ESG: From soft law to hard law

1. The Corporate Sustainability Due Diligence Directive (CSDDD)

A first major legislative initiative is the proposal for a "Corporate Sustainability Due Diligence Directive" or "CSDDD".

This proposal is made to address centrally any negative impact on human rights and the environment in the value chains.

1.1 Application of the CSDDD

The scope of the draft directive includes both EU companies and non-EU companies that have operations in the EU.

The EU companies covered are (a) large companies with more than 500 employees and a net worldwide turnover of EUR 150 million or more and (b) high risk companies with more than 250 employees and a net worldwide turnover EUR 40 million or more, that are active in so-called "high-impact sectors" (e.g. textile production, agriculture, extraction of minerals).

Non-EU companies will fall within the scope of the CSDDD if they either (a) have a net turnover in the EU of at least EUR150 million in the financial year preceding the last financial year, or (b) had a net turnover in the EU at least EUR 40 million but not more than  EUR150 million in the financial year preceding the last financial year, provided that they are active in one or more of the "high-impact sectors".

SMEs are not concerned by these rules, but the proposal provides supporting measures through which these companies could be indirectly affected.

1.2 Obligations of the CSDD

According to the Commission's proposal, covered companies will be obliged, among other things, to exercise "due diligence" with regard to human rights and the environment. This must be done by identifying, preventing, mitigating and accounting for external harm resulting from adverse human rights and environmental impacts in their own operations, their subsidiaries and in the value chain.  

In addition, certain large companies must have a plan to ensure that their business strategy is compatible with the goals to limit global warming to 1.5 °C in line with the Paris Agreement.

The directive also introduces obligations for the directors of EU companies covered by the directive. They have a duty to set up due diligence processes and oversee their implementation as well as integrate due diligence into corporate strategy. In addition to their duty to act in the best interests of the company, directors must now take into account the human rights, climate change and environmental consequences of their decisions.

The directive is not expected to be adopted until after 2024 and then member states have two years to transpose it into national legislation.

2. The Corporate Sustainability Reporting Directive (CSRD)

A Second major initiative is the "Corporate Sustainability Reporting Directive" or "CSRD".

This directive came into force on 5 January 2023 and must be transposed into national legislation by 6 July 2024. The aim is to modernise and strengthen the rules concerning the social and environmental information that companies must report on.

2.1 Application of the CSRD

Like the CSDDD, the reporting obligations provided for in this directive apply to both EU and non-EU companies.

EU companies fall within the scope if (a) they are a large company meeting at least two of the following three criteria: net turnover of EUR 40 million, a balance sheet total of EUR 20 million, and 250 employees, or (b) the company's shares are listed on a EU regulated market.

Non-EU companies will have to comply with the sustainability reporting obligations if, in each of the last two consecutive financial years, they achieved in the EU net sales of more than EUR 150 million and either (a) have an EU subsidiary that is large (see the criteria here above) or is listed on a EU regulated market, or (b) have an EU branch that achieved net sales of more than EUR 40 million in the previous financial year.

2.2 What does the CSDR sets forth ?

The directive requires covered companies to provide information in their board report on "sustainability issues" (which are defined as "environmental, social and human rights, and governance metrics") affecting the company and on the company's impact on sustainability issues.

Among other things, the board reports must include a description of the company's business model, strategy and objectives on the sustainability issues. In addition, companies should report on and describe the due diligence processes they apply with regard to sustainability.

3. The Sustainable Finance Disclosure Regulation (SFDR)

A third important ESG legislative initiative is the "Sustainable Finance Disclosure Regulation" or "SFDR", which entered into force in December 2019 and is fully applicable since 2022.

It is not a directive but a regulation that applies directly to financial market participants (FMPs) defined as the "major players", such as investment firms, pension funds, asset managers, insurance companies, banks, venture capital funds, credit institutions offering portfolio management, or financial advisers. It requires all financial market participants and financial advisers to provide information on their financial products, sustainability risks and negative sustainability impacts in their investment process.

Related to the SFDR is also the Taxonomy Regulation, which applies from 1 January 2022. The Taxonomy Regulation provides for a common set of technical screening criteria to test and measure the extent to which an economic activity qualifies as environmentally sustainable. It applies when financial market participants make available products that promote specific environmental characteristics or products that have sustainable investments as an objective.

4. What are the implications of ESG legislation?

The aforementioned European legislative initiatives create several new obligations for companies and non-compliance may lead to liability.

For example, the CSDDD proposal stipulates that member states must provide for effective, proportionate and dissuasive sanctions.

In addition, the proposal even explicitly provides for a liability regime for victims who suffer damages because a company has been negligent in preventing and eliminating adverse effects on human rights or the environment and, as a result, an adverse effect has occurred that should have been identified, prevented, reduced or eliminated, or whose magnitude should have been minimised through appropriate measures, and which has resulted in damage.

The proposal goes even further as it stipulates that directors of any company, when fulfilling their duty to act in the best interests of the company, must take into account the impact of their decisions on sustainability. This is therefore very important in the context of directors' liability.

Whether the aforementioned liability regimes from the CSDD proposal will be effectively adopted is  still the subject of negotiations between the European institutions and thus not yet certain.

Importantly, however, even if not explicitly included in the legislation, ESG is expected to increasingly find its way into case law anyway. For example, a Belgian court may take ESG aspects into account when determining the corporate interest, which in turn will have an impact on the assessment of directors' liability claims.

Consequently, ESG topics are no longer mere recommendations, but are increasingly being converted into firm commitments. Moreover, this trend can be expected to continue in the coming years.

Companies would therefore do well  to already draw up an ESG policy now, even if they do not (yet) fall within the scope of the existing or coming legislation.

Should you have any questions regarding this matter, please do not hesitate to contact our specialists: +32 (0)2 747 40 07 or info@seeds.law.