Companies may need to turn to AI-driven tools to help them navigate the EU’s CSDDD, a rule that could leave them facing reporting challenges in their supply chains and in emerging markets
The Corporate Sustainability Due Diligence Directive (CSDDD), which came into force in July, had a challenging road to ultimate adoption as a landmark European Union regulation. The directive mandates that companies operating within the EU, as well as those selling into the EU from abroad, adhere to rigorous human rights and environmental standards under state-based oversight.
The CSDDD enforces mandatory compliance, moving beyond voluntary guidelines to ensure businesses uphold human rights and environmental standards and do not cause or contribute to potential or actual adverse impacts through their own activities or those directly linked to their supply chain operations.
The directive will also underpin the EU’s Corporate Sustainability Reporting Directive (CSRD), and both will coexist cohesively, in that the CSDDD requires due diligence duty and the CSRD the reporting obligation. The EU Commission has already initiated infringement procedures against member states that fail to incorporate the directives into their national laws.
Consequences of CSDDD
As Prof. Radu Mares of the Raoul Wallenberg Institute of Human Rights explains, mandatory due diligence could result in unintended consequences both for companies that fall within the scope of the CSDDD and for those that do not. Some of these challenges include:
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- Supply chain complexity — Ensuring compliance throughout intricate global supply chains can be particularly daunting. Companies often need to allocate substantial resources to monitor and manage their suppliers’ practices. This increased demand for oversight can lead to significant supply chain disruptions, impacting companies’ ability to maintain consistent and reliable operations.
- Challenges in emerging markets — While higher standards can boost economic performance, in regions with weak rule of law like in Southeast Asia, compliance can prove challenging. Retail brands, for instance, might opt to leave certain markets or terminate relationships with suppliers in regions in which compliance becomes too difficult due to the high costs involved with conducting audits, ensuring traceability, and reporting.
- Legal and reputational risks — Companies, especially chemical manufacturers, can be caught off-guard by new regulations, leading to non-compliance and legal issues. When California’s Proposition 65 was updated to include certain chemicals commonly used as preservatives in cosmetics, many retail companies did not have the necessary documentation or were unaware that their products contained these chemicals. As a result, companies had to pull products off the shelves and update labels, even as they faced numerous lawsuits for non-compliance. A similar scenario took place when the EU’s Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH) regulation passed in 2006 and left international manufacturers unprepared, preventing them selling products in the EU markets.
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Actions for companies to mitigate CSDDD compliance challenges
Companies are already implementing third-party software solutions to support supply chain due diligence practices and reporting of environmental, social & governance (ESG) factors. Indeed, using tools driven by generative AI (GenAI) will alleviate the work of risk & compliance professionals by freeing up resources from repetitive tasks, speeding up key processes of data collection from suppliers, and automating risk assessment, according to the Future of Professionals Report 2024, published earlier this year by Thomson Reuters.
There are other areas that GenAI is disrupting across the ESG management and reporting landscape, according to the Thomson Reuters Institute’s 2024 State of Corporate ESG, including:
Enhancing due diligence with AI-driven solutions — Companies are implementing advanced due diligence solutions to meet expanding regulatory requirements by leveraging granular and timely data on specific risk factors like biodiversity and human rights. These solutions provide disaggregated scores, enabling targeted risk assessments and procurement optimization.
By utilizing AI-driven databases that screen millions of documents daily, businesses can customize risk metrics to align with their priorities, streamlining due diligence processes for financing, investment decisions, and supply chain management. “AI will help give us the capability of having much more information and knowledge about new suppliers,” said a data compliance manager at a premium automotive manufacturer in the Corporate ESG report. “This will help us shorten the procurement process, which in some cases is taking 14 to 15 months… but could be shortened to 3 to 4 months.”
Automating social compliance audits —AI can automate, streamline, and scale the social audit process, allowing for data collection from a broader and more diverse sample group compared to traditional in-person interviews. This significantly reduces costs for the reporting company and its business partners but also minimizes biases associated with human subjectivity. Real-time data collection enables continuous monitoring of workplace conditions, ensuring swift detection and resolution of any non-compliance issues, resulting in improved supplier performances.
Revolutionizing compliance — GenAI tools have the potential to revolutionize the role of chief risk & compliance officers by offering chat-based responses to questions about regulatory requirements. These tools also can integrate into existing systems, and continuously monitor global regulatory databases to send automated alerts about updates or changes that might impact operations. This allows companies to prepare for various outcomes and develop strategies to mitigate risks effectively by automating the compliance management process, from updating product labels to maintaining accurate records.
Conclusion
The CSDDD represents a pivotal shift in corporate responsibility by demanding rigorous adherence to human rights and environmental standards. While challenges like supply chain complexity and regional compliance persist, innovative solutions such as AI-driven tools are empowering businesses to streamline due diligence and enhance ESG management.
By embracing these technologies, companies can not only navigate the complexities of the directive itself but also foster sustainable practices that safeguard their operations and reputation. As the CSDDD and CSRD work in harmony, these directives pave the way for a more accountable and transparent business landscape, setting a new standard for corporate sustainability.
You can find more on the challenges of corporate compliance here.
