Clifford Chance

The product of extensive political negotiation, the EU's landmark human rights and environmental due diligence ("HREDD") legislation passes the final legislative hurdle, becoming a key component of the EU's sustainability goals.

Today, the EU's Corporate Sustainability Due Diligence Directive (the "CS3D") was finally adopted by the Council of the European Union (the "Council"), after passing a plenary vote of the European Parliament (the "Parliament") on 24 April 2024.

See our previous blog for further details of the political negotiations, and the terms of the final text of the Directive.

We highlight three key points to consider: the position of the financial services sector, the requirement for certain companies to adopt a climate transition plan, and the relationship between the CS3D and the Forced Labour Ban Regulation, which was voted through by Parliament on 23 April 2024, and is likely to receive Council approval in the coming days.

Financial sector

The inclusion of the financial sector within scope of the CS3D has long been a sticking point in negotiations.

The Commission's original proposal in February 2022 premised the financial sector's inclusion in the CS3D for larger companies. In December 2022, the Council's General Approach left the inclusion of the financial sector to the discretion of each Member State when implementing the Directive. By contrast, in June 2023 the Parliament voted in favour of including the financial sector within its draft text ahead of trilogue negotiations. By December 2023, the Council and Parliament had agreed to remove any requirement under the Directive for regulated financial undertakings to conduct downstream HREDD, creating a much lighter regulatory burden for the sector. This is particularly so given the downstream HREDD obligations for in-scope companies under the CS3D only relate to products, not services.

The final text adopted today by the Council reflects the provisional agreement between the EU institutions as they stood in December. Its drafting in relation to regulated financial undertakings benefits from close reading.

Recital 26 provides that "regulated financial undertakings” are only subject to due diligence obligations for their own operations, those of their subsidiaries and the upstream part of their chain of activities. This is also confirmed by Recitals 51 and 61.

However, this exemption of regulated financial undertakings from a requirement to conduct due diligence on their downstream value chain (i.e. those to whom they provide finance and financial services) is not necessarily going to be permanent, having been regarded as a "temporary" measure in the context of the December 2023 provisional agreement. Within two years of the CS3D's enactment, the European Commission will submit a report on the necessity and extent of any inclusion of the financial sector within the scope of the CS3D (Recital 98 and Article 36).

Further, reflecting text within the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct, Recital 51 states that regulated financial undertakings "are expected to consider adverse impacts and to use their so-called 'leverage' to influence companies", including through the exercise of shareholders’ rights.  This encourages a form of downstream supply chain due diligence even in the absence of a binding legal requirement within the CS3D as it currently stands.

Importantly, the exemption of regulated financial undertakings from the full scope of the due diligence requirements of CS3D is articulated only in the Recitals (which have no binding legal effect but can be considered in interpreting the Directive), while the operative elements of the Directive only include the mandatory review process (under Article 36) for HREDD obligations for regulated financial undertakings.  It will be interesting to see how Member States implement the Directive in these regards. 

Climate transition plan

Article 22 of the CS3D places an obligation on in-scope companies, including regulated financial undertakings, to adopt and put into effect a transition plan for climate change mitigation. Under Article 24, supervisory authorities will be designated to supervise compliance with this obligation, as well as the HREDD obligations of the Directive, and will have powers to impose pecuniary penalties (amongst other measures) for non-compliance under Articles 25 and 27. However, the civil liability regime of the CS3D (set out in Article 29) does not include a company's failure to comply with its climate transition plan obligations as a potential source of civil liability.

Through this climate transition plan, companies are to ensure - through best efforts – that their business model and strategy are compatible with the transition to a sustainable economy and with the limiting of global warming to 1.5 °C in line with the Paris Agreement as well as the objective of achieving climate neutrality (Article 22, see also Recital 73).

In short: there will be a legal obligation for companies to set and implement climate targets, though no absolute emission reduction targets are specified in the Directive.

The CS3D includes detailed requirements with regard to the design of the climate transition plan:

a)  time-bound targets related to climate change 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 greenhouse gas emissions for each significant category;

b) a description of decarbonisation levers identified and key actions planned to reach the targets referred to in point (a), including, where appropriate, changes in the product and service portfolio of the company and the adoption of new technologies;

c) an explanation and quantification of the investments and funding supporting the implementation of the transition plan for climate change mitigation; and

d) a description of the role of the administrative, management and supervisory bodies with regard to the transition plan for climate change mitigation.

Article 19 CS3D requires the Commission to produce practical guidance on the climate transition plan within 36 months of the Directive's entry into force.

In order to relieve the burden on in-scope companies, the EU legislature has decided to link the disclosure obligations under CS3D with the obligation to prepare a sustainability report in accordance with the Corporate Sustainability Reporting Directive ("CSRD") and the European Sustainability Reporting Standards ("ESRS").

If companies disclose information on their climate transition plan in accordance with the CSRD/ESRS, the obligation to adopt the plan under CS3D is deemed to have been fulfilled (Article 22(2)). What is novel is the requirement for all in-scope companies to then put into effect the climate transition plans prepared. The same applies to subsidiary companies, where a parent company reports on a climate transition plan which also applies to its subsidiary. For more information on the CSRD and the ESRS please refer to our recent briefing.

Forced Labour Ban Regulation

Finally, the Forced Labour Ban Regulation is expected to be approved shortly by the Council as well. The CS3D and the Forced Labour Ban Regulation contain complementary provisions and objectives.

The Forced Labour Ban Regulation prohibits the placing of products made with the use of forced labour on the EU market and applies to all "economic operators" (being any natural or legal person or association of persons who is placing or making available products on the Union market or exporting products from the Union).

The Regulation does not explicitly require companies to carry out due diligence on their supply chains for evidence of forced labour, but instead puts the onus on the Commission and National Competent Authorities to investigate and enforce the ban.

The CS3D, on the other hand, includes requirements on in-scope companies to undertake due diligence to identify and address the risk of forced labour (under the HREDD provisions of Articles 5 to 13, by reference to the rights protected under Annex Part I, Article 11, following the definition of forced labour in Article 2 of the ILO Forced Labour Convention (No. 29)) among the violations of rights and prohibitions constituting an adverse human rights impact. The Forced Labour Ban adopts the same definition of forced labour, specifying that this includes "forced child labour".

Forced labour due diligence is thus part of the mandatory HREDD obligations for companies within the scope of the Directive. For companies in-scope of the CS3D, this will assist in ensuring compliance with the Forced Labour Ban.

Next steps

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, at which point companies will be required to comply with the obligation to adopt and implement a climate transition plan under the Directive.

The timeline for implementation of other obligations is set out below.

Previous Clifford Chance publications on the CS3D:

• Briefing: Agreement reached on the EU Corporate Sustainability Due Diligence Directive – what financial services firms need to know (March 2024)
• Blog: The Corporate Sustainability Due Diligence Directive takes final shape (March 2024)
• Blog: Corporate Sustainability Due Diligence Directive provisionally agreed by the EU Council and Parliament (December 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: European Parliament adopts its position on the Corporate Sustainability Due Diligence Directive (CS3D) (June 2023)
• Blog: European Parliament moves closer to a negotiating position on the proposed Corporate Sustainability Due Diligence Directive (May 2023)
• Blog: Council of the EU adopts negotiating position on the proposed Corporate Sustainability Due Diligence Directive (January 2023)
• Briefing: The European Commission Proposes Mandatory Human Rights and Environmental Due Diligence (May 2022)