The concept of due diligence – translatable in Dutch to due diligence – plays a key role in quite a few European environmental and sustainability laws (such as the CSRD and the CSDD) that have been passed in recent years. So if you, as a company, want to comply with the new directives (or better yet, make real impact and use the laws as a springboard), a good understanding of due diligence in the context of sustainability is a prerequisite. This is why we at Empact have written a white paper on this, focusing on the CSRD and the CSDD. In this blog article, we briefly discuss its contents.
Due diligence in the context of sustainability
The principle of due diligence has its origins in the financial accounting context. When you, as a company, make an acquisition of another company or business unit, it is of utmost importance to do careful and structured research on what you are acquiring to determine its value. For example, you want to know if a company has debt, the profitability of parts and the state of property maintenance.
In the context of sustainability (and ESG in general), the European legislator has chosen to have companies similarly map their ESG performance and that of their value chain and act accordingly. So companies are not expected to have their value chain perfectly sustainable and socially responsible. This is not realistic (for now). However, they are expected to use processes according to guidelines to monitor (and depending on the law, improve) risks and performance on environmental, social and governance issues: a due-diligence process. The thinking behind this is that such a process automatically leads to more sustainable and responsible operations at large companies, and thus to 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 for short) and the OECD Guidelines for Multinational Enterprises on Corporate Social Responsibility (OECD Guidelines for short) are the guiding guidelines. These guidelines form the basis for the aforementioned EU laws requiring due diligence.
The image below visualizes the six steps the OECD guidelines prescribe for companies:
European sustainability laws focusing on due diligence
Among others, due diligence plays a major role in the following EU laws:
- Corporate Sustainability Reporting Directive (CSRD).
- Corporate Sustainability Due Diligence Directive (CSDDD).
- EU Deforestation Regulation (EUDR).
- EU Timber Regulation
- EU Conflict Minerals Regulation
- EU Forced Labor Regulation
- EU Batteries Regulation
Due diligence in the CSRD
Large companies are now familiar with the due diligence process in the context of the CSRD, as they are required to report under the guidelines of the CSRD starting this fiscal year. The CSRD, in which the R stands for “Reporting,” dictates transparency in reporting. And specifically with respect to due diligence, companies are expected to explain whether they have established a due diligence process and, if so, what this process looks like.
Importantly here, then, the CSRD only requires reporting on how due diligence is carried out in a company. How this process is further designed is irrelevant in the context of compliance with the CSRD. In practice, of course, this does not mean that the development and implementation of due diligence processes can be shelved: stakeholders such as regulators, lenders and customers will be reading along and will not be satisfied with vague promises.
Specifically, companies are expected to explain how they have implemented the five core elements of a due-diligence process, as defined in the European Sustainability Reporting Standards (ESRS), in their operations. The image below shows how these core elements relate to the OECD guidelines in this area.
Due diligence in the CSDDD
Besides the fact that stakeholders will read CSRD sustainability reports carefully, there is another reason not to wait to develop ESG due diligence processes: the CSDDD. In it, the first and second Ds stand for due diligence for a reason. In fact, the CSDDD mandates due diligence on ESG and thus goes a step further than the CSRD. Companies that have already made strides in this area will therefore have less trouble meeting the requirements of the CSDDD.
In addition to setting hard requirements for companies’ due diligence approach, the process of due diligence within the context of the CSDDD is also more comprehensive than within that of the CSRD. Where the CSRD specifies five core elements, the CSDDD requires that a company’s due-diligence process meet eight conditions. How these conditions compare to the OECD guidelines is shown in the chart below:
In summary, then, the CSDDD requires companies, in terms of due diligence, not only to report and mitigate according to established standards, but also to take action when wrongdoing is discovered in the supply chain and to enable others to voice complaints in an accessible manner.
What matters in our view, however, is that organizations develop and implement a mature due diligence approach. Whether it has five steps, meets eight conditions or consists of 10 guidelines, due diligence must lead to better business practices and thus realizing real impact. Because just filling out forms is not going to get us there.
Read more in our new white paper
Want to learn more about this topic and/or find out what requirements the CSRD, the CSDD and other European sustainability laws impose on your company’s due diligence process? Then download our white paper Due diligence on sustainability in the context of EU legislation here. It also includes a five-step plan to understand the scope and quality of your organization’s existing due diligence processes.