The EU’s Corporate Sustainability Due Diligence Directive – One More Step Towards Fully Accountable Finance

In an effort to beat an election cycle that risked compromising years of work and negotiations, the European Council and Parliament have struck a deal to adopt a landmark law in business and human rights. Once enacted, the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) will require large corporations to conduct human rights and environmental due diligence over harms in their value chains. A feature of the law is that regulated entities must meaningfully engage with rights holders affected by their actions by, among other things, introducing complaints mechanisms, communicating due diligence policies, and regularly monitoring for effectiveness. Those that fail to conduct adequate due diligence and facilitate remedy for harm could be liable for substantial fines and penalties.

For now, the law will exempt the financial sector from key requirements, thereby impeding what could be a quicker transition to a green economy that values long-term sustainability over short-term profits. Financial institutions are expected to perform only “upstream” due diligence to avoid purchasing from organizations complicit in human rights or environmental abuses. The law will not require them to safeguard against and monitor for harm in projects and programs that they support, in outright disregard of international standards like the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct. While all financial sector actors will be required to develop and implement climate transition plans in line with the 1.5°C ambition of the Paris Climate Agreement, it is not yet certain whether the law will require plans to effectuate a just transition that integrates respect for human rights.

While many are rightly disappointed about the favoritism afforded to the financial sector under the law, all is not lost. Exemption under the CSDDD does not absolve the financial sector’s responsibility for environmental and human rights impacts directly caused or enabled by their activities. Even if financial institutions are not yet subject to full liability, they can still be held accountable.

Financial institutions must set up accountability channels.

Financial institutions need to establish accountability channels to hear from people harmed by their downstream investments no matter whether the CSDDD is explicit about that or not. First, it is incumbent upon financial actors to develop credible and serious climate transition plans; accountability channels accessible to environmental defenders and frontline communities are necessary to ensure effectiveness and integrity in the implementation of plans and to respond to potential or actual harm accordingly. We know from our work that accountability mechanisms are antidotes to greenwashing and are critical processes for people to defend their local environment.

Second, other regulations and guidelines require financial institutions in Europe to set up accountability mechanisms. Under the EU’s Sustainable Finance Disclosure Regulation (SFDR), financial actors pursuing investments promoted as sustainable or having environmental, social, or governance (ESG) characteristics must disclose all material impacts adverse to sustainability (encompassing human rights, the environment, corruption, and social and employee matters). Buttressing the expectations of the SFDR is the Corporate Sustainability Reporting Directive and its corresponding European Sustainability Reporting Standards (ESRS), which will soon require financial institutions of a certain size to disclose their community-accessible grievance redress mechanisms and their policies for providing or cooperating in remedying adverse impacts to communities affected by their operations. Reporting must detail the number of grievances that raise “severe” human rights issues, and the law encourages disclosure of how lessons from complaints have influenced operational and decision making processes. The only way to systematically ascertain material or severe adverse impacts is for financial institutions to have accountability mechanisms in place to hear from people directly impacted by the projects and programs they support.

Solid expectations for stakeholder engagement and grievance redress have also been integrated into impact and sustainability reporting regimes like the Global Reporting Initiative and the SDG Impact Standards because, in principle, community-led accountability is good for the health of society and business (i.e., the triple bottom line – people, planet, and profit). These advancements have contributed to the emerging norm that impact investors must be responsible for their net environmental and social performance by embracing accountability mechanisms accessible to communities discretely impacted by activities supported by their portfolios. Asset allocators and managers alike are actively seeking to more deeply understand impact performance.

Money is power. It must be held accountable.

The essential problem with every existing reporting standard and guideline for the financial sector, and the reason why we advocate for financial institutions to be accountable for their downstream impacts on the environment and human rights, is discretion. Financial actors are provided far too much latitude to decide which, if any, of their human rights and environmental impacts are “financially material” or “severe” enough to engage with and disclose. The public ends up having to trust the benevolence of institutions likely more focused on profit than anything else. That is backward. A just economic system demands that we value human rights and a healthy environment for all above profits for the few.

From our work alongside communities seeking redress for environmental and social harm enabled by international finance, we know that communities living near and working at investment sites have far too long taken on the burden when investments cause harm. Institutional investors have backed large-scale agribusiness projects that led to deforestation, biodiversity loss, and violence against local communities. They have also backed the expansion of mining operations despite known labor and environmental abuses. And if it’s not complicity on the part of the financial sector, it’s complacency – a startlingly low number of financial institutions–less than 3% of 400 institutions assessed by the World Benchmarking Alliance–disclose how they identify human rights risks and impacts related to their financing activities.

Frustratingly, even financial institutions that have publicly championed environmental and social due diligence, stakeholder engagement, and grievance redress by committing to the Equator Principles, have largely failed to establish accountability mechanisms truly accessible to communities impacted by their funded projects. Despite repeated calls to establish accountability channels, Equator Principles banks have demonstrated that they won’t be accountable unless they are forced to. This is precisely why we and many others urged the EU to regulate the financial sector equal to other corporate actors under the CSDDD.

The work ahead.

Our response to the crises of our generation requires us to take a hard look at the role that the financial sector has played in bringing us closer to the precipice. If we seek a society that values respect for humanity over the value of capital, then we must hold the financial sector to account. Too rarely do financial institutions have the political will to use their leverage to safeguard human rights and the environment, but when they do, serious harm can be avoided, mitigated, and remediated. While we join many others in celebrating the CSDDD coming into force, our work is just beginning. Because the agreement commits to a review of whether the financial sector should be eventually included, we will continue to amplify community voices to demand a responsible and fully accountable financial sector.