EU regulates global sustainability ‘rules of the road’

RECENT years have seen surging international awareness of and interest in sustainability issues, helping drive a new wave of economic value creation. However, regulation of these trends has been largely stuck on the political backburner, but that may now be changing.

This is underlined by the journey that the European Union (EU) has been on with its proposed Corporate Sustainability Due Diligence Directive (CSDDD). The measure is expected to secure final ratification by the European parliament on Apr 24 after some four years of consideration by the Brussels-based institutions.

The CSDDD will oblige large EU and non-EU companies to document that products they import are compliant with human rights and environmental standards, including child and forced labour. As part of this, the measure will codify the UN Guiding Principles on Business and Human Rights, for the first time, in EU law.

The obligation to prevent, end or mitigate harms to human rights and the environment, such as child labour and biodiversity loss, applies to a firm’s so-called “upstream” partners in design or manufacture. Plus also “downstream” partners who transport, store and distribute products. That said, financial sector firms will only have to focus on upstream partners in their due diligence.

Firms will also have to prepare plans setting out how they will transition to a low-carbon economy. This includes deadlines for hitting climate targets, with key actions and investment required to deliver on this.

The perceived need for CSDDD stems from increased recognition of the need to act to address adverse effects of business on human rights and/or the environment, where progress is sometimes slow and/or uneven. The fragmentation of national rules across the 27 EU member-states on corporate sustainability-related due diligence obligations can also stymie take-up of good practices. Moreover, increasing complexity of supply chains can make it hard for firms to get comprehensive, up-to-date information on supplier operations.

The Brussels-based authorities assert one of the big advantages of the new measure is that it will avoid large companies having to navigate a plethora of potentially incompatible, national rules within the European single market. The CSDDD will apply to firms operating in the bloc that have more than 1,000 employees, and net worldwide turnover above 450 million euros (S$654.2 million).

Businesses will have to bear at least two new sets of costs. Firstly, those of establishing and operating the due diligence procedures. Secondly, transition costs, including the expenditure and investments to change corporate operations and value chains to comply with the due diligence obligation, where needed. Fines for not complying with the rules could be up to 5 per cent of net worldwide turnover.

The CSDDD rules will be mainly enforced via administrative supervision. That is, member states will designate an authority to supervise and impose sanctions, including fines and compliance orders. At the EU level, the Commission will set up a European Network of Supervisory Authorities that will bring together representatives of the national bodies to try to ensure a coordinated approach.

Yet, while the measure has been welcomed by some political and civil society stakeholders, numerous corporate groups have criticised it. This despite the fact that some 70 per cent of the businesses who responded to the public consultation said that EU action on corporate sustainability due diligence is needed.

One CSDDD opponent is Markus Beyrer, director general of lobby group BusinessEurope, who asserts it will “add unparalleled obligations, set harsh sanctions with potential existential implications for companies, and unilaterally expose them to litigation from all parts of the world”. He claims that “European companies with global operations, some with millions of indirect relationships, will be put at a disadvantage compared to their global competitors”.

On the other side of the ledger, some NGOs have criticised the messy “end game” compromises in recent weeks that they say significantly undermines CSDDD’s likely impact. Earlier drafts sought to target firms with more than 500 employees and a turnover of 150 million euros, which would have applied to a significantly larger net of corporates. The German and Italian governments lobbied against this, fearing it could hit their economies harder than most due to the relatively high numbers of small and medium firms in their business ecosystems.

Moreover, the latest draft of the measure has eliminated civil liability provisions that would have potentially permitted trade unions to sue non-compliant firms. That provision was opposed by several countries, including Finland.

There has also been a significant compromise in the proposals for a staged approach to introducing the rules over three to five years, depending on the size of firms. So this will see a multi-year transition period now into the second half of the decade.

For all the compromises and criticisms made of the CSDDD, however, what the likely passage of the measure points to is the continuing ambition that the EU has to entrench itself as a global regulatory superpower. With this latest measure, it is clearly seeking to help set the “rules of the road” for the global corporate sustainability agenda.

By developing far-reaching regulations that have a significant bearing on the global business environment outside of the 27 EU member states, the Brussels-based club is trying to ensure that European values shape policy in a wide spectrum of policy areas. This includes not just sustainability and the environment, but also antitrust, data privacy and consumer health and safety as a growing number of global firms adopt EU standards as global standards.

Last year, for instance, the EU hit the headlines for being a “first mover” in another key policy area with the world’s first comprehensive artificial intelligence legislation after a breakthrough deal was negotiated after many months of consideration. This new regulatory framework, which once again has been criticised by some business groups, will represent the strictest set of measures anywhere for the emerging technology.

For many observers of global affairs, this shows that the EU can legitimately have claims to be a genuinely impactful, world power. This despite its traditional lack of hard power, or military might, compared to some other nations such as the United States, China and Russia.

Taken together, the CSDDD is therefore only the latest example of the EU’s attempts to set the global regulatory agenda with key actions in a growing range of policy areas. While the new measure has been criticised by some non-governmental organisations for not going far enough, it is a first for any major global power, and its ambition may yet get scaled up over time.

The writer is an associate at LSE IDEAS at the London School of Economics