Overview: Corporate Sustainability Due Diligence Directive (CS3D)
In March 2024, the European Council achieved consensus on a final version of the Corporate Sustainability Due Diligence Directive (CSDDD or CS3D),
culminating two years of negotiations and changes since the Directive was originally proposed. In late April, the European Parliament approved the
Directive, representing a pivotal piece of legislation in Europe’s fight against climate change while integrating risk-based due diligence into corporate
operations. Finally, the Directive was approved by member state representatives and adopted by the European Council this May. EU member states must
proceed with formal adoption over the next two years. The CS3D requires companies to identify adverse impacts of their business on human rights and the
environment, and it obliges companies to establish formal mechanisms for remediating these impacts. This Directive is applicable across in-scope
companies’ value chains, including upstream and downstream activities relating to production, supply, transportation, storage, design, and distribution.
The CS3D complements the existing suite of sustainable policy initiatives from the EU. For example, it serves as an extension of the European Green Deal,
which aims to transition the EU to a climate-neutral, green economy. The CS3D will also complement the corporate reporting requirements of the
Corporate Sustainabilty Reporting Directive (CSRD), as well as inform investor obligations and decisions under the SFDR and Taxonomy. Specifically, the
CS3D is the first EU legislation which requires in-scope companies to enact a climate transition plan, which aligns with the CSRD’s disclosure requirements
around such a plan and enables the achievement of European Green Deal objectives. Furthermore, due diligence mechanisms and addressal of outcomes
required under the CS3D can be utilized to fulfill disclosures around human rights and environmental impacts for EU-based companies under guidelines
for the CSRD – namely the European Sustainability Reporting Standards (ESRS).
Overview of CS3D
Why :
• Ensures EU companies take real actions to mitigate or prevent adverse business impacts
• Complements the EU’s wider portfolio of sustainability regulations
What:
• Outlines steps that in-scope companies must take to identify and address adverse business impacts within their operations and across their value chains
• Requires that in-scope companies develop and implement climate transition plans aligned with Paris Agreement targets
Where:
• Nexus of EU member states and the business partners of in-scope companies, regardless of location
Who:
• Directly impacts four categories of companies based on corporate domicile, business model, revenue, and employee size
• Indirectly impacts upstream and downstream value chain partners of in-scope companies
When:
• The CS3D will be finalized in May 2024, transposed into national laws over the next two years, and phased in over 2027, 2028, and 2029
What are the requirements of the CS3D?
01. Due Diligence: Identification of adverse human rights and environmental impacts
The CS3D requires companies to implement and publicly communicate a comprehensive framework to identify adverse risks and impacts to human
rights and the environment within their operations, the operations of their subsidiaries, and certain operations of their business partners. The CS3D
includes adverse impact topics that are also referenced in other EU and EU-member regulations. For example, the CS3D final text requires the
identification and mitigation of the risks (i.e., due diligence) outlined by the OECD Guidelines and UN Guiding Principles. These are best practice,
international sources of guidance on responsible business conduct that are also referenced in the guidelines of the CSRD (i.e., ESRS), which mandates
reporting on many of the same sustainability-related topics covered under the CS3D. The CS3D is also expected to harmonize due diligence requirements
around the EU, succeeding country-level regulations (e.g., Germany’s ‘Supply Chain Due Diligence Act’, France’s ‘Duty of Vigilance’ Law, the Netherlands’
‘Child Labor Due Diligence Law’), complementing EUwide regulations (e.g., Conflict Minerals Regulation, Batteries Regulation, Regulation on
Deforestation-Free Products), and supporting EU policy initiatives (e.g., 2021 EU Action Plan Towards Zero Pollution for Air, Water, and Soil, the EU Action
Plan on Human Rights and Democracy 2020-2024, the EU’s 2030 Climate Target Plan, the UN Paris Agreement and the UN Sustainable Development
Goals).
