Two major proposals for ESG directives—the Corporate Sustainability Due Diligence Directive (CSDDD) and the Corporate Sustainability Reporting Directive (CSRD)—are currently working their way through EU institutions. Soon, more and more companies will have to take environmental, social and governance issues into consideration in the course of their day-to-day operations if they wish to stay in business and remain competitive. It is high time for companies to develop and implement an ESG strategy.
The proposal for the new CSDDD and the draft directive amending the existing sustainability reporting rules (CSRD) are expected to change the business reality in Europe in the coming years. Ultimately, they should help establish a sustainable European market, compliant with the standards of the European Green Deal and consistent with the Sustainable Development Goals developed by the United Nations. But they are already having an impact on companies’ operations, requiring them to develop and implement a development strategy taking into account environmental, social and governance issues.
Below, we summarise the main points of the draft CSDDD. We will soon follow this with an article on the CSRD proposal.
What entities will be subject to sustainability due diligence obligations in CSDDD?
The draft directive lays down obligations for companies regarding actual and potential adverse effects on human rights and the environment, with respect to their own operations, the operations of their subsidiaries, and value-chain operations carried out by entities with which they have an established business relationship. The proposal also regulates the liability for violations of these obligations.
According to the draft directive, environmental and human rights due diligence obligations are to be imposed on the following entities:
- Among entities formed in an EU member state:
- Entities that had more than 500 employees on average and had a net worldwide turnover of more than EUR 150 million in the last financial year for which annual financial statements have been prepared
- Entities that had more than 250 employees on average and had 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 this net turnover was generated in one or more “high-impact sectors,” i.e., the manufacture of textiles, leather and related products, agriculture, forestry, fisheries, or mineral extraction
- Among entities formed in a third country:
- Entities which generated a net turnover of more than EUR 150 million in the EU in the financial year preceding the last financial year
- Entities that generated a net turnover of more than EUR 40 million in the EU in the financial year preceding the last financial year, provided that at least 50% of the net worldwide turnover was generated in one or more “high-impact sectors.”
Although the draft directive directly applies to large companies, the directive will also indirectly affect SMEs and micro-enterprises as contractors and subcontractors of large companies. As a result, the obligations under the directive will also be shifted to smaller entities, and soon they will also have to establish environmental and human rights due diligence procedures.
What is sustainability due diligence as defined in the draft CSDDD?
The due diligence procedure itself is to include six actions taken by obligated entities for the purpose of identifying adverse environmental and human rights impacts and counteracting these impacts. Companies will have to:
- Include due diligence in all areas of their policies and implement a due diligence policy
- Take appropriate measures to identify the actual or potential adverse environmental and human rights impacts resulting from their activities
- Prevent and reduce potential adverse impacts on the environment and human rights, bring to an end actual adverse impacts, and minimise their extent
- Establish a complaint procedure and enable complaints related to actual or potential adverse environmental and human rights impacts to be submitted to them
- Monitor their own activities and applied measures in the context of adverse environmental and human rights impacts
- Publicly communicate on due diligence.
As mentioned, the proposal assumes that companies directly covered by the directive will be obliged to ensure that their business partners also exercise due diligence in the field of the environment and human rights. Among other things, this is to be expressed in requiring entities covered by the directive to seek appropriate contractual safeguards from business partners with whom they have direct relationships, under which the partners commit to a code of conduct (which large companies are to adopt as part of their due diligence policy) and a preventive action plan to the extent that the partners’ activities constitute part of the large companies’ value chain. In this context, to assist companies, the European Commission is to adopt guidelines relating to voluntary model contractual clauses as contractual safeguards as foreseen in the proposal.
What additional sustainability measures are foreseen in the CSDDD proposal?
One of the additional measures foreseen in the proposal is designation by each member state of at least one body tasked with overseeing compliance with national regulations adopted under the directive. Supervisory authorities would have the right to request information and conduct investigative proceedings, and natural and legal persons could report cases of companies’ failure to comply with due diligence to the authorities. Additionally, the European Commission is to establish a European network of supervisory authorities from individual member states, with the aim of improving cooperation between supervisory authorities and exchanging information between them.
The draft would also require member states to adopt national regulations under which sanctions can be imposed in the form of administrative penalties for non-compliance with obligations under the directive. In addition to administrative and legal sanctions, the directive would also provide for civil liability of companies if they fail to comply with due diligence procedures.
When are the new obligations under the CSDDD proposal to come into effect?
According to the proposal, the national implementing and administrative provisions necessary to implement the directive should be published by the member states no later than two years after entry into force of the directive. These provisions are to apply two years from entry into force of the directive, but for companies falling within the scope of the directive due to their activity in high-impact sectors, the provisions are to be applied with a two-year delay, and thus only four years after entry into force of the directive.
How to assess the main goals of the CSDDD proposal?
The draft directive is a welcome piece of legislation in the realities of the current world, including business reality. It seems likely to improve the observance of environmental and human rights regulations and refine corporate governance practices.
Above all, the main advantage of the proposal is that it would harmonise the activities of the member states in the context of sustainable development. Indeed, adoption of the directive will avoid the fragmentation of provisions regarding sustainability due diligence and guarantee legal certainty in the European single market. Some member states have already adopted internal regulations relating to sustainability due diligence, while others are only preparing relevant legislation or have not yet taken any action on the subject.
Additionally, the directive is intended to increase the accountability of companies for activities detrimental to the environment and human rights, and thus prevent the phenomenon of “greenwashing,” i.e. marketing strategies misleading customers into thinking that the company operates in accordance with principles of environmental protection.
The directive will have a cross-cutting impact, as it will impose sustainability due diligence obligations not only directly on large companies, but also indirectly on smaller ones that are contractors and subcontractors of entities directly obligated under the directive.
This means that both larger and smaller companies should already start developing and implementing an ESG strategy. In the coming years, lack of an ESG strategy could reduce a company’s competitiveness on the market, force it to scale back its operations due to difficulty accessing financing, and even expose it to sanctions for failing to meet sustainability due diligence requirements.
Julia Dolna, M&A and Corporate practice, Wardyński & Partners