Promising yet flawed: EU Law on corporate sustainability faces key challenges

After lengthy negotiations, in December 2023 European legislators reached a provisional deal on the much-anticipated Corporate Sustainability Due Diligence Directive (CSDDD). This deal means that large companies will be required to identify and address the impacts they have on human rights and the environment in their own operations and through their business relationships (so called “human rights and environmental due diligence”).

This deal is welcome, and the law could have a seismic effect on business practices around the world. It will mean that around 12,000 companies will soon have direct obligations to conduct human rights and environmental due diligence, with a much wider group of companies within their global value chains indirectly encouraged to elevate standards. The new obligations have the potential to affect human rights on a global level in a positive way if companies engage meaningfully with the due diligence process, rather than resorting to “checkbox compliance”.

However, there are some critical omissions which could jeopardise the law meeting its objectives.

Exclusion of the financial sector

Financial institutions are uniquely placed to exercise leverage and improve the human rights practices of thousands of real economy companies. There are good emerging human rights and environmental due diligence practices from the sector, and many institutions have voiced their support for finance being included in the CSDDD. However, as a recent benchmark - made by the Danish Institute for Human Rights - of the largest Danish financial institutions showed, the sector struggles to demonstrate respect for human rights. Following intense lobbying, the deal only requires the financial sector to do due diligence on its own operations and its supply chain, rather than being required to consider the impacts of investments, loans, insurance or other financial services. As it is these areas where the financial sector has the most risk of negative human rights and environmental impacts, this is a critical shortcoming of the deal and a missed opportunity to include a key player in the transition to a more sustainable global economy.

Due diligence in the value chain: “downstream” impacts

Companies can have impacts through their own operations and their supply chain, but also when product or service leaves the company, sometimes referred to as the “downstream”. The deal only requires companies to consider impacts arising from distribution, transport, storage and disposal, rather than impacts which arise from the use of products or services. These limitations mean that the EU’s flagship law on due diligence immediately lags behind the efforts of leading companies which are already conducting due diligence in the downstream. For some sectors, such as tech and finance, the most significant negative impacts occur in this part of the value chain meaning that these businesses are effectively excluded from the law.

Encouraging action on climate

The deal requires companies to adopt and put in place a climate plan to ensure that the business model and strategy of the company are compatible with the transition to a sustainable economy, limiting global warming to 1.5 °C in line with the Paris Agreement. However, the deal only requires that companies make best efforts, without a strong enforcement mechanism to ensure that climate plans are implemented effectively. Given the critical need to escalate efforts to address the climate crisis, stronger steps are needed to make sure that companies meet these requirements.

Civil liability

Importantly, the deal also includes a way for companies to be legally liable for harms caused by their failure to conduct adequate due diligence. This is a critical aspect to ensure not only that people who have been harmed can seek a remedy, but also to use the threat of legal liability to encourage effective due diligence. However, there are some limitations in the deal which could restrict litigation on environmental or climate change harms, missing another valuable opportunity to encourage companies to take effective action on the climate crisis.

So what else do we need?

There have been few recent EU legal initiatives that have been the subject of such intense lobbying and heated debate as the CSDDD. The final text of the law is still under negotiation, including which aspects of the law will be the subject to review in a few years. It is important that the issues highlighted above are expressly considered in the review to ensure that the law can be progressively improved over time.

In spite of its shortcomings, the deal is incredibly positive and has huge potential to have a significant impact, but only if companies are encouraged to engage with it in a meaningful way.

This requires not only the development of the law itself but a whole policy environment which creates enabling conditions for its effectiveness.

Everyone must play their part. Member States including Denmark need to make sure that national laws putting in place the requirements of the CSDDD are ambitious, and that compliance is overseen by supervisory authorities with adequate resources and human rights and environmental expertise. The EU needs to ensure that proper guidance is issued and that other accompanying measures are put in place to ensure that companies can effectively meet the requirements of the law and that civil society organisations, trade unions and others are supported to monitor its effectiveness. It also must consider how to support efforts in countries outside the EU through trade policy and development cooperation to ensure that the law encourages an elevation of human rights and an environmental standards throughout global value chains. Lastly, businesses everywhere, whether they are in scope of the law or not, need to take meaningful steps to address the impacts they have on people and planet.