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A Tiger Called CS3D

In an essay entitled America’s Green Strategy(1991), Harvard Business School’s Michael Porter challenged the idea of a static trade-off between the social benefits and compliance costs related to environmental regulation: ‘The conflict between environmental protection and economic competitiveness is a false dichotomy. […] Tough standards trigger innovation and upgrading.’ 

 

The essay morphed into a research report in 1995. A 2024 academic paper supports Mr. Porter’s views. As he argued thirty years ago, ‘the ‘Chicken Little’ mindset that regulation inevitably leads to costs and an adversarial posture toward regulators must be discarded.’

 

The ‘Corporate Sustainability Due Diligence Directive’ (‘CS3D’), which has just been adopted by all the relevant European Union instances, will further test the so-called ‘Porter Hypothesis.

 

CS3D is a splendid example of the Brussels Effect discussed in these notes a few weeks ago. It may have been born in Belgium, but it has global implications for trade (with critics decrying it as a form of neoprotectionism.) The new regulation will apply to companies operating in the European Union (EU) or are part of such companies’ supply chains in 2027. Translated to a corporate timetable, and considering the regulatory scope, this deadline is in just a few hours.

 

While the Corporate Sustainability Regulation Directive (CSRD) deals with transparency and disclosure, the CS3D ensures that firms take responsibility for the potentially negative impact of their activities along two dimensions.

 

First, it calls for implementing effective due diligence policies related to human rights (e.g., child labor, slavery) and environmental harm (e.g., pollution, excessive water use, noting that deforestation is subject to a specific regulation) along the entire value chain. These legal requirements build on existing OECD and UN guiding principles, which already inform multinationals’ policies (check the Corporate Human Rights Benchmark for a ranking of companies in relation to these guidelines.)

 

Second, it requires the establishment of a ‘Climate Plan.’ The plan must cover Scope 1, 2, and 3 emissions and be aligned with 2050 climate neutrality objectives. It will have to be updated every twelve months, and investments supporting its execution must be financially quantified.

 

At this stage, there is little point in commenting on the soundness or foolishness of the new regulation. According to the EU, 70% of businesses who responded to the public consultation welcomed a harmonized, unifying due diligence framework replacing national regulation (e.g., Germany or France.)

 

Furthermore, every firm is both an investee and an investor. Specifically, the new regulation will help derisk acquisitions. Buyers will be able to perform due diligence on CS3D-based due diligence processes and their findings to assess the quality of targets and their value. What is not to like?

 

As the actor John C. Reilly declared in the comedy ‘Cedar Rapids(2011), ‘You can fight the tiger, or you can dance with the tiger.’ The CS3D represents a new opportunity to build a competitive advantage through innovation.

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