New European Union rules have the potential to provide essential information for investors
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The first EU-wide requirements to report environmental, social and governance (ESG) information will come into effect in the financial year 2017. The requirements will apply to more than 6,000 large public-interest undertakings (in essence, publicly traded corporations, banks and insurers) with more than 500 employees. A number of member states have gone beyond the bare requirements of the directive. In Sweden, Iceland and Denmark, the requirements will apply to all companies with more than 250 employees, i.e. approximately 1600 companies in Sweden and 1100 companies in Denmark. These organisations will be required to disclose information on policies, risks and outcomes regarding environmental, social and employee matters; respect for human rights, anti-corruption and bribery issues; and board diversity.
The objective is to lay the foundation for a new model of corporate reporting that complements financial transparency with other information necessary for understanding of a company’s development, performance and position, as well as impact of its activity on society.
At a practical level, companies are required to disclose at a minimum the following information:
· description of the organisation’s business model
· description of policies regarding environmental, social and employee matters, respect for human rights, anti-corruption and bribery, including due diligence processes implemented;
· the outcome of these policies
· the principal risks relating to environmental, social and employee matters, human rights, anti-corruption and bribery
· non-financial key performance indicators (KPIs)
The information on principal risks must be provided with respect to the company’s direct operations as well as value chains, business relationships, and products.
There has been a lot of discussion about whether to identify the KPIs for businesses to report against, using either a general or a sectoral approach. In the end, the Commission has indicated that it will not provide detailed indicators but will rather leave it to member states or businesses to identify the KPIs that are most relevant to them. The reasoning is that non-financial reporting is at a relatively early stage compared to financial reporting, which has been refined over the course of several centuries. It may be that consensus will develop on how non-financial reporting should be done, and which point the EU or member states may impose more specific requirements. Similarly, the Commission has suggested in various conversations that it will not tell companies which reporting framework to use.
That leaves a number of international reporting frameworks that companies may opt to use to comply:
· Integrated Reporting < IR > Framework – Aims to provide a complete picture of a company’s assets, including intangible assets that are broken down into six ‘capitals’ that are considered to be an important part of value creation and that could otherwise be overlooked in a traditional report on financial assets.
· Global Reporting Initiative (GRI) G4 Sustainability Reporting Guidelines – Provides detailed metrics to report on ESG matters.
· Shift UN Guiding Principles Reporting Framework – For reporting on human rights issues.
· CDSB Framework for reporting environmental information.
The investor community is concerned about how the information that companies will disclose following the NFR Directive can be standardised. Jean Guillaume Peladan, Head of Environmental Investments and Research at Sycomore Asset Management believes that standardised disclosure is necessary but that there is currently “a very poor level of ESG and climate-related reporting and a wide variety of corporate business models.” According to him, “the solution relies on the bottom-up analysis carried out for each company at an activity or business unit level, such as the purpose of each activity, its main negative environmental impacts on a lifecycle basis and its main positive externalities too.”
It should be noted that the EU’s reporting requirements are not comply or explain. As European Commission policy officer Nicolas Bernier-Abad explained: The EU legislation is “you publish your balance sheet, and your profit and loss account, you have an annual report. Make sure you also report your environmental and social information because that is part of the same package. Information needs to be there, needs to be relevant, needs to be comprehensive.” Organisations may determine that one or more of the relevant matters are not pertinent to their business, in which case they should explain the reason(s) for failing to adopt the relevant policy in their non-financial statement. This does not, however, exempt those organisation from the obligation to identify and report on principal risks in any of the applicable areas.
Additionally, reporting on due diligence processes may have implications for evaluating a company’s civil and criminal responsibility for potential wrongdoings by its employees and, where provided for, business partners. This is particularly relevant with respect to corruption.
Member States were required to introduce the directive into national law by 6 December 2016, with a view to applying the regulations to reporting periods beginning on or after 1 January 2017.
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