What Is The CSDD Directive And How Will It Impact Issuers?

The European Commission has often communicated its commitment to encouraging corporate sustainability. And this mission has manifested itself in a number of pieces of legislation regarding how companies report their efforts in this regard. 

• The Non-Financial Reporting Directive (NFRD) of 2014 required large companies to report on their environmental, social and governance (ESG) strategy, including their performance on sustainability matters and the impact they have.
• The Sustainable Finance Disclosure Regulation (SFRD) from 2021 provided a standard framework by which investors could compare the sustainability of products more easily.
• The Corporate Sustainability Reporting Directive (CSRD), which came into effect in 2024, expanded on NFRD and brought more companies into scope, with more stringent reporting requirements.
• The Corporate Sustainability Due Diligence (CSDD) Directive, which was approved by the EU Council in March 2024 and adopted in the European Parliament a month later.

The reason behind this focus is, in the words of the European Commission: 

“The actions of companies have significant impacts on the lives of citizens in the EU and around the world. Not just in terms of the products and services they offer or the jobs and opportunities they create, but also in terms of working conditions, human rights, health, the environment, innovation, education and training.”

This article explores the CSDD Directive, its objectives, requirements and what it means for issuers. 

What is the EU Corporate Sustainability Due Diligence Directive (CS3D or CSDDD)?

EU Member States have two years from April 2024 to transpose the EU Corporate Sustainability Due Diligence Directive into national law. Once in effect, it will require in-scope organisations to implement a robust due diligence process into their environmental and human rights efforts as well as those of their subsidiaries and the entire value chain. 

Another facet of the directive is to require companies to develop, adopt and implement a climate plan that ensures their business activities are in-keeping with the Paris Agreement commitment to limiting global warming to 1.5 °C. 

The CSDDD is part of the European Green Deal, which promoted responsible corporate activity across the union. By complying with this latest legislation, it will be easier for in-scope organisations to meet the requirements of other laws such as CSRD and the EU Taxonomy Regulation.  

What are the main objectives of the CSDD Directive?

MEP Lara Wolters referred to the passing of the directive into law as “a milestone for responsible business conduct and a considerable step towards ending the exploitation of people and the planet by cowboy companies.”

The objectives of the directive include: 

• Standardising the legal framework for sustainability efforts 
• Encouraging improved risk management and flexibility
• Increasing the awareness of companies’ impacts on the environment and human rights
• Improving customer trust in organisations’ sustainability efforts
• Increasing the attractiveness of organisations to sustainability-conscious talent and investors 
• Encouraging a focus on innovation
• Facilitating access to additional funding opportunities
• Improving the environment for future generations
• Encouraging better working conditions across the world
• Increasing awareness of sustainability issues.

The intention is to implement practices that will help the world maintain the Paris Agreement commitment on climate change, reduce pollution and slow biodiversity loss. In addition, the directive is also aimed at combatting activities such as slavery, child labour and labour exploitation.

Who does the CSDD Directive apply to?

The CSDD Directive applies to European Union companies, and non-EU parent companies that have operations within the union, with more than 1,000 employees and a worldwide turnover greater than €450 million. 

CSDD Directive timeline

However, not all companies will fall into the scope at the same time. The directive will be applied gradually in the following manner: 

Although small and medium enterprises (SMEs) are not directly within the scope of the directive, they may be indirectly affected as part of a larger company’s value chain. 

Key requirements of the CSDD Directive for companies 

The directive requires companies to identify and mitigate risks related to environmental and human rights issues. Articles 5 to 11 of the directive use the OECD Due Diligence Guidance for Responsible Business Conduct as a basis for this process. 

The six-step due diligence process 

This requires companies to follow this six-step due diligence process:

1. Embed due diligence into company policy

Review your current policies regarding sustainability topics such as climate change and human rights to make sure they are robust enough. 

You should then ensure the due diligence processes for the significant risks faced by your organisation are documented and that you have communicated this to employees and value chain entities through a code of conduct. Explain how you will implement these processes and make this information publicly available.

2. Identify the actual and potential adverse impacts

Consider the exact risks that result from the operations of your company and its value chain. Look at each area of operation and assess the actual and potential adverse impacts on environmental and social aspects. 

Some of these risks may be obvious, but others might not. In these cases, consult with government reports, environmental campaign groups, trade unions and even your own records of complaints made through internal whistleblowing channels. 

By understanding the relevant risks and potential impacts, you can prioritise your due diligence efforts accordingly. 

