It has now been just over a year since the European Commission adopted its landmark proposal to introduce corporate environmental and human rights due diligence obligations. We report on how the proposal is progressing and its interaction with national initiatives across the EU.
It has now been just over a year since the European Commission adopted a proposal for a Directive on corporate sustainability due diligence (the "Proposal", which we reported on here). Since then, there have been significant developments in human rights and environmental due diligence obligations for companies, both at a jurisdictional and EU-wide level. Several regulatory due diligence requirements in various EU Member States have been proposed or come into force (including the German Act on Due Diligence in Supply Chains) and, at the EU level, the proposed EU Corporate Sustainability Due Diligence Directive ("CS3D") continues through the legislative process.
This update covers:
- the status of the CS3D and expected timing for its approval and implementation;
- the substantive areas of the CS3D that are under debate between the European Commission, Parliament and Council; and
- national due diligence initiatives being developed across the EU, alongside the EU-wide CS3D process.
With approval originally expected by early 2024 and implementation by early 2026, the CS3D continues advancing through the different stages of the legislative process. A few months ago, the Council adopted its negotiating position on the Commission's Proposal, suggesting substantive changes to its scope of application and liability provisions, among others.
However, adoption of CS3D is being delayed by failure of EU legislators to agree on the regulation of directors' duties and the application of the CS3D to financial institutions. In this regard, although the Parliament's position is yet to be defined (it is expected in the next few months), Member States – through the Council – have expressed their support to exclude these matters from the CS3D.
Meanwhile, several Member States are developing their own environmental and human rights due diligence initiatives, such as Germany, whose "Supply Chain Law" entered into force on 1 January 2023, and the Netherlands, where several political parties formally submitted an amended due diligence bill on 2 November 2022. In others, however, the legislative process seems to be stalled – this is the case in Spain, where the topic seems to have dropped of the national legislative agenda.
In any case, whether under the CS3D or independent national legislation; and whether due to direct application of these regulations or as part of the value chain of an undertaking subject to them, companies will most likely have to comply with environmental and human rights due diligence obligations sooner rather than later.
THE CS3D: STATUS AND EXPECTED APPROVAL
The European Commission adopted the Proposal in February 2022 and, in November 2022, the European Council (the “Council”) adopted its negotiating position (general approach) on the Proposal.
The Council's suggested changes to the Proposal relate to:
- Scope of application: The Council proposes a phased-in approach to the application of the CS3D, with only very large companies expected to comply initially.. The Council does not propose any changes to the thresholds defining a “very large company” as set out in the Proposal (for EU companies, over 1,000 employees and €300 million net worldwide turnover or, for non-EU companies, €300 million net turnover generated in the EU).
- "Value chain" vs "chain of activities": The Council proposes that the Commission's "value chain" concept be replaced with a new "chain of activities". The latter has a narrower meaning and focuses solely on the company's suppliers and omits most downstream activities (such as the provision of the company's services or the use of its products).
- "Business partner" vs "(established) business relationships": The Council proposes that the Commission's definition of "(established) business relationship" be replaced by a definition of (direct and indirect) "business partners". This, according to the Council, is more aligned with international standards and would entail a prioritisation of the adverse impacts based on their severity and likelihood, allowing companies to first address the most significant ones before moving on to less significant ones.
- Application to financial undertakings: The Council proposes leaving it up to Member States to decide whether the CS3D obligations should apply to companies in the financial sector.
- Due diligence at group level: The Council proposes a new provision allowing parent companies to fulfil due diligence obligations on behalf of subsidiaries falling within the scope of CS3D.
- Directors' duties: The Council proposes the removal of provisions related to directors' duties, including the requirement to link directors’ variable remuneration to the long-term interest and sustainability of the company, and the imposition of a duty on directors to establish and oversee the due diligence actions of their companies.
- Civil liability: The Council has sought to clarify the circumstances where a company could be held liable under the CS3D, specifying that victims of human rights and/or environmental adverse impacts would be entitled to full compensation when the following four conditions are met: (i) damage is caused to a natural or legal person; (ii) there has been a breach of due diligence obligations; (iii) there is a causal link between (i) and (ii); and (iv) there is fault (intention or negligence).
The European Parliament must now determine its initial negotiating position on the CS3D, which is expected in the new few months.
Then, the European Parliament and the Council will negotiate to arrive at a final and agreed text, after which Member States will have two years to transpose the CS3D into their domestic legislation.
CHANGES CURRENTLY UNDER DEBATE
There is no doubt that there is commitment and will on the part of each of the co-legislators to introduce obligations on companies to undertake human rights and environmental due diligence. However, there are a number of significant points of contention between them, in particular in relation to directors’ duties and to whether the obligations should apply to financial institutions, which are delaying the adoption of the CS3D.
