Review of Non-Financial Reporting Directive: the pursuit of data that is relevant, reliable and comparable

The European Commission is carrying out a major review of the Non-Financial Reporting Directive (NFRD).

The consultation closed on 11 June 2020 and a draft Regulation is scheduled for Q1 2021 – see Adjusted Commission Work Programme 2020.

This forms part of the Commission’s wider European Green Deal and its fundamental policy shift to channel finance into sustainable businesses and away from those that are dependent on fossil fuels or with adverse social impacts.

This reporting proposal - coupled with the Sustainable Finance Disclosure Regulation and Taxonomy Regulation - will require a step change in the quality and breadth of environmental and social information that companies will be expected to disclose.

Who does this affect?

All large listed and financial companies in the EU that qualify as a large public interest entity (PIE) under the NFRD will be affected by the proposed changes – and possibly also a wider range of companies if the scope of the NFRD is expanded following the NFRD review.

Although it is not yet clear what the new rules will be, the consultation responses so far give a strong indication of what the new rules may look like.

What changes are being proposed?

The Commission considers that the non-financial information disclosed by companies at present under the NFRD does not meet the needs of investors and other stakeholders.

The three magic words for what investors (and the Commission) think is needed from issuers is information that is relevant, reliable and comparable. Also, importantly, investors (and the Commission) want to go beyond just backwards-looking data on non-financial/ESG issues. The latter is particularly important when assessing climate risks.

In particular, the Commission thinks that:

• current information is not sufficiently comparable or reliable;
• companies do not report on all the non-financial information that investors need; and
• companies are struggling to decide which non-financial information to report on and how and where to report on it.

The NFRD consultation sought views on a number of issues, including whether:

• the current approach of non-binding guidelines should be maintained or whether they should be made mandatory;
• companies should be required to disclose information about other non-financial matters (e.g. climate change scenario analysis);
• having a new, single EU non-financial reporting standard would help and if so which aspects of existing ESG reporting frameworks (e.g. SASB, GRI, IIRF, TCFD, etc) should a new EU reporting standard include;
• the scope of the NFRD should be extended to types of organisations other than just large PIEs; and
• the non-financial information should be subject to auditing or other assurance requirements.

The Commission also asked if the requirements in the NFRD should be aligned with the new disclosure requirements in the EU Disclosure Regulation and the Taxonomy Regulation. The Taxonomy Regulation, in particular, will require further changes to the NFRD. This was not covered in the NFRD consultation as the Taxonomy Regulation had not yet been formally adopted when the NFRD consultation was launched. For more information on the Disclosure Regulation, see here.

Commission asks EFRAG to start preparatory work on EU non-financial reporting standards

Alongside the review of the NFRD, the Commission has asked the European Financial Reporting Advisory Group (EFRAG) to begin preparatory work on recommendations for possible EU non-financial reporting standards.

EFRAG has been asked to submit a progress report by 30 October 2020 and a final report by 31 January 2021. EFRAG’s preparatory work is to be carried out by a task force to be appointed by the steering group of the European Reporting Lab at EFRAG, with a call for candidates for this body to be issued shortly.

The Commission says that it has not yet taken any decisions about the future role, if any, of non-financial reporting standards in the context of the forthcoming revision of the NFRD but that it is necessary to start preparatory work now to allow for the swift adoption of European standards should that be included in the Commission’s final proposal (see here).

The Commission also says that EFRAG must build on existing reporting standards and frameworks “to the greatest possible extent” and that the relevant standard-setting organisations, as well as ESMA, should work closely with EFRAG. Which is why, in the NFRD consultation, the Commission asked which elements of the existing ESG reporting frameworks (such as SASB, GRI, IIRF, TCFD, etc) should be incorporated in a new EU standard.

Although the shorter-term goal is to pursue European standardisation of the reporting rules on non-financial information, the longer-term goal is still to achieve international standardisation on this. However, seeing as the latter is unlikely to happen anytime soon, the EU has decided to press ahead with preparatory work for its own ESG reporting standard – but without recreating the wheel from scratch (see here).

The Commission’s request reflects the recommendation made by ESMA in 2019 in their report on undue short-term pressure on companies, which was endorsed by the Council of the EU conclusions on the Capital Markets Union at the end of 2019.

What do the consultation responses indicate?

The European supervisory authorities - ESMA, EBA and EIOPA - have replied to the consultation urging the Commission to:

• make the requirements in the NFRD mandatory rather than voluntary;
• extend the scope the NFRD to a larger group of companies;
• require non-financial information to be audited;
• ensure the NFRD is consistent with the Disclosure Regulation, the Taxonomy Regulation and the prudential disclosure requirements (for example, in the Capital Requirements Regulation for credit institutions); and
• press ahead with developing an EU non-financial reporting standard.

In addition to their individual responses to the consultation, see also their joint letter to the Commission.

An informal group which describes itself as “a group of stakeholders with different backgrounds, but a common interest in sustainable finance” - including EFAMA (the industry group for European asset manager), the Association of German Banks, Schroders, the Association of Chartered Certified Accountants (ACCA), AccountancyEurope, the Climate Disclosure Standards Board (CDSB), the Institutional Investors Group on Climate Change (IIGCC) and ShareAction - have issued a joint statement about the NFRD consultation. The key message is that the NFRD needs a “leap forward”. The group identified seven issues as being “instrumental” for the upcoming revision of the NFRD, including:

• expanding the scope of NFRD reporting to a larger group of companies;
• strengthening reporting on social and governance aspects;
• developing minimum mandatory reporting requirements;
• building on existing reporting initiatives to achieve comprehensive non-financial reporting;
• ensuring legislative consistency and avoiding duplication of reporting legislation.

Although the Commission has not yet said which changes it plans to take on board, the views of the European supervisory authorities and those of the new informal group of sustainable finance stakeholders give a good indication of the new shape the NFRD could take.

Why do issuers need to think about this now?

It has become abundantly clear that the quantity and quality of non-financial/ESG data that is currently being disclosed by issuers – not just in the EU but globally – is not regarded as sufficient to enable investors to make properly informed decisions about climate-related and other ESG issues. The ultimate aim is to deliver decision-useful data that is relevant, reliable and comparable.

Big changes in what non-financial information is required and how issuers report on that are afoot. Although the changes are not going to happen tomorrow, in the EU, they will start impacting from next year through the Sustainable Finance Disclosure Regulation.

From March 2021, EU-regulated funds will be required, under the Sustainable Finance Disclosure Regulation, to disclose their approach to taking positive and adverse ESG impacts into account in investment decision-making. Buyside entities (such as funds, asset managers, etc) will need to gather and disclose granular information on a wide range of ESG impacts. As a result, companies may begin to receive more detailed ESG related questions from investors - for example, in respect of the principal adverse impact indicators that have been identified in the draft technical standard being developed for the Disclosure Regulation.

It is also worth bearing in mind that, in the UK, the FCA is consulting on a new rule that will require premium listed companies to report on climate change issues in accordance with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) on a comply or explain basis. The new rule is expected to apply to financial years beginning from 1 January 2021.

Companies need to start preparing for this new level of disclosure now, as the changes they will – inevitably – have to make are not things that can be rolled out overnight once the new legislation has been adopted.

Companies should also assume greater engagement by the investment community in pushing for improvements in performance, as well as increased commercial and liability risks associated with incomplete or inaccurate environmental and social information.