02. Risk Management Systems: Integration of due diligence, addressal, and remedial mechanisms
Companies are obligated to establish a process for mitigating risks and eliminating violations, and they must create effective grievance, notification, and
remediation mechanisms. Where not feasible to prevent or mitigate all identified adverse impacts, companies should prioritize adverse impacts based on
severity and likelihood of the adverse impacts. Companies should also carry out meaningful engagement with relevant stakeholders – including those
persons affected by identified adverse impacts and their legitimate representatives (e.g., civil society organizations, labor unions) – providing notification to
them, answering their requests for information, and responding to their complaints. Furthermore, in-scope companies are obligated to provide
remediation (e.g., financial or non-financial compensation, such as restitution) from actual adverse impacts on affected persons or the environment. In
cases where adverse impacts include business partners, companies can temporarily or permanently suspend such business relationships, should the
partners nor take appropriate steps to address such impacts. These due diligence and remediation mechanisms must be translated into policies and
integrated into enterprise risk management systems – a process that is required to be reviewed on an annual basis.
03. Climate Transition Plan: Enactment of plans to reduce global warming to 1.5 degrees
The CS3D is also the first EU law which mandates companies to adopt and implement a climate transition plan aligned with a 1.5-degree Celsius global
warming scenario. The transition plan should ensure that companies’ business models and strategies are compatible with the transition to a sustainable
economy, limit global warming in line with the Paris Agreement, meet the objectives of the EU Climate Law, and address exposure to fossil fuel-related (i.e.,
coal, oil, and gas) activities. This agrees with the goals of the European Green Deal and supports fulfillment of reporting requirements for companies
subject to the CSRD. Therefore, companies already reporting such a plan in accordance with the CSRD already comply with the CS3D’s obligation to adopt
such a plan and are exempted, although the CS3D also requires companies to implement the plan. As per the CSRD guidelines (i.e., ESRS), the plan must
include relevant targets, plans and other topics relevant to companies’ business strategy and financial plans. These largely overlap with recommendations
from the Taskforce for Climate-related Financial Disclosures (TCFD)
04. Enforcement: Liability, penalties, and awards
The Directive will be enforced through fines of at least up to 5 percent of a company’s global net turnover at the consolidated level of the ultimate parent
company, with EU member states permitted to set higher maximums, as well as public statements indicating company responsibility and the nature of
infringements should the company fail to comply with the fine within applicable time limits. EU member states will develop national supervisors to
monitor implementation of the CS3D and ensure that companies comply. Additionally, when a company has directly or jointly caused an actual adverse
impact, it should provide remediation (i.e., restitution of the affected person(s), communities, or environment and public authorities to a situation
equivalent to, or as close as possible to, the situation they would be in had the actual adverse impact not occurred, proportionate to the company’s
implication in the adverse impact). In-scope companies would not be liable for damages only caused by business partners, but they would be held jointly
liable for damages caused jointly by such companies, their subsidiaries, and indirect or direct business partners. However, when an adverse impact has
been solely caused by an in-scope company’s business partner, remediation is voluntary, and the company is recommended to influence its value chain
partner to enable remediation.
To whom does the CS3D apply?
01. Overview of CS3D Applicability: Four categories of companies
The CS3D will apply to four types of companies, based on firm characteristics including corporate domicile, business model, revenue, and employee size in
the prior financial year. Broadly speaking, the CS3D applies to EU companies employing more than 1,000 individuals with a global turnover greater than
EUR 450M. Non-EU companies do not have an employee threshold and will be affected as long as they generate turnover of at least EUR 450M within the
EU. Franchisees or licensees whose royalties exceed EUR 22.5 million and meet a revenue threshold of EUR 80 million in the prior financial year would also
be subject.
The graphic in the PDF defines these four categories for applicability of the Directive’s requirements. The requirements of the CS3D will phase in across 3
years starting in 2027 (see next section: ‘When will the CS3D apply?’)
