The Financial Sector and the Corporate Sustainability Due Diligence Directive (CSDDD): In or Out?

In recent years, the European Union (EU) has adopted a broad array of sustainable finance-related legislation, such as the Sustainable Finance Disclosure Regulation (SFDR), the Taxonomy Regulation, and the Corporate Sustainability Due Diligence Directive (CSDDD). In this context, much ink has been spilled around the extent to which the financial sector should be included in the CSDDD and should thus undertake due diligence with respect to adverse human rights and environmental impacts.

After prolonged debate, the CSDDD limits the due diligence of in-scope ‘regulated financial undertakings’ to their own operations, those of their subsidiaries, and the upstream of their chain of activities (thus excluding their downstream, e.g. their clients). Reasons put forward for this exclusion include concerns about regulatory burden and the perceived distance between financial undertakings and downstream impacts.

As we argue in our paper, although this exclusion appears to severely curtail the inclusion of the financial sector in the CSDDD, it raises more questions than it answers (1), and the effects of this exclusion may be more limited than expected when considered alongside with other sustainable finance-related legislation (2).

1. The Ambiguity of the Upstream and Downstream in the Financial Sector

Under the CSDDD, businesses are required to conduct sustainability due diligence with respect to their adverse human rights and environmental impacts. This due diligence process extends to a business’s own operations, its subsidiaries, and business partners in its ‘chain of activities’.

This chain normally encompasses the activities of upstream business partners related to the products and services of the business, as well as those of downstream business partners involved in distribution, transport, and storage of products, provided these activities are conducted for the business or on its behalf (CSDDD, Art 3(1)(g)).

As regards the financial sector, the CSDDD narrows the scope of ‘chain of activities’ for ‘regulated financial undertakings’ by limiting their due diligence obligations to their own operations, those of their subsidiaries, and only the upstream of their chain of activities. Downstream activities are explicitly excluded in these terms: ‘[f]or regulated financial undertakings, the definition of the term “chain of activities” should not include downstream business partners that receive their services and products’ (CSDDD, Recital 26).

Yet distinguishing between upstream and downstream activities in the financial sector is far from straightforward. Some scholars view this choice of terminology as unfortunate and ill-suited to the financial sector. While excluding downstream activities appears to set aside scenarios such as corporate lending, it remains unclear how the relationship between asset managers and asset owners or the relationship between them, their products and asset classes would be captured in the CSDDD.

For example, if an asset owner is considered a client of an asset manager, this would suggest that the asset manager's due diligence obligations do not extend to the activities of the asset owner. However, given that the operations of an asset manager depend on funding by asset owners, could one argue that an asset owner falls within the upstream of the asset manager’s activities? Alternatively, should asset owners view their asset managers as part of their own upstream activities because they manage assets which could be part of products asset owners offer to their beneficiaries? These interrogations are further complicated by the fact that the CSDDD does not apply to alternative investment funds and undertakings for collective investments (CSDDD, Art. 2(8)).  

2. The Broad Scope of the EU’s Sustainable Finance-related Instruments

Additional questions arise about how the exclusion of downstream activities from the perimeter of due diligence interacts with other EU sustainable finance-related instruments.

As noted earlier, the EU has recently adopted a range of sustainable-finance related instruments, some of which refers to sustainability due diligence either directly or indirectly. Yet, these instruments do not purport to limit due diligence to upstream activities, as recently noted by the EU Commission (and EFRAG) with respect to the CSRD. The discrepancy between these instruments and the CSDDD potentially limits the effect of the CSDDD’s exclusionary provisions regarding the financial sector. Such divergences and possible overlaps in terms of scope and perimeter can also raise practical challenges for the financial sector, in particular around conflicting interpretations of sustainability due diligence requirements.

Due diligence obligations concerning human rights impacts provide a striking example. Regulations such as the Taxonomy Regulation, for economic activities to be deemed taxonomy aligned, require entities or economic activities to be aligned with minimum safeguards, inter alia, the OECD Guidelines on Multinational Enterprises (OECD Guidelines) and the United Nations Guiding Principles on Business and Human Rights (UNGPs). The SFDR adopts a similar approach for funds that have sustainability as an objective.

In this context, alignment may reasonably entail implementing a process of human rights due diligence that encompasses the entire value chain, as outlined in the OECD Guidelines and the UNGPs, thus including both the upstream and downstream of financial actors. Consistent with this approach, the CSDDD, despite its exclusions, also references the OECD Guidelines in its recital, stating that they ‘provide indications of the types of measures that are appropriate and effective for financial undertakings to take in due diligence processes’ (CSDDD, Recital 51).

Furthermore, several financial actors will fall within the perimeter of the due diligence processes of large businesses required by the CSDDD, as they are integral to the ‘chain of activities’ of these businesses, upstream or downstream. Consequently, they could be required to conduct due diligence through contractual assurances.

Concluding Thoughts

It remains to be seen how the varying levels of obligations placed on the financial sector by different EU instruments will translate into practice, interact with one another, and perhaps converge in the future.  EFRAG’s forthcoming standards for the financial sector may help clarify how these various regulations interrelate. In addition, the sustainability due diligence practices of investors may be shaped by their portfolio companies or business partners that fall under the CSDDD, as well by their reporting obligations under the SFDR.

These developments will undoubtedly face scrutiny when, in two years, the Commission delivers its report, as provided by Article 36 of the CSDDD, assessing the necessity of additional due diligence obligations for regulated financial undertakings.

The authors’ complete article can be found here.

Elsa Savourey is a Lecturer at the Sciences Po Law School and ESSEC Business School and an independent legal adviser.

Daniel Litwin is a Researcher at the European University Institute and an independent arbitrator and legal adviser.