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.

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The current momentum in ESG policy-making is unprecedented, and keeping up with the latest developments is difficult. Datamaran's Regulatory Snapshot provides clients with a clear and concise overview of the most important policy-related issues worldwide on a regular basis. Read the September 2020 Datamaran's Regulatory Snapshot here, which features expert views from DLA Piper, a top tier law firm and Datamaran partner.

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.

Update: Datamaran submission to the NFRD public consultation

On 10 June 2020, Datamaran responded to the European Commission on Non-Financial Reporting Directive, focusing on the application of the materiality principle.

Our response can be articulated on four main pillars:

  • Materiality shouldn’t be considered exclusively as a reporting activity, but should be regarded as the foundation for a more complete strategic risk management process.
  • Technology has a dramatic impact on resource efficiency while ensuring accuracy of analysis, quality and auditability of data, and comprehensiveness of insights.
  • ESG rating agencies or investors should take into account a company’s materiality determination process, and not penalize lack of disclosure on non-material indicators.
  • Data driven materiality, based on a robust standardized procedure, would allow to move beyond idea that companies’ accountability consists in along list of indicators to disclose on, and bring it back where it belongs - to the Board.
  • 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. From 2013 to 2018, 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:

    • Environmental matters
    • Social and employee aspects
    • Respect for human rights
    • Anti-corruption and bribery issues
    • Diversity on board of directors

    Now, let’s drill into the key details for each of these points.

    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 Datamaran's Global Insights Report, from 2013 to 2018 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.

    Understanding the increase in the number of recorded ESG regulations - a look at the EU

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    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.

    The ultimate guide to the non-financial reporting directive

    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.

    Materiality Definition | regulatory 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”.

    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.

    From Reporting to Strategy: Best Practices in Corporate Materiality

    Based on a series of in-depth interviews, this free ebook explores how the boldest industry leaders have brought materiality beyond reporting, leveraging on digital solutions to make their analysis dynamic, transparent, and decision-useful. 

    You will learn how to enhance the voice of stakeholders in your assessments, why continuous monitoring is critical to stay on top of emerging risks, how to use technology to implement a more credible and systematic method of conducting reasonable assurance of your ESG data, and the best practices to streamline your materiality process.

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