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On 14 December 2023, the European Council and the European Parliament announced that they reached a provisional agreement on the text of the highly anticipated Corporate Sustainability Due Diligence Directive (CS3D), on which we have previously reported. If adopted, CS3D would impose obligations on large companies in relation to their actual and potential adverse impacts on the environment and human rights, whether arising from their own operations or those of their subsidiaries and business partners.
The finalised text has not yet been published but it is understood that the points below are now agreed. Even once published, the long journey of CS3D will not be completed until transposition within Member States' laws. The difficult work for companies (including the financial services sector) to implement the requirements is also only just beginning. We are expecting companies to face difficult interpretational and strategic challenges along the implementation journey, together with some heavy lift in undertaking gap analyses, reviewing and updating policies and procedures, renegotiating supplier agreements and upgrading governance frameworks.
Companies in scope of the CS3D (see below) will have to integrate due diligence into their policies and risk-management processes. In particular, in-scope companies will have to identify, assess, prevent, mitigate, bring an end to, and remedy actual and potential adverse impacts on the environment and human rights from their own operations, those of their upstream business partners, and those that stem from specified downstream activities, including the distribution and recycling of their products. The CS3D had previously envisaged an express duty on directors to establish and oversee the relevant due diligence policies; this particular provision will apparently not be included in the finalised text.
Companies that identify actual or potential adverse impacts on the environment or human rights by their business partners will be required to undertake steps to eliminate or mitigate these impacts. As a last resort, they must terminate those business relationships if the adverse impacts cannot be prevented or brought to an end (as the case may be).
Companies will also be required to communicate their due diligence policies, monitor their effectiveness, and conduct meaningful engagement with stakeholders affected by their actions, including through the establishment of a complaint mechanism.
The CS3D will apply to:
Non-EU companies will benefit from a three-year phase-in period from entry into force of the CS3D. To aid non-EU companies to identify their duties, the European Commission (Commission) will be required to publish a list of non-EU companies within scope of the CS3D. Notably, previous drafts of the directive had envisaged lower turnover thresholds for companies operating in specific high-risk sectors. It is currently unclear whether the final text will still include specific rules for these sectors.
The inclusion of the financial services sector has been a particularly controversial point and one closely monitored by the industry. Where we appear to have landed, based on statements from a press conference following the announcement of the provisional deal, is that financial institutions would fall within the scope of the CS3D but only with respect to their own operations and those of their upstream business partners (but not their downstream client activities). They would also be subject to the transition plan requirements (see below). The provisionally agreed text reportedly includes a future requirement for the Commission to conduct an impact assessment focusing on how the downstream activities of financial institutions may be included within the scope of the CS3D.
Persons affected by adverse environmental or human rights impacts of in-scope companies will be able to bring claims for civil liability within five years. This seeks to further reinforce access to justice by amending, compared to earlier drafts, the provisions relating to disclosure of evidence, injunctive measures and costs of proceedings for claimants.
As things stand, the informally agreed text is said to strengthen provisions relating to the obligation under Article 15 of the CS3D for in-scope companies to adopt and "put into effect" a climate transition plan. This includes time-bound emissions reduction targets and information on alignment with the Paris objectives.
Companies that fail to comply with the CS3D and fail to pay the fines imposed on them will be subject to several injunctive measures. These measures take into consideration the turnover of the company and impose additional financial penalties (of up to 5% of the company's net turnover).
CS3D will now need to be finalised by technical negotiators prior to its publication. Once published, it must be formally endorsed and adopted by the European Council and European Parliament before it enters into force. Once in force, EU Member States will have two years to transpose the CS3D into their domestic legislation.
The finish line of the political and legislative process merely marks the beginning of a new paradigm for human rights and environmental due diligence. Companies falling within scope of the CS3D will need to review their existing policies and processes to ensure compliance with the requirements to be introduced under the CS3D.
With thanks to Shannon Smyth for her contribution to this insight.
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2024