The Extraterritorial Impact of the Upcoming EU Corporate Sustainable Due Diligence Rules

Corporate sustainability has become a crucial aspect of business operations in recent years. While there is a rising awareness that companies should take responsibility for their environmental, social, and economic impact on people and the planet, the EU is developing its own standard for responsible business conduct. In response to growing concerns about the negative impacts of business activities on the environment and human rights and the call for companies to be held accountable for their actions, the EU’s initiative has the potential to change the way businesses operate in Europe and beyond.

EU’s Standard for Responsible Business Conduct

Part of a broader EU strategy to promote sustainable business practices, the Corporate Sustainability Due Diligence Directive (CSDDD)—unveiled by the European executive body in February 2022—lays down mandatory environmental and human rights due diligence obligations for a wide range of companies operating in the EU. The EU proposal goes beyond the existing international voluntary standards, such as the United Nations Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises and Due Diligence Guidance for Responsible Business Conduct.

This new framework requires companies to take a more comprehensive approach to sustainability. These groundbreaking rules ask in-scope companies to identify, prevent and mitigate any actual or potential adverse human rights and environmental impact in their own operations and in their subsidiaries, as well as require adequate governance, management systems, and measures in place to this end. This includes implementing policies and procedures to address issues like forced and child labor and environmental degradation.

In practice, companies will be required to assess and manage the impacts of their activities, as well as develop and implement sustainability strategies and report publicly on their progress towards achieving their sustainability goals to drastically increase transparency about their sustainability performance.

Companies will also have to address the risks posed by their established direct or indirect business relationships with entities in their value chain. This means the EU legislation would have implications that extend far beyond the bloc and concrete measures will be necessary when conducting business in the EU.

The Extraterritorial Impact of the Directive

While it intends to provide a level playing field for all companies operating in the EU, it also implies that many host companies will become subject to the same mandatory reporting obligations as in-scope EU companies. The extraterritorial reach of the proposed EU law represents one of the most challenging aspects for companies, implying far-reaching consequences beyond the EU borders.

The proposed Directive might potentially affect various categories of foreign firms, not only host companies meeting the threshold requirements (i.e., net turnover within the EU above €150 million or €40 million if it operates in high-risk sectors). This includes parent companies, whenever one or more of the European subsidiaries of a company’s parent meet the quantitative turnover and employment criteria. Unlike non-EU companies in scope, other companies that are parts of the value chain of a company subject to these new rules will most likely be pressured to comply with those as well, whatever size or activities, as long as they do business with European companies.

Being part of an EU-connected value chain indirectly imposes the EU standards on a wide range of companies in a firm’s operations and would require any company across the globe that wants to operate in Europe or even be part of the value chain of any large company operating in the European market to comply with these standards. It means being exposed to the extraterritorial reach of EU law in areas that are both highly politically and commercially sensitive. This exemplifies the “Brussels Effect” on foreign companies, the phenomenon whereby EU regulations have global impacts as the rules will affect companies around the world.

The development of the new EU’s due diligence rules has been subject to extensive consultation and engagement with stakeholders—including businesses, civil society organizations, and government bodies—and debates have been raging across the European Parliament since the European Commission proposed its vision for businesses to ensure their value chains are free from environmental and human rights abuse last year. The EU has also engaged with other countries and international organizations to ensure that the EU’s rules are aligned with international standards and best practices, however, the most crucial concerns remain: how far the law should go in imposing the EU’s Responsible Business Conduct standards to companies around the globe, as well as making them responsible for their own and suppliers’ practices.

Some business groups have raised concerns about the potential legal and financial consequences, and administrative burdens associated with complying with the future Directive; others have already taken a proactive and responsible approach to sustainability. In both cases, the development of the CSDDD represents a much-needed step toward promoting sustainable business practices across the globe and the consequences of neglecting these issues can be severe. Yet to be finalized, the upcoming EU rules might impose firms doing business with or in EU companies to face a choice, either stop doing business with those companies or adapt their own business practices and policies to the EU standards.