Europe needs mandatory non-financial reporting to underpin the COVID recovery

Main points:

  • Non-Financial Reporting (NFR) is critical to building a sustainable economy post the COVID-19 crisis. 
  • With a consultation in progress for the NFR Directive and the development of Tools and Mechanisms for the Integration of ESG factors into the EU Banking Prudential Framework and into Banks’ Business Strategies and Investment Policies the EU Commission has an opportunity to lead the world in refocussing corporate efforts. 
  • As academic research and evidence shows, it’s time to significantly strengthen reporting requirements.

A significant body of academic research overwhelmingly finds that transparency will not occur unless reporting “requirements” are mandatory and enforced by a pro-active regulatory body with powers to require changes.   Without it companies will leave out material negative impacts, twist the scientific literature to support their unsustainable activities and generally portray their performance in a more positive light.  Recently we’ve seen VW come unstuck after claiming to be the world’s leading automaker ‘ecologically’ and airlines underplaying health and climate change risks.  Such practice is bad for the European economy and bad for the environment and society. 

Research also shows that where company boards approves non-financial  reporting it influences the way boards think about risk and opportunity and how they incorporate it into strategy.  When reporting becomes mandatory Boards do get involved and organisations have access to new information leading to better decision making.  But companies tend to ignore mandatory requirements if they are not enforced. 

Research also shows that investors don’t ask the right questions, or enough questions, on sustainability issues.  (Such research is summarised here.)

A more substantial EU NFR Directive (or Regulation) can help companies help themselves by making them put a higher priority on social and environmental risks and opportunities that influence their ability to create value. Whilst often longer term, the consequences for companies can be short term and can have direct financial implications. This will increasingly be the case with rapidly growing pressure and scrutiny from public opinion, clients and customers. In addition, focussing corporate minds on impacts can help governments fulfil their commitment to achieving the UN Sustainable Development Goals. 

Creating value in the long term and impact on sustainable development issues are not mutually exclusive.  For example, a food retailer in a developing country guaranteeing fresh food to the wealthy by giving soon-to-be out of date stock to the poor is improving its brand and reputation whilst also having a significant impact on the poor.  But the issues are complex and interconnected. There are trade-offs between sustainable development issues and between sustainable development and long-term value creation. Further, stakeholder groups can have conflicting interests.  

The EU NFR reporting requirements need to be extended to reflect this complexity and ensure companies and their stakeholders have the information they need to make more informed decisions.   Companies invest significantly less in non-financial reporting than they do in financial, yet it is the things that don’t show up in the financial statements that can often make or break them. 

The NFR Directive must take the opportunity to increase incorporation of the best of the most used frameworks and standards.  These are the Global Reporting Initiative (GRI) Standards, the integrated reporting framework and the Taskforce on Climate-related Financial Disclosure Recommendations.  The recently published Sustainable Development Goals Disclosure (SDGD) Recommendations, aligned to all three, facilitate a focus on material sustainability development issues (i.e. those that influence value creation and/or impact) with an emphasis on informing strategy.

The Accountancy Europe proposal for sustainability reporting standards seems to have missed the fact that we already have the GRI Standards developed through rigorous and independent processes mirroring those of accounting standards. Endorsing these through an EU Directive or Regulation would mean they stayed up to date – so no need to keep revising legislation. 

Given that universities in the EU and elsewhere have conducted a substantial body of research with consensus on the need for extended mandatory NFR reporting, it is difficult to understand the decision to engage Black Rock to develop the NFR rules for banks.  Framework and standard setters go through a consultation process and academics research how disclosure requirements are implemented and how they change actions. Black Rock, on the other hand,  is a mega-sized global investor and CEO Larry Fink has nailed his colours to the mast in his recent letter to corporate CEOs  in favouring the US based Sustainability Accounting Standards Board (SASB) disclosures.  SASB Standards aim to only cover “sustainability topics that matter most to their investors” (and we know from research that most don’t ask the right questions) and have little traction with EU companies.  But more worryingly they are insufficient to alert corporate stakeholders on a range of impacts that matter to them or to provide confidence in management approach and governance oversight.

This article written by Carol Adams first appeared on EURACTIVE 

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