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The EU’s new sustainability directive compels large firms to walk the ESG talk and align their business models with climate targets or risk penalties.
Image Source: Getty
All European Union (EU) member states are gearing up to enact the Corporate Sustainability Due Diligence Directive into their respective national laws by July 2026. The EU Council adopted the Corporate Sustainability Due Diligence Directive (CSDDD) in July 2024, requiring eligible companies to prepare a climate transition plan aligned with the EU’s 2050 climate-neutrality goal. The Directive establishes a corporate due diligence duty, prompting companies to align their business models with the Paris Agreement's target to limit global warming to 1.5°C.
CSDDD requires designated companies to follow Greenhouse Gas (GHG) Protocol standards through a five-stage due diligence and risk assessment process. Companies must identify, mitigate, and remedy any adverse impacts across their value chain, including the operations of their business partners or subsidiaries. Article 22 provides detailed instructions on the climate plans submissions, requiring time-bound targets in five-year increments based on scientific research and, where appropriate, absolute emissions reductions. Plans must also identify decarbonisation levers and targeted actions, including adjustments to product or service portfolios, along with technology adoption. They must explain and quantify investments, funding, and the roles of administrative and supervisory bodies.
The EU’s new sustainability directive compels large firms to walk the ESG talk and align their business models with climate targets or risk penalties.
CSDDD takes effect in 2027 and 2028 for companies with turnovers over 1.5 billion euros and 900 million euros, respectively. Small and Medium Enterprises (SMEs) must comply by 2029.
While several member states reflect their commitment to EU climate goals by enforcing domestic Environmental, Social and Governance (ESG) policies, the approval and enforcement of the CSDDD will be implemented in two ways. First, designated authorities will handle administrative supervision, issue orders, and impose penalties on non-compliers in each Member State. The EU Commission will create a network to coordinate these efforts. Second, via civil liability, EU member states will ensure that victims receive compensation for damages caused by a company’s failure to conduct due diligence.
Despite its proposed EU-wide enactment, CSDDD remains a contentious issue requiring regulatory commitment. Economies of Germany, Italy, and France face challenges due to their extensive global value chains in their automotive, fashion, and luxury industry leadership. Italy and France withheld approval, apprehensive of burdening companies with unnecessary red tape and potential penalties under CSDDD’s extensive obligations.
In Germany—which already has a human rights-focused Supply Chain Due Diligence Act (SCDDA) that broadly defines environmental risks, banning pollution, mercury use, and poor waste management—the CSDDD received a hesitant reception. German businesses fear revenue loss and competitiveness against Chinese and Indian rivals who are exempt from such regulations. SCDDA has a lower scope of due diligence and climate-related requirements than CSDDD. Yet, it impacts many more companies, since it mandates companies with over 1,000 employees to comply with its due diligence policies regardless of revenue.
While initial compliance with due diligence, risk assessments, and climate planning is costly, these processes can become self-sustaining over time.
To ease the transition, the Omnibus Simplification Package proposed in February 2025 postpones CSDDD applications by one year to 2028. The Omnibus Package limited due diligence obligations primarily to direct (Tier 1) business partners, subject to exceptions. While it edicts the disclosure of climate transition plans, the package has removed the explicit legal obligation to ‘put into effect’ these plans. This creates an implementation gap where companies can report ambitious plans without binding legal enforcement. The removal of the EU-wide civil liability regime, leaving certain matters to national laws, creates a nuanced situation where the processes of due diligence might be harmonised across the EU. However, the consequences of non-compliance—particularly in terms of civil liability and access to justice for affected parties—will likely vary considerably among member states.
The EU and the United States (US) economic partnership includes strong trade ties and substantial US Foreign Direct Investment (FDI). The US Corporate Sustainability Reporting Directive (CSRD) also requires non-EU companies with a turnover of 150 million euros in the EU to comply with its requirements. Of the 9,288 companies that fell under its scope, 3,236 are incorporated in the US. The CSDDD further captures foreign firms with a net EU turnover exceeding 450 million euros. CSDDD faces heightened backlash under the Trump Administration, with a bipartisan proposal ‘Protect USA Act’, introduced in the Senate, which seeks to shield US firms from CSDDD, criticising its extraterritorial overreach and threat to US competitiveness. Initial US rules included greenhouse gas (GHG) disclosures but faced backlash from corporations and Republicans, prompting legal threats against the Securities and Exchange Commission (SEC). America’s distinct political and legislative environment—influenced by private sector lobbyists—prompted the exclusion of the scope 3 emissions requirement entirely. American lawmakers remain sceptical, with US entities operating in Europe susceptible to litigation risks and greater compliance burdens under CSDDD.
