EU Firms Liable For Supply Chain Performance Under New Due Diligence Directive
On the 23rd February 2022 the EU Commission adopted a novel proposal for a Directive covering corporate sustainability due diligence (CSDD), not to be confused with the proposed corporate sustainability reporting directive (CSRD), which is set to go live from the 2023 reporting year (see Verdantix: EU Corporate Sustainability Reporting Directive: Time To Gear Up For A Huge Opportunity). The new due diligence directive builds on the pre-existing responsibilities of members of the board and chief executives of EU-based firms, solidifying the due diligence process. What makes the directive unique is that it provides for both civil and private enforcement of its rulings, creating liability for board members and CEOs of offending firms.
The new directive will apply to all EU limited liability companies of ‘substantial size and economic power’, defined as those with over 500 employees and EUR 150m plus net turnover. Smaller firms which operate in high impact sectors – including textiles, agriculture, and extractives – will also need to conform to the directive. Non-EU based firms with turnover generated in the EU that aligns with the aforementioned categories will also fall under the new due diligence directive. In real terms, some 0.2% of all EU businesses will be impacted, totalling some 13,000 EU headquartered firms and 4,000 non-EU firms – far less than those impacted by the CSRD. SMEs are currently exempt from the directive.
Despite the fact that CSDD applies to a relatively small number of corporates, it’s impact could prove dramatic in driving change. The directive applies to a company’s own operations, subsidiaries, and value chains (defined as both direct and indirect ‘established business relationships’, covering both environmental impacts and human rights abuses. Firms will now be exposed to litigation risk from aggrieved parties across their supply chain; this could prove to be a potent mechanism for stakeholders to exert pressure on under-performing firms.
How will the directive impact corporate ESG reporting trends? Until firms receive clarity on the specifics of the directive – particularly on what constitutes ‘established’ business partnerships – expect firms to play a waiting game. It is also unclear to what extent data will need to be verified and assured, as is required by the CSRD and Green Bonds proposals. The effectiveness of the directive will hinge on the strength of penalties and sanctions faced by firms, and the exposure they may face to civil liabilities. 2021 saw Shell sued in the Netherlands for ineffective climate action by climate action group friends of the Earth; they have since followed with warnings to 29 other multinational firms. Such direct legal action could become a powerful mechanism for stakeholder dissatisfaction.. In the meantime, ESG-conscious firms should consider the role of technology vendors in boosting ESG performance across value chains, and prepare themselves for further supply chain reporting requirements, such as those proposed by the SEC.