A watershed in environmental supply chain due diligence

In recent years we have witnessed the widespread improvement in the business community’s collective commitment to the environment, perhaps most visibly in the development of environmental, social, and governance strategies (ESG).

Although supported by some mandatory requirements, improvements in supply chain due diligence have largely been voluntary, perhaps attributable to a combination of changing organisational values, the prospect of competitive advantage, and/or reputational risks stemming from consumer awareness.

The new European Corporate Sustainability Due Diligence Directive (CSDD) is poised to intensify and accelerate improvements in supply chain due diligence, with mandatory new requirements for corporate behaviour across all sectors of the economy. These changes are central to the European Union’s transition to a climate-neutral and green economy.

We examine these proposals to help you answer two key questions:

• will you be affected?
• what should you being doing to prepare?

What is the idea behind CSDD?

Environmental impacts arise throughout the supply chain, not just at production sites. Depending on the sector, around 80 percent of all CO2 emissions are estimated to occur in the supply chain (World Economic Forum 2022). By focusing on its supply chain, a company can therefore make far-reaching positive impacts on the environment and human rights.

For some time there has been a trend towards increasing environmental due diligence in supply chains, led by a combination of national law making, developments in international organisations and business initiatives. CSDD provides the foundation for a more cohesive framework within which to promote supply chain sustainability.

Correct. CSDD is a proposal within the EU legislative process and, in any event, has passed the deadline for becoming part of the body of retained EU law. In short, CSDD will have no direct applicability to the UK.

It’s significance for UK companies comes from the fact that:

• they may be indirectly affected by its requirements, (see below)

• despite currently having no plans to review its approach, the Government may find it difficult to ignore CSDD in a truly global economy, (particularly in a post-Brexit era where it has promised to be a global environmental leader and undertaken not to weaken national environment standards).

Who will the CSDD apply to?

‘Group 1’ EU Companies - EU limited liability companies with:

• more than 500 employees
• a net worldwide turnover of in excess of EUR150 million.

‘Group 2’ EU Companies - EU limited liability companies that:

• generate at least 50% of their net turnover in a defined high-impact sector*
• have more than 250 employees
• have a net worldwide turnover of in excess of EUR40 million.

Non-EU companies that are active in the EU - Non-EU companies that:

• are active in the EU
• have a net turnover generated in the EU that exceeds the net turnover threshold of group one or group two.

* Sectors with a high risk of human rights breaches or harm to the environment as listed in CSDD e.g., agriculture, food, textiles, extraction of mineral resources.

The European Commission estimates that 13,000 EU companies and 4,000 non-EU companies will be within the scope of the CSDD as currently drafted, producing;

• estimated one-off compliance costs of EUR 500 to 680 million
• ongoing annual compliance costs of EUR 1.72 to 2.37 billion

My company does not fall within the above groups — could it still be affected?

Small and medium-sized companies are excluded from the direct scope of the proposal, but they may be indirectly affected by virtue of being part of a larger company’s supply chain.

In fact, the EU’s Impact Assessment acknowledges that companies that are not under the scope of the initiative, (e.g. subsidiaries and value chain partners), will still bear indirect trickle-down costs.

So, consider the activities relating to the production of your goods or the provision of your services, (your value chain). Where you identify a company in your value chain within the scope of CSDD you may be indirectly affected.

CSDD applies to my company — what must it do?

Companies have a corporate due diligence duty to identify, bring to an end, prevent, mitigate, and account for negative human rights and environmental impacts in their own operations, subsidiaries, and value chains.

But what does that mean? In summary, affected organisations must:

• integrate due diligence into all policies — including measures to extend compliance to established supply chain relationships
• identify actual/potential adverse impacts from company operations on human rights and the environment — within the company and its supply chain
• act to prevent, mitigate and end any such adverse impacts — a requirement to take appropriate measures
• establish and maintain a complaints procedure
• monitor the effectiveness of due diligence policies
• publicise information on their approach to due diligence – including an annual statement published on their website.

Whilst the proposals still need to go through the formal process of review and amendment, if adopted CSDD must be transposed into national law by EU Member States within two years.

Each of the above will require careful consideration and, where possible, a period of bedding in ahead of the required deadlines.

Are any individual obligations imposed?

In addition to the above, CSDD introduces new personal duties on directors of EU Group 1 and Group 2 companies (see above) to:

• set up and oversee the implementation of due diligence processes and integrate them into the corporate strategy
• take into account the human rights, climate, and environmental consequences of their decisions in the short, medium, and long term, as part of their general duty to act in the best interests of the company.

What are the consequences if you don’t comply?

The CSDD will provide for a combination of sanctions and civil liability:

• sanctions — EU Member States will designate a regulatory authority to supervise and impose effective, proportionate, and dissuasive sanctions. These will include fines and compliance orders.
• civil Liability — victims will have a direct right to compensation for damages resulting from failure to comply with CSDD obligations.

What can we take from CSDD?

Companies are already working hard to consider the social and ethical dimensions of corporate behaviour embodied by the ESG movement and its increased focus upon supply chain due diligence.

CSDD signals an intent amongst European policymakers to play a greater role shaping corporate behaviour in this area, reflective of the significant role that global supply chains can play in respect of the environment and human rights.

Unavoidably, changes required by CSDD will require thought and will impose a significant cost on businesses. Adopting a narrow interpretation, this will impose an additional compliance consideration on many. A broader interpretation is that CSDD provides the foundation for the next stage of development in ESG strategy and corporate behaviours within supply chains.