Under the Proposal, the directors' duty to act in the best interests of the company would have to consider, where relevant, consequences on the environment, climate change and human rights, including in the short, medium and long term.
On top of this, in those cases where directors' variable remuneration was linked to their contribution to the company's business strategy and long-term interest and sustainability, this would have to consider the company's climate transition plan (including, where applicable, the contribution to emission reduction objectives).
However, the Council's general position removes these provisions, arguing that the form and structure of directors' remuneration are matters primarily falling within the competence of the company and its relevant bodies or shareholders.
Application to financial institutions
Similarly, the inclusion of the financial sector within the scope of the CS3D is the subject of significant debate among EU institutions and Member States.
Under the Commission's Proposal, the financial sector would be required to conduct due diligence in the pre-contractual phase (i.e., before entering into contracts with business partners). However, as mentioned above, Member States opted to carve out financial services from mandatory due diligence obligations in the Council's negotiating position. In any event, replacing the concept of "value chain" with "chain of activities" (as the Council proposes) would exclude most of the downstream part of the value chain, and would therefore render the due diligence requirements for banking and investment institutions negligible in practice.
Whilst the Parliament's approach on this point has not yet been defined, most of the committees so far seem to lean towards including mandatory due diligence rules for the financial sector, albeit with different scopes. For instance, the trade committee's approach is aligned with the Proposal (i.e., limiting the due diligence exercise to "the activities of the clients receiving such services, and the subsidiaries thereof whose activities are linked to the contract in question"), whereas the economic affairs committee states that "the activities of the companies or other legal entities that are included in the value chain of that client should not by priority be covered to avoid the overlap of due diligence exercises of regulated financial undertakings that have partially overlapping value chains".
However, the committee on legal affairs considers that financial institutions should be excluded, stating that "[d]ue to the specificities of the financial sector, the additional hinderances of tracing their chain of activities beyond the first tier and the regulatory overlap with the CSRD, taxonomy, sustainable finance and other proposals, the financial sector should not be covered here".
In parallel to the negotiations relating to CS3D, there are several regulatory initiatives across EU Member States relating to environmental and human rights due diligence.
Following the 2017 introduction of the French Duty of Vigilance Act – which was the first regulatory intervention of this kind – other countries have taken steps to introduce similar regulations.
As we reported here and here, Germany was among the first to go down this road. The German Supply Chain Due Diligence Act obliges companies to take measures to identify and prevent human rights and environmental risks and impacts in their business activities and supply chains. The German Act entered into force on 1 January 2023 for enterprises with more than 3,000 employees (and it will enter into force on 1 January 2024 for those with more than 1,000 employees).
Momentum is also building in the Netherlands. As reported here, on 2 November 2022 several Dutch political parties formally submitted an amended bill for the Responsible and Sustainable International Business Conduct Act to the Dutch House of Representatives. If passed, the bill would require large undertakings (as defined by the EU Accounting Directive) to implement due diligence processes to investigate, prevent, mitigate or terminate the potential and actual adverse impacts of their activities and those of their business relationships on human rights and the environment in countries outside the Netherlands. This bill would supersede the Dutch Child Labour Due Diligence Law, which required companies to investigate whether their goods or services had been produced using child labour but which has not come into effect, apparently in view of the government's intention to introduce a broader due diligence law.
However, there are other countries where the legislative process seems to have come to a complete halt.
This is the case in Spain, where the topic seems to have dropped of the national legislative agenda. As we reported here, Spain included in its 2022 Annual Legislative Plan the approval of a law requiring companies to undertake due diligence “to guarantee business practices supporting sustainability and human rights”. The consultation on the proposal ran from 14 February 2022 until 3 March 2022.
Since then, there have been no further developments (nor news on the outcomes of the consultation process), and – for reasons unknown – Spain's Annual Legislative Plan for 2023 no longer foresees any regulatory initiatives concerning sustainability due diligence.
WHAT TO EXPECT NEXT
The adoption of rules requiring companies to conduct environmental and human rights due diligence processes across their value chains continues to be a priority on the European legislative programme.
It is expected that these obligations will be imposed via independent national legislation – as has been the case so far in France and Germany – and via the national implementation of the CS3D in due course. How this patchwork of regulation will interact remains to be seen. However, it will be important for companies within the scope of various due diligence requirements to understand the similarities and differences between them, so as to develop systems and processes that ensure compliance with all requirements with as much efficiency as possible.
Aside from direct impacts, there will also be indirect impacts. Even where companies are not required themselves to comply with European due diligence regulations, they may be part of the value chain of a company subject to those laws. In those cases, they are likely to be required to provide information and comply with certain standards in order that other businesses can comply with their upstream due diligence obligations.