The Non-Financial Reporting Directive: What You Need To Know

Does your company have offices within the European Union (EU) with over 500
members of staff*? If yes, pay close attention to this blog – because it can help your
business navigate a changed regulatory environment.

*Or 250 members if based in Sweden or Finland, or 10 if based in Greece.

The Non-Financial Reporting Directive (NFR Directive) came into effect in all EU
member states in 2018. All 28 countries have since adapted the Directive into national
law, and it is now up to companies to comply.

The EU Non-Financial Reporting Directive is enshrined in the Treaty on the

Functioning of the EU, which allows Member States to exceed the requirements set by
the EU in matters of environmental protection.
We will tell you more about this later (in the section ‘Enforcement – Do Directives
Present A Business Risk’), but for now take a look at what you need to know. Here is
a snapshot.

 The number of regulatory initiatives requiring non-financial disclosure is

growing rapidly. Since 2013, there has been a 72% increase in the number of
recorded regulations concerning non-financial issues. And this trend looks set to
continue.
 Simultaneously, the cost of non-financial risk is rising. Between 2008-2012, the
top ten global banks lost close to $200 billion through litigations compensation
claims and operational mishaps.
 Countries have adapted the NFR Directive to varying degrees – business must
understand what is required by each relevant country in order to effectively mitigate
risk.
 Required disclosure broadly falls into the following categories:

o Environmental matters
o Social and employee aspects
o Respect for human rights

Anti-corruption and bribery issues

o

o Diversity on board of directors

Now, let’s drill into the key details for each of these points.
 1
The Regulatory Space for Non-Financial Disclosure is Blowing Up

2
The Rising Cost of Non-Financial Risk

3
So, What is the Non-Financial Reporting Directive?

4
What is Required?

5
The Consultation Document and Materiality

6
How Have Countries Adopted the NFR Directive into Law?

7
Enforcement – Do Directives Present Business Risk?

The Regulatory Space for Non-Financial Disclosure is Blowing Up

It’s not an exaggeration to say the regulatory space is blowing up on non-financial

disclosure. The NFR Directive is just one of the 4,000+ initiatives globally that require
or recommend disclosure on non-financial issues – and this number is rising at a high
speed.

According to the Global Insights Report 2018 since 2013, there has been a 72 percent
increase in the number of recorded regulations concerning non-financial issues. And
this trend looks set to continue.
 Understanding the increase of the number of recorded ESG regulations.

Click to enlarge
Recently, organizations such as: the TCFD, The World Economic Forum, The World
Federation of Exchanges (WFE), and a joint work by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and the World Business Council
for Sustainable Development (WBCSD) – have all published their recommendations
on how they expect companies to manage and disclose their non-financial
risks.

The NFR Directive is a leading example of how the landscape has changed – and
continues to change. The evolution of accountability shows us it is only a matter of
time before prominent voluntary initiatives will become mandatory regulations, as
such being ahead of the curve will help business mitigate any backlash.

Companies of much smaller size are impacted by the NFR Directive too. Business
who fails to take note of the change are leaving themselves exposed.
Additionally, if part of your supply chain is based in the EU but the entities operating
within do not comply with the EU Directive, this could have knock on effects for your
business.
Companies must not only provide more granular information on non-financial risks
and opportunities within their own operations, they must also consider these across
their value chain.

A recent French law – “the duty of care of parent companies” or “devoir de vigilance
des entreprises donneuses d'ordre” is a landmark example of how regulators are
demanding more information from companies. For the first time, a National
Government is requiring that large companies assess and address adverse impacts
across their supply chain.
Coming into force in March 2018, “the duty of care of parent companies” gives us a
sense of what is to follow in the next decade.

The Rising Cost of Non-Financial Risk

So, what happens if companies do not comply with these laws?

As it can be seen in the infographic below, the top 10 banks globally lost
$200bn through litigation compensation claims and organizational mishaps related to
non-financial issues between 2008 and 2012.
The rising cost of non-financial risk.

Click to enlarge
The infographic above also shows that there is a disparity between the percentage of
companies that believe themselves to be prepared for the EU Directive, and the
percentage of investors who believe companies are prepared.

This highlights a gap between the level of detail companies provide and investor
expectations.

The question is how can your company get ahead of these rising risks and
opportunities?

So, What is the Non-Financial Reporting Directive?

The directive requires public disclosure documents such as annual reports,

sustainability reports, and integrated reports to include the below topics. You need to
ensure you are disclosing the impacts of your business activities on issues that fall
into the following categories:

 Environmental matters
 Social and employee aspects

 Respect for human rights

 Anti-corruption and bribery issues

 Diversity on board of directors

The disclosure must include a description of the company’s business model, a

description of the policies adopted regarding the listed issues, the outcome of said
policies, the risks related to those matters linked to the company’s operations, and
non-financial key performance indicators relevant to the particular business (as
referenced within the NFR Directive).

The Directive applies a “comply or explain” system, meaning if no policy is in place

in one of the above matters, your company must explain the reasons behind this. The
“comply or explain” principle ensures that if a company does not apply a policy
regarding these issues, it will be disclosed publicly, encouraging companies to
address this gap, in order to avoid negative publicity.
What is Required?

