitions & considerations, and regulations, it is becoming clear the companies will have to comply with environmental and human rights due diligence obligations sooner rather than later.

While the CSDD directive has been welcomed as a positive step towards promoting corporate sustainability, it is important to address the criticisms and ensure that the directive is implemented effectively and fairly. By embracing the opportunities presented by the directive, companies can demonstrate their commitment to sustainability, build trust with stakeholders, and help to create a more sustainable and equitable society. This will require ongoing dialogue and collaboration between stakeholders, as well as ongoing monitoring and evaluation of the directive’s impact.

Headmind Partners can help companies in planning, structuring, and formalizing their CSR strategies and the implementation of such strategies. We provide support in the CO2e emissions calculations, risk assessment & management, stakeholders’ dialogues and all necessary steps required for an adequate sustainable reporting.