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Navigating the New Terrain: How US Companies Can Prepare for EU ESG Directives

Navigating new terrain: US companies' preparation for EU ESG directives. Ensuring compliance and sustainability alignment.

The European Union (EU) is set to introduce two major pieces of legislation that will have a significant impact on corporate reporting and sustainability practices worldwide. The Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD) will require companies to report on their human rights and environmental impacts and establish a duty of corporate due diligence to prevent adverse effects in their operations and value chains.

The CSDDD’s Role in Harmonizing ESG Due Diligence Regulations

The proposal for the Corporate Sustainability Due Diligence Directive (CSDDD) was published by the European Commission on February 23, 2022. The European Council adopted its negotiating position on the proposal on December 1, 2022, and on June 1, 2023, the European Parliament adopted the CSDDD as a negotiating text. The next step in the process is a trilogue negotiation between the three governmental bodies, which is expected to conclude by 2024. Once officially adopted, EU member states will have two years to transpose the directive into domestic laws.

The CSDDD aims to establish a comprehensive framework for corporate due diligence, requiring companies to identify and mitigate risks to human rights and the environment. The directive will apply to a company’s entire “chain of activities,” including upstream and downstream operations, subsidiaries, and value chains. Its purpose is to improve the regulatory framework for human rights and sustainability due diligence and support the EU’s transition to a climate-neutral and green economy.

Furthermore, the CSDDD will harmonize existing EU directives such as the Non-Financial Reporting Directive, the CSRD, and the Sustainable Finance Disclosure Regulations. It will also seek to standardize ESG due diligence regulations to promote the EU’s functioning as a unified market, as some EU jurisdictions have already implemented ESG due diligence requirements.

For example, the German Act on Corporate Due Diligence Obligations in Supply Chains, known as “Lieferkettensorgfaltspflichtengesetz,” has been in effect since January. This law mandates that both German and non-German companies registered in Germany with 3,000 or more employees must conduct human rights and environmental due diligence. Failure to comply can result in fines of up to 2% of their global revenue.

Similarly, France’s “Loi de Vigilance” or Law of Vigilance, adopted in 2017, applies to French companies with over 5,000 employees in their French-based subsidiaries or over 10,000 employees in both direct and indirect subsidiaries worldwide. This law requires these companies to conduct environmental and human rights due diligence and to publish a plan addressing violations throughout their supply chain. Authorities enforce the Loi de Vigilance through penalties and civil liability provisions.

In addition, the Norwegian Transparency Act, effective since July 1, 2022, mandates the identification of actual and potential risks related to adverse impacts on decent working conditions and human rights. Other EU member states, such as Belgium, the Netherlands, Luxembourg, and Sweden, have also proposed new supply chain due diligence laws, which are likely to evolve in response to the CSDDD.

This harmonization will ensure consistency across different regulations and enhance the effectiveness of ESG due diligence laws in creating a level playing field within the EU.

Shaping the Future: Pioneering EU ESG Directive Negotiations

While there is a general consensus in favor of adopting the CSDDD, the trilogue negotiation process will tackle various key issues and potentially make amendments to specific provisions. The negotiation will determine turnover and employee thresholds for companies in scope, with proposals ranging from 1,000 employees and €300 million global net turnover to 500 employees and €150 million global net turnover.

Financial services companies’ applicability to the directive is also under consideration. The trilogue will determine whether member states should have discretion in including financial services companies or if the directive should encompass all companies meeting the turnover and employee thresholds.

Another topic of discussion will revolve around the duties of directors regarding due diligence, with a focus on whether they should extend due diligence responsibilities to “business relationships” or “business partners” and how to define these terms.

The scope of due diligence requirements across the supply chain, chain of activities, or value chain will also be debated. This scope covers the production, distribution, sale, and waste management of a product or service, including the actions of individual consumers.

The trilogue will further explore the identification and prioritization of adverse human rights and environmental impacts. Adverse human rights impacts may include forced labor, child labor, modern slavery, workplace discrimination, and inadequate health and safety measures. Adverse environmental impacts may encompass greenhouse gas emissions, pollution, biodiversity loss, and ecological degradation.

Liability for civil damages and penal sanctions for noncompliance will be subjects of negotiation as well. The trilogue will determine whether liability should depend on proof of fault and the extent of monetary sanctions. Member states may designate supervisory authorities to enforce the directive and impose penalties based on turnover.

During the negotiation process, stakeholders will also scrutinize how the CSDDD interacts with existing legislation in some member states, such as Germany and France.

Implications for US Companies and the Need for Proactivity

While the CSDDD is an EU regulation, its global impact demands attention. Even if US companies are not directly covered by the directive, they could still face implications if they are part of the value chains of EU businesses in scope. Therefore, US companies should evaluate their value chains and operations for adverse human rights and environmental impacts.

To prepare for the CSDDD, US companies can take proactive steps to ensure compliance and gain a competitive advantage. These steps include:

  1. Identifying existing and potential adverse impacts: Conduct environmental and human rights impact assessments specific to the company’s operations and value chains. Regularly consult with stakeholders to strengthen the assessment process.
  2. Preventing potential adverse impacts: Adopt preventative strategies by redesigning operations and value chains, collaborating with partners, and updating policies and procedures.
  3. Mitigating adverse impacts: Establish practices to prevent, mitigate, and account for ongoing adverse impacts. Collaborate with stakeholders and adjust business relationships if necessary.
  4. Creating effective grievance and remediation mechanisms: Implement procedures for handling complaints from rights holders, their representatives, and civil society organizations.
  5. Tracking and monitoring ESG due diligence outcomes: Continuously track, monitor, disclose, and report on environmental and human rights impacts. Maintain transparency and make necessary adjustments to mitigate risks.

By taking these proactive measures, US companies can avoid future disruptions in their value chains and operations, as well as potential penalties. Implementing or streamlining due diligence policies now will position US companies favorably and maintain a global reputational advantage.

Conclusion

The introduction of the CSDDD and the CSRD signifies a significant shift in corporate reporting and sustainability practices. US companies, even if not directly within the scope of the directive, should prepare for potential implications by evaluating their value chains and operations for adverse human rights and environmental impacts. By taking proactive steps to identify, prevent, and mitigate these impacts, US companies can comply with the directive, avoid penalties, and maintain a competitive advantage in the global market. As the trilogue negotiation process continues, it is crucial for US companies to stay informed and adapt their strategies accordingly.

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