10 questions and answers on CSDDD or CS3D (Corporate Sustainability Due Diligence Directive)

Due diligence is a process that enables companies to identify, prevent, mitigate and account for how they address their actual and potential adverse impacts. In this post we summarise the highlights of the new European Corporate Sustainability Due Diligence Directive (CSDDD).

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1. What is the background of the new Directive?

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The new CSDDD Directive or CS3D (Corporate Sustainability Due Diligence Directive or Regulation on corporate sustainability due diligence) is based on:

• the United Nations Guiding Principles on Business and Human Rights (2011),
• the OECD Guidelines for Multinational Enterprises,
• the importance of responsible behavior on the part of companies,
• and is in line with internationally recognised labor and human rights standards.

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Several EU member states (including France, the Netherlands and the United Kingdom) already have national ESG due diligence standards (Environmental, Social and Corporate Governance criteria). The EU-wide directive seeks to harmonise the application and frameworks of civil and criminal liability, as well as to expand efforts across the block.

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2. What objectives does the CSDDD pursue?

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This Directive, approved on April 24, 2024 by the European Parliament after a long legislative process, aims to impose due diligence with respect to potential or actual adverse impacts on:

• human rights (for example, child labor and worker exploitation)
• and the environment (for example, pollution and loss of biodiversity) derived from the activities of companies, their subsidiaries and their global value chains.

The CSDDD directive will regulate the responsibilities of companies with regard to potential adverse impacts on human rights and the environment. This includes their own operations, those of their subsidiaries and those carried out by companies within their chain of activities (supply, production and distribution). It will also address liability in the event of non-compliance with these obligations. Finally, it will require companies to adopt and implement a transition plan to reduce the effects of climate change. This plan seeks to ensure that the company's business model and strategy are compatible with the transition to a sustainable economy and with the goal of limiting global warming to 1.5°C.

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3. What is the scope of application of the CSDDD?

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It will affect large EU companies (more than 1,000 employees and 450 million euros in global turnover). Its application will be progressive and phased depending on the size of the company.

After several negotiations, the latest version of the text reduces the initially planned scope of application by 70%, placing it at around 0.05% of all companies in the Union (5,400 large companies) .However, large companies will apply the requirements in cascade to their partners and suppliers, so indirectly this Directive will affect many more companies across the region and in global value chains.

Specifically, the proposed Directive will apply to the following companies:

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Companies incorporated in the EU

They are required to comply with due diligence:

• companies established in the Union with more than 1,000 employees on average and a worldwide net turnover of more than 450 million EUR in the last financial year for which annual financial statements were prepared or should have been prepared (provided that they meet these criteria for two consecutive years).

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Third country companies with activities in the EU

The scope of application of the directive is established in companies that have been incorporated in accordance with the legislation of a third country and that meet any of the following conditions:

• companies with 1,000 or more employees,
• have generated a net turnover of more than EUR 450 million in the Union in the financial year preceding the last financial year; or
• The approach to high-risk sectors has been excluded.

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The rules of the proposed Directive will first apply to very large companies with more than 5,000 employees and a net global turnover of 1.5 billion euros. Companies with more than 3,000 employees and a turnover of 900 million euros will have four years. Those with more than 1,000 employees and a turnover of 450 million euros will have five years.

Several precautionary measures are included for companies that do not pay the fines imposed in the event of a violation. In addition, the company's turnover is taken into account to impose financial penalties (that is, a maximum minimum of 5% of the company's net turnover).

And companies will be required to make a significant commitment, including a dialogue and consultation with affected stakeholders. In addition, the agreement states that compliance with the CSDDD could be qualified as criteria for the award of contracts and public concessions.

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This directive will regulate the obligations of companies in relation to actual and potential adverse impacts on human rights and the environment.

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4. How will CSDDD affect companies outside the EU?

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Non-EU companies will also be subject if they operate in the EU.

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Third country companies included in the scope of application must appoint an authorised representative within the EU.

