On 23 February 2022, the European Commission (the Commission) published a proposal for a Directive on Corporate Sustainability Due Diligence (CSDD or the Directive). This note summarises ten key issues enterprises active in the EU should know about the proposed Directive.
1) Aim of the proposal
The proposed CSDD serves a number of purposes. First, the CSDD should improve corporate governance practices to better integrate risk management and mitigation processes of human rights and environmental risks and impacts, including those risks that stem from value chains, into corporate strategies. Second, the CSDD is aimed at increasing corporate accountability for adverse impacts, and ensuring coherence for companies with regard to obligations under existing and proposed EU legislation as well as policies on responsible business conduct. Finally, the CSDD should improve access to remedies for persons affected by adverse human rights and environmental impacts of corporate behaviour.
Article 2 sets out the personal scope of the CSDD. In general, the Commission decided to exclude small and medium-sized enterprises for the purposes of the Directive. Instead, it proposes that the CSDD will be applicable to EU companies with more than 500 employees and a net worldwide turnover of more than EUR 150 million. In addition, EU companies with more than 250 employees and a net worldwide turnover of more than EUR 40 million will also fall within the scope of the Directive, if at least half of their net turnover was generated in a high-risk sector. The high-risk sectors are: the manufacturing of textiles, leather and related products; agriculture, forestry and fisheries; and the extraction and manufacturing of mineral products.
The scope of the CSDD extends to third-country companies that generate a net turnover of more than EUR 150 million in the EU. In addition, third-country companies that generate a net turnover of more than EUR 40 million in the EU, and of which at least half of their worldwide turnover is generated in one of the high-risk sectors, also fall within the proposed scope of the Directive. In-scope third-country companies must designate an authorised representative located within the EU.
3) Interaction with other pieces of legislation
The CSDD is an important component of the general EU policy on environmental, social and governance (ESG) issues. In particular, it interacts with the following EU initiatives and legislation:
- On 21 April 2021, the Commission published its proposal for the Corporate Sustainability Reporting Directive (CSRD). The CSRD amends the existing reporting requirements under the Non-Financial Reporting Directive (Directive 2014/95/EU) (NFRD) to introduce, among others, more detailed non-financial reporting requirements as well as a requirement to report according to mandatory EU sustainability reporting standards. The European Financial Reporting Advisory Group will develop these standards. The CSDD is closely interlinked with the CSRD, as the CSRD requires setting up processes that are closely related to identifying adverse impacts in accordance with the due diligence duty introduced by the CSDD (see point 5 below). The CSRD also covers the reporting phase of the CSDD due diligence duty for companies that are within scope of both pieces of legislation.
- For financial market participants, Article 4 of the Sustainable Finance Disclosures Regulation ((EU) 2019/2088) (SFDR) requires in-scope entities to publish a statement on their due diligence policies with respect to principal adverse impacts of their investment decisions on sustainability factors on a comply-or-explain basis. This requirement is, however, mandatory for financial market participants with more than 500 employees. The CSDD will apply to a larger group of companies, including all financial market participants that reach the thresholds under Article 2 (see point 2 above).
4) Due diligence obligations
Under Articles 4 and 5 of the CSDD, Member States must ensure that in-scope companies integrate due diligence into all their corporate policies and that they have a due diligence policy in place. The due diligence policy must contain a description of the company’s approach to due diligence as well as a code of conduct. The due diligence policy must also provide a description of the processes put in place to implement due diligence in the company’s processes, including the measures taken to verify compliance with the code of conduct and the extension of its application to established business relationships. The due diligence policy must be updated on an annual basis.
5) Adverse impacts
Companies will be required to identify actual and potential adverse human rights impacts as well as actual and potential adverse environmental impacts arising from their own business operations or the business operations of their subsidiaries (see Article 6). If related to their value chain, companies must also identify these impacts (potentially) arising from their established business relationships. Smaller companies that fall within the scope of the CSDD through their involvement of a high-risk sector (see point 2 above) need only to identify these actual or potential adverse impacts for that sector. In-scope regulated financial undertakings, when they provide credit, loans or other financial services, must identify actual or potential adverse human rights or environmental impacts before providing that service.
