The EU’s Due Diligence Directive ushers in a new era of more responsible supply chains

With the EU Corporate Sustainability Due Diligence Directive (CSDDD) now approved by the European Parliament, companies will face renewed scrutiny to demonstrate accountability for social and environmental impacts that they, their subsidiaries and their supply chain partners are responsible for.

Although not coming into force for at least for two more years,* CSDDD establishes obligations that will require businesses to identify, prevent or at least mitigate and finally terminate adverse impacts on human rights (such as forced labour, and inadequate workplace health and safety) and the environment (greenhouse gas emissions, biodiversity loss, waste disposal). Furthermore, by mandating certain corporate due diligence measures and duties, it is hoped that CSDDD will also improve corporate governance practices and encourage a culture of responsible behaviour.

In that regard, CSDDD will work in tandem with the Corporate Sustainability Reporting Directive (CSRD), effective for some companies from 2025 (based on FY 2024 data), although, as the name implies, CSRD requires setting up disclosure procedures in support of sustainability statements, whereas CSDDD is aimed at holding companies accountable for due diligence failures.

As with CSRD, there are applicability criteria that determine the point at which businesses fall under the CSDDD; these are:

• EU companies with more than 500 employees and a global turnover of €150 million+ (such companies also need to have a plan to ensure that their business model and company strategy are compatible with limiting global warming to 1.5°C in line with the Paris Agreement).
• Non-EU companies that generated turnover of €150 million+ in the EU market.
• EU companies with more than 250 employees and a global turnover of €40 million+, with 50% generated in a high-risk sector.
• Non-EU companies that generated turnover of €40 million+ in the EU market, with 50% generated in a high-risk sector.

(Here ‘high risk’ is defined as textiles, leather, clothing, footwear and related products; agriculture, forestry, fisheries and food products; and mineral resources, metal products and chemicals.)

Companies found in violation of CSDDD will be subject to sanctions, including fines and compliance orders, and victims impacted by any malpractices will be owed compensation.

So how can businesses best ensure they can plan for the impact of CSDDD?

Plan

CSDDD requires the development of a due diligence policy, setting out a company’s approach to due diligence on adverse human rights and environmental impacts for which it, its subsidiaries and its supply chain partners are responsible. Such a due diligence policy will require input from a number of internal stakeholders, from Procurement to HR to Operations, possibly via a dedicated committee or working group, so it can be better integrated into corporate strategy. It is also important to consider how progress is incentivised, with opportunities to review remuneration criteria for key internal stakeholders. For example, for Group 1 companies, if executive pay is currently linked to the contribution of a senior manager to the company’s business strategy, long-term interests and sustainability, then variable remuneration will need to be set with the company’s climate mitigation plan in mind.

Identify

The directive ensures that the company is held to account for its impact across all tiers of the supply chain, which will be a departure for companies that historically have focused on the impact of their top supply chain tiers via the lens of spend. Companies will need to undertake deeper evaluations of the types of issue they impact, working with key stakeholders to identify the causes and develop solutions for tackling them. It may mean developing more detailed human rights policies to outline obligations,and establishing mechanisms for reporting human rights and/or environmental concerns.

Most companies already have in place some level of contractual obligations with their supply chain partners to ensure certain levels of standards are maintained, but this will need to be reviewed in light of the breadth of issues that CSDDD will bring in. Companies should also think about how supplier compliance is audited, and whether all of the supply chain has appropriate resources to comply with new standards (possibly assigning budget to support smaller partners).

Prevent

If areas are identified where there is potential risk, it is important that a preventative action plan is developed with affected stakeholders. This will provide a deeper level of understanding than simply relying on data platforms, which may show trends but omit any situational context.

Mitigate (and terminate)

Where adverse impacts are identified, companies will need to minimise or even stop activity, depending on the issue and severity of impact. This will once again require an understanding of the issues, and collaborating with key stakeholders to design solutions. If suppliers do not comply with standards and mitigation plans, then companies need to consider how to exit such business relationships and seek compensation/damage from the suppliers for the affected stakeholder groups.

Report

Companies will be required to report year-on-year progress on their due diligence approach and the effectiveness of the measures in place. This will mean collaborating closely with the supply chain and key stakeholders, to build transparency in reporting.

The European Commission’s ambition is that CSDDD be integrated into relevant policies, measures and duties with respect to harm (companies will have to comply with the rights and prohibitions included in the list of international treaties listed in the CSDDD). In doing so, it will force businesses to truly account for impacts, and while many will see this as an added compliance burden, it should also be viewed by companies as an opportunity to develop greater engagement with suppliers and key stakeholders in the communities in which they operate.

Given that Covid-19 caused such a seismic disruption to ‘business as usual’, CSDDD should be considered as a means to strengthen supply chain resilience and identify innovative new business models, while raising standards in countries with weaker regulations and building trust in brands.

*Depending on the timeliness of the legislative procedure, the CSDD Directive is expected to be transposed by Member States into their national legislation by 2025-26, due to the two-year implementation period of EU directives.

 

Author: David Fatscher, Director – ESG Strategic Advisory