The European Commission, via its proposed Corporate Sustainability Due Diligence Directive (CSDDD), has put forward a legislative framework to oblige companies, to demonstrate what action they are taking to protect the environment and human rights. But what is the CSDDD, and how does it apply to your business?
Updated 2 June 2023: This article has been updated to reflect the latest developments with the CSDDD.
What is the CSDDD?
The CSDDD is an EU proposal which will require companies to exercise reasonable due diligence in their own business lines and in their “value chains” to prevent or minimise human rights or certain environmental risks and to end human rights or certain environmental violations.
Unlike current EU and member state legislation on human rights and sustainability due diligence, the CSDDD will have a bigger impact on non-EU companies that export goods to the EU or have connections with EU entities.
The first draft of the CSDDD was published in February 2022, and on Thursday, 1 June, lawmakers in the European Parliament voted in favour of new draft proposals for the regulation with a majority of 366-225. Later this month (June) negotiations with EU member states will begin.
Similar to the CSRD, member states must transpose the CSDDD into national law.
What does the CSDDD require?
The CSDDD defines several measures to be taken for a company to fulfil its due diligence obligations:
- Undertaking appropriate risk management by integrating due diligence into policies
- Carrying out risk analyses to identify actual or potential adverse impacts
- Preventing and mitigating potential adverse impacts and bringing actual adverse impacts to an end and/or minimising their extent
- Establishing and maintaining a complaints procedure
- Monitoring the effectiveness of their due diligence policy and measures
- Publicly communicating the due diligence undertaken
- Creating climate transition plans aligned with the goals of the Paris Agreement
- Companies with over 1,000 employees will need to link their performance on the climate transition plan targets to the variable compensation of directors
The CSDDD does not state specific requirements for climate transition plans, close monitoring of further legal developments in each member state will be necessary.
Who will CSDDD apply to?
The CSDDD will apply to companies based both inside and outside of the EU, based on the following rules.
EU companies can be categorised into two groups:
- Comprises companies with an average employee count of 500 or more and a net worldwide turnover exceeding EUR 150 million in the last financial year.
- Companies operating in high-risk sectors. These companies must have over 250 employees and a net worldwide turnover exceeding EUR 40 million in the last financial year, with at least 50% of this net turnover generated in one or more of the high-risk sectors.
For non-EU companies active within the EU, the rules are as follows:
- Companies with a net turnover in excess of EUR 150 million within the EU during the financial year preceding the last financial year.
- Companies with a net turnover exceeding EUR 40 million, but not exceeding EUR 150 million, within the EU during the financial year preceding the last financial year. Additionally, at least 50% of this net worldwide turnover should have been generated in one or more of the high-risk sectors.
- More than 500 employees on average and a net worldwide turnover of more than EUR 150 million in the last financial year for which annual financial statements have been prepared.
- More than 250 employees on average and a net worldwide turnover of more than EUR 40 million in the last financial year for which annual financial statements have been prepared, provided that at least 50% of the net turnover was generated in a high-risk sector.
The draft legislation contains a definition of “high-risk sectors” which includes textile manufacturers, certain food/agricultural businesses, and businesses relating to mining and the manufacture and sale of certain metals and mineral products.
Financial institutions may or may not be included in the final legislation. Negotiations with EU member states soon be underway (throughout June 2023), whilst the EU Parliament wants to include financial services, EU states want to give member states the choice to apply the law to the financial sector.
What should firms do?
The CSDDD may be subject to negotiations in a number of areas, but it is clear that the European Commission, Council, and Parliament all agree that corporate due diligence has an important role to play in sustainability.
Discussions with EU members are currently underway, so the final proposal may change slightly. The directive is unlikely to come into force until 2025 at the earliest, but given the political moves to make progress in this area, financial service firms may find it helpful to pre-empt any mandatory actions and consider how some of their existing practices could be improved to align with the overall trajectory of the CSDDD.
What happens if an applicable business does not comply?
Companies failing to comply with the new rules may face sanctions and supervisory measures, such as the removal of their goods from the market, imposition of fines up to 5% of their global revenues, or, for non-EU companies, bans on participating in EU public procurement, which the commission considers as ‘effective, proportionate, and dissuasive.’
When does the CSDDD come into force?
As of 1 June 2023, the draft proposal has been approved by the EU Parliament. Following the vote, negotiations with EU member states will begin. These negotiations will focus primarily on disagreements around the scope of the new rules and the timeline for their implementation.
Depending on the results of negotiations, it is quite possible that the due diligence obligations could begin to apply as early as 2025.
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