The Corporate Sustainability Due Diligence Directive (CSDDD) – a paradigm shift for ESG
In Europe, the ESG architecture is particularly complex, covering areas as wide-ranging as taxonomy, benchmarking, investor decision-making, data disclosure and access. At the heart of this ESG architecture lies the much-awaited Corporate Sustainability Due Diligence Directive proposal, revealed by the European Commission on 23 February 2022, that provides a governance framework to foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance. These new rules aim to ensure that businesses address adverse impacts of their actions, including in their value chains, whether they are inside or outside Europe.
Before the publication of the European CSDDD, some Member States have already adopted national legislation that introduce similar rules on companies, including France, in the form of the Duty of Vigilance Law, and Germany, in the form of the Supply Chains Act. The European CSDDD promises however to go a lot further in terms of the scope (although the scope of the CSDD targets explicitly large companies, there will be an indirect impact on smaller companies that are suppliers of large groups) and the risks of civil liability for companies that do not respect the due diligence obligations.
In this respect, the CSDDD is perhaps most importantly representative of a significant shift from disclosure requirements and ex post facto liability, to harmonised proactive duties and liabilities that include third-party actions.
The compliance headache
Such a robust framework would in principle lead to a reduction of human risks, environmental threats, and potential reputational damage for the company. Improved financial performance can also be expected due to a correlation between better risk management and greater innovation.
Yet, as our European public affairs consultancy, FairValue Corporate & Public Affairs, has alerted to many concerned business leaders and CEOs, there are deep concerns about the feasibility of such an approach towards ESG that demands processing of vast amounts of information, some of which may be difficult to obtain from third party suppliers, in order to meet all relevant member state and EU standards. Businesses will have to therefore adopt appropriate methodologies that harness technology and suitable software solutions, as well as utilize communication to justify the appropriateness of the measures taken to meet the different legal requirements. Rather alarmingly, in a study conducted by Coupa Software, a specialist in enterprise expense management, 60% of companies believe that the data available to them from third parties is insufficient and 74% believe that their current solutions are insufficient "to assess the ESG risk and compliance of direct and indirect suppliers".
Businesses will nonetheless have time to influence and adapt to the new ESG paradigm, something that FairValue Corporate & Public Affairs accompanies companies through via tailor-made CSR and public affairs strategies, as the Commission's proposal is still subject to amendment during the process of adoption by the European Parliament and the Council. Once the CSDDD has been adopted though, Member States must then transpose the measure into their national laws, with the obligations applying within two years for the largest companies, and within four years for those companies covered in the specific ‘at risk’ sectors.
Geopolitics – the hidden “G” in ESG
In the midst of the ongoing Ukraine-Russia war, the deterioration of US-China relations, and continued instability in the Middle East region, it is increasingly difficult in the complex and volatile geopolitical environment in which business now operates, to dissociate the cross-cutting impact of geopolitical issues with ESG. This relationship will only strengthen as climate change is likely on one hand to instigate future conflicts as natural resources become scarcer, and on the other, provoke migration flows as areas of the world become uninhabitable. At the same time, attaining climate objectives will be an increasing source of contention as states argue over who has the responsibility to act and pay, and compete to secure the new technologies and materials needed to develop greener energy sources.
In this prism, the definition of ESG becomes increasingly hazy.
If we take for instance the example of the Ukraine war, does Russian aggression requalify what can be compatible with ESG in this particular context? Do activities linked to arms manufacturing to support the defense of Ukraine, or the development of nuclear power to reduce dependance on Russian gas and oil, now constitute a common good that reframes what is eligible under ESG? Alternatively, even if certain business activities with Russian suppliers could have been fully compatible with ESG requirements, does the current conflict in Ukraine automatically make these now incompatible?
In this sense, the wider question of whether business ties can be forged with autocratic regimes, where basic citizen freedoms and human rights are suppressed and the rule of law is neglected, presents itself. As long as there is transparency and that there is no infringement of any existing sanctions, it may be argued that this should be left to the discretion of the business. However, this decision goes beyond a moral judgement, as it is also about risk management and ESG due to the clear inherent risks of conducting business in such volatile zones and the potential use of the funds to prop up regimes that have negative external geopolitical consequences for society. Maintaining links to totalitarian regimes is also susceptible of creating reputation damages on firms that far outweigh the potential economic gains.
As part of ESG, the ‘Social’ and ‘Governance’ components are meant to evaluate business ethics and ensure that business activities have positive effects on society. Such activities with autocratic regimes would therefore be difficult to justify as being compatible with these objectives.
The concept of ESG is therefore not as black and white as we would like it to be, considering geopolitical issues are now more than ever intertwined with business strategies and activities. As the notion of ESG takes on a legal dimension and becomes de facto increasingly embedded in the management of businesses, the challenges and complexities involved in evaluating business impacts are set to be highlighted more than ever.