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Even if the company falls outside the scope of the EU CSDDD, increased pressure to align operations and supply chains with ESG objectives is likely to drive similar legislation in other jurisdictions.

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5. How will CSDDD affect SMEs?

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The text of the Directive does not propose rules directly applicable to small and medium-sized enterprises, but it does state that, if they are suppliers or participate in any way in the supply chain of any eligible company, they must be aligned with the latter's policies.

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In the event that these SMEs do not have their own capacity to comply with company policies, the latter will be responsible for supporting them so that they can improve their performance.

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The proposal provides for specific support to help SMEs to gradually incorporate aspects related to sustainability into their business activities.

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6. How will CSDDD affect the waste vector?

Companies affected by this rule will have to adopt a transition plan to make their business model compatible with the 1.5°C global warming limit set by the Paris Agreement.

7. How will compliance be guaranteed?

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Member States should:

• monitor that companies comply with their obligations and, in this regard, they may impose sanctions or issue orders requiring them to comply;
• they shall designate a competent national authority that will ensure their application and that the sanctions imposed are effective, dissuasive and proportionate. In addition, when sanctions are monetary, they must be proportional to the company's business model;
• they must also provide a means of communication so that any natural or legal person can exercise their right to submit their concerns if there are suspicions that a company could have identified or mitigated an adverse impact with appropriate due diligence measures.

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Companies will be required to:

• identify and, if necessary, prevent, end or mitigate the negative impact of their activities on human rights and the environment, such as child labor, slavery, labor exploitation, pollution, environmental degradation and loss of biodiversity.
• monitor and evaluate the impact of their partners in the value chain, including not only suppliers, but also sales, distribution, transportation, storage and other areas.

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8. How will it benefit large companies?

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The approval of the Directive will mean for companies subject to this standard:

• Have common and clear rules on due diligence in the area of business sustainability.
• An incentive for consumers to be more attracted to products manufactured in an ethical and environmentally sustainable way, a fact that will bring greater benefit.
• Better meet the expectations of investors who demand transparency requirements and consistent benchmarks to be sure of the due diligence standards applied in the value chain.
• Strengthen risk management and increase the resilience of companies by better integrating social, environmental and health considerations into their business strategies.
• Despite its reduced scope and ambition, the Directive is expected to help “level the playing field” for companies based or operating in the EU by creating a harmonised due diligence framework.

9. When will it enter into force?

The European Parliament approved the CSDDD on 24 April 2024, and the Council of the EU gave its final approval on 24 May 2024. The directive entered into force on 25 July 2024.

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Member states will have two years after entry into force to transpose the legislation into national law, and the requirements will start to apply to companies three, four and five years after entry into force, depending on the size of the company.
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This regulation will gradually apply to EU companies (and to non-EU companies reaching the same EU turnover thresholds):
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In 2027, to EU companies with 5000 employees with a worldwide net turnover of more than €1500M and non-EU companies that meet the aforementioned business threshold in the European market.
In 2028, to EU companies with more than 3000 employees and a worldwide net turnover of more than 900 M€, and non-EU companies with the same turnover threshold in the European market.
In 2029, to all other companies subject to the Directive.

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10. How does it relate to the CSRD?

It is important to highlight the connection between the CS3D Directive and the CSRD Directive, especially with regard to corporate sustainability reporting. For example, in order to prepare the sustainability reports required by the CSRDD, processes that are linked to the identification of the negative impacts of the CSDDD will be required.

For more information:

• Where does shared producer responsibility end? Miguel Varela, April 19, 2023
• 10 questions and answers on CSRD (Corporate Sustainability Reporting Directive) TEIMAS, 12.05.2023

Sources:

• Why It's Important That European Governments Are Moving To Regulate The Treatment Of Workers Globally. Forbes, June 06, 2023

• European Parliament gives green light to the Sustainability Due Diligence Directive. Garrigues, 24.04.2023

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