Unwrapping businesses

2nd November 2016

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Lisa Maddocks

Environment law expert Colleen Theron provides a guide to the EU Non-Financial Reporting Directive

Financial and non-financial reporting provides shareholders and other stakeholders with a comprehensive view of performance and the position of companies. There is a global trend to move away from voluntary disclosure of non-financial information towards mandatory disclosure.

The EU Non-Financial Reporting Directive (2014/95/EU) is one example and a further step towards developing a legal framework that covers environmental and human rights reporting.

Back to basics

The European Parliament acknowledged in 2013 the need to increase companies’ accountability and transparency. MEPs backed two resolutions on corporate social responsibility, urging the European Commission to develop a legislative proposal on the disclosure of non-financial information by businesses. The first resolution referred to accountable, transparent and responsible business behaviour and sustainable growth; the other emphasised promoting society’s interests and the need for a route to sustainable and inclusive recovery.

The parliament and European Council adopted the directive in 2014. Its purpose is threefold:

  • to increase transparency of large companies (these are public interest companies with more than 500 employees – see below);
  • improve boardroom diversity; and
  • enhance accountability and performance.

The directive also establishes minimum legal requirements on the information that should be available to the public and authorities across the EU.

The directive entered into force on 6 December 2014 with member states given two years to transpose it into national legislation. Non-binding guidelines for reporting non-financial information are expected by the end of this year. Companies subject to the directive will be required to produce a non-financial statement containing information ‘to the extent necessary for an understanding’ of five matters and how the organisation’s performance, position and activities affect each one. The five are: environmental, social, employee, human rights, anti-corruption and bribery.

The statement should include:

  • a brief description of the organisation’s business model;
  • a description of the policies relating to the five matters, including due diligence processes;
  • the outcome of those policies;
  • the principal non-financial risks listed above that are linked to the reporting of a company’s operations, including a reference to:
  • business relationships, products or services that are likely to cause adverse impacts in those areas, and how those risks are managed; and
  • non-financial key performance indicators relevant to the business.

Although reporting is mandatory, in built flexibility allows companies to adopt a ‘comply and explain’ approach. Under this, a company that fails to pursue policies in relation to one or more of the five matters is required to provide a clear, reasoned explanation. According to the European Coalition of Corporate Justice, the national platform for NGOs, trade unions, consumer organisations and academics to promote corporate accountability, this does not free a company from the obligation to identify and disclose principal risks.

Companies can rely in their reports on UN Global Compact, UN Guiding Principles on Business and Human Rights, OECD guidelines for small and medium-sized enterprises or ISO 26000, but they should disclose which framework they use. They can also rely on international, European and national guidelines. The implication is that companies will have to set up policies and procedures that meet the requirements of at least one of these frameworks.

Businesses subject to the directive are also required to provide a description of their diversity policy, including age, gender, geographical spread and educational and professional background. This information must be included in the corporate governance statement. If a firm does not have a diversity policy it must explain why.

Companies covered

The disclosure obligations apply only to large undertakings – firms with more than 500 employees and which are deemed public interest entities (PIEs). The European Council defines these as ‘companies, such as listed undertakings, banks and insurance companies, or undertakings which are of significant public relevance because of the nature of their business, size or their corporate status’.

The requirements outlined in Art 19(a) of the directive also apply to public interest entities that are parent undertakings of a large group – ‘exceeding on its balance sheet dates, on a consolidated basis, the criterion of the average number of 500 employees during the financial year’ (inserted as Art 29(a)).

Relatively few large companies in Europe – just 6% or 6,000 – are expected to be subject to the directive, however.

It will be mandatory for auditors to check that the non-financial statement has been provided. It is up to member states whether the information should be included in the non-financial statement or in the separate report and whether it needs to be verified by an independent assurance services provider.

Differences with UK legislation

There are several differences between the EU Non-Financial Reporting Directive (2014/95/EU) (NRF) and the UK Companies Act 2006 (Strategic Report and Directors) Regulations 2013 (CA2006), which requires listed, large and medium-sized companies to report on their non-financial information.

Only listed companies have to provide key performance indicators (KPIs) under the CA2006, whereas the NFR directive requires large ‘public interest companies’ (PIEs) with more than 500 employees to include non-financial KPIs.

The scope of what has to be disclosed differs. The CA2006 requires a fair review of the company’s business and a description of principal risks and uncertainties. Under the NFR directive, information relating to at least environmental, social and employee matters, respect for human rights and anti-corruption and bribery matters have to be disclosed. The test for disclosure also differs. Both tests are ‘to the extent necessary’ but under the NFR directive the test includes the impact of a business activity.

Due to the scope of the NFR directive there is only a small number of unquoted companies that fall within the definition of PIE – around 6,000 across Europe.

Unlike the directive, the CA2006 does not require companies to refer to national, EU or international frameworks. There is also a difference in relation to the disclosure on diversity. The directive takes a broader view of this issue than the CA2006. It requires disclosure to cover age, education and professional background as well as gender. Disclosure must also go beyond board policy, to being one that covers the administrative, management and supervisory bodies.

The directive requires non-financial information to be provided as part of the management report. In the UK, this information is included in the strategic report, which forms part of a firm’s annual report and accounts.

There is no reporting requirement in the directive equivalent to the obligation in the CA2006. So, as it stands, failure to provide the statement will not lead to personal liability for directors.

The Institute of Chartered Accountants in England and Wales has stated that the most efficient and effective approach to introducing the new requirements would be to amend the existing UK strategic report requirements and extend them to other entities that are not quoted but will fall within the scope of the directive. The UK standards body, BSI, is considering whether compliance with the directive can be made easier through standardisation.

What should companies be doing?

Businesses should be asking:

  • Does it have more than 500 employees?
  • Does it constitute a large undertaking that is a public-interest entity?
  • What policies does it have in place to address environmental, social, human rights and bribery issues?
  • Does it have a diversity policy?
  • Has it considered how to have the report audited?

The Climate Disclosure Standards Board believes the EU Non-Financial Reporting Directive (2014/95/EU) will help investors access more relevant information. It has produced guidance on environmental reporting and the directive (bit.ly/1VHe5xl).

Directive and the UK

Member states have until 6 December 2016 to transpose the EU Non-Financial Reporting Directive (2014/95/EU) (NFR), and organisations covered by the legislation will need to start reporting from their 2017 financial year. The UK government published a consultation in February seeking views on implementing the directive. The responses were still ‘being analysed’ as the environmentalist went to press.

Since the EU referendum, there have been questions as to whether the UK will transpose the legislation. The UK will remain a member state of the EU until Art 50 is triggered (which the prime minister has said would be by the end of March 2017) and the exit negotiations are completed, in around March 2019. While the UK remains a full member of the EU it retains all the associated rights and obligations. The UK will need to continue to work towards implementing the new EU requirements on schedule.


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