CSDDD: ‘a critical opportunity to accelerate the net-zero transition’

Investment professionals have indicated that the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) is a critical opportunity to encourage behavioural changes within companies that will help investors deliver impact on the real economy to accelerate the net-zero transition.

CSDDD establishes a corporate due diligence duty for companies to identify, prevent, end or mitigate the negative impacts of their operations on people and the environment. The directive will apply to a company’s own operations, its subsidiaries and their supply chains, including direct and indirect business relationships.

The directive aims to support the EU’s transition to a green economy, with the European Parliament set to adopt a formal negotiation position on it in March/April 2023.

Emily Murrell, climate policy programme director at the Institutional Investors Group on Climate Change (IIGCC), told Net Zero Investor: “CSDDD presents a critical opportunity to encourage the long-term perspectives and behavioural change that we need to accelerate the transition to a net-zero economy.”

Importance for investors

Murrell highlighted that the directive is important for investors as it sets out obligations for companies to adopt and implement transition plans to align their business model and strategy with a 1.5°C world and the goals of the Paris Agreement.

“These proposals will underpin the transition plan disclosures that will need to be made under the EU’s Corporate Sustainability Reporting Directive (CSRD) with robust frameworks and processes, better enabling investors to assess their holdings’ capacity to align with net zero and informing investment decisions and capital allocation,” Murrell added.

She suggested that carrying out due diligence can enable investors to gain a deeper understanding of their exposure to sustainability-related risks stemming from their portfolios as well as how effective their holdings are at identifying and managing them.

Companies in the scope of CSDDD include all EU limited liability companies with 500 or more employees and €150m or more in worldwide net turnover (group one) as well as limited liability companies operating in defined high-impact sectors, including mining and extractives, agriculture and textiles, that have more than 250 employees and a net turnover of €40m or more worldwide (group two).

The directive will also apply to non-EU companies that are active in the EU and have an EU-generated turnover threshold aligned with groups one and two. Small and medium enterprises are not directly in scope for the proposal.

Human rights focus

Part of the CSDDD’s aim is to also anchor human rights in companies’ operations and corporate governance. Elise Attal, head of EU policy at the Principles for Responsible Investment, said that meeting human rights expectations leads corporates and investors to “more effectively and proactively” manage a range of environmental, social and governance (ESG) issues.

She told Net Zero Investor: “With regards to net zero, strong environmental and human rights due diligence processes will help investors support a transition that is just, but also delivers impact on the real economy and aligns with the UN Sustainable Development Goals.”

Going beyond existing regulations

Attal also detailed that CSDDD will help investors better manage ESG impacts and risks as it goes beyond current European regulations such as the Sustainable Finance Disclosure Regulation (SFDR). This is because SFDR requires financial market participants to have a due diligence policy. However, the requirements for what is included in the policy are “based on descriptions instead of actions”.

SFDR is also a disclosure framework, so there is no requirement for companies to carry out due diligence, just to be transparent about the due diligence being undertaken.

“Conversely, the CSDDD requires regulated financial undertakings to carry out due diligence, based on a set of specified actions and a comprehensive approach in line with international standards.

“CSDDD represents a political opportunity to create a level playing field in the EU and raise the ambition by creating behavioural change requirements for financial and non-financial companies,” Attal added.

CSDDD ‘offers more teeth’

Guillaume Croisant, managing associate at Linklaters’ ESG practice, echoed Attal’s point. He said that CSDDD “offers more teeth to due diligence duties than existing soft law instruments, which it will be hoped leads to more impact on the ground”.

He detailed that CSDDD should play a “complementary role” to other current regulations, which are related but have different scopes and intentions.

“The CSDDD as proposed by the European Commission would be of more general application and would mark a shift from a ‘duty to report’ to a ‘duty to act’, as it would require companies to identify and address the adverse environmental and human rights’ impacts of their operations, their subsidiaries and their business relationships,” he added.

However, Croisant noted that CSDDD still has some way to go before it becomes law, as a compromise must be reached among the EU institutions, while the European Parliament has to adopt its formal negotiation position. “Further, potentially significant, changes should be expected before the regime is finalised.”

In December, the Council of the EU’s general approach towards the regulation was adopted, which proposed strong exemptions for financial undertakings. One of the decisions favoured by the council was to leave it to each member state to decide whether CSDDD will regulate the provision of financial services by financial undertakings.

The Council also suggested a phased-in approach to implementation. Very large companies (EU with more than 1,000 employees and greater than €300m net worldwide turnover) and non-EU (greater than €300m net turnover in the EU) would be required to comply within three years after the directive comes into force. Large EU and non-EU companies meeting the scoping criteria would then be required to comply after four years and high-risk EU and non-EU companies after five years.

‘Urgent need to strengthen’ CSDDD

Both Attal and Murrell suggested that there remains “an urgent need to strengthen and extend” CSDDD’s climate-related provisions, and to “truly support investor’s net-zero objectives”.

Attal said: “The text needs to be significantly improved and tailored to take into account the specificities of different investment strategies and asset classes.

“Regulators must provide specific guidance on how to conduct due diligence depending on asset classes specificities, with clear indication of what should be done when potential or actual human rights violations are identified.”

Whereas Murrell pointed out that, at present, only certain companies in the scope of CSDDD are required to adopt transition plans, and there is minimal detail as to how companies should adopt these plans in practice.

“IIGCC believes that all companies in the scope of CSDDD should be required to adopt transition plans and that these should be fully coherent with the reporting requirements established under CSRD and the forthcoming European Sustainability Reporting Standards,” Murrell added.