Has it got any teeth, the EU Non-Financial Reporting Directive?

BY:
Alex Nichol

The Directive on Disclosure of non-financial and diversity information (2014/95/EU) entered into force in December 2014. First reports are to be published in 2018 (on financial year 2017).

The reason? The EU NFR Directive aims to improve transparency of large EU companies. It aims to lead to stronger long-term performance to the benefit of Europe’s long­term competitiveness and the creation of jobs. Investors are clearly more interested in (so-called) “non­financial” information in order to have a comprehensive understanding of a company’s performance and to factor this in their investment decision process.

If companies report authentically, they could realise commercial benefit from integrating environmental, social and financial value in their business models. They can then send a message to the outside world about how important and relevant sustainability is in their businesses. I think that in doing so they can contribute to the ‘nudging forward’ of the way markets, institutions and policy frameworks operate. If these don’t align with the needs of sustainable development then we will see the journey to sustainability stall.

The Directive requires “large public-interest entities” such as listed companies, banks, insurers…, with more than 500 employees (of which there are about 6,000 in Europe) should disclose in their management report (or equivalent) “relevant and useful” information on policies, principal risks and “outcomes relating to at least” the following topics: environmental, social, employment, human rights, anti-corruption, and Board level diversity.

Member States had to finalise the transposition into national legislation by 6 December 2016. France’s Grenelle II and Germany’s DNK Code are examples of how it will work in those two Member States.

Extensive stakeholder engagement and consultation took place in the development process. Recent international developments, such as at G20 and FSB levels, were accounted for in the planning of the Directive. An example was the work of the industry-led Task Force on Climate-related Financial Disclosures set up by the Financial Stability Board (FSB). “Non-binding guidelines” will be published in the Spring 2017.

There is a lot of flexibility for companies when disclosing relevant information. They can also report in a separate report document. They can also use international, European or national guidelines such as the UN Global Compact, the OECD Guidelines for Multinational EnterprisesISO 26000, etc.

Article 1 of the Directive establishes that the non-­financial statement (report) shall include:

  • Brief description of the business model;
  • Description of the policies pursued by the reporting entity in relation to those matters, including due diligence processes implemented;
  • The outcome of those policies;
  • The principal risks related to those matters linked to operations including, where relevant and proportionate, business relationships, products or services which are likely to cause adverse impacts in those areas, and how the reporter manages those risks;
  • Non-­financial key performance indicators relevant to the particular business.

What does this mean “in real life”?

It means that companies have yet another signal from international bodies that sustainability risk must have a coherent place in company commercial strategy. Doing nothing is even less of an option, business-as-usual is becoming a risky option.

A materiality assessment process will be shown once again to have great value for a company in its work to meet the Directive’s requirements.

Be aware that starting early (well, on time) pays massive dividends. You will need to work out what is material, convene roundtable sessions internally, assess risks, assign KPIs and collect information and data.

Note that if you don’t already produce a sustainability report, there are big benefits from doing so. Why not do that first, then meet the EU NFR Directive in said report?

Some of the 6,000 companies may well be producing a report, using GRI G4 or GRI’s new reporting Standards. Some maybe using the Integrated Reporting Framework. These should be the go-to guidance frameworks to meet the Directive’s requirements. No repetitive cost burden should exist.

In the same way that companies mapped their sustainability reports to UNGC Communication on Progress (COP), they can also map the connection between their existing reporting and the EU Non-Financial Reporting Directive. There is guidance already available to map the requirements of the NFR Directive to the corresponding requirements and principles of the CDSB Framework, and questions in the CDP Climate, Forest and Water Information Requests to help companies reduce the reporting burden and ensure that information is connected across various reporting channels.

So, a quick check:

  • Are you a public interest company (PIE)? For example, you are listed on a regulated market, a bank (listed or non-listed), insurance company (listed or non-listed), you’re designated by a Member State as a PIE due to your size, type of business etc.
  • Do you need to collect new data? Unlikely, if you already do sustainability reporting. And some Acts of Parliament already require disclosures of some relevant information.
  • Are sustainability risks incorporated into your key business structures? Probably not yet at most entry-level reporters, so this is a good point to do so.
  • What are the outputs? A ‘Non-financial Statement’ (the five bullets above) and a ‘Diversity Disclosure’ (policies and performance).
  • Do you “comply” or “explain”? Relevant information is required to be reported, or companies must state why they are not including it. It is up to each Member State to set the details during transposition.
  • Is the NFR Directive asking for significantly more than existing UK legislation? There are differences but not major obstacles to compliance for UK companies (content and scope related).

And teeth?

  • In our view the Directive and likely Guidelines will not be super-ambitious in pushing far-reaching progressive remodelling of businesses. But it’s a step in the right direction.
  • Like many other important reporting rules and requirements, such as by stock exchanges, the ‘police’ will unlikely be bone-crunchingly severe, in the early days.
  • There is no requirement for assurance as far as we can tell, so companies are effectively ‘self-policing’.
  • It only has teeth if the right strategic assessment of material risks is done correctly. Environmental, Social and Governance (ESG) matters need to be recognised in the business before that happens.
  • The Directive is broad in scope, encompassing every Member State. And any use of the law will likely be indirect – nudging companies forward.
  • Since it is a Directive that probably aims to help protect the single market and level the playing field across the Union.
  • It may mean that, indirectly companies who don’t report, will fail investor screening. Such laws end up influence investor toolkits – so it has ‘indirect teeth’, in a sense.
  • Finally, even if the UK takes 10 years “to Brexit”, the NFR Directive will have mild impact owing to the UK’s already advanced reporting requirements.

Want to know anything else about the EU Non-Reporting Financial Directive? Contact us here.

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Author: Alex Nichol

Alex Nichols, Senior Sustainability Reporting Consultant, Director ANCL and Associate Director Paia Consulting. Alex works with AB on reporting projects. To take advantage of AB’s support based on over 10 years of reporting experience, along with our specialist reporting associates, then please do get in touch.

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