The Directive requires companies to report on business impact, development,

performance and position relating to a set list of non-financial issues.
A number of countries have added requirements regarding the publication of
information regarding the diversity of the Board of Directors, distribution of
employees in terms of age and gender, and executive remuneration. This includes
Austria, Belgium, Bulgaria, Cyprus, Finland, Germany, Ireland, Italy, Portugal, and Spain.

France adopted the directive with the most stringency. France went further than the
other countries by adding more topic specificity. There are direct mentions of granular
environmental topics, such as pollution prevention and circular economy. Similarly, on
social issues, France went into more detail on issues, such as employee retention and
workforce diversity.
Twelve countries in total have simply directly inserted the text of the Directive into their
national legislation, however, these include no additional details from the EU directive.

These include environmental issues (i.e greenhouse gases, energy use); social and
employee aspects (such as employee development, employee compensation and
benefits); respect for human rights (such as human rights, children rights, labor rights);
anti-corruption and bribery (such as bribery, corruption); and diversity on the board of
directors (such as workplace diversity and inclusion, board composition, board diversity
and independent board directors).

Companies are given the freedom to disclose this information in the way they find
useful or in a separate report. In preparing their statements, companies may use
national, European or international guidelines, such as the UN Global Compact,
the OECD guidelines for multinational enterprises or the ISO 2600 according to the EU
Commission.

International guideline for non-financial reporting: a timeline.

 Click to enlarge
An important point here is that while most countries encourage the use of voluntary
frameworks, companies are required to disclose which framework was used, if
any.
A number of voluntary frameworks exist, which can be followed to report on the
issues.

Notably, the GRI standards can be used for each topic and are the most commonly
used framework. They have released the following to help companies implement the
Directive: Linking the GRI Standards and the European Directive on non-financial and
diversity disclosure (14 Feb 2017).

The Consultation Document and Materiality

The recent Consultation Document on the Update of the Non-Binding Guidelines on

Non-Financial Reporting, released by the European Commission in February 2019
clarifies the disclosure frameworks and materiality analysis process, in particular.
The Consultation Document is worth the attention as it provides a clear picture of
where the next generation of disclosure requirements is heading.
Companies can make a decision concerning the materiality perspective (financial or
environmental & social, or both) they are adopting when disclosing the information.
This evidently calls for enhanced transparency from the board on what materiality
perspective is adopted and why. Best practice in this sense would be Statement of
Significant Audiences that Eccles and Youmans already proposed in 2015.
Additional details around materiality determination process is required in relation to
the following:

 A comply or explain mechanism on the materiality methodology: “Companies

that conclude that climate is not a material issue are advised to consider making a
statement to that effect, explaining how that conclusion has been reached.”
 Setting the boundaries of the materiality assessment so that “natural, human,
and social capital dependencies” of climate-related issues are reflected.

 Specific materiality methodology disclosure requirement. “Describe the

company’s processes for identifying and assessing climate-related risks over the
short, medium, and long term and disclose how the company defines short,
medium, and long term”.
Read more about the NFR Directive’s materiality recommendations and its alignment with the TCFD
requirements.

How Have Countries Adopted the NFR Directive into Law?

As is the rule in EU Law, Directives must be transposed into national law by each
member state, giving them a certain amount of liberties in the ways to implement the
requirements set by the Union – as long as the outcome of the Directive is upheld.
Countries are mandated with interpreting and deciding the best method of
implementation.
The implementation of the Directive is not straightforward as each country has
interpreted it in its own way. For some cases the Directive applies for all types of
companies and in the other cases for publicly listed only.

Overall, the scope of the Directive has been defined in reference to the average
number of employees, balance sheet total and net turnover.

The Directive sets the minimum scope as “Large Public Interest Entities” with more
than 500 employees during the financial year.
Significantly, some countries have chosen more strict standards. Sweden, for
example, applies its rules to all types of companies with over 250 employees,
while Luxemburg lowered the minimum employee threshold to 250 employees for
Public Interest Entities (PIE), or Greece where Companies with over 10 employees
and a net turnover of over EUR 700,000, and balance sheet total of over EUR
350,000, must report on environmental performance and employee matters. If a
company doesn’t meet at least one of the requirements, then the Directive applies to
companies with over 500 employees.
The interactive map below shows how the EU member-states are required to report
on the Non-financial Reporting Directive:

Through this, these countries demonstrate their engagement with the issue, and may
set a trend for more countries to adopt similar measures in the future.

We are expecting to see major shifts in the ways in which companies report, and
more details on the relationship between company financial statements, and the non-
financial issues impacting business and society.

Enforcement - Do Directives Present Business Risk?

Once approved, EU Directives must be transposed into national law. This means
the country in which your business is based will take decision on the details in terms
of enforcement.
Once the transposition measure is adopted, it is enforced through the national
administrative mechanisms applicable to national law.

Therefore, prosecution and penalties for non-compliance can present a serious

business risk – both in terms of a regulatory risk, but also a reputational risk.
The violation of the requirements of a Directive is therefore considered as a violation
of the transposition measure itself. National tribunals and courts will have jurisdiction
over the non-financial statements, and will judge according to the texts of relevant
national laws, and not the Directive.

https://www.datamaran.com/non-financial-reporting-directive/