A last-minute compromise has saved a landmark EU reform to hold the bloc’s biggest companies accountable for environmental, social and governance (ESG) abuses in their supply chains. But the need to dilute the rules to win political buy-in, plus a US decision to scrap supply chain obligations from the country’s fresh climate-disclosure rules, reveals the difficulty of holding firms legally responsible for their business partners’ actions.

After several failed and postponed votes, the European Council agreed on a revised Corporate Sustainability Due Diligence Directive (CSDDD) on March 15, paving the way for it to be passed into law in a European Parliament vote scheduled for April.

It requires EU-based companies with global turnover of at least €450m and 1000 employees to identify, mitigate and prevent negative impacts on human rights and the environment in their upstream and downstream supply chains, or risk being fined up to 5% of net turnover. 

“The delays and hurdles to the CSDDD reflect the tensions between the ambition to protect human rights and the environment, while maintaining the competitiveness of EU companies in international markets,” said Cristina Larrea, who leads sustainability standards at the International Institute for Sustainable Development (IISD). 

Compared to the original draft, the threshold for firms caught by the CSDDD has been tripled from €150m and employee numbers doubled from 500. Lower thresholds for high-risk sectors, such as textiles, agriculture and mining, have also been scrapped. 

The compromise came just one week after the US announced its long-awaited climate-related disclosure rules, which require the country’s large, publicly listed companies to disclose their greenhouse gas emissions and how they are mitigating them. The original proposal to include scope 3 emissions, or those from supply chains, was axed following strong pushback during the public consultation phase to the rule’s steep business costs.

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Top three concerns

Consumer advocacy groups and parts of the private sector support making large corporates responsible for ESG risks in their supply chains. In February, three of the biggest confectionary companies operating in Italy wrote to the national government urging it to approve the original wording of the CSDDD. 

But pushback over the difficulty and expense of controlling ESG standards in complex supply chains has created pressure that can scupper these rules. The situation in Germany, which got ahead of the EU by introducing a national Supply Chain Due Diligence Act a year ago, shows there are no shortcuts to compliance. German authorities have clamped down on firms trying to transfer their legal responsibilities onto suppliers by requiring them to sign an ESG code of conduct. “It’s not sufficient just to ask your supplier to fulfil everything,” said Julia Sitter, a partner at law firm White & Case in Frankfurt. “You have to control and report on it.” 

Another top concern among the private sector and politicians is the emerging patchwork of laws regulating ESG in global supply chains. On top of Germany’s rules, in the EU alone there is also a French law requiring firms to monitor supply chains for human rights and environmental abuses since 2017, and the European Council recently agreed to introduce a Forced Labour Regulation that bans certain goods from entering the bloc. Australia and Canada also have ESG transparency rules regarding supply chains.

“Various countries are looking at measures that may be focused on reporting, due diligence or trade prohibitions,” said Clare Connellan, a White & Case partner in London. “They’re all trying to get the same [point], but from different angles. That can make it quite difficult for companies to work out what to do when looking at their own supply chains.” 

The third big risk created by these rules is that firms limit their exposure by simply cutting ties with businesses in at-risk countries, stifling rather than stimulating responsible investment. “Stricter rules like the CSDDD could make it harder for businesses, particularly small and medium-sized enterprises in developing countries, to remain part of global supply chains,” said Lukas Schaugg, an international law analyst at the IISD.

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