What does the CSDDD mean for Hungary? Do Hungarian companies need to worry?

The CSDDD (Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937 and Regulation (EU) 2023/2859 – "CSDDD") was approved by EU Member States on 15 March 2024, after Belgium, chairing the Council of the EU, worked to address concerns over red tape.

In response to the growing demand from civil society for more transparency and responsibility from companies on social and environmental issues, the CSDDD is part of the EU's legislative efforts to align with international standards on business and human rights, such as the UN's Guiding Principles and the OECD Guidelines.

The original version of the CSDDD lacked clarity as a legal measure, so it understandably still faces opposition today. The CSDDD was extensively revised because of resistance from Germany and Italy, who claimed that the directive would create disproportionate obligations and expenses, especially for SME companies, amid global crises. As a result, the final version of the CSDDD diverges considerably from its initial draft, as it narrows the range, eliminates the civil liability clauses, and diminishes the monetary incentives for managers to achieve climate objectives.

The CSDDD still needs to be formally endorsed by the European Parliament from a juridical standpoint, which is anticipated in April 2024.

Thus, the question arises as to how this directive will affect enterprises headquartered in CEE states such as Hungary.

What does the CSDDD mean for Hungary in the short term?

The CSDDD will become legally binding 20 days after its publication in the EU's Official Journal, following its final approval. Member States will then have a two-year deadline to incorporate the CSDDD into their domestic legislation. Therefore, we are keen to observe the process and outcome of the CSDDD's transposition into the contentious context of Hungarian national law.

We note that the Hungarian Parliament's legislative process could and most probably will influence many local legal requirements as well.

Scope

The CSDDD covers companies with a global net turnover of EUR 1,500m and more than 5,000 employees from 2027. These thresholds will decrease over time, and by 2029 companies with a global net turnover (the calculation is based on Directive (EU) 2013/34 of the European Parliament and of the Council) of EUR 450m and at least 1,000 employees will be included in the due diligence requirement. The CSDDD also affects non-EU companies that have a net turnover of EUR 450m or more in the EU in the previous financial year. However, few Hungarian companies would exceed these thresholds.

Furthermore, the CSDDD encompasses firms that (i) have engaged in EU franchising or li-sensing contracts for which they receive royalties exceeding EUR 22.5m within the EU, and (ii) have a net turnover surpassing EUR 80m. This criterion also applies to the ultimate holding companies of corporate groups that collectively meet these conditions.

Based on projections, the new threshold will affect over 5,000 firms, thereby placing Hungary on the map as well. Additionally, Hungarian enterprises that do not belong to the supply chain or have direct business relations with the in-scope companies may still face CSDDD implications, as the in-scope companies are expected to engage their (smaller) commercial associates in their assessments of due diligence.

Companies' obligations under the CSDDD

In its present form, the CSDDD requires large companies that operate in the EU to exercise due diligence not only over their own operations, but also over those of their direct associated entities and their full supply chain.

The CSDDD sets out the core obligations for companies, compelling them not only to reassess their operations and supply chains but to actively engage in changing corporate conduct for a more sustainable future.

Integrating due diligence: Companies covered by the directive are required to conduct due diligence regarding their own operations and those of their supply chains. Companies must also develop and maintain a risk-based due diligence policy containing a relevant code of conduct. To ensure sufficient updates to their policies, companies must systematically monitor and assess their own, their subsidiaries' and, where related to the company's chains of activities, their business partners' operations.

Assessment and prevention of adverse impacts: Through due diligence, companies must audit and identify sustainability risks within their operations (including subsidiaries) and supply chains. Companies must also as far as possible prevent or mitigate potential adverse impacts, or where adverse impacts have already occurred, must end and remedy these impacts by means of prevention action plans, contractual assurances from business partners, investments, infrastructure upgrades, operational processes or strategies. Pursuant to the CSDDD, if a company cannot prevent or mitigate a severe adverse impact, as a last resort, it may even be required to suspend or terminate the relevant business relationship.

