Introduction: Accelerating the Path to Sustainability
The concept of sustainability extends beyond the realm of climate alone, and the significance of businesses in safeguarding the environment and addressing broader concerns like human rights has captured the interest of politicians, investors, consumers, and other parties involved. Recognizing the escalating call for environmental accountability and sustainability, the European Parliament has implemented substantial initiatives to foster responsible practices.
The parliament officially adopted the CSDDD Directive on June 1, 2023. This regulation requires affected businesses to exercise due diligence and accept responsibility for human rights violations and environmental degradation within their global value chains. The objective is to effect a fundamental transformation in business operations in order to foster a more sustainable future.
This article provides an overview of the European Parliament’s Corporate Sustainability Due Diligence Directive (CSDDD). It examines the directive’s essential elements, including due diligence requirements, risk mitigation, public reporting, grievance mechanisms, and the integration of CSDDD and ESG principles into corporate governance. In addition, it addresses enforcement measures and the consequences of noncompliance, highlighting the importance of solid continuity planning. For a more sustainable and inclusive future, it emphasizes the necessity for businesses to prioritize sustainability, ethical conduct, and accurate ESG reporting.
The European Union’s Commitment to Ethical Standards
The proposal for The Corporate Sustainability Due Diligence Directive (CSDDD) was adopted in February 2022, as an example of the European Union’s dedication to ethical standards. The European Union (EU) has shown its commitment to ensuring that human rights and environmental protections are considered in business practices by passing this directive.
The resolution of the parliament, supported by a large majority of 366 votes in favour, emphasizes the far-reaching effects of the directive. However, it is unfortunate that the reasons behind the opposition of 225 dissenting voices remain unclear. Despite these obstacles, the European Union continues to work toward its goal of increasing the dedication of company boards and directors in order to guarantee strict compliance with the newly established law.
Corporate Sustainability Due Diligence Directive (CSDDD): An Introduction
The EU’s Directive on Corporate Sustainability Due Diligence (CSDD) sets out a cross-sector EU standard for a human rights and environmental due diligence strategy for companies to adopt. It will require both EU and non-EU companies to identify, and, if necessary, take steps to prevent or mitigate adverse impacts on human rights and the environment in companies’ own operations, their subsidiaries, and their supply chains.
If implemented, the CSDDD would place obligations on businesses to assess the risks posed by their operations to human rights and the environment, and to take steps to eliminate or reduce such risks.
It would require them to conduct due diligence not only on their own operations, but also on those of their subsidiaries and other entities within their value chains with whom they have direct or indirect business relationships. They would be required to create and implement ‘prevention action plans,’ obtain contractual assurances from their direct business partners that they will comply with the plans, and then verify compliance.
Key Elements of the CSDDD
1. Supplier Compliance and Due Diligence: Multinational corporations operating within the European Union will now be obligated to conduct comprehensive evaluations of their suppliers’ adherence to the CSDDD. Any instances of non-compliance must be promptly addressed to avoid severe penalties.
2. Applicability Scope: The CSDDD will initially focus on companies that have over 500 employees and generate revenues of more than €150 million. Over time, it will expand its scope to include enterprises with more than 250 employees and €40 million in revenue. Furthermore, non-EU entities that earn revenues exceeding these thresholds within the EU will also be obligated to follow the principles of the directive.
3. Climate Transition Plans: Companies are required to develop climate transition plans in alignment with the objectives of the Paris Agreement. This includes addressing emissions across Scope 1, 2, and 3 and conducting comprehensive due diligence regarding climate impacts.
4. Variable Compensation and Milestones: Companies with more than 1,000 employees must tie their directors’ variable compensation to the achievement of targeted milestones outlined in their climate transition plans. This provision aims to align financial incentives with the pursuit of sustainable practices.
CSDDD and ESG Integration: Paving the Way for Responsible Business Conduct
The Corporate Sustainability and Due Diligence Directive (CSDDD) along with the integration of Environmental, Social, and Governance (ESG) factors is emerging as a powerful framework to drive responsible business conduct.
CSDDD and ESG integration share a common goal: promoting responsible business conduct. Together, they create a powerful framework for organizations to address societal and environmental challenges. ESG integration provides companies with a systematic approach to assess and improve their ESG performance, aligning them with CSDDD requirements.
By integrating ESG factors into their due diligence processes, companies can identify and mitigate risks related to human rights violations, supply chain sustainability, climate change, and more. This integration not only facilitates compliance with CSDDD but also positions businesses as responsible corporate citizens committed to sustainable practices.
Benefits of CSDDD and ESG Integration:
Enhanced Risk Management
CSDDD and ESG integration enable businesses to identify and manage potential risks, such as reputational damage, legal liabilities, and operational disruptions resulting from non-compliance with responsible business practices.