Article 7 of the CSDD also provides requirements for companies to take appropriate measures to prevent or mitigate identified potential adverse human rights or environmental impacts. Required actions described in the proposal include implementing a prevention action plan, seeking contractual assurances and making necessary investments. Under Article 8, identified actual adverse impacts must be brought to an end. If that is not possible, companies must minimise the extent of such an impact.
Under Article 9 of the CSDD, companies must have a complaints procedure in place that provides natural and legal persons with the possibility to submit complaints in the event of legitimate concerns regarding actual or potential adverse human rights or environmental impacts in connection with their own operations or value chains. Affected persons or persons that have reasonable grounds that they might be affected by an adverse impact could submit complaints. The complaints procedure must also be open to trade unions and other workers’ representatives representing individuals working in the value chain concerned and civil society organisations that are active in the areas related to the value chain concerned. If a complaint is well founded, the adverse impact that was the subject of the complaint is deemed to be identified, which means that it must be prevented, mitigated or brought to an end in line with Articles 7 and 8 of the CSDD.
7) Climate transition plans
The CSDD contains an obligation for EU companies with more than 500 employees and a net worldwide turnover of more than EUR 150 million and third-country companies with a net EU turnover of more than EUR 150 million to adopt a climate transition plan. The plan must ensure that the company’s business model and strategy are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5 ⁰C in line with the Paris Agreement. The plan must also identify, based on information reasonably available to the company, the extent to which climate change is a risk for, or an impact of the company’s operations. If climate change is, or should have been, identified as a principal risk for, or principal impact of, its operations, the company must also include emission reduction objectives in its plan.
The CSDD introduces due diligence requirements for which a reporting obligation exists under the CSRD. Companies that fall within the scope of the CSDD, but are not caught by the CSRD and NFRD are required to publish an annual statement on their websites describing their due diligence, potential and actual adverse impacts and actions taken on those. This report must be published by 30 April each year. The CSDD provides powers to the Commission to adopt delegated acts to provide details on the content and criteria for such reporting.
9) Supervision, sanctions and civil liability
Supervision will take place at Member State level. Each Member State must appoint one or more supervisory authorities to assess compliance with the obligations described in points 4 to 8 above. Financial undertaking supervisors can also be designated as the supervisory authority for the purposes of the CSDD. The supervisory authority will have investigatory powers and can impose pecuniary sanctions where the rules have been infringed. Pecuniary sanctions must be based on the sanctioned company’s turnover. The Directive does not lay down an upper limit to the pecuniary sanction, so Member States are free to set it themselves.
The CSDD also introduces civil liability for companies that fail to take appropriate measures to prevent or mitigate identified potential adverse human rights or environmental impacts, or that fail to end identified actual adverse impacts (see point 5 above). The company will in principle be liable for damages if the adverse impact occurred and led to damage.
10) Application and next steps
The publication of the Commission proposal is the start of the formal legislative process. The European Parliament and the Council will work on their respective positions on the file and adopt amendments to the Commission text over the coming months. We expect that the two co-legislators will adopt their formal positions by the end of 2022, after which the European Parliament, Council and Commission will engage in so-called trilogue negotiations to reach a common compromise. Following a trilogue compromise, the CSDD needs to be formally adopted by the co-legislators and published in the Official Journal of the EU (OJ). It will enter into force 20 days after publication in the OJ.
Following its entry into force, Member States have two years to transpose the Directive into their respective national legal systems. The Directive will start to apply two years after its entry into force for EU companies with more than 500 employees and a net worldwide turnover of more than EUR 150 million and third-country companies with a net EU turnover of more than EUR 150 million. For all other in-scope companies, the Directive will apply four years following its entry into force.