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Risk & Compliance ESG & Sustainable Finance

Political agreement reached on the final text of the CSDDD: A bittersweet victory?

Date:April 3, 2024

On December 14, 2023, the European Parliament (EP) and the European Council (EC) reached a provisional agreement on the Corporate Sustainability Due Diligence Directive (CSDDD/CS3D). Normally, the official votes that follow are merely a formality. However, after the provisional political agreement, countries such as Germany, Italy, and France withdrew their support. This made it uncertain whether a directive would be implemented to compel large enterprises to address human rights abuses and environmental damage. Opposition to the draft law was fueled by Germany, which already has a national supply chain due diligence law, and pro-business lobby groups, fearing that the directive would impose additional bureaucratic pressure on companies and pose liability risks.

On March 15, 2024, after heavy and lengthy negotiations, the ER finally agreed to the directive. The Legal Affairs Committee of the EP quickly followed suit by endorsing the compromise text on March 19, 2024. The CSDDD will now be sent to the EP’s plenary session in April 2024 for formalization through a vote. The European Commission will follow a similar timetable for formalizing the CSDDD. We anticipate that this process will proceed more smoothly than the vote at the ER because the draft text from the European Parliament contains more stringent obligations than the compromise text negotiated by the European Council.

This directive imposes an obligation on ‘very large’ enterprises to conduct environmental and human rights due diligence in their ‘chain of activities’. In our article dated June 21, 2023, we discussed the expected points of contention, indicating that the final text of the CSDDD was still far from complete. Nevertheless, it was clear that due diligence in the realm of ESG was inevitable, although the exact form remained uncertain.

This directive imposes an obligation on ‘very large’ enterprises to conduct environmental and human rights due diligence in their ‘chain of activities’.

The CSDDD imposes extensive obligations on enterprises within its scope. Therefore, it is important to become familiar with the obligations in a timely manner and understand how they will affect your business operations. Non-compliance can result in high costs and serious reputational damage. In this article, we address the outcome of the negotiations regarding the aforementioned points of contention. For more background information on the CSDDD, we refer you to the Wiki page.

Outcome of CSDDD negotiations

Scope

The CSDDD has a limited scope for enterprises directly covered by the directive. The directive applies only to ‘very large’ enterprises. Due to the significantly raised threshold values resulting from the negotiations, only 0.05% of European enterprises fall within scope. However, since the directive includes provisions regarding the chain of activities, other enterprises indirectly involved, but not within scope, may still face information requests and measures from enterprises falling within the scope (if they are direct business partners).

The compromise text has moved away from the ‘high-risk sector’ approach. This means that enterprises from certain ‘risk sectors’ will no longer fall within the scope of the CSDDD if they have a total net turnover of more than 40 million EUR, of which at least 20 million EUR is generated in these ‘risk sectors’ and employ more than 250 workers. However, the text includes a revision clause to potentially adopt this approach in the future. The calculation of threshold values remains at company group level,, based on the consolidated financial statements of the group. The threshold values for employees and net turnover are also mentioned as one of the issues in the revision clause of the compromise text, allowing them to be reassessed later.

The compromise text also includes a phased implementation (applicable from the moment the CSDDD comes into force), which looks as follows:

EUNon-EUWhen
Enterprises with more than 5000 employees and a turnover of €1500 millionEnterprises with a turnover of more than €1500 million generated in the EU3 years after CSDDD comes into force
Enterprises with more than 3000 employees and a turnover of €900 millionEnterprises with a turnover of more than €900 million generated in the EU4 years after CSDDD comes into force
Enterprises with more than 1000 employees and a turnover of €450 millionEnterprises with a turnover of more than €450 million generated in the EU5 years after CSDDD comes into force
Franchises receiving 22.5 million royalties worldwide and generating more than 80 million net turnover worldwideFranchises receiving 22.5 million royalties in the EU and generating more than 80 million net turnover in the EU5 years after CSDDD comes into force

Chain of activities

The term ‘value chain‘ has been removed. The final text adopts the definition given by the EC, namely ‘chain of activities‘. This definition includes upstream business partners and, to a limited extent, downstream business partners.[1] The phase in which the use of products and/or services takes place is excluded, and the downstream chain includes only direct downstream business partners.

Upstream

The chain of activities must include the activities of a company’s upstream business partners related to the production of goods or the provision of services by the company. This includes the design, extraction, provision, production, transportation, storage, and delivery of raw materials, products, or parts of products, and the development of the product or service.

Downstream

The chain of activities of the downstream business partner must include activities related to the distribution, transportation, and storage of the product, with the business partners performing these activities directly for or on behalf of the company based on contractual agreements. The dismantling, recycling, composting, and disposal phases have also been removed in the latest negotiations.

Additionally, the chain of activities must not include the distribution, transportation, storage, and disposal of a product already subject to export control by a member state (e.g., weapons).

Transition plan

Enterprises must implement a transition plan in accordance with the CSRD to mitigate climate change, ensuring that the business model and strategy align with the transition to a sustainable economy and with limiting global warming to 1.5 °C, as outlined in the Paris Agreement.

