The concept of due diligence plays a key role in numerous European environmental and sustainability laws (such as the CSRD and CSDDD) adopted in recent years. If your company wants to comply with these new directives—or better yet, make a real impact and use the laws as a springboard—a thorough understanding of due diligence in the context of sustainability is essential. That’s why we at Empact have written a white paper focusing on the CSRD and CSDDD. In this blog post, we’ll briefly discuss its content.
Due Diligence in the Context of Sustainability
The principle of due diligence originates in financial accountancy. When a company acquires another business or part of it, it is essential to conduct careful and structured research to assess its value. For example, you need to know if the company has debts, the profitability of its components, and the condition of its real estate.
In the context of sustainability (and ESG more broadly), the European legislator has chosen to apply a similar approach, requiring companies to map their ESG performance and that of their value chains and act accordingly. Companies are not expected to have perfectly sustainable and socially responsible value chains—this is not realistic (for now). However, they are expected to implement processes to monitor risks and performance related to environmental, social, and governance issues (and, depending on the regulation, to improve them): a due-diligence process. The underlying idea is that such processes will automatically lead to more sustainable and responsible business operations for larger companies and, ultimately, a better world.
UNGPs and OECD Guidelines as Guidance
When it comes to due diligence in the context of ESG, both the UN Guiding Principles on Business and Human Rights (UNGPs) and the OECD Guidelines for Multinational Enterprises serve as the leading standards. These guidelines form the foundation for the EU laws requiring due diligence mentioned earlier.
The following image visualises the six steps prescribed by the OECD Guidelines for companies:
European Sustainability Laws Where Due Diligence Is Central
Due diligence plays a significant role in the following EU laws, among others:
- Corporate Sustainability Reporting Directive (CSRD)
- Corporate Sustainability Due Diligence Directive (CSDDD)
- EU Deforestation Regulation (EUDR)
- EU Timber Regulation
- EU Conflict Minerals Regulation
- EU Forced Labour Regulation
- EU Batteries Regulation
Due Diligence in the CSRD
Large companies are now familiar with the due-diligence process within the context of the CSRD, as they are required to report under its guidelines from this fiscal year onwards. The CSRD, where the “R” stands for Reporting, dictates transparency in reporting. Specifically, regarding due diligence, companies are expected to explain whether they have implemented a due-diligence process and, if so, what this process entails.
It is important to note that the CSRD only requires companies to report on how due diligence is conducted. The exact design of the process is irrelevant in the context of compliance with the CSRD. However, this does not mean that developing and implementing due-diligence processes can be postponed: stakeholders such as regulators, financiers, and customers will be paying attention and won’t accept vague promises.
Companies are expected to explain how they have integrated the five core elements of a due-diligence process, as described in the European Sustainability Reporting Standards (ESRS), into their operations. The following image shows how these core elements align with the OECD Guidelines on this topic.
Due Diligence in the CSDDD
In addition to stakeholders thoroughly reviewing CSRD sustainability reports, there is another reason not to delay developing due diligence processes for ESG: the CSDDD. The first two Ds in its name stand for due diligence for a reason. The CSDDD makes due diligence in ESG mandatory, going a step further than the CSRD. Companies that have already made progress in this area will find it easier to meet the requirements of the CSDDD.
Beyond setting strict requirements for companies’ due-diligence approaches, the process under the CSDDD is more comprehensive than under the CSRD. While the CSRD specifies five core elements, the CSDDD requires a due-diligence process to meet eight conditions. The following table shows how these conditions align with the OECD Guidelines:
A Mature Approach to Due Diligence
In summary, the CSDDD requires companies not only to report and mitigate risks following established standards but also to take action when issues are identified in the supply chain and to provide accessible mechanisms for filing complaints.
However, in our view, the focus should be on developing and executing a mature due-diligence approach. Whether it consists of five steps, eight conditions, or ten principles, due diligence must lead to better business operations and, ultimately, to creating real impact. Simply filling out forms will not get us there.
Read More in Our New White Paper
Would you like to learn more about this topic and understand the requirements the CSRD, CSDDD, and other European sustainability laws impose on your organisation’s due-diligence processes? Download our white paper, Due Diligence in Sustainability within the Context of EU Regulation. It also includes a five-step plan to help you assess the scope and quality of your organisation’s existing due-diligence processes.