The PRI’s position on the EU’s corporate sustainability due diligence proposals – a good start but more is required

The Principles for Responsible Investment (PRI) has published a position paper on the European Commission’s proposal for a directive on Corporate Sustainability Due Diligence (CSDD). The ambitious draft directive, in its current form, will mark a substantial shift. It would require in scope EU and non-EU businesses not just to report on adverse environmental and human rights impacts they cause - but also to act to address them. It would also oblige companies to require those in their value chain with whom they have an established business relationship to do the same.

The question for businesses is whether the CSDD will remain in its current form, be watered down or beefed up. Looking at what big names like the PRI amongst others have to say may offer useful insight.

Whilst supportive of the proposal, the PRI has recommended various improvements which “will be needed to make it an ambitious and efficient policy.” The PRI also emphasises the need to align the CSDD with other similar or overlapping legislation, such as the Sustainable Finance Disclosure Regulation, the Taxonomy Regulation and the Corporate Sustainability Reporting Directive (CSRD).

What are the PRI’s key recommendations? 

• Investor Due diligence 

The scope of investor due diligence ought to be expanded to include broad ongoing assessments, rather than a one-off assessment conducted before providing a financial service. The PRI’s recommendation includes requiring due diligence pre- and post-investment, and conducting it throughout the value chain (not simply on clients receiving the investment), including SMEs present in the value chain, who may have insufficiently robust procedures in place.  

The PRI further recommends broadening the scope of the directive to include smaller companies, and to sequence this in line with the CSRD to ensure alignment. The CSDD is currently only set to catch less than 1% of EU companies directly (although many more are expected to be impacted indirectly).

• Executive remuneration

The PRI proposes a toughening up of Article 15(3) of the CSDD proposal, which will be of keen interest for boards and directors. Article 15(3) sets out that where directors have a variable remuneration package that is already linked to sustainability, companies must take into account the fulfilment of sustainability obligations (such as implementing a transition plan) when setting variable remuneration. According to the PRI, such conditionality ought to be removed, and ESG-linked remuneration packages implemented more broadly.

In addition, variable remuneration packages should reflect the fulfilment of E, S and G obligations, and not solely those related to climate change. Companies should select the relevant factors that are most material to them, with suitable checks and balances applied to avoid the risk of “pay padding” (i.e. purposefully selecting targets which are easier to quantify and/or meet to enhance remuneration packages).

Finally, companies should consider the wider workforce when setting director remuneration, “to ensure proportionate pay policies and structures are in place.”

• Transition plans 

Requirements on large companies to adopt transition plans demonstrating their commitment to limiting global warming to 1.5°C ought to be strengthened, to include information on how to adopt such plans and the detail that companies must provide when setting out their plans. The CSDD proposals should seek to align as closely as possible with those of the CSRD, to ease the compliance burden for companies.

The PRI encouraged legislators to adopt wording relating to the concept of a “just transition”, reflecting a more holistic approach to a sustainable economy “as a whole”. Transition plans should deliver a social impact, and align with the UN Sustainable Development Goals.

Cautioning against ‘established business relationships’ and ‘contractual cascading’

The CSDD introduces a number of novel and potentially fraught concepts. The PRI has strongly cautioned against two in particular:

• ‘established business relationships’; and
• ‘contractual cascading’.

Under the current terms of the proposal, due diligence obligations on companies extend to their ‘established business relationships’. The PRI fear this could lead to companies missing impacts and risks further down their value chains. Companies could also ‘game’ the system by entering into more short-term business relationships to avoid falling in-scope.

The concept of ‘contractual cascading’ requires a company to seek contractual assurances that their business partners will comply with the company’s code of conduct, in order to prevent and/or bring to an end negative human rights and environmental impacts. Those partners in turn would be expected to ‘cascade’ that contractual assurance onto their partners all the way along the value chain.

The PRI are deeply sceptical of the effectiveness of this concept, stating that “It is unclear how the use of contractual clauses would effectively allow for prevention and remediation of adverse impacts throughout value chains.”

An expansion of directors’ duties?

The PRI have highlighted that the CSDD proposal presents an opportunity to more effectively harmonise the directors’ duties regime in the European Union, “to allow a more holistic approach for the maximisation of social, environmental, as well as economic/financial performance.” Whether legislators will brave venturing into this potentially contentious area remains to be seen however, and the directive itself recognises that its ambition does not go so far as to require changes to existing national corporate structures.

Now that the PRI has marked the Commission’s homework, we must wait to see which (if any) of the PRI’s suggestions legislators will take up. Lawyers and their clients will be watching the development of the CSDD with interest, given its significant potential to usher in a new, tougher regime in Europe and beyond.