In April, the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) was passed by MEPs by a majority vote, a move whose impact will be felt beyond the EU’s borders.
The directive targets both environmentally and socially detrimental activity and requires corporates, as well as their supply, production and distribution partners, to prevent or mitigate adverse impacts such as slavery, exploitation, biodiversity loss, pollution or destruction of natural heritage.
‘We shouldn’t understate what a huge milestone the new regulation is’
The European Parliament’s adoption of the directive represents, says Lina Hilwani, director, value chain sustainability and human rights lead at KPMG UK, a significant milestone.
Significant change
It is the first regulation at EU level imposing legally enforceable sustainability due diligence obligations on large EU companies. It also takes in large non-EU corporates generating significant revenues in the EU, Hilwani points out.
The final draft of the directive limits its scope compared with earlier drafts in terms of the size of company caught by the new regulations. According to estimates, the finalised legislation will put around 5,500 companies directly in scope.
It’s a much needed move. A European Commission report from 2020, Study on Due Diligence Requirements through the Supply Chain, found that only around a third of global businesses were voluntarily conducting environmental and human rights due diligence, and fewer still were doing so in respect of their value chain.
The changes CSDDD brings in are truly significant, Hilwani says.
‘The directive imposes rigorous obligations in terms of human rights and the environment’
‘We shouldn’t understate what a huge milestone the new regulation is, and how significant this is for sustainable business practices,’ she says. ‘The scope of the CSDDD across the entire chain of activities of an organisation, and the impact this will have, is definitely a positive step.
‘Also, it is important to bear in mind that this directive imposes rigorous due diligence obligations in terms of both human rights and the environment, covering a huge range of issues, which will lead to more coordinated efforts to address these interconnected sustainability issues.’
Multiple regimes
The finalised legislation abandoned an approach that would have applied lower thresholds to so-called ‘high-risk’ sectors, resulting in few companies being directly covered by the legislation. However, the directive will nevertheless impact those companies, says Julia Grothaus, German head of litigation, arbitration and investigations at Linklaters.
‘When identifying and assessing actual and potential adverse impacts, in-scope companies must take into account risk factors including business operations, geographic, product and service, and sectoral risk factors,’ she says. ‘Therefore, the impact on “high-risk” companies will be massive, albeit they will not face public enforcement if they are not directly in scope.’
There is no doubt that we are seeing environmental, social and governance (ESG) regulations widening, as Grothaus explains.
‘The CSDDD is complemented by numerous more specific regimes, such as the Conflict Minerals Regulation, the Deforestation Regulation and the Batteries Regulation, all of which include due diligence obligations as well,’ she says, adding that the EU Parliament recently approved a new regulation enabling the EU to prohibit the sale, import and export of goods made using forced labour.
Reporting drive
Last year saw the introduction of the Corporate Sustainability Reporting Directive (CSRD), which requires all large companies and all listed companies (with the exception of micro enterprises) to disclose on the risks and opportunities arising from social and environmental issues (see Sustainability reporting faces challenges).
‘You might think you have a few years to comply, but it is never too early to start the process’
According to the 2024 Workiva ESG Practitioner Survey, companies are facing challenges when it comes to disclosing information under CSRD. Some 69% of the 2,000 ESG practitioners surveyed (including accounting, internal audit, legal and compliance professionals across North America, Europe and Asia) admit to challenges around disclosing sustainability information under the directive.
The additional requirements of the CSDDD mean that thousands of companies, both inside and outside the EU, will face greater reporting requirements – including the need to integrate human rights concerns with data on environmental impacts.
Be prepared
Given the complications and worrying workload for finance, accounting and ESG professionals, what do advisers believe companies should take on board at this stage?
Hilwani points out that compliance will take time, especially since companies will be looking for the first time at the whole value chain and beyond direct relationships. ‘While you might think you have a few years before you are obliged to comply, it is never too early to start the process and making sure you have what you need in place,’ she says.
‘The role of partnerships and collaborations forms part of the strategic response to this regulation’
Additionally, there are practical considerations for operating models for sustainability. ‘The requirements, for most organisations, would span multiple functions, and so it is important to consider how to best use existing systems and processes, where to update frameworks, how to upskill teams, and whether there is a role for technology to enable accurate and dynamic monitoring at scale,’ Hilwani says.
‘The role of partnerships and collaborations is key, and forms part of the strategic response to this regulation, as well as of how companies can make lasting positive impacts that are measurable and reportable.’
Silke Goldberg, partner and global head of ESG at Herbert Smith Freehills, points out that the directive is not a standalone set of obligations. ‘It is another piece of the complex and ever-growing puzzle of sustainability laws, alongside CSRD and the issue-specific due diligence laws on deforestation, forced labour, sustainable batteries and conflict minerals, to name just a few,’ she says.
‘There is lot to get to grips with. Those that fall short will face the consequences, but those that rise to the challenge with enthusiasm could reap real reputational and commercial rewards.’
