Political Friction Threatens EU Due Diligence Rules

Narrowed scope of finance sector falling under the directive a point of ongoing contention.  

The European Parliament has taken a step closer toward consensus on the Corporate Sustainability Due Diligence Directive (CSDDD), but industry experts are concerned remaining sticking points will cause further friction during trilogues.  

On 24 April, MEPs on the Legal Affairs (JURI) Committee adopted their position on CSDDD, which will require in scope firms to identify, prevent, and mitigate the negative impact of their activities on human rights and the environment, such as child labour and biodiversity loss.  

Julia Otten, Policy Officer at law firm Frank Bold, told ESG Investor that it “wasn’t an easy negotiation [for MEPs], as it’s quite a new subject to regulate for the EU”.  

“We’re happy to see such strong support for the political compromise that has been negotiated,” she said, noting that, while there are similar existing regulations in member states like Germany and France, “the idea behind CSDDD was to find a common European baseline for responsible corporate conduct”.  

However, the agreed text has “loopholes” and was “watered down during the negotiations”, noted Otten.  

“Light touch” rules for finance sector 

One point of contention is whether, and to what extent, due diligence rules should apply to the financial sector.  

MEPs agreed that CSDDD should apply to asset managers and institutional investors, but pension funds, alternative investment funds, market operators, and credit rating agencies can be excluded at the discretion of individual member states.  

“We are very disappointed […] to see that the rules for financial institutions were weakened on many accounts,” said Isabella Ritter, EU Policy Officer at NGO ShareAction, noting that the MEPs’ current proposal requires the in-scope finance firms to “only carry out light touch due diligence, in clear contrast with international standards”.  

Considering that the financial sector has a critical role in protecting the people and planet, it is important that financial institutions make full use of the tools that are available to them to take actions against environmental harm and human rights abuses,” she said. “We need a regulatory framework that will achieve this, but the report voted [24 April] doesn’t go far enough.” 

Guillaume Croisant, Managing Associate in law firm Linklaters’ ESG team, noted that this was also hotly debated by the European Council, which adopted its position on CSDDD last November.  

In view of the divergence of views among member states, the Council favours leaving it to each member state to decide whether it wishes the directive to regulate the provision of financial services by financial undertakings, and which financial undertakings should be included,” he told ESG Investor. 

The Council’s position clarifies what is meant by financial services, limiting the ‘chain of activities’, in a financial undertaking context, to direct lending and insurance/reinsurance,” he added.  

Frank Bold’s Otten said it is ultimately “a good thing” that banks, insurers and investors fall under the scope of the JURI Committee’s CSDDD iteration.  

“Their policies are a key part of effectively addressing climate change, [and] they have big leverage over their value chains and investee companies.” 

Linking ‘E’ and ‘S’ 

Both Otten and Croisant have welcomed MEPs’ support for measures tying together human rights and environmental due diligence. 

They have included corporate climate obligations and mandatory transition plans for all in scope companies, which we think is very important,” said Otten.  

“The EU is moving from a disclosure obligation, where companies only need to say that they have a transition plan, to ensuring that it becomes a core part of responsible corporate conduct.” 

This iteration would require directors to have responsibility and oversight of the setting and implementation of these transition plans, linking them to a proportion of directors’ variable remuneration for companies with over 1,000 employees.  

“There will likely be continued discussions on whether the directive will provide specific provisions on whether directors’ variable remuneration is linked to the achievement of the targets in the company’s transition plan for combatting climate change, since the Council suggested to drop this part of the Commission’s proposal, while the text of the [JURI] Committee maintains wording on this aspect,” said Linklaters’ Croisant.  

The MEPs’ iteration of the directive would apply to EU-based companies to those with more than 250 employees and a worldwide turnover higher than €40 million (US$44.2 million), and parent companies with over 500 employees and a worldwide turnover over €150 million. The rules will also apply to non-EU companies with a turnover higher than €150 million, if at least €40 million was generated in the EU. 

Member states will be allowed to fine non-compliant companies at least 5% of their net worldwide turnover and ban them from public procurement. 

Heated debates 

The European Parliament plenary vote, within which it will adopt its negotiating position, is expected to take place on 1 June, with trilogues beginning in early July.  

“Ahead of this plenary vote, MEPs from other European Parliament Committees can table amendments to the report, so it is not yet clear whether there will be any significant changes in the plenary session,” warned Croisant. 

Once a final agreement is reached during trilogues, the new due diligence obligations would apply after three or four years, depending on the company’s size and turnover. 

“It is likely that there will be further significant changes to the CSDDD proposal between now and its final adoption,” said Croisant.  

“Heated debates are likely on a number of topics for which the institutions appear to disagree, including the thresholds to define the companies subject to the due diligence duties, whether the provision of financial services should be subjected to the same, how the value chain should be defined, and whether an express obligation for directors to take into consideration sustainability considerations in the exercise of their duty of care should be included.” 

The European Commission first published its proposal for CSDDD in February 2022.  

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