Expert Analysis: How CS3D Will Impact You and Your Business

The Corporate Sustainability Due Diligence Directive provides new obligations for many businesses in the EU and those operating in the EU market. In this Expert Analysis, 3E experts Sanaa Chakibi, Cassidy Spencer, and Grimanesa Till examine the details of these new obligations and what they mean for the organizations in scope. 

Having received all necessary approvals from the European Union Parliament and Council, the Corporate Sustainability Due Diligence Directive (CSDDD or “CS3D”) will enter into force by September 2024, with member states having until September 2026 to integrate it into national law.

CS3D applies to EU companies with at least 1,000 employees and over 450 million euros in turnover, and to non-EU companies active in the EU market with over 450 million euros in turnover.

Concerned organizations must identify and address the potential for negative impacts on human rights and the environment in their own operations and along their entire supply chain. They must also make their best effort to adopt and put into effect a transition plan for mitigating climate change impacts from their operations in accordance with the 2050 goals of the Paris Agreement and any additional targets under EU law.

This article looks at some of the most important requirements of CS3D, as well as its potential impact on 3E customers and product offerings.

Why Is CS3D Necessary?

CS3D is another step in the right direction to ensuring organizations meet their due diligence obligations to do business in the EU. In addition to the administrative penalties outlined here, organizations that fail to meet these compliance obligations face the possibility of damages claims and civil litigation.

Without a mandatory rule that imposed legal obligations, many organizations have evaded their due diligence responsibilities both in the EU and around the world. The main reason for this was that to establish liability under the fiduciary duty or the general duty of care, the process was lengthy, costly, and discouraging. As a result, this created an unfair outcome: the good players, who followed and exceeded their sustainability due diligence obligations and proactively spent the necessary resources to be compliant, were at a disadvantage, while other companies supplied markets unethically, cut compliance costs, and therefore had an unfair advantage.

It is worth noting that most mergers and acquisitions now require organizations to perform a sustainability due diligence gap analysis. This requirement is only going to increase, as a gap analysis decreases risks and reveals sustainability due diligence practices that can have legal ramifications. While most organizations have always performed a general, pre-merger due diligence gap analysis, expanding it to be an ESG due diligence study reveals far more about the parties and their suppliers, materials origin, and any human rights or labor compliance issues. Companies can reduce noncompliance risks and prevent market disruption by integrating sustainability due diligence with their management systems and vetting partners in mergers and acquisitions.

EU companies and foreign companies operating in Europe must now verify that their materials, suppliers, and practices are in line with human rights, labor, and environmental obligations across their entire supply chain. This will have an enormous impact on preventing the unethical sourcing of goods or materials to the EU market if they are the product of environmental destruction or human rights violations such as forced labor, slavery, or other illegal practices.

CS3D complements the Corporate Sustainability Reporting Directive (CSRD), with each taking different approaches to addressing sustainability. CS3D is built on the principle of due diligence throughout the global supply chain to identify and mitigate the impact of practices that have a negative impact on the environment and on human rights. CSRD promotes sustainability reporting for organizations operating in the EU. It requires organizations to report social and environmental impacts of their operations using the European Sustainability Reporting Standards (ESRS) developed by EFRAG (previously known as the European Financial Reporting Advisory Group). A critical component of CSRD is the principle of double materiality, in which organizations must report on both the impact of environmental risks on their operations and the impact of their operations on the environment. CS3D and CSRD both address the due diligence and reporting requirements of a larger sustainability strategy.

Review of CS3D

Member states must appoint supervisory authorities to ensure due diligence and climate change-related requirements for CS3D. These authorities will have the power to:

• Demand information from organizations about CS3D due diligence
  Conduct investigations and inspections
• Enforce corrective actions, when necessary, including granting organizations additional time to remedy noncompliance
• Order cessation of actions that constitute infringement
• Enforce actions to prevent repetition of the infringement
• Propose corrective actions and remediation
• Impose penalties, and
• Propose interim measures to mitigate the risk of imminent and severe harm.

According to industry research, more than 57% of C-suite leaders believe they will not be able to comply fully with CS3D until at least 2030. Only 32% said they measured the impact of their suppliers' operations on human rights, and a mere 27% said they think their organizations understand how to conform to the requirements for CS3D. The research demonstrates that there is a significant gap between what organizations commit to in supporting ESG principles and what they actually do in practice.

CS3D will apply according to a scaled timeline of three phases.

• Phase 1: 2027. Organizations with 5,000+ employees and 1.5 billion euros in turnover.
• Phase 2: 2028. Organizations with 3,000+ employees and 900 million euros in turnover.
• Phase 3: 2029. Organizations with 1,000+ employees and 450 million euros in turnover.

Parent companies are considered in aggregate with their subsidiaries to determine their size and turnover value, with the exception of franchises.

Imposing and enforcing penalties for noncompliance with CS3D rests with the national authorities of member states, who have the power to:

• Initiate inspections and investigations
• Impose fines up to 5% of worldwide turnover, with the potential for higher fines at the discretion of member states, and
• Issue injunctive measures, including orders to cease certain activities or undertake remediation.

For parent companies, fines are based on consolidated turnover, potentially leading to significant penalties and reputational damage.

When applying fines, authorities will consider a number of issues, including the following:

• The nature, gravity, duration, and impact of the infringement
• Preventative, mitigative, and remedial measures the organization has taken to avoid the infringement
• Previous infringements
• Collaboration with other entities, and
• Financial benefits gained or losses avoided from the infringement.

Non-EU organizations that place products on the EU market are subject to the national authorities connected to their operation or major turnover. The maximum penalty for these organizations is at least 5% of revenues.

In addition to financial penalties, public organizations can consider an organization's compliance with CS3D when awarding public contracts.

Further, organizations are subject to civil liability. If they fail to address adverse impacts from their noncompliance, victims have up to five years to pursue civil action in the applicable member state. Member states may also allow third-party claims.

What Does CS3D Mean for Your Business?

With the EU adopting the CS3D, and many other countries following suit with similar initiatives, companies now have specific sustainability and environmental compliance actions that extend to their suppliers and that can be enforced against them, in addition to the general obligation to conduct business by lawful means.

Under the new CS3D requirements, companies' leadership must ensure that there are compliance systems in place in order to meet the obligations for safer products from them and their suppliers. Companies must develop a list of requirements or a checklist that is in line with the CS3D to manage product compliance. Requesting the right information from suppliers is crucial in the implementation of these obligations. Considering the fact that the CS3D is the beginning of a trend and that many more jurisdictions have adopted or are adopting similar legal obligations, companies are advised to regularly monitor laws and regulations in the locations in which they operate, distribute, or sell. Providing this information to all their product stewardship teams will enable them to prepare for meeting these new requirements, thereby preventing market disruptions and non-compliance.

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Editor's Note: 3E is expanding news coverage to provide customers with insights into topics that enable a safer, more sustainable world by protecting people, safeguarding products, and helping businesses grow. Expert Analysis articles, produced by 3E subject matter experts, researchers, and consultants as well as external thought leaders, examine the regulations, trends, and forces impacting the use, manufacture, transport, and export/import of chemicals.