Collaboration and transparency: The directive emphasises collaboration among companies, stakeholders and authorities to address sustainability challenges effectively. As transparency is crucial, companies must set up a fair and publicly available procedure for dealing with complaints. Companies must ensure that persons or entities affected by the adverse impacts, their advisors, those working in the companies' chain of activities and experienced environmental organisations may submit a complaint. To ensure transparency, companies must publish an annual statement on their websites on their actions in respect of corporate sustainability. The content and criteria for the reporting is expected to be set out by delegated acts of the Commission by 31 March 2027.

The CSDDD allows for the obligations to be adopted at a group level, i.e. by a parent company, provided that certain criteria, such as full cooperation, is ensured between the parent company and its subsidiaries. The subsidiaries must also integrate the policies developed by the parent company. This option will greatly simplify the implementation of the above measures for group companies with many affiliates.

Financial sector

Under the terms of the 15 March 2024 deal, the "chain of activities" notion should not encompass downstream business partners for regulated financial undertakings who are recipients of their services and products. Therefore, as for regulated financial undertakings, only the upstream part of their chain of activities is covered by the CSDDD, resulting in the Hungarian relevance being low at present.

Yet the nature of financial services and the OECD Guidelines for Multinational Enterprises suggest suitable and effective measures regarding the downstream sector to prevent and mitigate adverse impacts, including RBS impacts, in their due diligence process. Regulated financial undertakings may therefore have to take measures for their downstream part using their "leverage" (OECD Guidelines, II, Commentary, 19), leading to the voluntary use of corporate sustainability due diligence by large financial companies.

In addition, the Commission has a duty to report to the European Parliament and the Council on whether and how further sustainability due diligence obligations should be imposed on regulated financial undertakings in relation to their financial services and investment activities, as well as their impacts, in line with the objectives of the CSDDD, and considering all other EU legal instruments that affect them. This report should be submitted as soon as practicable after the entry into force of the CSDDD, but no later than two years thereafter, and should be accompanied by a legislative proposal, if appropriate.

The CSDDD itself does not create any new reporting obligation for financial undertakings to avoid duplications. The sustainability reporting obligations for regulated financial undertakings are established by Directive 2013/34/EU and Regulation (EU) 2019/2088.

Given the significant implications of the CSDDD for the financial sector, it would appear prudent to implement the directive's provisions in advance, rather than having to conform to them under pressure and within a tight deadline.

Non-compliance

The CSDDD obliges Member States to appoint a public enforcement body with the mandate to monitor and sanction compliance with the due diligence obligations. In Hungary, this role is typically assigned to the State Attorney's Office, which will have the power to conduct investigations and impose fines of up to 5 % of the violating company's global net turnover.

Additionally, the CSDDD establishes a civil liability framework for harm resulting from a breach of the due diligence duties, entitling the victims to full compensation. This implies that Hungarian companies may be exposed to litigation.

Remarks

Hungary will likely face the same challenges described in the criticisms by Italy and Germany regarding the sustainability reporting of SMEs, which constitute more than 95 % of the Hungarian market. Hungarian SMEs will have to disclose their sustainability performance or the absence thereof and provide credible proof to large EU enterprises of it. If they fail to adequately address or incentivise such performance, they may risk non-compliance.

The CSDDD is bound to affect the business environment and the legal framework in the EU and beyond. Its implementation and effectiveness in each country will require careful scrutiny and assessment. Our focus is on Hungary and the challenges it faces in finding a comprehensive, balanced, neutral and proportionate legislative response to the implications of the CSDDD.

read more: https://www.schoenherr.eu/content/eu-s-corporate-sustainability-due-diligence-directive-is-here-to-stay

Authors: Gábor Pázsitka, Adrián Menczelesz, Bálint Bodó, Zsófia Rideg