Regulatio Ad Absurdum

Commentary by William Alan Reinsch

Published December 9, 2024

I complained last week about the frustrations of getting caught up in perpetually responding to the latest Trumpian trade rant at the risk of failing to finish my regular work. This week I will avoid that trap by ignoring Trump completely and focusing instead on something going on in Europe. Rest assured, I will return to addressing U.S. trade policy shortly.

Today's rant-mine, not Trump's-is about the European Union's Corporate Sustainability Due Diligence Directive (CSDDD), which creates a due diligence duty to identify and address adverse human rights and environmental impacts in companies' operations, their subsidiaries, and their value chains. Much of the directive is based on the rights established in a number of UN covenants, many of which focus on worker rights, including conditions of work-fair wages, safety and health, equal pay and non-discrimination, and the right to form unions and strike.

In addition, the directive has a significant climate element, requiring companies to put in place a transition plan for climate change mitigation consistent with the Paris Agreement and the European Climate Law. The plan should cover all operations, suppliers, and partners, set emission reduction targets for Scope 1, 2, and 3 emissions, outline the investment and funding necessary to accomplish that and be updated annually along with regular reports on progress. The directive also requires the companies to prevent environmental damage, such as soil degradation, water or air pollution, harmful emissions, excessive water use, land degradation, or other negative impacts on natural resources like deforestation, and to prevent or reduce harm to biodiversity.

Enforcement will be carried out by the member states, which will be able to issue injunctive orders and impose fines. Victims will also be allowed to seek compensation for damages resulting from companies' failure to perform due diligence. There is a phase-in period. Large companies-those with more than 5,000 employees and €1.5 billion worldwide turnover, and non-EU companies with more than €1.5 billion turnover generated in the European Union have until July 26, 2027, to comply. Medium-sized companies-those with more than 3,000 employees and €900 million worldwide turnover, as well as non-EU companies with more than €900 million turnover generated in the European Union-have until July 26, 2028. Other companies, including large non-EU companies with more than €450 million turnover generated in the European Union, have until July 26, 2029.

The directive has aroused a good bit of opposition, mostly based on practical issues surrounding implementation and compliance. After all, no one wants to stand up and say fair pay, non-discrimination, and dealing with the climate crisis are bad ideas. From the left comes the complaint that the definition of what companies are covered leaves out more than two-thirds of European companies, which means its impact will be proportionately reduced.

From the right come complaints that the requirements are vague, that requiring companies to assume responsibility for their suppliers is a stretch, that the rule is extraterritorial since it will affect non-European upstream suppliers indirectly as well as large non-European companies directly, that the rule goes beyond current established concepts of civil law by making companies liable for damage caused by the actions of others rather than themselves, that the civil liability provisions should be limited to violations occurring intentionally or through gross negligence which causes or directly contributes to the adverse impact, that the rule potentially overlaps or conflicts with other EU rules, and that the European Union should provide more help to companies on compliance. The rule is also being compared unfavorably with the U.S. government's National Action Plan on Responsible Business Conduct, which has similar objectives and is based on similar principles but is voluntary.

This battle has been mostly fought in Europe, but since the rule directly impacts foreign companies, including some in the United States, you can expect concern about it to spill over, particularly as the compliance deadlines loom closer. From my perspective, this is one more example of the European Union's regulatory overreach, although it is less prescriptive than some other recent regulations such as those dealing with digital trade. In this case, however, that may be a liability-the directive does not appear to give companies enough direction about what they are supposed to do to comply rather than too much.

Like other EU regulations, the directive raises the questions of the appropriate relationship between government and private business in an increasingly complex economy, and, from a practical perspective, what are the consequences of unfunded mandates on companies' ability to compete and innovate. The recent Draghi report, which we featured in a Trade Guys podcast, made clear the liability of excessive regulation, evident in the lack of European company representation on many lists of innovative companies in a variety of sectors. The CSDDD will likely be one more chain around companies' ankles holding them back, although its extraterritorial nature means that it will not just be holding European companies back-others will also be obligated to comply.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.

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