The new rules would oblige companies to integrate their human rights and environmental impact into their management systems.
On December 14, 2023, the European Council (Council) and European Parliament (Parliament) reached provisional agreement on the Corporate Sustainability Due Diligence Directive (CSDDD). The agreement follows an extensive negotiation processes, which began in June 2023, after the European Commission had initially proposed the CSDDD in February 2022.
The CSDDD’s key aim is to enhance the protection of the environment and human rights globally. The CSDDD as proposed will set obligations for companies regarding the actual and potential adverse impacts of their own operations, those of their subsidiaries, and those carried out by business partners, described as the “business chain of activities.” The CSDDD would also establish a requirement for large EU companies to adopt a plan to ensure that their business model and strategy are compatible with the Paris Agreement, i.e., including concrete targets and measures in line with limiting global warming to 1.5 °C.
The proposed CSDDD would establish rules on penalties and civil liability for infringements (although these will ultimately be set by Member States).
Scope of Application
The CSDDD as currently proposed would apply to the following entities:
- “Large” EU companies that have more than 500 employees and a net worldwide turnover of at least €150 million
- EU companies that operate in specific high-impact sectors, have more than 250 employees, and generate a net worldwide turnover of at least €40 million (with more than 50% of turnover being generated in a high-risk sector)[i]
- Non-EU companies and parent companies with equivalent (i.e., more than €150 million, or more than €40 million with 50% generated in a high-risk sector) turnover in the EU
In this way, the CSDDD is clearly intended to apply to companies active in the EU market, even if the company is headquartered outside of the EU. The CSDDD would therefore have the extra-territorial effect that has been the subject of much discussion and which has been considered controversial. The rules would apply from 2027 at the earliest.
Approach to Financial Institutions
The extent to which financial institutions are included in the CSDDD has been a key area of negotiation. The Parliament’s proposal explicitly included the financial sector (with certain carve-outs), in contrast to the Council’s position, which would have allowed Member States to decide on the CSDDD’s applicability to financial services.
According to the provisional agreement, financial services companies (including insurers and asset managers) would be subject to obligations in relation to their upstream supply chain, and also face requirements regarding adopting and effecting a transition plan for climate change mitigation. However, the compromise is that investment and lending activities will be excluded from the scope of CSDDD. This approach will be reviewed two years after the CSDDD comes into force to decide whether financial institutions should also be covered by downstream diligence requirements.
Requirement for a Transition Plan
Rapporteur Lara Wolters confirmed that large EU companies in scope of the CSDDD will be required to not only draft, but also take steps to implement a transition plan for climate change mitigation. The announcement was made in order to avoid the potential issue of companies drafting, but not taking steps to adopt, changes to their business model and strategy.
Further, company director remuneration of such companies will have to reflect how well the plans have been implemented, and Member States will be required to include this provision in their implementing regulation.
Supervision and Enforcement
Each EU country will designate a supervisory authority to monitor compliance obligations. Companies will be liable for breaching due diligence obligations, and any party that was adversely impacted will have the right to be compensated for damages.
The provisional deal includes the potential for pecuniary penalties that Member States will need to include when implementing the Directive into national legislation. The agreement notes that the maximum penalty for non-compliance should be at least 5% of the company’s net turnover.
Small and medium-sized enterprises (SMEs) are out of scope of obligations in the provisional agreement. However, they may still be caught in the value chain obligations and therefore indirectly be impacted by the CSDDD. Commissioner Didier Reynders confirmed available support in terms of technical assistance and advice on fulfilling obligations, in corporation with the supervisory bodies across the Member States.
The provisional agreement now needs to be endorsed and formally adopted by the Council and Parliament. Following adoption, Member States will have two years to implement the CSDDD into national legislation.
Latham & Watkins will review the draft text of the legislation when made available, and continue to monitor developments in relation to the CSDDD and other legal initiatives on supply chain due diligence in the EU and globally.
[i] In this context, high-risk sectors refer to manufacture and wholesale trade of textiles, clothing and footwear, agriculture including forestry and fisheries, manufacture of food and trade of raw agricultural materials, extraction and wholesale trade of mineral resources, or manufacture of related products and construction.