CSDDD’s extraterritoriality can raise incompatibilities with established international economic law framework norms. While World Trade Organization (WTO) jurisprudence has evolved to permit the regulation of production processes, the CSDDD's extensive verification mechanisms in production sites worldwide could still be contentious if deemed an ‘unnecessary obstacle to trade’ under the WTO Technical Barriers to Trade (TBT) Agreement. Certain requirements could potentially be challenged as discriminatory or technical barriers to trade, which differently impose burdens or necessitate specific production processes that are more challenging for non-EU companies to meet.
America’s distinct political and legislative environment—influenced by private sector lobbyists—prompted the exclusion of the scope 3 emissions requirement entirely.
While CSDDD embeds safeguards against fragmented ESG taxonomies, inconsistent metrics, and unclear materiality criteria limit its effectiveness. Without broader ESG coherence, CSDDD compliance may not guarantee comparability or credibility, underscoring the need for wider standardisation beyond the directive’s remit.
An estimated 5,300 companies must incorporate the CSDDD requirements, with revenue thresholds ensuring that companies with the largest-scale production and potential GHG emissions are targeted first. Unlike the SCDDA, which severely impacts SMEs, the CSDDD relieves them of reporting responsibilities while providing additional support if they are part of an eligible company’s operational chain. The EU CSDDD's phased rollout is designed to give companies adequate preparation time, potentially boosting compliance.
CSDDD regulates the full operations lifecycle of companies, from production practices to grievance redressal for affected stakeholders. It goes beyond alignment with international standards like the Organization for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises and the United Nations Guiding Principles on Business and Human Rights by harmonising and operationalising its diligence standards. However, its potential hinges on combining synergies with parallel instruments such as the Carbon Border Adjustment Mechanism (CBAM), the US Corporate Sustainability Reporting Directive (CSRD), and the EU Taxonomy for sustainable activities, creating a coherent ESG governance architecture.
Key Performance Indicators (KPIs) should be developed for both leading and lagging metrics, tracking progress on human rights and environmental impact mitigation, and ensuring alignment with specific sustainability goals.
CSDDD prioritises long-term corporate responsibility over immediate profits. The data generated from due diligence will enhance transparency in the opaque supply chains of large corporations. An effective CSDDD monitoring framework should integrate mandatory corporate self-reporting, robust independent third-party audits for verification, and accessible civil society feedback mechanisms to ensure comprehensive oversight and accountability. Key Performance Indicators (KPIs) should be developed for both leading and lagging metrics, tracking progress on human rights and environmental impact mitigation, and ensuring alignment with specific sustainability goals.
While CSDDD’s initial adoption can negatively impact profits, planning ahead provides cushioning to ease the transition, gradually unlocking monetary gains with the prioritisation of green investing and climate-resilient supply chain infrastructure.
CSDDD represents a legal shift by unequivocally establishing a corporate due diligence duty, an ambitious attempt to promote climate consciousness in the long run. In the short run, states face backlash over increased corporate costs weighing against unequal benefits. Companies may need to drastically alter their overseas operations, enhancing the manufacturing and distribution costs. This may adversely impact importers, service providers, manufacturers, and labour from developing economies. This phenomenon may amplify the ideological divide between the EU and the Global South for climate-driven commerce. The EU’s strategy entails stringent and uniform legislation with tangible benefits and consequences. This approach contrasts with developing economies preferring nationally determined practices and expecting minimal non-tariff barriers for domestic stakeholders in the CSDDD lifecycle.
CSDDD is more than a compliance requirement—it is a legal framework reshaping corporate responsibility.
Though the instrument succeeds in the pragmatic instilling of responsibility, it falls behind in incentivising corporations with predictable outcomes. Eligible companies may view it as a cumbersome checklist hindering the ease of doing business, which may disproportionately favour some competitors or newer market players. While initial compliance with due diligence, risk assessments, and climate planning is costly, these processes can become self-sustaining over time. Such compliance leads to better data, attracting more revenue from conscious investors and consumers, creating a positive feedback loop. However, the CSDDD is more than a compliance requirement—it is a legal framework reshaping corporate responsibility. True success will be measured not only by adherence but also by its ability to drive real change in global supply chains and climate action.
Dharmil Doshi is a Research Assistant at the Centre for New Economic Diplomacy, the Observer Research Foundation.
Ananya Kalantri is an Intern at the Observer Research Foundation.
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
Dharmil Doshi was a Research Assistant at ORF’s Centre for New Economic Diplomacy, where his research spans international commercial law (encompassing treaties and conventions, foreign ...
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