Stakeholder Trust and Reputation
By embracing CSDDD and ESG integration, organizations demonstrate their commitment to ethical conduct, sustainability, and societal well-being, fostering trust among stakeholders and enhancing their reputation.
Companies that prioritize responsible practices gain a competitive edge by attracting conscious consumers, socially responsible investors, and business partners who value sustainability and ethical standards.
Long-Term Value Creation
CSDDD and ESG integration encourage businesses to adopt sustainable strategies that drive long-term value creation, resilience, and profitability.
To effectively implement ESG integration and fulfill the requirements of CSDDD, it is crucial for companies to prioritize accurate and reliable ESG reporting. While ESG reporting may seem daunting, especially for companies navigating the complexities of CSDDD compliance, seeking assistance from industry professionals can streamline the process.
Partnering with a specialized ESG reporting provider like IRIS Carbon, Digital ESG Reporting, and Disclosure Management not only ensures compliance with CSDDD but also collates data from multiple source systems so teams can efficiently combine data and narrative to the company’s sustainability efforts.
What are the requirements of the CSDDD?
The requirements of the Directive broadly cover five main areas of action. Affected organizations must:
Conduct due diligence
Organizations must conduct due diligence to identify and prevent environmental and human rights risks. This includes assessing the potential impact of their operations and their supply chains on the environment and human rights.
Organizations must take steps to mitigate any risks identified during due diligence. This may include developing and implementing policies and procedures to address identified risks, as well as engaging with suppliers to address any issues if they arise.
Organizations must be transparent about their due diligence processes and publicly report their efforts to address environmental and human rights risks. This may include publishing an annual sustainability report or making information available on their website.
Establish grievance mechanisms
Organizations must have functional reporting channels for workers and stakeholders to raise concerns, as well as processes to address and follow up. This may include setting up a hotline or email address to report, as well as a process for investigating and addressing those concerns.
Embedding CSDDD and ESG principles into company governance
The integration of CSDDD and ESG principles signifies a significant shift in company decision-making, risk management, and stakeholder engagement. This fosters ethical decision-making, considers the impact on stakeholders, and strengthens risk management practices.
Enhanced Decision-making: Embedding CSDDD and ESG principles into EU company governance frameworks enables organizations to make more informed and ethical decisions. These principles encourage consideration of the impact on various stakeholders, such as employees, customers, suppliers, communities, and investors, leading to more responsible and sustainable business practices.
Long-term Sustainability: By integrating CSDDD and ESG principles into company governance, organizations align their operations with societal and environmental goals. This approach promotes long-term sustainability, ensuring that business activities contribute positively to the well-being of both society and the environment.
Mitigation of Risks: Embedding CSDDD and ESG principles strengthens risk management practices within EU companies. Proactively assessing and addressing ESG risks allows organizations to navigate the complex regulatory landscape effectively. It also helps in anticipating emerging societal concerns and building resilience against potential environmental and social disruptions.
Compliance and Reputation Management: Incorporating CSDDD and ESG principles into governance frameworks goes beyond mere compliance. It helps EU companies manage risks associated with non-compliance and safeguards their reputation. By aligning with these principles, companies can demonstrate their commitment to responsible practices, which can enhance their standing in the market and among stakeholders.
Innovation and Value Creation: Integrating CSDDD and ESG principles encourage EU companies to identify opportunities for innovation. Considering environmental, social, and governance factors can lead to the development of new products, services, and business models that address sustainability challenges. This approach promotes value creation while aligning with societal and environmental needs.
Stakeholder Engagement: Embedding CSDDD and ESG principles into EU company governance facilitates meaningful stakeholder engagement. By considering the interests of stakeholders in decision-making processes, companies can build stronger relationships and foster trust. This engagement also provides valuable insights that can inform strategic initiatives and help address concerns raised by stakeholders.
EU company governance that incorporates CSDDD and ESG principles encourages ethical and sustainable business operations. Incorporating these concepts into governance frameworks will allow businesses to make better decisions, avoid penalties, respond to public concerns, and create long-term financial success.
Impacted Companies under the CSDDD
As per the current details of the proposal, which is subject to change, the CSDDD is expected to have an impact on the following companies:
EU Incorporated Companies
- Companies with an average of over 500 employees and a net turnover exceeding €150 million in the last financial year.
- Companies with an average of over 250 employees and a net turnover exceeding €40 million in the last financial year, provided that at least 50% of this turnover was generated in a high-impact sector (textiles, clothing, mineral extraction, agriculture, forestry, fishing, or metal manufacturing).
- Companies with a net turnover exceeding €150 million generated within the European Union during the last financial year.
- Companies with a net turnover exceeding €40 million (but not exceeding €150 million) generated within the European Union, provided that at least 50% of their net worldwide turnover was generated in a single high-risk sector.
