Published by The Jakarta Post on Friday, September 8, 2023
Mohamad Mova AlAfghani and Suryani Motik*
Two recent developments in the European Union that will affect ASEAN, namely the Corporate Sustainability Reporting Directive (CSRD) and the Draft Corporate Sustainability Due Diligence Directive (CSDD). There is criterion within both of these directives that requires non-EU companies to comply with EU requirements. The CSRD has been in force since January 2023 while the CSDD’s , if passed, may come into effect in 2025.
The CSRD requires companies to report on their sustainability performance, including their social and environmental impacts.
Meanwhile, the CSDD obliges companies to conduct due diligence towards their environmental and human rights impacts. As such, the two documents are highly interlinked, the due diligence processes introduced by the CSDD is expected to inform the sustainability reporting required by the CSRD.
Under CSRD, non-EU companies may be required to disclose detailed sustainability information which concerns both internal and external impacts and should therefore involves not only the company’s perspective but also the perspective of its stakeholders (the so called “double materiality”). The European Financial Reporting Advisory Group (EFRAG) is still discussing on how to conduct assessments, including on double materiality — under CSRD.
CSRD applies to non-EU companies through certain situation which connects it to the EU market in some ways, such as, having a subsidiary in the EU, having a branch in the EU or is a subsidiary of an EU Company.
There are other thresholds in which the CSRD applies, for example, for an EU subsidiary it needs to be considered a “large entity” or a public interest entity. Technically, the legal obligation would be on the entity located in the EU.
If a subsidiary is in the EU, then its non-EU parent companies may need to prepare consolidated sustainability reports (Article 19a of Directive 2013/34/EU, as amended by CSRD), which could involve disclosure on the details of group-wide operations outside the EU.
Another application of the CSRD would be if a non-EU company has a branch in the EU (article 40a of the CSRD). If certain turnover criteria are met, the branch would then be required to publish sustainability report of the individual company or its group company.
For subsidiaries of an EU company, there are obligations imposed to the EU company so that its “…reporting at group level provides an adequate understanding of the risks for, and impacts of, their subsidiary undertakings”. This means that the EU parent company will request sustainability information from its subsidiaries worldwide.
There are other situations in which non-EU companies could be “indirectly” affected by the CSRD, for example if it is a part of a value chain to the EU market and is requested by the purchaser to disclose some information. This is because the CSRD requires companies to identify, assess and take actions for any risk and impact to sustainability in its value chain.
The draft Corporate Sustainability Due Diligence Directive (CSDD) is wider in scope, detailed in terms of process and broader in terms of application compared to CSRD. The CSDD are applicable directly to non-EU companies that operate within the EU market.
Companies with certain turnover threshold in the EU (150 million EUR for group 1 and 40 million EUR for group 2) would be required to comply with the CSDD. Interestingly, the lower threshold (group 2, EUR 40 million) would be applicable to companies provided that at least 50% of worldwide net turnover comes from the textile and garment, agriculture, forestry, fisheries, food beverages and natural resources extractions industries. Presumably, the EU sees those companies as having higher risk of environmental and human rights violations.
As with the CSRD, the CSDD will also require certain compliance within the value chain, and thus, suppliers to companies subjected to CSDD would be required to provide information. In other words, they would “indirectly” be required to comply. Should their business partners fail to adequately mitigate its human rights and environmental risks, Article 7(5) of the CSDD require companies to refrain from contract extension, suspend commercial relation or even terminate its business relationship.
Part 1 of the CSDD Annex listed down numerous international human rights agreements ranging from labor rights, child rights the International Covenant for Civil and Political Rights and International Covenant on Economic, Social and Cultural Rights. Part II on the other hand listed down numerous international conventions from Stockholm (Persistent Organic Pollutants), Minamata (Mercury) and the Convention of Biological Diversity, among other. Group 1 companies (>150 million turnover) are also required to identify the extent to which climate change is a risk for or an impact of the company operation in line with the 1.5-degree Paris climate target (Article 15). It is also worth noting that the EU also seeks to align its internal policies with the CSDD, among which is the Batteries Directive (to be replaced by Batteries Regulation) and the Draft Regulation on Deforestation Free products.
Indonesia recently disputed EU’s measures related to palm oil to the WTO. The CSRD and CSDD however is much broader and much more comprehensive than any other measures that has ever been imposed by the EU with regards to trade and the environment. Beyond the EU, CSRD and CSDD will become the gold standard for sustainability audits. Even if not caught directly within the directives, multinational corporations and international financial institutions could use and apply the standards “voluntarily” across its value chains.
Indonesian government’s downstreaming agenda, ASEAN’s extractive industries and ASEAN’s export to the EU may be affected by the Directives. On the one hand, ASEAN companies need to increase their capacity in conducting Environmental and Human Rights Due Diligence (EHRDD). On the other hand, compliance with the directives may require certain facilities to be built. For example, Part 2 of the CSDD Annex mentions various conventions related to chemicals managements. ASEAN countries may not have the capacity to detect and dispose many of the chemicals in those conventions.
While “large undertakings” targeted by the directives may readily comply with the directives, capacity in the ASEAN value chains might be limited. There must be a way that the compliance cost for those “indirectly” affected by the directives be set to a minimum. This may rest on the type of “assurances” acceptable in the EU.
These directives also rest on the assumptions that the EU will have a significant market power to increase the bar on environment and human rights standards for third country businesses that are deeply connected to it. Indeed, the climate crisis makes it extremely difficult to ignore environmental concerns. However, if the compliance cost is prohibitive, businesses and countries may simply opt to strengthen ties with trade partners that are less concerned with environment and human rights standards.
Regardless, ASEAN and Indonesian companies will need to start thinking on how to comply with these higher sustainability rules. This is important, not only because it will be imposed on companies exporting to — or is in anyway related to– the EU market through equity or lending, but also because these initiatives will become the benchmark for global sustainability standards beyond the EU market due to heightened climate change concerns.
*Mohamad Mova AlAfghani is Director of the Center for Regulation, Policy and Governance (CRPG); Suryani Motik is the Vice-Chairman of the Indonesian Chamber of Commerce (KADIN).
Contact author, Dr. Mohamad Mova AlAfghani at mova(at)crpg.info