The clock is ticking on a sweeping new European corporate due diligence regime that will impact thousands of European and foreign companies doing business in the bloc.
The Corporate Sustainability Due Diligence Directive, or CSDDD, was formally adopted in late May after a long and fractious journey and will begin rolling out in two years. The directive ushers in a new era of corporate due diligence – one that could unlock a wealth of sustainability and human rights data on companies’ supply chains and boost investor efforts to mitigate risk and drive impact.
In a nutshell, the directive forces some 5,300 large companies in the EU to identify, address, and mitigate negative environmental and human rights impacts across their value chains starting in 2027. Increasing numbers of firms will be brought into the regulation in 2028 and 2029, including non-EU companies that generate revenues of at least €450 million ($490 million) within the bloc.
“It’s a win for investors,” says Richard Gardiner, head of EU policy at the World Benchmarking Alliance, which helps measure companies’ performance on the Sustainable Development Goals.
Investors don’t always engage long-term with companies, often because they have no leverage, he says. With CSDDD, they now have “a legal mandate to act on.”
When environmental or human rights violations are uncovered in corporate supply chains, CSDDD requires them to take appropriate action. That could mean amending contracts with problematic suppliers, or providing targeted assistance to them via training or investment.
“This will really bring into the light of day how companies are dealing with their value chains and subsequently allow investors to make considerate choices in the companies they want to invest in,” says Isabella Ritter, EU policy officer at sustainability advocacy group ShareAction.
Acronym soup
CSDDD is the latest initiative in what is becoming an alphabet soup of sometimes diverging corporate sustainability and disclosure requirements.
In its sweeping scope, some have argued that CSDDD usurps US corporate law, which to date has relied more on voluntary standards. The US Securities and Exchange Commission has hit pause on its climate disclosure laws amid legal threats, and has yet to propose a long-awaited human capital rule. California, meanwhile, has passed a law mandating climate disclosure for some 5,000 large public and private companies doing business in the state.
The directive gives teeth to the EU’s ESG disclosure rules, which are enshrined in the Corporate Sustainability Reporting Directive, or CSRD. That law requires more than 50,000 companies to publish detailed information on their sustainability, climate, and other non-financial risks in accordance with 12 European Sustainability Reporting Standards, or, ahem, ESRS.
Though the criteria for the two directives are different, and more firms come under the reporting-focused CSRD than the action-oriented CSDDD, companies covered by both will have to adhere to what is emerging as a new gold standard of due diligence and reporting.
“The two regulations can be complementary by ensuring companies are both acting to improve their sustainability and reporting on this publicly,” says Shabano Soomro, deputy head of policy and public advocacy at Impax Asset Management, a $49 billion investor.
CSRD, for example, sets out how companies should disclose a climate transition plan if they have one in place, but does not force businesses to make one. Firms that fall under CSDDD, on the other hand, are required to produce transition plans that align with limiting global warming to 1.5°C.
“The CSRD by itself is not highly effective due to its ‘comply or explain’ gap,” says Soomro. “If a reporting company does not already have targets and transition plans in place, it can simply explain why that is the case.”
“CSDDD,” she adds, “is an important step in bridging gaps in climate-related disclosure.”
ShareAction’s Ritter is hopeful that many firms will apply CSDDD standards even if they don’t fall under its purview, making their CSRD reports more useful, too. “Many companies have already been preparing for the entry into force of the CSDDD,” she says. “There has been a huge wave of companies being very vocal about their support, and we see quite a number of companies already implementing key steps of the process.”
The role of investors
Investors can take steps to nudge companies into compliance even before CSDDD kicks into gear in 2027.
“We have a good sense of what will be expected from companies in the future, and we can start engagement with companies now on topics that in our view are insufficiently focused on by investors and under-reported on by companies,” says Lisa Beauvilain, global head of sustainability and stewardship at Impax.
Once the directive takes force, investors will have an important role to play scrutinizing companies’ supply chain assessments. Public regulators and private litigators are responsible for ensuring compliance with the directive (noncompliance can result in civil penalties). But investors are well positioned to evaluate the quality of the assessments and what they say about how “sustainability-ready” their investees are.
Beauvilain says it will be important for investors “to assess the level of transparency that companies provide of actual cases of grievance in their supply chains.” Those companies that do not report such cases, or do so only at a very high level, may not necessarily be skirting the
law. They may instead simply lack the right tools to monitor supply chain practices in the first place. Investors can advise on remedies or provide support, either directly or by pushing lawmakers for help.
Beyond compliance, CSDDD may prove a useful bulwark against short-termism, spurring companies to prioritize long-term sustainable growth over next quarter’s profit margin. After all, the hard work of making supply chains sustainable can’t be done overnight.
“Investors can now actively say: ‘you have a responsibility to invest in your supply chain. Why are you paying out so much when you could take X amount of that and try and tackle the issues you have in your, for example, garment supply chain or your pesticides or things like this?’” says Gardiner.
Finance’s free pass
The adoption of CSDDD follows a 374-235 vote in the European Parliament in April that capped a protracted journey through the bloc’s three-headed political system. In the political horse-trading over the law, certain provisions were scrubbed that advocates argue would have made the directive tougher and more comprehensive.
Concerns over the regulatory burden for smaller companies led to higher thresholds exempting smaller firms from the law.
Moreover, financial institutions were all but carved out of the directive. Under the final version, they only have to conduct due diligence on their own operations. That excuses banks and asset managers from the hard work of checking how each of their investments measures up on human rights and sustainability grounds.
This decision was bitterly contested, and sustainability advocates are not ready to give up. “Financial institutions should be meaningfully included. We really, really have a key focus on that,” says Ritter of ShareAction.
The biggest risks and opportunities for carbon reductions and social impact lie in financial firms’ portfolios. And investors arguably stand to benefit most from the directive, given that it will furnish them with decision-useful information on the corporations they finance.
“CSDDD is unlikely to be the complete solution or silver bullet to these information asymmetries for investors, Impax’s Beauvilain sums up, “but it is likely to provide more transparency into companies’ supply chains, which is a welcome start.”
