In recent years, marked by an increasing awareness of environmental and social issues, the European Union’s Corporate Sustainability Due Diligence Directive (CSDDD) has emerged as a key legislative measure. It is designed to embed sustainable practices into corporate operations, aligning with the EU Green Deal, Paris Agreement, and broader EU policies, to ensure responsible business conduct across various industries and supply chains.

The objectives of the CSDDD are laudable. It aims to enhance human rights protections, such as defending people’s right to manage their land’s natural resources and ensuring safe work environments for workers, as well as mitigating negative environmental impacts, for example by addressing issues related to hazardous waste and chemicals. However, while aimed at enforcing accountability, the CSDDD also reveals policymakers’ mistrust in business and their tendency to overregulate, imposing additional legislative burdens on companies. This sentiment was reinforced after a somewhat disappointing compromise was adopted by the Permanent Representatives of the Member States in mid-March, and the same text was approved by the competent Committee of the European Parliament.

At the time of writing, we are awaiting a plenary vote by the Parliament at the end of April 2024 to confirm its position. Once formally approved by the co-legislators, the directive will enter into force following its publication in the EU Official Journal.

In this period of anxious waiting, this opinion briefly examines one of the many critical issues of this legislation, namely how the directive will negatively impact SMEs.

A closer look at the directive demands

The CSDDD imposes rigorous obligations on companies to protect human rights and environmental integrity within their global chains. It mandates a comprehensive due diligence process, requiring large companies to undertake due diligence not only on their own activities but also those of their suppliers. This includes identifying, ending, preventing, mitigating, and accounting for negative human rights and environmental impacts in the company’s operations, value chains, and subsidiaries.

The directive integrates sustainable practices deeply into corporate strategies, requires proactive measures to identify and mitigate adverse impacts, and emphasizes remediation and stakeholder engagement.

Furthermore, the CSDDD contains stringent provisions regarding the consequences of violating its obligations. Sanctions can be severe, ranging from publicly exposing and condemning the company, removing its products from the market, to prohibiting them from participating in certain public procurement processes, and imposing fines amounting to at least 5% of the company’s global revenue.

These elements set a high bar for compliance, especially for SMEs linked to larger corporations, and they stretch their operational capacities and resources, potentially affecting their core activities with the weight of compliance and reporting requirements.

The (unseen) impact on SMEs

Ironically, while primarily targeting larger entities, the Directive significantly affects SMEs, presenting challenges that could undermine the foundation of Europe’s economic fabric. These businesses, crucial to the EU’s economy, face a compliance situation that could stifle their innovation and growth. The Directive’s comprehensive approach increases operational costs and complicates daily management for SMEs.

Consider an SME with a 100-employee workforce suddenly facing the complexities of the CSDDD and the rest of ESG legislation with only one or two staff members managing diverse roles such as Human Resources, Quality, Safety, and Environment, Corporate Social Responsibility, and others. These two employees are overwhelmed with compliance requirements, including detailed questionnaires about their governance and green practices demanded by both large corporations and public authorities. This scenario, based on real experiences from Luxembourg, highlights the disproportionate burden placed on these businesses at EU level.

For SMEs, each new regulation or certification adds complexity to their operations. They must manage these with limited resources, often relying on a small team for a wide range of compliance and operational tasks. This setup raises critical questions about the proportionality and the sustainability of such regulatory pressure on smaller businesses.

The discord of harmonisation

Can we at least expect that an SME, once compliant with the legislation in Luxembourg, will find the same rules applied in other EU states? Unfortunately, no. One of the Directive’s oversights is its failure to ensure harmonisation across the EU. While aiming to create a unified framework for due diligence practices, it allows Member States to enact stricter measures, leading to a patchwork of regulations rather than a coherent set of standards.

This inconsistency can lead to significant challenges for these businesses as they face increased compliance costs and greater operational complexity. For instance, stricter environmental rules in Luxembourg than in neighbouring countries might isolate its businesses, making them less attractive as partners compared to their competitors in States with less stringent regulations. This not only affects Luxembourg’s businesses but also undermines the integrity of the EU’s single market.

Member States’ option to impose stricter rules could put local businesses at a competitive disadvantage, possibly forcing them to downscale or relocate, which could lead to higher unemployment. The burden is particularly heavy for SMEs, which often cannot influence regulatory outcomes or relocate flexibly. These smaller enterprises may find themselves disproportionately affected, unable to effectively navigate through diverse regulatory landscapes, thus stalling their ability to compete and innovate.

In conclusion

The CSDDD represents a significant stride towards integrating sustainability within the corporate framework of the EU. However, its application raises critical concerns especially for SMEs, which are pivotal to the European economy. While the directive’s extensive requirements are well-intentioned, they often place a disproportionate burden on SMEs, potentially stifling their ability to innovate and grow.

Additionally, the directive’s failure to ensure uniformity in regulatory standards across Member States further complicates matters, leaving SMEs to navigate a labyrinth of varied and stringent local laws.

To truly foster a resilient and sustainable economic landscape, Member States will need to recalibrate the CSDDD when transposing it into their national laws, providing more tailored support and clearer guidelines for SMEs. Streamlined processes, financial aid, and regulatory consistency will be crucial in empowering these businesses to meet sustainability goals without sacrificing their operational viability. Such adjustments will not only support SMEs but also enhance the overall effectiveness of the directive in promoting a greener and more responsible European market.

Francesco Fiaschi
Head of European Affairs at FEDIL