After a turbulent few months, the Corporate Sustainability Due Diligence Directive (CSDDD or CS3D) was formally adopted by the European Council on May 24, marking a significant step towards more responsible business practices in the EU and beyond. But its scope is likely to be fairly limited.
This long-awaited directive aims to promote sustainable and responsible corporate behaviour and will hold large companies accountable for their impact on the environment and human rights. Indeed, since the collapse of the Rana Plaza factory in Bangladesh, which killed more than a thousand women and men working in the textile industry, many people have become increasingly vocal about the need for companies to be more ethically responsible.
The directive is part of the European Green Deal along with other measures such as the Corporate Sustainability Reporting Directive (CSRD) and the European Green Taxonomy, designed to promote sustainable economic growth across the EU.
Companies covered by the CS3D will have to carry out due diligence (HREDD) against a wide range of human rights, labour rights and environmental standards, to identify, prevent, mitigate and account for adverse impacts arising either from their own operations or from their ‘chain of activities’. In-scop firms will therefore have to integrate due diligence into their policies, make related investments, seek contractual assurances from their partners, improve their business plan or provide support to small and medium-sized business partners to ensure they comply with the new obligations. When conducting due diligence, companies are required to engage meaningfully with stakeholders and affected people. In-scope companies are also required to adopt a climate transition plan, in line with the Paris Agreement on climate change.
Scope and applicability
The CS3D will affect large EU and non-EU companies operating in the EU market. Specifically, it will apply to EU companies with more than 1,000 employees and a worldwide turnover of more than €450 million. It will also apply to companies with franchising or licensing agreements in the EU ensuring a common corporate identity with worldwide turnover higher than €80 million if at least €22.5 million was generated by royalties. Non-EU companies and companies with franchising or licensing agreements in the EU reaching the same turnover thresholds in the EU will also be covered.
Smaller companies may be indirectly affected through their business relationships with covered companies, by having to comply with due diligence requirements as part of their contractual relationships with them.
Critics argue that the scope of the directive is too narrow, excluding more than 99% of EU-based companies. The European Coalition for Corporate Justice estimates that fewer than 5,500 companies will be covered by the directive. This leaves many smaller but potentially impactful companies unregulated, limiting the overall effectiveness of the directive.
This small number of affected companies is partly the result of opposition during the final stages of the directive’s adoption by key Member States, notably Germany, Italy and France, which feared that the stringent requirements could be detrimental to business and therefore demanded that the initially proposed thresholds of 500 employees and €150 million turnover be raised.
Chain of activities
Due diligence must cover not only a company’s own operations and those of its subsidiaries, but also those of its business partners in the company’s ‘chain of activities’.
A company’s ‘chain of activities’, a shortened form of the value chain, covers the activities of ‘upstream’ business partners related to the company’s production of goods or provision of services (including the design, extraction, sourcing, manufacture, transport or development of products or services).
It also covers certain “downstream” activities, including the distribution, transport or storage of products, when undertaken for or on behalf of the enterprise. Disposal of the product (including dismantling, recycling, composting or landfilling) or the activities of a company’s downstream business partners in relation to the services provided by the company are excluded from the due diligence obligation.
Lobbying by financial institutions also influenced the legislative process, leading to the decision to exclude downstream financial activities, such as lending, from the original directive. This is seen by NGOs as a major gap. Through their investment decisions, financial institutions play an important role in enabling corporate activities that can lead to human rights abuses and environmental damage. However, the Commission will carry out an evaluation of the directive within two years of its entry into force, including the need to establish rules for additional due diligence requirements specific to the financial sector.
Climate change
The directive requires companies, including those in the financial sector, to draw up a climate change transition plan that outlines how they will adapt their operations to meet the goals of the Paris Agreement, in particular to limit global warming to 1.5°C. The transition plan must be updated annually and include a report on the company’s progress. However, it does not impose any binding due diligence obligations on companies regarding their impact on climate change, and there would be no penalties for failing to meet emission reduction targets, which many see as insufficient given the urgency of the climate crisis.
Enforcement Mechanisms, Civil liability and Stakholder engagement
Member States are responsible for designating authorities to monitor compliance and impose penalties for non-compliance, including fines of up to 5% of the company’s worldwide net turnover. In addition, companies may be subject to civil liability, which allows victims to claim compensation for damages caused by a company’s failure to exercise due diligence. Compliance with the CSDDD must also be taken into account as part of the criteria for the award of public contracts and concessions.
Implementation
The CSDD will enter into force on the twentieth day following its publication in the Official Journal of the European Union. Member States will then have two years to implement the regulations and administrative procedures to comply with this legal text.
The directive provides for a staggered compliance timetable based on company size. Companies with more than 5,000 employees and a turnover of €1.5 billion will have to comply within three years (2027), those with more than 1,000 employees and a turnover of €450 million will have five years (2029) and those with more than 3,000 employees and a turnover of €900 million will have four years (2028).
Conclusion
By harmonising due diligence requirements across the EU, the directive aims to promote a fairer and more sustainable economy, balancing the needs of businesses, citizens and the environment. The success of this directive will depend on effective implementation, enforcement and stronger national legislation by EU Member States to close loopholes.
Samuel Poos, Enabel’s Trade for Development Centre coordinator.
This text is the sole responsibility of its author and is intended as a contribution to the debate. It represents neither the opinion of Enabel nor that of Belgian Development Cooperation.
