Author – Anchal Singh

• The EU Corporate Sustainability Due Diligence Directive is a groundbreaking EU-wide regulation requiring large companies to adhere to human rights and environmental standards.
• The directive currently exempts financial institutions from undertaking due diligence, enabling them to fund harmful activities without being held accountable.
• By excluding the financial sector, the CSDDD limits the ability of banks to influence and improve the sustainability practices of companies they finance.
• Financial institutions face only indirect accountability through financed companies, which is insufficient to drive significant changes in practices.
• The European Commission might reconsider the directive to encompass financial institutions, but prevailing political conditions create uncertainty, leading to a gap in achieving complete sustainability.

The adoption of the EU Corporate Sustainability Due Diligence Directive (CSDDD) represents a significant milestone, as it establishes the first EU-wide legislation requiring both EU and non-EU companies within its scope to adhere to human rights and environmental standards. The directive imposes big responsibilities on companies, requiring them to validate that they have implemented all the necessary measures to effectively identify, mitigate, address, and remediate actual and potential adverse impacts on human rights and the environment. It also mandates that companies adopt and implement a transition plan for mitigating climate change. However, despite its revolutionary nature, the Directive has several limitations. It applies only to companies with over 1,000 employees and a net worldwide turnover exceeding EUR 450 million, while excluding certain downstream activities and, notably, exempting the financial sector from due diligence obligations.

The exclusion of the financial sector from the CSDDD presents a significant risk to its effectiveness in promoting sustainable and responsible corporate behaviour. Here, we examine the key impacts of this exclusion and why including the financial sector could be crucial in achieving the directive’s goals.

Continuation of Harmful Practices

By excluding financial institutions, the CSDDD allows banks and other financial entities to continue financing activities that may contribute to human rights abuses and environmental degradation without conducting due diligence on their downstream impacts. Banks can still invest in fossil fuels and other high-risk sectors without accountability, effectively giving them an opportunity to prioritize profit over sustainability. As a result, financial institutions can perpetuate harmful practices without facing repercussions, undermining the directive’s objectives.

Missed Opportunities for Influence

Financial institutions play a crucial role in shaping the economy by allocating capital. Their exclusion from the CSDDD limits their ability to influence the sustainability practices of the companies they finance. By not being required to assess the environmental and human rights impacts of their investments, financial institutions miss opportunities to drive better practices across industries. This absence of influence weakens the potential for transformative change in corporate behaviour that the directive aims to achieve.

Indirect Accountability

Although financial institutions are exempt from direct due diligence requirements, they may still face indirect accountability. For instance, companies they finance that are subject to the CSDDD could request information about the financial institutions’ practices. However, this indirect accountability is not as robust as direct obligations and may not lead to significant changes in behaviour. Without binding requirements, financial institutions will have little incentive to alter their practices or prioritize sustainability.

Transition Plans and Climate Goals

While larger financial institutions are required to adopt climate transition plans, the vagueness of voluntary obligations may not ensure substantial changes. These plans are expected to align to limit global warming to 1.5°C, but without stringent requirements, there is a risk that they may lack the necessary rigor to drive genuine progress in reducing emissions. Without specific targets and accountability measures, financial institutions may continue to fall short of making meaningful contributions to climate goals.

Future Considerations

The European Commission is set to review the CSDDD within two years, opening the possibility for future inclusion of the financial sector in due diligence obligations. However, given the current political climate, this inclusion remains uncertain. In the meantime, a significant gap in accountability for financial institutions persists, potentially undermining the directive’s effectiveness in promoting comprehensive sustainability practices.

Conclusion

The exclusion of the financial sector from the CSDDD significantly diminishes the directive’s potential to foster comprehensive sustainability practices across the corporate landscape. By allowing harmful practices to persist without adequate oversight, the directive misses an opportunity to leverage the financial sector’s influential role in shaping corporate behaviour. Including financial institutions in due diligence, obligations could enhance accountability and drive transformative change, aligning corporate practices with global sustainability goals. As the EU progresses with its sustainability agenda, addressing this exclusion will be crucial for realizing the full potential of the CSDDD.

References:

https://commission.europa.eu/business-economy-euro/doing-business-eu/sustainability-due-diligence-responsible-business/corporate-sustainability-due-diligence_en

European Union: CSDDD – No escape for the financial sector? – Baker McKenzie InsightPlus

https://www.whitecase.com/insight-alert/time-get-know-your-supply-chain-eu-adopts-corporate-sustainability-due-diligence