Editorial by Trustnet.Trade
The European Union (EU) has been working for years on the Corporate Sustainability Due Diligence Directive (CSDDD), and after extensive negotiations and compromises, a final version of the agreement was reached on 15th March 2024. This comprehensive directive aims to ensure that companies operating within the EU adhere to strict sustainability standards, taking appropriate measures to identify, prevent, mitigate adverse impacts, and address environmental, social, and governance (ESG) issues throughout their supply chains.
Timeline and Transposition
The CSDDD negotiations concluded in December 2023, but the adoption process faced several hiccups due to concerns raised by various Member States. The European Parliament voted on 24 April 2024, to pass the CSDDD. This means the CSDDD has completed all the stages needed for approval within the EU. EU member countries now have two years to turn this directive into their own national laws.
Under these rules, companies must check if they are respecting human rights and the environment in their own operations, those of their subsidiaries, and with their business partners, both direct and indirect. This applies to their entire supply chain activities, whether the impacts happen inside or outside the EU.
Scope of Application
One of the most significant changes in the final CSDDD agreement is the narrowed scope. The directive will now only apply to the largest companies in Europe - those with more than 1,000 (previously 500) employees and 450 (previously 150) million Euros in turnover. This is a significant reduction from the initial proposal, which would have covered around 16,000 companies in the EU.
The agreement also includes a cascading timeline, with the largest companies (over 5,000 employees and 1.5 billion Euros in turnover) being covered first, followed by medium-sized companies over the next few years. The full scope will be applied five years after entry into force.
The directive covers approximately 5,300 companies within the EU. Parent companies are covered if they reach the thresholds on a consolidated level, and there are specific exceptions for franchising models. Non-EU companies are also in scope if they generate at least 450 million Euros in revenue within the EU. There is no employee threshold for non-EU companies.
Smaller companies worldwide, working within the networks of larger covered companies, will feel the impact of contractual rules set by these bigger companies. This is often known as the "trickle-down effect."
The agreement outlines how the CSDDD will be gradually put into action for EU companies or groups. For companies outside the EU, similar revenue benchmarks apply, but there are no employee requirements:
- Companies with over 5,000 employees and revenue of 1.5 billion Euros must comply within three years.
- Companies with over 3,000 employees and revenue of 900 million Euros must comply within four years.
- Companies with over 1,000 employees and revenue of 450 million Euros must comply within five years.
This will also affect companies that have franchising or licensing deals in the EU. These companies need to have a common corporate identity and a global turnover of over 80 million Euros, with at least 22.5 million Euros coming from royalties. Non-EU companies, as well as parent companies and those with franchising or licensing deals in the EU meeting the same turnover requirements, will also need to follow these rules. They will have to include due diligence in their policies, invest accordingly, seek contractual assurances from their partners, improve their business plans, or support their small and medium-sized business partners meet the new obligations.
Businesses need to stay vigilant and keep an eye on the legislative process as there might be more changes coming up. Especially for businesses with over 5,000 employees and revenue of 1.5 billion Euros, the timeline is tighter, demanding immediate attention.
Requirement by CSDDD
- Conduct a scoping exercise: Companies must identify where adverse impacts are likely or severe and focus their due diligence efforts on those suppliers.
- Assess risks: Companies must conduct in-depth risk assessments on high-risk suppliers and parts of the supply chain related to their production or service provision.
- Implement due diligence obligations: Companies must take appropriate measures to prevent, mitigate, and account for adverse impacts in their operations, supply chains, and business relationships.
Civil Liability and Sanctions
The final agreement also addressed the controversial issue of civil liability. Companies can now only be held liable if they directly caused the damage themselves, limiting liability compared to earlier proposals. However, the agreement also includes new "access to justice" measures, such as a five-year limitation period and the ability for victims to mandate NGOs or trade unions to bring cases to court.
Regarding sanctions, the initial proposal for trade bans was removed, but the new EU regulation on forced labour will still prohibit the import of products connected to forced labour. Other areas to address include exploitation of workers, just and favourable working conditions, fair and adequate living wages, unequal treatment in employment and the right to freedom of association and environmental issues such as emissions, deforestation, pollution, handling of hazardous wastes and chemicals, protection of the ozone layer, pollution, use of mercury and water usage.
Failure to comply could lead to penalties like fines and orders to ensure compliance, and there's a chance of facing civil liability. Moreover, the obligations regarding directors' duties remain in force under the existing laws of EU Member States.
Risk Assessment and Due Diligence
The CSDDD maintains a risk-based approach to due diligence, focusing on human rights and environmental risks. Companies will need to conduct a scoping exercise to identify high-risk areas in their supply chains, both at the tier one and deeper tiers. This scoping process will be crucial, as it will determine the scope of the subsequent in-depth risk assessment and mitigation measures.
Climate Targets and Financial Sector
The final agreement also includes provisions on climate targets, but these have been significantly watered down. The climate plan, originally designed to fulfill the Paris Agreement objectives, now requires companies to adopt a climate plan without strict enforcement. Companies already falling under the CSRD (Corporate Sustainability Reporting Directive) fulfill the transition plan requirements through their reporting, hence exempted from this obligation.
The financial sector is also included in the CSDDD's scope, but only regarding their procurement activities. The financial sector companies are subject to the obligation of adopting and implementing a transition plan. Their lending, investment, and other downstream activities are excluded from the directive's requirements. Additionally, financial incentives for directors have been removed.
After the Council's approval, regulated financial firms will remain part of CSDDD, but only for the upstream part of the supply chain. Any mentions of the specificities of the financial sector in the due diligence process have been removed.
All in-scope companies, including those in finance, must adopt a plan to help limit global warming to 1.5°C. Companies with over 1000 workers will receive financial benefits for implementing the plan. We do not know all the details yet, like who exactly will get the benefits (the original proposal mentioned "directors" instead of "management"), whether adopting the plan is mandatory, and if it might negatively affect remuneration.
Implementation Challenges and Next Steps
The implementation timeline for the CSDDD is still uncertain, with potential delays due to translation and legal procedures. However, it's crucial to note that the CSDDD must now undergo the process of being transformed into national law in each EU member state. Once the EU has finalised the CSDDD, each member state will be required to enact corresponding national legislation within a specified deadline. For instance, in Germany, this will lead to an update of the German Supply Chain Due Diligence Act (SCDDA or LkSG).
Companies are encouraged to start the scoping process as soon as possible, especially those with multiple complex or high-risk supply chains. The CSDDD interacts with existing legislation, such as the SCDDA, and will require companies to adapt their due diligence processes accordingly.
The CSDDD poses significant implementation challenges for companies, particularly in the areas of risk assessment, scoping, and stakeholder engagement. Companies must establish robust due diligence processes, integrate sustainability into their operations, and engage with stakeholders to address potential and actual adverse impacts. It’s important to understand the CSDDD's requirements and take proactive steps to ensure compliance. By understanding the CSDDD's key changes and implications, companies can proactively address these challenges and contribute to a more sustainable future.
Conclusion
The CSDDD represents a significant step forward in the EU's efforts to ensure corporate sustainability and accountability. Companies must adapt to these new requirements, which will impact their operations, supply chains, and stakeholder engagement. Companies are encouraged to familiarise themselves with the CSDDD’s requirements and begin the scoping process to ensure compliance and contribute to a more sustainable future. The final agreement reflects significant compromises, particularly in terms of the scope and the strength of the provisions. As the directive is transposed into national law and implemented, it will be crucial to monitor its effectiveness and the impact on companies and supply chains.