Organizations that meet the thresholds are required to conduct human rights and environmental due diligence not only within their own operations but also in relation to their subsidiaries and any entities within their value chain with whom they have established business relationships.
Once the Directive is implemented, organizations will be held accountable for the CSDDD proposal, and the review process may involve updating the thresholds accordingly to reflect the exact impacts of the Directive.
Enforcing the New Rules on CSDD
The implementation of new rules on corporate sustainability due diligence represents a major step toward promoting responsible business conduct and addressing environmental and social impacts. As with any regulatory framework, enforcement mechanisms are vital to ensuring compliance.
Administrative Supervision: Member States will designate authorities responsible for overseeing compliance with the new rules. These authorities will have the power to supervise and enforce effective, proportionate, and dissuasive sanctions. Such sanctions may include fines and compliance orders. At the European level, the Commission will establish a European Network of Supervisory Authorities, bringing together representatives from national bodies to ensure a coordinated approach. This collaborative effort aims to harmonize enforcement practices and maintain consistency across member states.
Civil Liability: To safeguard the interests of victims, Member States will ensure that compensation is available for damages resulting from the failure to comply with the obligations set forth in the new proposals. This provision establishes a legal pathway for affected parties to seek redress for any harm caused by non-compliance with corporate sustainability due diligence requirements. By holding accountable those who neglect their responsibilities, civil liability provisions incentivize companies to prioritize sustainability and mitigate potential adverse impacts.
Directors’ Duties: The enforcement of directors’ duties under the new rules relies on existing Member States’ laws. The directive does not introduce an additional enforcement regime specific to directors. Instead, it reinforces the notion that directors have a fiduciary duty to act in the best interests of the company, which includes taking into account environmental and social considerations. Directors who fail to comply with their obligations under this directive may be subject to legal action and remedies available under national laws.
Through administrative supervision, civil liability provisions, and the reinforcement of directors’ duties, compliance with these regulations will be monitored, sanctioned, and enforced.
This comprehensive approach aims to drive responsible business practices, protect the interests of stakeholders, and advance the collective goal of achieving sustainability and social responsibility in the corporate sector. By upholding these enforcement mechanisms, we can foster a culture of accountability and make substantial progress toward a more sustainable and inclusive future.
Developing Effective Continuity Plans for Organization
The CSDDD mandates that businesses account for the environmental and social impact of their suppliers. Consequently, it is essential to plan and manage business continuity in the event of supply chain disruptions, be they caused by a breach of contract, failings to uphold ethical business processes, disruptions or delays in production or delivery, etc.
To manage these risks, business continuity plans should:
- Identify key suppliers to assess the potential impact of supply chain disruptions on operations and investigate concerns in line with other due diligence duties.
- Develop contingency plans to identify alternative suppliers and develop plans and statements around managing inventory and resource gaps, especially across high-risk business areas. These plans should also cover communication protocols with suppliers.
- Regular review to ensure any continuity processes are up-to-date and reflective of changes to operations, supply chain, and social, political, or economic risk.
Consequences of Non-compliance with CSDDD Requirements
The CSDDD includes provisions for enforcement and penalties for non-compliance through fines and other sanctions. Failure to address environmental and human rights risks in operations and supply chains can result in legal action via national supervisory authorities, as well as reputational damage, loss of business, and damage to brand value.
Another major risk is being excluded from public procurement processes or being subject to additional monitoring and reporting requirements to have access. Civil liability may be considered in instances where preventative measures could have avoided any damage.
Sustainable Corporate Synergy: Igniting a Purposeful Shift in the EU
The introduction of mandatory due diligence requirements has been strongly pushed for by a wide range of interested parties, including civil society leaders, EU citizens, enterprises, and business associations. The corporations participating agreed, according to the findings of the public consultation, that the European Union should get involved in the debate over corporate sustainability and due diligence.
Businesses must play a pivotal role in promoting a more stable and equitable economic and social system. Although one-third of businesses recognize the need to take action to alleviate the harmful effects of their operations on human rights and the environment, progress in this area has been slow and inconsistent. Supply chains are becoming increasingly complex worldwide, making it challenging for businesses to gather accurate data on their supplier’s operations.
Furthermore, the widespread adoption of best practices is hampered by the variation in national rules concerning business sustainability and due diligence duties. While some Member States are making strides, this is not enough to enable businesses to function sustainably and reach their full potential.
In conclusion, by the adoption of the Corporate Sustainability Due Diligence Directive (CSDDD) by the European Parliament, businesses can contribute to a more stable, equitable, and sustainable economic and social system. In addition, businesses can generate good change, safeguard the environment, and secure a prosperous future for future generations by integrating CSDDD with ESG principles through collaborative efforts.
Companies must prioritize accurate ESG reporting, and industry leaders such as IRIS Carbon® provide the expertise and technology required for reliable and comprehensive reporting to establish trust and create long-term value.