“Neutered.” “Toothless.” “Watered down.” Those were just a few of the adjectives used to describe the final version of the Corporate Sustainability Due Diligence Directive (CSDDD) that was approved by the Legal Affairs Committee of the European Parliament, earlier this month. While the final version of the directive certainly reflected a compromise from the original proposal, businesses looking to keep themselves on the right side of history would be wise to focus less on how the CSDDD was scaled back and more on the significant changes they’ll need to make to comply with it.
The landmark piece of legislation establishes obligations for companies to identify, assess, prevent, mitigate, address and remedy actual and potential impacts on people and planet in their upstream supply chain and downstream activities. It places a particular emphasis on disclosures related to pollution and emissions, deforestation and damage to ecosystems and human rights issues such as child labor and forced labor. Importantly, it is the first major regulation of its kind to introduce a legally mandated standard for how companies conduct supply chain due diligence, and it could result in serious penalties for companies that do not comply. Among the possible penalties outlined in the directive are a public statement indicating the company responsible and the nature of the infringement and fines upwards of 5% of the net worldwide turnover of the company.
The Art of Deal
Under the final agreed terms, the directive will apply to companies with more than 1,000 employees and revenues of €450 million ($486 million) or more, and it will be phased-in over the course of three-to-five years. Most news reports following the final vote latched onto those numbers as a symbol of the weakening of the foundation of sustainability-oriented regulation. Yes, in fact, the 1,000-employee number was increased from 500 in the original draft, the revenue threshold was increased from €150 million and the phase-in period was extended. But that’s not really the point.
We’ve seen a similar phenomenon in reporting of the U.S. Securities and Exchange Commission’s (SEC) new climate disclosure rule and the European Green Deal, both of which have faced intense lobbying efforts that have eventually led to compromises. It’s not a particularly new concept. Regulators and legislators have been introducing aggressive reforms and negotiating them down since the Magna Carta.
What is new in the world of sustainability-related regulation is the perception that any ground given up by regulators in the negotiation process is a referendum on the perceived value of corporate sustainability writ large. In fact, if the CSDDD had been introduced initially with a focus on only the largest companies and a five-year phase-in period, no one would have called it weak. Quite the opposite, commentators and critics would have pointed to the fact that the directive’s core focus on the multinational supply chain would end up catching a lot more smaller companies in its net. They might also have noted that the companies in scope will have to dramatically overhaul their existing third-party risk management and supply chain due diligence processes to comply with the new standard.
What’s Really at Stake
At the core of the CSDDD is a demand for increased corporate transparency across the value chain. In practical terms, that means the big multinationals that will be subject to the mandate will need to get their suppliers – many of whom will be much smaller companies that do not fit the scope of the regulation – on board with delivering the same level of transparency around human rights and environmental impacts of their operations. That will no doubt force some difficult conversations with suppliers and some rigorous new vendor screening protocols.
The mandate will also introduce a standard set of benchmarks for evaluating sustainability risk, which will, in turn, provide more data and metrics for investors and consumers to continue to evaluate businesses through a sustainability lens. The end-result is a foundation of sustainability-oriented risk metrics that will ultimately link business fundamentals, such as profitability and earnings growth with environmental and human rights risks.
It should also be noted that this regulation also carries the requirement for “independent third-party verification of compliance.” So, transparency and scrutiny are also built into the very structure of the law.
Had a regulatory mandate like that been introduced even 10 years ago, jaws would have dropped at the boldness of its intent. Today, after two years of haggling over the particulars of the final package and in the midst of a brewing culture war that has made sustainability a controversial topic, most commentators have become a bit more cynical than that. But for the businesses at the center of this regulation, don’t be fooled: the CSDDD and the growing chorus of U.S. and European sustainability regulations are going to have a big impact, watered down or not.