By requiring the measurement of on-the-ground risks and adverse impacts, the EU regulation will shift focus from pledges to action, argues Alexandra Mihailescu Cichon
The EU's emerging Corporate Sustainability Due Diligence Directive (CSDDD) is a big step in the right direction in the vast and varied world of regulation.
The directive's emphasis on impact and accurate measurement is a de facto signal about which parts of a company's business conduct are important to measure. It is also a signal on which parts are not: pledges.
Importantly, the CSDDD signals an ideological shift that occurred over the past few years – the management of ESG issues becoming part-and-parcel of fiduciary duty.
Progress and a tectonic shift
The directive is a breath of fresh air in its call for disclosures of adverse impacts and prevention and mitigation of potential risk. It is in accordance with the EU Commission's stated goals of:
- fostering sustainable and responsible corporate behaviour and
- anchoring human rights and environmental considerations in companies' operations and corporate governance.
As the world moves past the recent era of commitments and pledges, and companies move into execution mode, regulators should ensure that companies have the appropriate due diligence procedures in place to identify, mitigate, and manage actual adverse impacts and risks.
Until now, most regulations and voluntary sustainability initiatives have largely focused on disclosures, including policies and processes. Making pledges and drafting policies are good, but at the end of the day they are just intentions. There needs to be verification of whether those intentions translate into on-the-ground action. The CSDDD to a large extent does just that by requiring the measurement of on-the-ground risks and adverse impacts.
Article 4 of the directive outlines a number of environmental and human rights due diligence processes that must be carried out by companies that fall within its scope, including:
- due diligence integration into company policies,
- public communication of those policies,
- identification of actual or potential negative human rights and environmental impacts,
- and prevention and mitigation of the potential impacts.
Because the necessary requirements cover companies' value chains and business relationships, they establish a matrix of accountability. A company required to get its house in order will necessarily have to call on others – in its value chain – to do the same, thus creating a positive domino effect.
The marriage of ESG and fiduciary duty
The directive clarifies the duties of directors: in addition to overseeing the requirements mentioned above, directors are explicitly required to take into account the human rights and environmental adverse impacts of the decisions made when fulfilling their duty to the company.
In other words, risk assessments are inherent to fiduciary duty and the execution of reasonable care.
"Making pledges and drafting policies are good, but at the end of the day they are just intentions. There needs to be verification of whether those intentions translate into on-the-ground action. The CSDDD to a large extent does just that by requiring the measurement of on-the-ground risks and adverse impacts"
The breaking down – and subsequent unification – of the "ESG" and "fiduciary duty" silos has been a slow but observable change over the past few years. One significant indicator of this convergence is the tying of director remuneration to the inclusion and achievement of sustainability and human rights targets in companies across the world.
The central tenet of fiduciary duty is operating in the best interests of the company. The CSDDD expands the scope of fiduciary duty to include ESG – once on the periphery – as a central and defining element.
This is a clear signal: the management of ESG and business conduct risk is in the best interest of the company.
CSDDD is both necessary and long overdue
The approach of the CSDDD is both necessary and long overdue. RepRisk data shows that between 2020 and 2022, more than 10,500 public and private companies across geographies and sectors were linked to a supply chain related ESG risk incident. This is no small challenge.
The CSDDD expands the scope of fiduciary duty to include ESG – once on the periphery – as a central and defining element"
It is true that elements of the CSDDD have drawn criticism, such as the inherent complexity of disclosures that fully encompass supply and value chains. I freely concede that it is no small task and that the CSDDD won't be a silver bullet for the industry. It is, however, a step in the right direction.
Ultimately, progress happens when we don't make perfect the enemy of good. We must start somewhere, and importantly, we must start now.
Alexandra Mihailescu Cichon is Chief Commercial Officer at risk-focused business conduct and ESG data provider RepRisk.