Clifford Chance

After no shortage of political drama, two recent votes crystallise the EU's landmark human rights and environmental due diligence legislation, which advances to the final Parliament vote in late April.

When the Council of the European Union (the "Council") and the European Parliament (the "Parliament") reached political agreement on a text of the proposed Corporate Sustainability Due Diligence Directive ("CS3D") on 15 December 2023, it was widely expected that CS3D would pass through the final hurdles of the EU's legislative process in that form ahead of final EU institution votes in late January 2024.

See our previous blog for background, and a summary of the position agreed between the Council and Parliament at that point in December 2023.

However, following threats of abstention – first signalled by a German coalition partner on 1 February 2024 – the Council broke with the usual legislative conventions of the EU, which tend to treat a politically agreed text as near-final. Among other countries, German, Italian and French representatives pointed to the regulatory burden of the CS3D on SMEs as a primary point of concern.

Given the threatened abstentions, the Belgian Presidency of the Council twice pulled votes before tabling a vote which failed to pass on 28 February. A vote on 8 March was further postponed pending still ongoing political negotiations, and more concessions, before the CS3D was finally voted through by the Council on 15 March.

On 18 March, the text received the support of the Parliament's Committee on Legal Affairs ("JURI") and is now widely expected to pass a plenary vote of the Parliament on 24 April 2024.

In this blog, we summarise the key elements of the CS3D, and significant changes made since the December 2023 political agreement. The full text of the CS3D can be read on the EUR-Lex website here. We plan to publish a more detailed briefing, when it becomes clear that the legislation will be passed in final form. 

Mandatory human rights and environmental due diligence and reporting

Responsible business conduct – in particular, preventing adverse human rights and environmental impacts of business activity - has been the driving ethos behind CS3D's provisions on human rights and environmental due diligence, or "HREDD".

Under the CS3D, in-scope EU and non-EU companies will be obliged to adopt and implement due diligence policies and processes to identify and address adverse human rights and environmental impacts with which the companies may be involved, either (i) through their own operations, (ii) those of their subsidiaries or (iii) through business relationships in their chain of activities.

The human rights and environmental impacts covered by the CS3D's HREDD obligations are set out in a closed-list annex to the Directive, referencing international human rights (Part I) and environmental (Part II) instruments.

Companies will be required to publicly communicate on their compliance with the CS3D, where they are not already subject to the reporting requirements of the Corporate Sustainability Reporting Directive, which entered into force on 5 January 2023.

Scope

Increased thresholds

The most significant amendment to the CS3D in recent weeks has been the reduction in scope of its application, meaning it will now apply to a much smaller pool of very large companies.

In its previous iteration, the CS3D was set to apply to EU companies with more than 500 employees, and an annual net worldwide turnover of more than EUR 150 million. These thresholds have now been changed to limit the Directive's application to EU companies with more than 1000 employees, and with EUR 450 million turnover.

Furthermore, CS3D was also previously drafted to apply to all non-EU companies generating an annual net turnover of more than EUR 150 million in the EU. This figure has also increased to EUR 450 million. It has been suggested by some close to the negotiations that the final Directive will apply to around 5,300 companies. This is a significant reduction from the 16,800 companies within the scope of the Commission's original proposal in February 2022.

No "high-impact sectors"

Previously the CS3D would have applied at lower thresholds to sectors which were considered to have a higher risk of adverse human rights and environmental impacts, such as textiles, agriculture, and the extraction and wholesale trade of mineral resources. The final draft has removed this distinction, creating a homogenous threshold for the application of the CS3D to companies, regardless of their sector.

The scope of the CS3D is to be reviewed within six years of its entry into force, and every three years after that.

Timing

Member States will still have two years to transpose the Directive into national law after its entry into force. Should the Parliament's plenary vote on 24 April 2024 ratify the CS3D, the legislation will enter into force 20 days later, on 14 May 2024.

More time for companies to prepare

Companies will have significantly more time to prepare for compliance with the CS3D than under previous proposals.

Under the previous draft, all companies with over 1000 employees would have had three years to prepare for compliance with the CS3D.

Supply chain coverage

The main objective of the CS3D has remained intact since the provisional text was agreed in December 2023. The CS3D still requires in-scope companies to adopt HREDD policies and integrate HREDD processes within their risk-management systems. Through these, they will be required to take appropriate measures to:

• identify, assess and, where needed, prioritise actual or potential adverse human rights and environmental impacts in their operations and their "chains of activities" (both upstream, such as through the sourcing of parts for a product, and downstream, such as the distribution, transport and storage of a product, except in the case of the financial sector – see below);
• prevent or mitigate potential adverse impacts; and
• bring to an end, minimise and remedy actual adverse impacts.

