EU mulls changing ‘non-financial’ in the NFRD overhaul, but how did it get there in the first place?

The term ‘non-financial reporting’ has never garnered many supporters, but in the absence of a better alternative it has endured the test of time, at least for now. Of all the prefixes that could have been chosen to characterise ESG information with financial relevance (i.e. material), ‘non-’ is the most nihilist option, which leads to a contradiction in terms. In fact, when RI conducted a survey of the most hated phrases in responsible investment last year, ‘non-financial’ came in second place. 

The European Commission adopted it when in 2012 it started to amend EU laws on financial statements and corporate reporting, resulting in the now key piece of legislation for sustainable finance: the 2014 Non-financial Reporting Directive (NFRD).

For background read: A new dawn for mandatory ESG reporting: how it came about … and what to expect next

Other possibilities were not considered any better: from 'non-accounting’ and ‘extended’ to ‘pre-' and ‘extra-financial’ information. Not even ‘sustainability reporting’ made the cut back then. But as the Commission now undertakes the review of the NFRD with a draft expected in Q1 this year, the question of how to name the new bill will come back.

A spokesperson for the Commission confirmed what it is an open secret: “As for the terminology, we are indeed looking at this issue, but no decision has been made.”

Richard Howitt, the former British MEP who was involved with the NFRD legislative work since inception, told RI that the term ‘non-financial’ has always been misleading as it can imply that risks with deeply financial consequences are dismissed.

Howitt, now an independent strategic advisor after a two-and-a-half-year stint as CEO of the International Integrated Reporting Council, said ‘sustainability’ is the term with the broadest recognition.

“It is understandable if the European Commission moves in this direction, as long as it is interpreted broadly and with the objective of integration in financial reporting and decision-making.

Howitt, however, added: “The equal drawback in using the term ‘sustainability’ was always that some people only understand this to refer to the environmental and not social impact of the company, and may reinforce the lack of integration between sustainability and financial reporting.”

Likewise Donato Calace, Innovation Vice-President at ESG risk management software firm Datamaran and member of the expert groups of the European Financial Reporting Advisory Group, believed the Commission will favour ‘sustainability’ reporting. 

Calace told RI: “After all they're talking about ‘EU Sustainability Standards’. Other expressions would be more convoluted even if fascinating: ‘enterprise value reporting’, ‘comprehensive corporate reporting’, etc.”

Filip Gregor and Susanna Arus from Frank Bold also agreed that ‘sustainability reporting’ will likely be the term chosen by the Commission as it would be suitable for a legal text.

Across the pond, the term ‘non-financial information’ has appeared in two reports that were instrumental for the creation of the Sustainability Accounting Standards Board (SASB). The first was the Jenkins Committee Report published as early as 1994. It was the result of the American Institute of Certified Public Accountants’ Special Committee on Financial Reporting, chaired by the influential Edmund Jenkins. The Jenkins Committee studied whether business reporting and financial statements should be supplemented with other information.

Such information was also referred to as ‘nonfinancial’: “Companies also are changing the types of information they use to manage their businesses. For example, they are developing new performance measures often designed to focus on activities that provide long-term value, including nonfinancial measures such as product development lead time and financial measures such as economic value added.

The second report was Improving Business Reporting: Insights into Enhancing Voluntary Disclosures, published in 2001 as part of a research project sponsored by the Financial Accounting Standards Board (FASB) to study the information that corporations were reporting outside of financial statements. 

As part of that project, FASB was already asking stakeholders: “Should the FASB broaden its activities beyond financial statements and related disclosures to also address the types of nonfinancial information that would be included in a comprehensive business reporting model?”

But there is another term to take into account that has recently become a buzzword: double materiality. SASB has specialised in identifying what is material in that non-financial information for an audience of mainly investors. This approach is normally referred to as single materiality.

The NFRD, however, will be guided by a so-called double materiality principle. That would mean corporate reporting standards able to cover the impact of sustainability in companies and investors (i.e. single materiality) , and vice versa, the impact of companies and investors in society, therefore encompassing the needs of other stakeholders beyond investors.

An early use of the term ‘double materiality’ can be found in the 2019 European Commission’s Guidelines on non-financial reporting: Supplement on reporting climate-related information.