The EU’s Corporate Sustainability Due Diligence Directive: A Turning Point for ESG?

6 March 2023

The issue of supply chain due diligence is at the forefront of the corporate agenda as more and more companies suffer financial and reputational damage as a result of their failure to conduct such due diligence effectively. These risks were highlighted in July 2021 when it was reported that Inditex, the parent company of Zara, and Sketchers were profiting from forced labour by sourcing clothing from factories in China where Uyghurs were interned (see Figure 1). Recognising the financial and reputational damage that these reports could cause, both Inditex and Sketchers released statements reiterating their zero-tolerance policy on forced labour.

Figure 1: A Themis Search investigation detailing adverse media surrounding Inditex SA following reports that they sourced clothing from factories where forced labour was used.

In February 2022, the European Commission announced that it had adopted a proposal for a Corporate Sustainability Due Diligence Directive (CSDDD). The CSDDD, which is expected to pass into law by the end of this year, is underpinned by a growing desire to foster responsible and sustainable corporate behaviour among companies. While a number of the EU’s Member States have already introduced similar legislation domestically, as seen in France with the Loi sur le Devoir de Vigilance, the EU has adopted the CSDDD to reduce reliance on unstandardized voluntary action. The CSDDD focuses on the following companies:

  • All EU limited liability companies with over 500 employees and €150 million in net turnover worldwide
  • EU limited liability companies that operate in defined high impact sectors and do not meet the above threshold but have over 250 employees and €40 million in net turnover worldwide
  • Non-EU companies that are active in the EU with turnover threshold aligned with those above, generated in the EU

and requires them to:

  • integrate due diligence into policies across the whole of their business
  • identify actual or potential adverse human rights and environmental impacts
  • prevent or mitigate potential impacts
  • bring to an end or minimise actual impacts
  • establish and maintain a complaints procedure
  • monitor the effectiveness of the due diligence policy and measures
  • and publicly communicate on due diligence

The CSDDD’s emphasis on appropriate measures and due diligence should therefore lead to more comprehensive efforts from companies to mitigate and prevent adverse human rights and environmental impacts across their supply chain. This should also reduce the incidence of associated financial crimes, namely environmental and wildlife crime and modern slavery and human trafficking (MSHT), as more rigorous checks by companies leave criminals with far less room than they currently have to profit from such crimes.

Companies may suffer financial loss if they fail to adhere to the directive as national administrative bodies can penalise them with financial penalties; those who fall victim to damage that could have been avoided with proper due diligence will also be able to launch civil claims against companies. Significantly, such cases invariably lead to reputational damage. The CSDDD has a broad scope by virtue of the fact that it applies to an eligible company’s subsidiaries and value chains in addition to their own operations. As a result, the CSDDD has been heralded for ensuring that governance frameworks give adequate attention to environmental and social risks in their decision-making as well as the externalities of these decisions.

While the CSDDD appears to be a momentous development at first sight, it has been reported that the Council of the European Union has currently agreed to exclude banks and investment funds from the directive. This would be a significant omission given that financial institutions lie at the heart of combating the likes of MSHT, enabling the flow of associated illicit funds. In addition, the effectiveness of the CSDDD is hindered further by its narrow scope; while small and medium-sized businesses (SMEs) may be affected indirectly by virtue of their involvement in a larger company’s supply chain, it does not apply to SMEs despite this group accounting for 99% of the companies in the EU.

If the imminent passage of the CSDDD into law has you concerned about the risks that your business may be exposed to, the Themis Supplier Risk Assessment can put you at ease. This newly released tool helps you identify and assess the specific financial crime threats your business is exposed to through your suppliers and third parties. Having your suppliers and other third party stakeholders complete the diagnostic will enable you to understand which of them represents the greatest financial crime risk to your business and in which area, be it in their governance framework and/or controls to mitigate specific financial crime risks, including modern slavery.

Themis’ Anti-Slavery Hub also provides complimentary guidance to financial institutions on the ways they can identify and tackle modern slavery and human trafficking by providing an array of resources, including digital learning and red flags. The Illegal Wildlife Trade Toolkit, meanwhile, mirrors this by providing financial institutions with free guidance on the ways they can identify illicit funds linked to the trade among other things.

If you would like to read further about the issue of supply chain due diligence, we’ve recently released a briefing note, No Firm is an Island: The Importance of Supply Chain Due Diligence, which you can read here.

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