Removal of "disposal" from downstream supply chain due diligence

However, the definition of "chains of activities" has now been amended to remove the disposal of a company's product from the downstream element of its due diligence obligations, removing the requirement for an in-scope company to carry out the measures detailed above in relation to, for example, businesses dismantling, recycling, composting or landfilling their product.

Treatment of the financial sector

As in the provisional December draft of the CS3D, the financial sector has been carved out from some important aspects of the due diligence obligations defined in the Directive.

It has been widely reported that the definition of "chain of activities" for regulated financial undertakings will not include any downstream elements of their supply chain. This will be a far lighter regulatory burden, excluding due diligence requirements for loans or investments, for example.

We note that reference to this approach has been included in the Recitals (which has no legal effect) to the CS3D, and alluded to in relation to the review process for the potential inclusion of the financial sector within the full scope of the Directive at a later date (see directly below). At present there is no specific operative element to the draft voted on by the Council and JURI committee which expressly excludes regulated financial undertakings in the manner described. This may well be amended prior to final ratification.

The current draft also retains a commitment that the Commission will submit a report to the European Parliament and the Council to consider the inclusion of financial services within the full scope of the CS3D's obligations. This report should be published "at the earliest possible opportunity" after the date of entry into force of the Directive, and after no later than two years, accompanied, if appropriate, with a legislative proposal.

The final wording of the CS3D includes within the definition of "regulated financial undertakings" financial institutions such as banks, insurers, institutional investors and asset managers.

Notably, pension funds operating social security systems are entirely excluded from the scope of the Directive.

Climate change

The current draft retains a requirement for companies to "adopt and put into effect" a transition plan for climate change mitigation, "through best efforts" in line with the Paris Agreement's target of limiting global warming to 1.5 °C, and the EU's intermediate targets and its 2050 target of climate neutrality. Companies that report a transition plan for climate change mitigation in accordance with CSRD are deemed to have complied with the "adoption" element of transition planning. The plan should include time-bound targets related to the company's climate objectives for 2030 and in five-year steps up to 2050 based on conclusive scientific evidence and where appropriate, absolute emission reduction targets for greenhouse gas for scope 1, scope 2 and scope 3.

As has been understood for some time, the CS3D will not create any specific directors' duties to take into account the consequences of their decisions in relation to sustainability matters. Now the proposed requirement for companies with over 1000 employees to offer financial incentives for managers linked to “promoting the implementation of” climate transition plans has also been dropped.

Civil liability

The civil liability elements of the CS3D as agreed in December have largely been retained. Companies found to have intentionally or negligently failed to comply with their obligation to prevent potential adverse impacts, or bring actual adverse impacts to an end can be held liable where they cause damage to a natural or legal person as a result of the breach. The limitation period for victims to bring claims will remain at least five years.

Notable limitations have been placed on the ability of trades union, NGOs or national human rights' institutions to bring actions under the CS3D. Member States are free to decide the conditions under which trade unions, NGOs or national human rights institutions can bring collective redress mechanisms on behalf of victims. The ability of such an entity to bring a claim “in its own capacity” has been deleted and Member States are no longer required to extend their national laws on representative actions to claims under the directive.

What happens next?

As noted above, the Parliament is set to vote on the CS3D in plenary on 24 April 2024. Should it be voted through as expected, the CS3D will enter into force 20 days after its publication in the Official Journal. Member States will then have two years to transpose the provisions of the CS3D into national law.

Previous Clifford Chance publications on the CS3D:

• Briefing: The European Commission Proposes Mandatory Human Rights and Environmental Due Diligence (May 2022)
• Blog: Council of the EU adopts negotiating position on the proposed Corporate Sustainability Due Diligence Directive (January 2023)
• Blog: European Parliament moves closer to a negotiating position on the proposed Corporate Sustainability Due Diligence Directive (May 2023)
• Blog: European Parliament adopts its position on the Corporate Sustainability Due Diligence Directive (CS3D) (June 2023)
• Briefing: One Step Closer: U.S. Companies Active In Europe Will Need To Track Potential New Due Diligence Requirements As New Questions Arise (June 2023)
• Blog: Corporate Sustainability Due Diligence Directive provisionally agreed by the EU Council and Parliament (December 2023)