Update on the proposed Corporate Sustainability Due Diligence Directive
Update on the proposed Corporate Sustainability Due Diligence Directive
Last year, we published an overview of the European Commission's (Commission) initial proposal for a Corporate Sustainability Due Diligence Directive (Directive). The proposal aims to further the EU's ambitions to be climate neutral by 2050 and to assist with delivery of the EU's Green Deal. The Directive is intended to foster sustainable corporate behavior and to address the adverse human rights and environmental impacts of global value chains.
European Commission proposal
If adopted as initially proposed, the Directive would, in summary:
impose due diligence obligations on in scope companies to identify, prevent, mitigate and account for adverse human rights and environmental impacts from the company's own operations, those of its subsidiaries and those of entities with which there is an established business relationship in the company's value chain
impose obligations on certain large companies to adopt a plan to ensure that their business model and strategy are compatible with a transition to a sustainable economy and limiting global warming
require directors to take into account human rights and climate change impacts when fulfilling their duty to act in the best interests of the company
EU legislative process
The EU's legislative process in respect of the Directive has continued to progress since the Commission's proposal was published. On 1 December 2022, the Council of the EU (Council) adopted its position in respect of the Directive. Some key differences in the Council's position are summarised below.
While the diligence requirements proposed by the Commission remain broadly unchanged, the Council's negotiating position contains proposed amendments that include:
the thresholds for in scope companies remain the same as proposed by the Commission, but in the Council's proposal must be met for at least two consecutive financial years, narrowing the universe of in scope companies somewhat
the application of the Directive to in scope companies is phased in with very large companies required to comply from three years after entry into force of the Directive and others to comply four years after entry into force of the Directive
the concept of 'established business relationship' being deleted and replaced with 'business partners', intended to align more closely with international frameworks
a risk-based approach being taken in respect of dealing with adverse impacts, expressly allowing for prioritisation when dealing with such impacts based on severity (assessed against criteria including gravity and ability to restore the status quo ante) and likelihood of a risk eventuating
deleting references to 'value chain' and replacing them with the term 'chain of activities' thereby removing the downstream phase of use of a company's products from the due diligence obligation
leaving it to member states to decide whether to include within scope the provision of financial services by regulated financial entities
removing provisions relating to explicitly expanding directors' duties to include the duty to mitigate adverse human rights and environmental impacts, and removing the requirement to link variable director remuneration to achieving sustainability targets
On 1 June 2023, the European Parliament (Parliament) adopted its negotiating position which differs from the Commission's proposal in certain key respects as outlined below.
One fundamental difference is Parliament's position on the scope of the Directive. Under Parliament's proposal the Directive would apply to a broader cohort of companies being:
all EU companies with more than 250 employees and €40m in net annual turnover or EU parent companies with more than 500 employees and €150m in net annual turnover on a group basis
all non-EU companies with €40m net annual turnover generated in the EU or non-EU parent companies with more than 500 employees and worldwide net annual turnover of €150m with at least €40m of that turnover generated in the EU on a group basis.
In a further change, for non-EU companies, EU turnover would be calculated to include third party companies based in the EU which have entered into a vertical agreement in return for royalties with the relevant non-EU company.
Parliament envisages a staggered introduction of the Directive which aligns with the above thresholds, similar to the phased introduction of the requirements of the Corporate Sustainability Reporting Directive. Under Parliament's proposal the Directive would apply first to companies with more than 1,000 employees and worldwide turnover of more than €150m, three years after coming into force. Other companies would be subject to its requirements four years after the Directive coming into force, although companies with more than 250 employees and more than €40m worldwide net annual turnover, but which do not exceed €150m net annual turnover in their most recent financial statements, would be able to delay implementation until five years from the Directive coming into force.
Under Parliament's proposal, directors would be made explicitly responsible for overseeing compliance with the Directive's requirement for in scope companies to adopt a plan that ensures that the business model and strategy of the company are aligned with the transition to a sustainable economy and the limiting of global warming to 1.5 °C. In addition, for larger companies with more than 1,000 employees, part of the directors' remuneration would be explicitly linked to the achievement of targets of the company's transition plans.
Parliament's proposal including regulated financial undertakings within the scope of the Directive. It is anticipated that this element of the proposal will attract considerable debate as negotiations progress.
Lastly, under Parliament's proposal the ambit and scope of sanctions for non-compliance have been further clarified. These expressly include pecuniary sanctions, public statements of censure, the obligation to perform an action and the suspension of products from free circulation or export. Parliament proposes that the limit for pecuniary sanctions shall be not less than 5% of worldwide turnover for the relevant company in the financial year preceding the fining decision, and that third country undertakings may be excluded from public procurement processes if they fail to comply with the Directive.
Now that each of the European legislative institutions have adopted their position regarding the Directive, trilogue negotiations will take place. These commenced on 8 June 2023 and it is anticipated that discussions will be detailed, extensive and result in changes to the text of the Directive before it is finalised. Accordingly, the precise scope of the Directive remains uncertain for now – not least as to the types of companies that will fall in scope. It is likely that the Directive will come into force by early 2024, with member states having two years from that date to enact transposing legislation, noting that the implementation dates for in scope companies remains unknown.
While the precise scope of the Directive remains uncertain, it is clear that significant interrogation of value chain impacts will be required of companies that are ultimately required to comply with the Directive. For larger companies where the only question in terms of compliance is when they will need to comply with the Directive, now may be a good time to start to engage with value chain analysis and risk mitigation planning. In particular where work has already commenced in terms of compliance with the reporting obligations under the Corporate Sustainability Reporting Directive.
If you would like more information on the Directive as it progresses through the EU's legislative process please contact, Paul White, Partner, Corporate M&A, Jill Shaw, ESG & Sustainability Lead, Liam Murphy, Senior Knowledge Lawyer or your usual ALG contact or visit our ESG & Sustainability hub.