Regulation watch: What do CSDD changes mean for risk managers

On 25 April, the Legal Affairs Committee of the European Parliament voted to adopt their position on the Directive on Corporate Sustainability Due Diligence (CSDD) and on today, the European Parliament set its position for trilogue.

The rationale for the Directive

The proposed Directive will require organisations operating within the EU to identify and, where necessary, prevent, end, or mitigate the adverse impacts of their activities on human rights, such as child labour and exploitation of workers, and on the environment, such as pollution and biodiversity loss.

The proposal is designed to promote greater harmonisation in the context of corporate due diligence in response to the growing number of EU Member States developing similar due diligence-related legislation.

The aim is to ensure a level playing field, providing greater legal certainty regarding companies’ obligations, as well as to build on existing international standards.

Significant risk shortcomings

Given the nature of the directive and the focus on value-chain due diligence, corporate risk managers will have a central role working with other functions such as procurement and other front-line functions to deliver on the multiple requirements of the legislation.

However, in its earlier iteration, there were multiple shortcomings within the directive that made its application very complex.

Foremost amongst these was the fact that while the draft legislation had a clear risk management core built around risk management and mitigation, it lacked any form of risk-based framework.

Moving in the right direction

The Commission’s proposal has since been scrutinised by the European Parliament’s Legal Affairs Committee, which has proposed a number of amendments to the text. It is important to note that these amendments to the text will go through political negotiations and will need to be agreed in trilogue.

Risk-based approach

Introducing the notion of a risk-based approach into the directive has been a pivotal move. The text now states that “‘risk-based’ means proportionate to the likelihood and severity of potential adverse impacts”. By introducing this into the text and including terminology relevant to the risk community, this will hopefully make adhering to the report requirements more practicable. However, it is important to note that the scope of the legislation will still place considerable demands on organisations.

Prioritisation

The revised text now introduces the critical notion of prioritisation which was viewed as a business imperative. In effect, this grants organisations the ability to prioritise those mitigation strategies likely to have the most impact on limiting environmental or human rights damage. The newly introduced text means that the directive now provides “practical guidance on the development and implementation of prioritisation strategies, including practical guidance on how proportionality and prioritisation”.

Value Chain

The revisions also address the expansive nature of the reference to value chain. There were calls to narrow the scope to supply chain – which would have mirrored a number of existing pieces of due diligence regulations. However, while the directive still refers to value chain, this relates now only to activities concerning sale, distribution, and transport.

Challenges Remain

A major shortfall in the revised text is the fact that the issue of civil liability has not been addressed. Central to the notion of liability is the concept of damages. Where the legislation currently falls short is that there is no real clarity as to how damages are defined from an operational perspective.

The water is muddied further by the fact that there are multiple different civil liability regimes across the EU Member States.

If, for example, a corporation is operating across multiple different states, the complexities regarding meeting the liability requirements under the local legislation plus under the directive are likely to be considerable – add the common law of the UK to the legislative mix and the complexity rises further.

It is also important to recognise the legislative context into which this directive is being introduced. When brought into force, the directive will become one more in a long list of sustainability or environmental-related reporting requirements that companies are faced with.

”The Corporate Sustainability Due Diligence Directive will have a significant impact on how European companies conduct their business activities and it is therefore critical that all organisations have a clear understanding of their requirements under the planned legislation.”

FERMA recognises the criticality of adhering to the highest possible standards on these fronts, but also acknowledges the need for a balanced approach between the requirements placed on companies and what is practicable to deliver.

In our recent contribution to the Swedish Presidency agenda, FERMA emphasised the critical role of risk leadership in supporting its ambitions to strengthen the competitiveness of the EU.

It is imperative that the balance is struck between creating a legislative framework that is fit for purpose and ensures standards are maintained, while also enabling companies to maintain their competitiveness.

FERMA will continue to monitor developments relating to the directive and will focus on raising awareness and sharing best practice on due diligence reporting – a subject which will be a key area of focus at the FERMA Seminar 2023.

The Corporate Sustainability Due Diligence Directive will have a significant impact on how European companies conduct their business activities and it is therefore critical that all organisations have a clear understanding of their requirements under the planned legislation.