Corporate Sustainability Due Diligence Directive: A Potential Game-Changer for Business and the Planet

As the world faces a growing array of environmental and social challenges, it is more important than ever for businesses to take a proactive and responsible approach to sustainability. The consequences of neglecting these issues can be severe not only for the planet, but also for companies, as it can lead to supply chain disruptions, legal costs, reputational damage and decreased competitivenessThe upcoming Corporate Sustainability Due Diligence Directive (CSDDD) provides an unprecedented opportunity to end destructive business practices on the one hand, and help companies effectively manage sustainability-related risks on the other. The Directive aims to harmonise national legislation in EU Member States, thereby ensuring a level playing field, lowering the administrative burden and bringing clarity for companies.

To realise the full potential of the Directive, it must include at least the following three key elements:

Companies must identify and address the adverse environmental impacts in their operations and value chains.

The Directive will guide companies to make sure they consider the impact their business has on the environment every step of the way. From the development of products to their consumption, this Directive can empower companies to make informed decisions and act responsibly to minimise adverse impacts and capitalise on sustainability-related opportunities.

However, for due diligence to be truly effective, the Directive should define the negative environmental impacts not as a mere list of violations of international environmental conventions, but as a comprehensive set of environmental categories. As a minimum, the definition should align with the environmental categories of the EU Taxonomy (i.e. climate change mitigation and adaptation, sustainable use of water and marine resources, biodiversity and ecosystem protection, pollution prevention, and circular economy).

Including this range of adverse environmental impacts in the Directive’s scope would ensure that companies have a comprehensive approach to assessing and managing environmental risks, create a level-playing field and provide clarity and consistency for all businesses. Omitting certain environmental risks would distort the market and create unfair competition.

Companies must set and implement robust environmental targets and plans to accelerate their transition.

The CSDDD should offer a fair and equal chance for EU companies to excel in sustainability, without penalising the leaders or ignoring the laggards. By mandating companies to implement strong criteria for their sustainability targets and transition plans, the Directive can benefit both companies and financial institutions with better decision-making, reduced risks and clear legal guidelines.

To make companies’ transition plans effective and not an excessive burden, the CSDDD should align with the Corporate Sustainability Reporting Directive, and provide clear, concise information on key elements. These elements should include at least time-bound plans, absolute greenhouse gas reduction targets which are aligned with the Paris Agreement, and comprehensive coverage of not only climate change but all environmental issues, consistent with the EU Taxonomy.

Many financial institutions have called for more granular transition targets and plans in the CSDDD, as these would help reassure investors on the investee companies’ resilience and sustainability performance, and support engagement with the companies.

Companies must incentivise directors to achieve their environmental targets and transition plans by linking directors’ pay to the company’s sustainability performance.

The environmental targets and plans will be impactful only if the management is genuinely incentivised to implement them. As evidenced by corporate leaders, linking directors' variable remuneration to sustainability performance is a crucial step in ensuring that a company achieves its sustainability goals. By incentivising the management to implement its sustainability commitments, a company can reap the benefits of sustainability, including:

• Increased profits through reduced costs, increased efficiency, and a potentially larger market share, as consumers and investors increasingly demand sustainability from businesses.
• Mitigation of legal, financial and reputational risks, as the company proactively addresses sustainability issues in its operations and value chains.
• A meaningful positive impact on communities and the environment, as the company strives to achieve its sustainability targets and plans.

Leading investor groups, such as the UN Principles for Responsible Investment, Eurosif, and the Investor Alliance for Human Rights, have asked policymakers to require companies to incorporate sustainability factors into directors' variable remuneration.