Déjà vu: Financial sector and corporate sustainability due diligence, in or out?

The EU should include financial markets in the scope of its Corporate Sustainability Due Diligence Directive (CSDDD) to help reorientate capital markets towards more sustainable investments while making European financial markets more consistent and reliable, argues Richard Gardiner.

Richard Gardiner is the head of EU public policy at the World Benchmarking Alliance.

It has been almost a year since EU ministers last met to discuss a law to make business value chains more ethical and climate-friendly. During this meeting, there was a fierce discussion on the role that finance should play, with the final agreement essentially carving out the sector.

Now Member States are returning to the negotiating table, and some things have not changed: there is an emerging deadlock with Paris supporting a complete exclusion of the financial sector, meaning we risk having zero discussion on the unique opportunity the EU has to reorientate its capital markets to a more sustainable footing.

“Plus ça change, plus c’est la même chose” – last year it was COP27, this time it is New York Climate Week and the 78th United Nations General Assembly, which provides the international background to key regional debates in the European Union.

Yet, while the European Commission first committed to tabling a legislative proposal on Corporate Sustainability Due Diligence (CSDDD) in 2020, entering the latter stages of 2023 we are still debating key fundamental principles of the law.

None of these is as key as to whether or not the financial sector must be accountable for its impact on climate and social progress.

Throughout October, the Spanish President will guide Member States to review its position on CSDDD and try to reconcile the conflicting views on how the sector should be covered.

This ongoing debate on CSDDD is happening in parallel with the debate on the EU Sustainable Finance. The latter focuses on transparency and classification of financial products, whereas CSDDD is intended to complement this by asking the sector to mainstream sustainability risk mitigation across all of its activities.

CSDDD is rightly focusing on the downstream risks that the financial sector faces when offering financing and investment services.

It has been repeatedly shown that the sector has a big problem, no more so than in the WBA Financial System Benchmark which shows that only 3% of the sector discloses how they identify human rights risks and impacts within their financing activities, and less than 5% of financial institutions assessed acknowledging any process to identify the impact of their financing activities on nature.

If governments are serious about leveraging the undoubtedly awesome power of the financial sector, the current landscape shows they need to force a change.

In a year where political rhetoric on “growth and competitiveness” is increasingly being narrowly interpreted as “rules are bad and prevent growth”, there are common misconceptions about what various EU laws are aiming to do.

One such misconception is that asking finance to look into the impact of its lending, insuring and investment activities will force them to stop lending, cut business relationships and rapidly divest from perceived risky business. This interpretation is simply wrong and needs to be called out.

Will CSDDD prevent banks from lending to companies with known human rights issues? No, but they will need to better understand those risks and monitor their development

Will it prevent asset managers from investing in a carbon-intensive company? No, they will need to meaningfully engage and push for a clean transition.

Will this prevent insurers from underwriting a risky infrastructure project? Again, no, but they will need to identify these risks and factor that into your business relationship.

This law will not make the European financial sector less competitive; on the contrary, it will make it more reliable, consistent, and trustworthy. And most importantly, it will give finance a role as an accountability gatekeeper where they will move from being part of the problem to part of the solution.

Without accountability, the companies that are leading the way with their actions to manage environmental and social impacts are not rewarded, while those that lag or are completely inactive are not penalised.

The clock is ticking, and this favours the nay-sayers.

But as WBA highlights in its newly published whitepaper “Corporate accountability: Closing the gap in pursuit of sustainable development”, governments remain responsible for driving action to accelerate the transformation – so regulation is an essential part of a well-functioning corporate accountability process.