The EU Directive for CR Reporting: A game changer or a hollow victory?

Nana Guar asks whether the EU’s new rules on non-financial reporting will lead to a step-change in sustainability, or just longer annual reports.

On 15 April 2014, the European Parliament adopted a directive requiring about 6,000 large EU companies to disclose information on environmental, social, diversity, and employee-related matters, respect for human rights, and anti-corruption and bribery issues. The Directive applies only to public-interest entities, and includes both listed and unlisted companies, such as banks, insurers and other companies with more than 500 employees. In the following weeks, the European Parliament and EU Member States in the Council will need to jointly adopt the Directive in order for it to become law.

This Directive isn’t an entirely new concept – it improves on existing legislation that addresses the disclosure of non-financial information. Details and specific guidelines for how it will be implemented are still a work in progress. However, the Commission is clear on what it hopes to achieve:

1. Increase transparency and performance on environmental and social matters. The Commission believes that increased transparency will result in accountable management of environmental and social challenges. This will lead to better performance, which will in turn contribute to long-term economic growth and employment.
2. Drive corporate social responsibility and regain public confidence.The Commission believes that increased transparency will not only drive more effective management of environmental and social challenges, but it will go a long way towards restoring trust and public confidence in companies following the economic crisis.
3. Create a ‘level playing field’ for all 28 EU member countries. The Commission admits that existing legislation on the disclosure of non-financial information is unclear and ineffective, and different Member States apply it in different ways, if at all. Currently, just over half a dozen member States have non-financial disclosure requirements that already go beyond the directive, whilst others have unclear or ineffective requirements. As a result, fewer than 10% of the largest EU companies disclose such non-financial information regularly.
4. Everybody wins. The Commission anticipates that ‘each individual company disclosing transparent information on social and environmental matters will realise significant benefits over time, including better performance, lower funding costs, fewer and less significant business disruptions, better relations with consumers and stakeholders.’ Investors and lenders will benefit from a more informed and efficient investment decision process.

All noble ambitions. However, opinions have been split on whether this Directive will really make a difference.

Paul Simpson, chief executive of the Carbon Disclosure Project, has hailed it as “an essential market mechanism to drive more sustainable decision-making.” Nigel Sleigh-Johnson, the head of ICAEW’s financial reporting faculty, agrees, saying: “Non-financial narrative information forms an increasingly important part of companies’ communication with investors and other stakeholders, providing insights into the long-term success of the business.”

Jürgen Thumann, President of BusinessEurope, thinks the proposal “will create red tape and further disadvantage for a large number of European businesses in international markets…” He believes the requirements are “aimed at placating public policy aims, rather than the genuine needs of investors.”

Corporate Justice outlines several loopholes in the Directive, pointing out that weak wording, an overly flexible choice of standards and indicators, and the absence of clear monitoring and sanction mechanisms will allow some companies to avoid or limit their reporting.

So will this Directive lead to the outcomes hoped for by the European Commission?

The answer to that question is probably ‘it depends…’

Whilst transparency and accountability have become increasingly important to a variety of stakeholders, we have to remember that just because a company reports non-financial data, it doesn’t mean the information will be of interest or consequence to investors, decision-makers or other stakeholders. Research has shown that there is a lack of consensus about what Environmental, Social, and Governance (ESG) issues are important, leading to a confusing and growing list of over 2,000 ESG metrics.

This raises the issue of materiality – and how companies will determine the most important issues and metrics to disclose. A materiality process, if done properly, should take into account the priorities of stakeholders (not only investors) through meaningful stakeholder engagement. But mandatory reporting requirements do not guarantee that materiality assessment and stakeholder engagement – both building blocks of trust and accountability – will be carried out in a credible way.

In essence, reporting is not a guarantee that responsible and sustainable behaviour is being practiced at the Board level or embedded in the organisation. And it does not necessarily mean that decision makers are driven by ethical considerations. Some companies may seize the opportunity to establish more credible and rigorous process to identify and address risks within their business and across their supply chain. Others may choose to publish statements on why they are not disclosing more information.

Whilst it is a foregone conclusion that the new Directive will drive the number of disclosures or reports published in the EU, the broader implications of this mandate will depend on how decision-makers go about determining exactly what to disclose and how they are addressing material disclosures. The Directive may not be the step-change in mandated reporting that many hoped it would be; however, the regional reporting mandate for the largest economic area in the world is nevertheless a significant achievement.

Nana Guar is a Senior Consultant at Corporate Citizenship.