EU companies and those importing certain products and commodities into the bloc could face new reporting requirements as well as civil liabilities from the Corporate Sustainability Due Diligence Directive (CSDDD) proposal, which aims to address environmental and human rights violations across supply chains. The proposed law, the initial draft of which was introduced in February 2022 by the EU Commission, is positioned to affect corporates with substantial size or economic power in Europe (both EU and non-EU companies), along with those operating in what the directive defines as high-impact sectors.
The proposal moved further along the legislative process when the EU Council finalised its draft in December 2022. The EU Parliament is due to set out its position on the proposal in 2Q23, after which the proposal can be approved or amended and enter an additional reading. While the CSDDD has several legislative hurdles to jump and is likely to see revisions before becoming EU law, Fitch explores some potential high-level impacts that could arise if and when the directive is implemented by EU countries.
According to the UN, deforestation and associated land use changes are responsible for around 10% of global GHG emissions. As such, supply-chain due diligence – like that proposed under the CSDDD – can be a tool for addressing adverse environmental impacts. However, given the difficulty of monitoring upstream supply-chain activities, complying with the CSDDD would be a significant burden for many companies exporting into the EU, with potentially material compliance spending implications for imported soy, beef, palm oil, wood, cocoa and coffee, along with several derived products.
Although financing activities have been removed from the mandatory scope of the directive, Sustainable Fitch believes that lending practices will continue being increasingly influenced by supply-chain considerations, particularly with lenders facing greater scrutiny over the environmental and social externalities of loans.
Emerging Markets Are Most Exposed to Compliance Risks
With environmental and social protections already being in place within the EU, the CSDDD was created with the intention of addressing the adverse impacts that European imports have on the environment and society beyond the bloc’s borders. Based on the products and commodities covered in the proposed directive, Sustainable Fitch believes this places disproportionate focus on supply chains originating from emerging markets, with Brazil and Indonesia notably affected as major exporters of several of the commodities under review.
Criticism of the directive has focused on its associated compliance requirements and costs, which are expected to be significant given that it will require companies to produce due diligence reports for all eligible products.
Effect of Compliance Will Vary Between Supply Chains
Although commodities will be equally subject to the requirements of the CSDDD, exposure to issues like deforestation and human rights concerns vary across different commodity supply chains. Similarly, regional considerations and differences in supply-chain structures also significantly influence vulnerability to these issues. As a result, compliance with the CSDDD will
be felt differently across different commodities.
For instance, commodities with significant reliance on smallholder farming (i.e. production originating from many small-scale operations), such as cocoa and tea, are likely to feel the greater strain from human rights requirements under the CSDDD, due to the prevalence of child labour in their supply chains. The International Labour Organization estimates that agriculture
accounts for the largest share of child labour, with 85% of all child labour in sub-Saharan Africa (SSA) being associated with the sector.