Corporate sustainability – sharing the Green Deal burden

In February 2022, the European Commission published a proposal for the Corporate Sustainable Due Diligence Directive (CSDD-proposal) as part of its European Green Deal action plan. The CSDD-proposal fits in the context of the UN Guiding Principles on Business and Human Rights (UNGP) and OECD Guidelines for Multinational Enterprises.

The CSDD-proposal lays down rules on obligations for large companies regarding actual and potential adverse impacts on human rights and the environment, with respect to their own operations, those of their subsidiaries, throughout their global supply chain.

Regarding the reduction of hazardous anthropogenic climate change, the CSDD also requires a climate reduction plan. Recital 50 of the CSDD provides: "In case climate is or should have been identified as a principal risk for or a principal impact of the company’s operations, the company should include emissions reduction objectives in its plan." In addition, Article 7 and 8 of the CSDD obliges companies to take preventive measures, as well as to end activities that result with an adverse climate change impact. Furthermore, Article 15 of the CSDD includes a requirement to adopt a plan that ensures that the company’s business model(s) and strategy(/ies) are compatibility with the transition to a sustainable economy and the limiting of global warming to 1.5 °C in line with the Paris Agreement. The plan should, in particular, identify the extent to which climate change is a risk for, or a result of, the company’s operations. If risks are, or should have been, identified, the company must include emission reduction objectives in its plan. Furthermore, the variable remuneration of directors should be linked to the achievement of the plan if ESG aspects are taken into account in the remuneration.

Furthermore, the CSDD-proposal not only imposes environmental and human rights due diligence monitoring for both EU-based and non-EU companies but also imposes a combination of administrative enforcement and civil liability to ensure overall compliance.

 The CSDD Directive is proposed to apply two main groups of companies, based in the EU:

• Group 1 - large EU limited liability companies that on average employ more than 500 people and whose worldwide annual net turnover surpasses euro (EUR) 150 million.
• Group 2 - other EU limited liability companies that do not reach these two thresholds, but which operate in certain high-risk sectors (for example, the garment, agriculture and food manufacturing, and extractive and mineral resources industries), have on average more than 250 employees and a worldwide annual net turnover of over EUR 40 million.

In addition, the CSDD Directive is proposed to apply applies to non-EU based companies that generate income within the EU according to the Group 1 or Group 2 thresholds. Small and medium-sized enterprises (SMEs) do not directly fall within the CSDD’s scope, but will inevitably be affected indirectly through due diligence activities of their large trading partners and affiliated companies. Also, they may be covered by member states’ legislative measures.

The CSDD aims to oblige companies to integrate environmental and human rights due diligence into their corporate policies including a specific Code of Conduct and implementation process describing the measures to comply in the context of their business relationships.

Moreover, companies will be required to monitor and report on CSDD compliance as well as establish a complaints procedure. This procedure should allow affected persons and certain trade unions, workers’ representatives and civil society organizations related to the value chain concerned, to submit complaints if they have legitimate concerns regarding actual or potential human rights violations.

Finally, not only the company may be subject to civil liability for damages as well as public enforcement resulting into fines and sanctions by national supervisory authorities but also its directors will be responsible for implementation of the due diligence measures.

The European Commission estimates that currently around 13,000 EU and around 4,000 non-EU companies would meet these criteria.

General approach of the Council

Currently, the CSDD-proposal is being debated by the European Parliament and the Council. On 1 December 2022, the Council adopted its negotiating position ('General Approach'), which provides them with a mandate to start negotiations with the European Parliament. In short, the Council proposes the following significant changes – mostly dilutions – of the CSDD-proposal:

Scoping the CSDD Directive

• The Council proposes that only companies that meet the criteria during two consecutive financial years fall within the scope of the CSDD directive;
• With respect to non-EU companies, the Council proposes that the Commission will set up a secured system of exchange of information about the net turnover generated in the EU by non-EU companies;
• The list of high-risk sectors was supplemented and clarified by the Council in an Annex with NACE industry codes;
• The Council proposes a broader transition period allowing companies more time to prepare for complying with the CSDD obligations. It should first apply only to very large companies with more than 1,000 employees and a worldwide turnover of more than EUR 300 million (from 3 years after entry into force of the CSDD directive and then be expanded to consecutively to Group 1 and Group 2 sized companies in de subsequent 2 years.
• The Commission is tasked with evaluation of the thresholds relating both employee numbers and turnover, as well as on the type of entities or persons in scope of the directive.

Priorities-based and group-level approach to compliance

• In the situation a company is not capable of addressing all identified adverse impacts at the same time to the fullest extent, the company concerned should be allowed to prioritise adverse impacts by using a risk-based approach;
• Parent companies falling within the scope can also fulfil the main due-diligence related obligations under the CSDD directive on behalf of their subsidiaries within the scope;
• The obligations relating to climate change have been aligned with the Corporate Sustainability Reporting Directive;

Directors’ duties and exposure deleted

• The proposed link between variable remuneration of directors and their contribution to the company’s business strategy and long-term interest and sustainability in relation to climate change goals has been deleted due to strong concerns of various member states;
• Likewise, the provision regulating directors’ duties of care has been deleted at the request of member states. The same applies to the directors’ role and duties for setting up and overseeing due diligence actions.
• The obligation imposed on directors of companies to take into account the consequences of their decisions for sustainability matters, including, where applicable, human rights, climate change and environmental consequences, should be deleted according to the Council.

Civil liability for non-compliance

• The General Approach clarifies the conditions in order for a company to be held liable for civil damages. In deviation from the Commission’s proposal, it introduces an element of fault and the right to full compensation while avoiding overcompensation e.g. by punitive damages.
• Clarifications have been added of the joint and several liability of a company and a subsidiary of business partner.

The next legislative step concerns the adoption of a position by the European Parliament, which is expected in the first quarter of 2023, after which the negation process with the Council and the Commission will commence. We suspect that the Commission will push for finalisation of the CSDD directive before the end of 2023.

To note: the Corporate Sustainability Reporting Directive entered into force!

The Corporate Sustainability Reporting Directive 2022/2464 (CSRD) was adopted on 28 November 2022 and entered into force on 5 January 2023. The CSRD has to be transposed by the EU member states into national legislation on 6 July 2024.

In short, the CSRD imposes a more detailed reporting obligation on a whole range of sustainability issues relevant to the company's business in comparison than to the predeceasing Non-Financial Reporting Directive (NFRD). Companies will have to report on how their business model affects their sustainability throughout their own supply chain, and on how external sustainability factors (such as climate change or human right issues) influence their activities. Furthermore, companies have to formulate long-term ESG targets and annually publish their progress on these targets. The sustainable targets, and performance linked to those targets, must also be incorporated into the annual report, which is subjected to an independent audit. In addition to the CSRD, the European Financial Reporting Advisory Group (EFRAG) is currently drafting mandatory EU sustainability reporting standards (ESRS). Subsequently, The European Commission has to finalize the submitted ESRS on 30 June 2023 by adopting a ‘delegated act’.

Finally, reporting under the CSRD is based on the concept of ‘double materiality’. This means that companies not only have to report on sustainability risks affecting the company (financial materiality), but also on the company’s own impacts on society and the environment (impact materiality).

For more information on the CSRD, please see Background, reason for and objective of the Corporate Sustainability Reporting Directive (CSRD)