3. Stop, mitigate and prevent adverse impacts

The company has a responsibility to stop any adverse impacts that its operations are having on sustainability factors. For potential adverse effects, it should create a prevention action plan setting out targets and deadlines for implementation. Where this refers to the actions of business parties in the value chain, the company should seek contractual assurances that partners will comply. 

In addition, where the business partner is an SME that might struggle to afford the measures needed to prevent the adverse impact, the company should provide support to enable them to do so.

Where an adverse impact cannot be fully prevented, the company should seek a way to mitigate its effects. When it is neither possible to prevent or mitigate an impact in the value chain, the company should terminate the relationship or suspend it, if allowed by local law. Otherwise, it should commit to not enter a new agreement with that partner or to extend the current contract. 

4. Create a complaints procedure

Companies should encourage a speak-up culture by developing a complaints procedure where employees, affected persons, workers’ representatives and civil society organisations can report adverse impacts of the company’s operations on the environment and human rights. 

You should publish your procedures and inform stakeholders of the process by which they make complaints, the company considers them and reports back on them. You should allow complainants to request a follow-up on investigations and the opportunity to meet with representatives of the company to discuss their concerns. 

5. Monitor performance

Companies are required to carry out periodic assessments of their performance with regard to the directive. This should include activity within the business as well as its subsidiaries, business partners and the value chain. 

They should take place at least annually and use qualitative and quantitative indicators to report on the way that stakeholders identify, cease, mitigate and prevent adverse impacts on sustainability elements. However, where there is a strong case to suggest adverse impacts are occurring, the company should immediately implement an assessment. 

Use the results of the assessment to update your due diligence policy. 

6. Communicate outcomes

The company should publish an annual statement on its website regarding its due diligence policy and performance in relation to that policy. The exact content requirements will be established at a later date by an implementing act, and the report should be published by April 30th each year. 

Directors’ responsibilities

Under the directive, directors have a duty to integrate due diligence into company strategy and to set up and oversee the due diligence process. In addition, as part of their regular board work, they should take into account the impact of all decisions on environmental and social matters. 

Impact on issuers

The directive will impact on issuers in the following ways: 

• They will have to ring-fence significant resources for establishing and operating due diligence processes. In addition, there will be transition costs to bear, including changing operations and supporting value chain partners to comply with the obligations.
• Increased transparency through reporting. When companies are compelled to show their procedures for carrying out due diligence and the results of their efforts, they improve the transparency for shareholders who want to consider the risks of their investments.
• Issuers can be held legally accountable for failing to stop, prevent or mitigate the human rights and environmental risks in their value chain. This legal liability requires close consideration from compliance teams in order to adhere to the law
• The opportunity to improve investor perception through compliance with the CSDDD, showing a commitment to sustainability and ESG. This can lead to a competitive edge. However, the opposite can also be true if the company falls short in its efforts. 
• Potential financial and operational impacts if the company is required to invest in new technologies and partnerships to meet its obligations. Support for smaller companies within the value chain could also prove costly. 
• Emphasis on strategic partnerships and supply chain management to align all stakeholders with your due diligence policies. This requires additional communication efforts and the possibility of having to renegotiate contracts and conduct regular audits. 

What are the consequences for companies failing to comply with the CSDD Directive? 

Member States are charged with designating an authority to supervise the implementation of the directive. They can impose “effective, proportionate and dissuasive sanctions” on non-compliant companies. This could mean receiving compliance orders or financial penalties. Organisations can be named and shamed, with fines allowable of up to 5% of the company’s net worldwide turnover. 

Companies are also legally liable for compensating victims of the adverse impacts of their operations and failure to follow the requirements of the directive. 

FAQ

How does the CSDDD differ from CSRD?

CSDDD and CSRD both aim to encourage companies to consider the impact of their operations, but they do so in different ways. CSDDD is about carrying out due diligence to prevent adverse impacts and monitoring the success or otherwise of that process. CSRD monitors performance in a range of areas related to ESG. The two directives complement each other in such a way that compliance with CSDDD is likely to lead to improved performance against CSRD. 

How does the CSDD Directive complement existing EU sustainability regulations?

CSDDD is a good filter through which companies can hone their approach to ESG matters. It helps companies develop the correct culture to allow them to comply with other sustainability legislation. 

How does the EU CSDDD impact organisations outside the EU?

If non-EU companies have operations within the EU that meet the scope of the directive, they will have to comply with the requirements of the directive for those subsidiaries. For supply chain entities outside of the EU, the in-scope company with which they partner should ensure that they meet the requirements in order to fulfil their own obligations, too.