Corporate reporting on ESG: the European Commission’s consultation on the EU's Non-Financial Reporting Directive

The European Commission (the Commission) has started a public consultation to collect the views of various stakeholders regarding suggested revisions to the Non-Financial Reporting Directive (NFRD), which closes on 11 June 2020. The revision of the NFRD might lead to the introduction of a centralised reporting regime, which will be applicable to a greater number of businesses than are caught by national laws implementing the current NFRD. The Commission is expected to present the first proposal at the beginning of next year.

The consultation 

In its 11 December 2019 communication on the European Green Deal, the Commission committed to review the NFRD as part of its strategy to strengthen the foundations of sustainable investment.

Accordingly, on 20 February 2020 the Commission launched a public consultation on the review of the NFRD, asking stakeholders for their views on possible revisions of the NFRD by 11 June 2020. The consultation is targeted at those who prepare, and use published non-financial information (such as investors and civil society organisations), as well as other stakeholder groups (like academics, national authorities and rating agencies). It will be accompanied (inter alia) by targeted surveys addressed to SMEs, interviews conducted with sustainability rating agencies, and workshops with stakeholders. The NFRD review is accompanied by a number of studies and other consultations, like the study on due diligence requirements through the supply chain (2019), a public consultation on corporate reporting (2018) and a targeted consultation on climate-related reporting (2019).

Sources indicate that a legislative proposal for a revised NFRD will be published in early 2021, building on these consultations. If and when a revised version of the NRFD is enacted by the European Parliament, member states of the EU would then be obliged to transpose its provisions into national law.

Deficits of the current NFRD identified by the Commission

The Commission highlights the necessity for revision of the current NFRD to better align with the needs of the investment community, who require more complete and accurate non-financial information from businesses in order to effectively factor sustainability considerations into their investment decisions. According to the Commission, at present companies and investors do not fully meet each other’s expectations. While some businesses disclose immaterial information (thus incurring unnecessary costs), others leave out essential information (or do not report at all, as they do not (yet) fall within the scope of the NFRD).

In addition, the NFRD is embedded in an EU-wide sustainability reporting system (e.g. incl. the Regulation (EU) 2019/2088 of 27 November 2019 on sustainability‐related disclosures in the financial services sector, operative as of 10 March 2021) that will be effective soon and can only be operational with improved non-financial reporting.

The Commission’s consultation paper also stresses that companies, regardless of their size and resource capabilities, and irrespective of the information they publish as a result of the NFRD, face difficulties in complying with various competing reporting standards, set by different rating agencies, data providers, and civil society. Not only does compliance with divergent standards carry a cost to businesses, it also compromises the reliability and comparability of the information published by companies operating in different countries.

Key themes of the consultation

In order to address these and other problems, the consultation touches (inter alia) upon the following subjects:

• the establishment of a unified EU-wide reporting standard (without reference to the existing global ones);
• the extension of the scope of relevant topics on which companies must report, i.e. additional themes to the four topics set out in the present NFRD (environmental, social and employee-related matters; respect for human rights; anti-corruption and bribery matters);
• the establishment of guidelines for the double-materiality principle and the clarification of this principle, which sets out that companies have to report material information on: (i) how sustainability issues may affect the company; and (ii) how the company itself affects society and the environment; and
• the necessity for disclosure of additional non-financial information regarding intangible assets or related matters (e.g. intellectual property, software etc.).

While the personal scope of the current NFRD only applies to large public-interest entities with more than 500 employees, the consultation now includes a discussion on whether it should be extended to non-listed companies with less than 500 employees or SMEs. The Commission suggests that the exclusion of non-listed companies regarding non-financial information may no longer be justified, given they can have significant impact on society and the environment. According to the Commission, SMEs, often acting as suppliers for large companies, are already under disclosure pressure by their business partners. Additionally, financial institutions/investors are also increasingly seeking non-financial information from them.

Conclusion 

The EU insists that recovering from the current crisis entails not just restoring the economy to its pre-pandemic state but rebuilding it on markedly more sustainable foundations. 

Accordingly, the consultation contributes to this agenda by paving the way for the introduction of a unified non-financial disclosure regime that will likely apply to a greater number of companies. The consultation could produce a range of opinions on whether such extension of personal scope, i.e. mandatory non-financial reporting obligations also for SMEs, will not pose an excessive burden on such companies.

It is conceivable that a unified reporting regime for the EU might influence reporting standards elsewhere and could serve as best practice disclosure standards utilized by investors irrespective of a company’s seat. It remains to be seen if other regulators will try to align their domestic legislation to a certain extent with the EU’s non-financial reporting standards.  

Whatever the outcome of the consultation, it seems likely that reputational risks of non-compliance with national laws introduced under the revised NFRD may increase in the post-COVID-19 world, particularly if investors and policymakers continue to take sustainability issues seriously.