To avoid duplicative reporting obligations from the CSRD (see ESRS E1-1), enterprises compliant with the CSRD are exempt from the obligation to adopt a climate transition plan. The climate-related obligation of the CSDDD is thus directly linked to the CSRD. However, the CSDDD goes significantly further than mere transparency by obligating enterprises to (i) adopt a detailed Climate Plan, and (ii) actually implement the Climate Plan on a best-efforts basis. CSRD reporting entities are compliant if they provide transparency: ‘no’ is also an option. If you fall under the CSDDD, there is no escape; you must take it seriously.

To avoid duplicative reporting obligations from the CSRD enterprises compliant with the CSRD are exempt from the obligation to adopt a climate transition plan.

The transition plan must include the following elements:

  • climate objectives with a time-bound nature
  • a description of identified decarbonization mechanisms and planned key actions,
  • a statement and quantification of investments and financing to support the implementation of the transition plan.
  • a description of the role of the board, management, and supervisory bodies of the company concerning the transition plan.

Every 12 months, the company must update the transition plan and include information on the progress made towards achieving its objectives.

In the compromise text, the obligation for companies within the scope of the CSDDD with more than 1000 employees to link the progress of the transition plan to financial incentives for members of the board, management, or supervisory bodies has been removed.

Financial sector

The definition of ‘chain of activities’ implies for regulated financial enterprises that only the upstream chain of activities falls within the scope of the directive and the company’s own business activities. This means that the financial sector is not excluded! Furthermore, the financial sector is subject to a specific provision requiring the EC to report to the EP and the ER within two years of implementation on the need for additional due diligence requirements tailored to the characteristics of the financial sector, as well as their impact. Otherwise, the obligations for regulated financial institutions are the same as for other enterprises.

Directors’ duty of care

The directors’ duty of care to consider the consequences of their decisions for sustainability issues has been completely removed. However, this does not mean that other regulations already provide for this or can provide for it.

The ER’s provision regarding the civil liability provision has largely remained intact. Member states must ensure that a company can be held liable for damage caused to a natural or legal person, provided that:

  • the company intentionally or negligently fails to comply with the obligations set out in Articles 7 and 8 CSDDD; and
  • as a result of a negligence as mentioned in point (a), damage is caused to the legal interest of the natural or legal person.

Companies that have participated in corporate or multi-stakeholder initiatives, or that have used third parties for verification or have negotiated contractual clauses with business partners, can still be held liable in accordance with this article. A company cannot be held liable if the violation is solely caused by a business partner or another player in the chain of activities.

Practice what you preach

It may take years for a company to identify all risks within the chain of activities, given the challenges of obtaining sustainability information and the time required to rectify or terminate identified abuses. In the meantime, existing soft law instruments can provide valuable guidance before the CSDDD comes into force. Existing soft law norms are also incorporated into the business strategies and investment decisions of multinational corporations and institutional investors worldwide. To comply with the CSDDD, enterprises within scope must implement the following points:

Integration of sustainability and human rights due diligence into procurement policies.

  • Identification of harmful effects on human rights and the environment in the chains.
  • Prevention or reduction of (potential) negative effects in the chain of activities.
  • Termination or minimization of actual negative effects.
  • Establishment and maintenance of a complaint’s procedure for labor rights in the chains.
  • Monitoring the effectiveness of policies and measures for due diligence.
  • Public communication and reporting on the conducted due diligence process.
  • Establishment of sustainable leadership and governance, including clear role and process descriptions, and the establishment of sustainability working groups and committees.
  • Material assessment to identify and prioritize key sustainability issues.
  • Mapping, engaging, and prioritizing chains, with an emphasis on strategic and high-risk suppliers.
  • Accurate data collection and reporting on sustainability, considering the use of specialized software for larger organizations. Also, consider archiving, version control, and governance for continuous reporting. Due diligence is an ongoing and reciprocal process that responds to changes.

Understanding chain risks leads to cost savings and minimizes negative effects. By taking responsibility for negative effects in the chain, companies contribute to the growing demand for transparency and sustainability, leading to better reputation and trust from customers, investors, and other stakeholders, while also generating new business opportunities and partnerships that strengthen the company’s position.

How can Projective Group help?

Although the compromise text disappoints many CSDDD advocates, it still represents a significant advancement in the regulatory framework for sustainable corporate governance in Europe. The new rules retain the core concept of mandatory due diligence on sustainability, requiring companies to identify – and prevent, mitigate, or reduce – negative impacts on human rights or the environment from their activities worldwide.

While the CSDDD may not have retained the same vigor and scope, it still marks progress in promoting ESG within the EU. All eyes are now on the EP to see if it takes the position that any form of agreement is better than none. We do not foresee further obstacles and expect the CSDDD to be published in this form. Although the first companies are not required to report on their due diligence efforts until 2027, understanding and mapping chains takes time and dedication – sometimes even years. Thorough preparation is therefore crucial to meet the requirements and become compliant. Learn more about our services related to the CSDDD.


[1]
These are legal entities (i) with which the company has a commercial agreement regarding the activities, products, or services of the company or to which the company provides services (direct business partners), or (ii) that conduct business activities related to the upstream chain of activities of the company (indirect business partners).