A Basic syllabus of corporate responsibility regulation – PART 1: The content of the CS3D in brief

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There are a lot of developments taking place in corporate sustainability and responsibility legislation at the moment – for instance, the amount of new legislation at the EU level has increased enormously in recent years and more legislation or specifying guidance is yet to come. It can be difficult to follow the rapidly increasing legislation, as some of the EU legislation is in the form of regulations, which are directly applicable as such, for instance the so-called Forced Labour Regulation and the Deforestation Regulation, or directives, such as the Directive on Corporate Sustainability Reporting (“CSRD”) and the Directive on Corporate Sustainability Due Diligence (“CS3D” or “CSDDD”), which still require transposition in member states’ national legislation. Many projects at the EU level also have connecting factors with each other, making it challenging to manage the nexus of legislation and to form an overall picture. From globally operating companies’ perspective, compliance is further complicated by the fact that they also have to take into account various national level laws, for example in the US and in different EU member states, to ensure that their business is conducted appropriately in each of the countries where they operate.

The purpose of this three-part blog is to provide a concise overview of the current state of corporate sustainability and responsibility legislation, in particular based on the CS3D.

The content of the CS3D in brief

The CS3D that provoked a lot of discussion in the media was adopted in its renegotiated form by the European Parliament in late April 2024 and entered into force on 25 July 2024, when it was published in the Official Journal of the EU. The CS3D must be transposed into national legislation by 26 July 2026. The deadline for national transposition of the directive may seem long, but in reality, it is not, considering all that the directive requires of companies and the EU Member States. Moreover, regarding that some of the obligations of the CS3D are included in the already applicable CSRD, there is barely any transitional or separate preparation time in practice.

In its final adopted form, the CS3D is directly applied to companies that meet the below threshold progressively as follows:

  • three years after the CS3D enters into force, companies with 5,000 employees and a turnover of EUR 1,500 million or more;
  • after four years of entry into force, companies with 3,000 employees and a turnover of EUR 900 million or more; and
  • after five years of entry into force, the obligations will apply to companies with 1,000 employees and a turnover of EUR 450 million or more.

These thresholds mentioned in paragraphs 1-3 are higher than those in the proposal for directive published in 2022. The scope of application of the CS3D therefore includes fewer companies than originally intended, and this compromise was made because the adoption of the CS3D was at risk.

  • Additionally, the scope of application of the directive extends to such companies outside of the EU that derive a certain proportion of their turnover from the EU.

The CS3D applies directly to companies that exceed the above thresholds. The CS3D also requires these companies to take into account the human rights and environmental risks of their own operations and those of their subsidiaries in their chain of activities as well as of their direct (and, if necessary, indirect) business partners. The obligations of the CS3D will therefore be indirectly extended to small and medium-sized enterprises in the chains of activities of large companies.

Additionally, it is worth to note regarding the scope of application of the CS3D that the turnover thresholds mentioned in the list are calculated based on the consolidated financial statements, so the application of the CS3D cannot be avoided, for example, by splitting the operations into different subsidiaries. However, in the final adopted form of the CS3D, lower turnover thresholds will no longer be set for companies operating in high-risk industries (e.g. textiles or mining), as proposed in the proposal for directive. In this respect, companies will be in the same position regardless of their line of business.

The CS3D requires a due diligence process

The CS3D requires companies to comply with a risk-based due diligence concerning human rights and environment, which in practice aims to prevent harmful effects on human rights or the environment. These harmful effects are determined based on the international agreements listed in the annexes to the CS3D.

The risk-based due diligence concerning human rights and environment, (Article 5) required by the CS3D is divided into the following process:

  • Integrating due diligence into the company’s policies and risk management systems. In addition, companies must have a policy concerning due diligence in place to ensure a risk-based due diligence approach
  • Identifying, assessing and prioritising actual and potential harmful effects (consultation with company stakeholders is essential both here and e.g. in addressing harmful effects)
  • Preventing and mitigating potential harmful effects and eliminating actual harmful effects or at least minimising the extent of effects + obtaining contractual assurances in the chain of activities where relevant
  • Providing remedies alone / in cooperation with another party in the chain of activities, in case actual harmful effects have occurred
  • Establishing a notification mechanism and complaints procedure to allow individuals, trade unions and civil society organizations, which are objects of the effects, to submit complaints
  • Communication (annual report), monitoring and evaluation of the effectiveness of the measures (and points 1-6 again)

The ideology behind the CS3D is that the due diligence concerning the environment and human rights should permeate the company’s entire operations. Compliance with the due diligence requires increased and open dialogue between the different functions of a company – a lawyer commenting on agreements may not necessarily always know how, for example, sourcing organisation views the risk and the likelihood of potential harmful effects of a certain chain of activities unless it is openly discussed.

The companies which are within the scope of the CSRD have already largely implemented the due diligence process as a part of their operations, as the process is effectively incorporated into Chapter 7, Section 7 of the Finnish Accounting Act. However, the obligations of the CS3D cannot be fulfilled by simply obligating subcontractors to respect human rights and the environment by agreement.

The climate transition plan should include concrete targets

In addition to tackling harmful effects relating to human rights and environment, the CS3D contains a third – less talked about, but even more important – element. That is to say, the CS3D requires companies to prepare and implement a climate transition plan that aligns their business model and strategy with Paris Agreement target on climate change to 1.5 degree Celsius and the transition to a sustainable economy and achieving climate neutrality. The transition plan should include, inter alia, the company’s medium-term climate change targets, the role of management and the management’s reward criteria in this regard, as well as emission reduction targets for all scopes 1-3 (1 = direct emissions from own operations, 2 = indirect emissions from purchased energy and 3 = other indirect emissions such as transport and distribution, waste from the use and disposal of products sold and investments). As an administrative burden reduction, if a company already drafts a corresponding transition plan based on the CSRD, it can also be considered as acceptable plan under the CS3D.

The above-mentioned consideration of scope 3 emissions will directly lead to the legislation also extending to small and medium-sized enterprises, as research show that 90% of a company’s emissions are generated at this stage of distribution of the finished product. It is therefore essential that these operators are aware of their own greenhouse gas emissions so that they can provide information to the companies included in the direct scope of application of this legislation. Further, it is to be expected that companies included to the scope of application will ask for information related to corporate responsibility legislation themes, such as harmful effects concerning human rights and environment as well as emissions, for example already at the project bidding stage, so every company should prepare for the application of corporate responsibility legislation by, for example, identifying the emissions of their own operations. In case company wants to outsource the calculation of emissions, it shall be noted that it often takes several months for an external expert to complete the calculations.

The CS3D also contains several other noteworthy provisions, such as contractual assurances to ensure that either direct or indirect business partner, as the case may be, is committed to the company’s code of conduct and, if necessary, to a corrective action plan. In addition, the CS3D contains provisions on monitoring of obligations, sanctions, responding to harmful effects, model contract clauses and for example regarding public support, which can have an impact on participation in public procurement.  Sanctions and monitoring, as well as responding to harmful effects, will be considered more specifically in the following parts of this blog series.

 

Read the part 2: Why should we care about corporate responsibility?

Read the part 3: Corporate responsibility legislation challenges traditional contracting models

 

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