02. Financial Services: Limited scope of CS3D obligations
Companies operating within the financial services sector, which is considered high risk by best practice guidance such as the OECD Guidelines, will have
only be subject to CS3D obligations for their direct operations and upstream business partners. Instead, for downstream activities, financial services firms
are expected to consider adverse impacts and use their leverage (e.g., shareholders’ rights) to influence companies where possible, as recommended by
the OECD Guidelines.
The CS3D will exclude their downstream (i.e., investment) activities, which may make up most of the emissions, human rights, and environmental impacts
within their value chains. For example, financial services firms will still be required to develop climate transition plans under the CS3D, but they will not be
obligated to consider financed emissions in their strategies. The CS3D shall also not impose additional reporting obligations for in-scope financial services
firms, including under the CSRD and SFDR.
03. Knock-on Effects: Companies indirectly impacted by the CS3D
The CS3D may also have knock-on effects for businesses worldwide with strong existing commercial relationships with in-scope companies. Specifically,
the operations of upstream and certain downstream business partners of in-scope companies will be covered by CS3D requirements, on a risk-based and
proportionate manner. The direct and indirect business partners of in-scope companies include those with whom the in-scope companies maintain:
• A commercial agreement related to the operations, products, or services of in-scope companies.
• No commercial agreement, but still carries out business operations related to the operations, products, or services of in-scope companies.
When will the CS3D apply?
The Directive was approved by the EU Parliament on April 24, 2024 and has received final approval by EU ministerial vote in May 2024, after which the
CS3D will have come into force following publication in the Official Journal. Member states will have two years (i.e., by 2026) to transpose the provisions into
national law. The CS3D will then begin applying on a phased approach dependent on firm size and turnover, starting in 2027, with additional in-scope
companies subject over the subsequent two years. This means that all in-scope companies should prepare to meet the requirements of the CS3D before
the end of this decade. The phased implementation approach applies to firms as set out below:
Uniqus POV
01. How does the CS3D fit within the EU’s suite of various sustainability initiatives?
CS3D and European Green Deal –
The CS3D supports the objectives of the European Green Deal, an overarching initiative which aims to transition the EU to a climate-neutral, green
economy. The European Green Deal is a set of policies aimed at mitigating environmental degradation and reducing Europe’s net GHG emissions by at
least 55% by 2030, compared to 1990 levels, a target which aligns with the goals set by the Paris Agreement. In pursuit of these targets, the CS3D requires
in-scope companies to mitigate their environmental business impacts and reduce their emissions according to Paris Agreement-aligned transition plans.
CS3D and CSRD –
The CS3D complements the CSRD, which requires all large and listed companies in the EU to report on standardized and audited corporate sustainability
information, in accordance with the European Sustainability Reporting Standards (ESRS) starting in 2024. Many in-scope companies under the CSRD will
also be covered by the requirements of the CS3D.
CS3D and SFDR –
The CS3D can also be understood in the context of the already in-force Sustainable Finance Disclosure Regulation (SFDR), a law which stipulates
requirements around how financial market participants (e.g., asset managers) market investment products and communicate sustainability-related fund
and firm-level information to investors in the EU. Specifically, in-scope financial market participants must make statements on the due diligence policies
guiding their investment decisions around social and environmental factors, and these investment decisions can be informed by the actions of investee
companies subject to the CS3D.
CS3D and EU Taxonomy –
The CS3D is related to the EU Taxonomy, a classification system which establishes clear definitions of sustainable business activities. The Taxonomy
supplements the reporting requirements of the CSRD and SFDR, and it allows investors and companies to make informed decisions when understanding
the sustainability of investment and business activities.
02. How can companies prepare for the CS3D?
While companies are not obligated to adhere to the Directive until at least 2027, they can begin aligning their organization today with several preparatory
steps. Uniqus recommends the following to guide companies in preparing for the CS3D:
01. Understand Applicability
02. Conduct a Baselining and Gap Analysis
03. Prepare an Implementation Plan
04. Build Internal and External Capacity
05. Communicate with Internal and External Stakeholders
06. Monitor Regulatory Developments
07. Leverage Technology
