In December 2019, as part of the European Green Deal1, the European Commission committed to reviewing the Non-Financial Reporting Directive 2014/95/EU (NFRD). The objectives of this review are two-fold: first, to improve disclosure of climate and environmental data by companies to better inform investors about the sustainability of their investments and, second, to give effect to changes required by the new Disclosure Regulation2 and the forthcoming Taxonomy Regulation.3

The underlying objective of the European Green Deal (which has been described as “Europe’s man on the moon moment”) is to ensure that the EU is carbon neutral by 2050. Key to the delivery of that objective is the need to reorient significant amounts of public and private capital into sustainable activities. It is hoped that the disclosure of robust environmental data by corporates will speed up the rate of investment into green and other environmentally sustainable activities.

The underlying objective of the European Green Deal (which has been described as “Europe’s man on the moon moment”) is to ensure that the EU is carbon neutral by 2050. Key to the delivery of that objective is the need to reorient significant amounts of public and private capital into sustainable activities. It is hoped that the disclosure of robust environmental data by corporates will speed up the rate of investment into green and other environmentally sustainable activities.

However, the Commission has identified that, at present, the non-financial information disclosed by companies does not meet the needs of investors and others in this space. In particular, the Commission considers that disclosed information does not adequately detail how non-financial issues (and sustainability issues in particular) impact companies and how companies themselves impact society and the environment.

The Commission has outlined a few reasons for this, being that:

  • reported information is not sufficiently comparable or reliable;
  • companies do not report all non-financial information that users think is necessary;
  • some companies do not report this information at all;
  • it is hard for investors and others to find non-financial information even when it is reported; and
  • companies face uncertainty and complexity when deciding what non-financial information to report, and how and where to report that information.

The Commission's emphasis thus appears to be on the need to provide further direction to corporates and other issuers under the NFRD so that reliable, comparable and relevant non-financial information can be disclosed.

First NFRD consultation

On 30 January 2020, the Commission published an initial, high-level roadmap for consultation about possible changes to the NFRD.4 That consultation closed on 27 February.

In it, the Commission suggested three policy options:

  • continue with the current approach of non-binding guidelines and update them;
  • endorse an existing or future standard on non-financial reporting, which would remain voluntary for companies to use; or
  • revise and strengthen the existing NFRD provisions by:
    • adding more detail;
    • requiring some or all of the companies under the scope of the NFRD to use a non-financial reporting standard;
    • modifying the scope of the NFRD (to add certain categories of company not currently covered and/or to exclude certain categories of company that are currently covered);
    • strengthening the provisions regarding the assurance of non-financial information;
    • strengthening the enforcement and supervision of non-financial reporting requirements; and
    • clarifying where the non-financial information should be reported.

Early indications were that the Commission prefers the third policy option, as it considers that the current system of voluntary guidance is not effective in responding to the non-financial information needs of the investment community and other stakeholders. This is in line with the Commission's statements about work commencing on an EU-wide non-financial information standard (see further below) and the tone of the Commission’s second NFRD consultation.

Second NFRD consultation

On 20 February 2020, the Commission published a second, more detailed consultation on changes to the NFRD. That consultation closes on 14 May.

The second consultation consists of an online questionnaire with 45 detailed questions.5 Key questions include:

  • Should companies be required to disclose information about other non-financial matters? At present, the NFRD requires information about the environment, social and employee issues, human rights, and bribery and corruption.
  • Should companies be required to disclose information about scenario analyses, targets, more forward-looking information or how a company aims to contribute to society through its business activities? At present, the NFRD requires information about a company’s business model, policies (including due diligence processes), outcomes, risks and risk management and key performance indicators.
  • Under the current system, will companies in the financial sector have all the information they need about their investee companies to be able to meet the new disclosure obligations under the Disclosure Regulation and Taxonomy Regulation? Banks, asset managers, pension funds and others in the financial sector are concerned that, as things currently stand, they do not have all the information they need from the companies they invest in – which in turn could put financial institutions in breach of their own disclosure requirements.
  • In order to better align with the forthcoming Taxonomy Regulation, should the NFRD define environmental matters by reference to the same six objectives in the Taxonomy Regulation (namely, climate change mitigation, climate change adaptation, water, circular economy, pollution and biodiversity)?
  • Would having a single non-financial reporting standard help provide non-financial information that is more reliable, comparable and relevant? And should any such standard include sector-specific elements?
  • Would application of an existing standard or framework on its own resolve the problems (e.g. the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB) or International Integrated Reporting Framework (IIRF))?
  • If there were a common EU non-financial reporting standard, to what extent should it incorporate the principles and content of existing standards and frameworks, such as the GRI, SASB, IIRF, Task Force on Climate-related Financial Disclosures (TCFD), CDP, UN Guiding Principles Reporting Framework on human rights, etc?
  • Should EU law require stronger assurance requirements for non-financial information reported by companies under the NFRD? At present, non-financial information statements (whether provided in a management report or a separate report) under the NFRD are not subject to auditing or assurance requirements.
  • Should the scope of the NFRD be extended, for example to include all EU companies securities listed in regulated markets regardless of size; all large public interest entities regardless of size; companies that are subsidiaries of a parent company that reports non-financial information at group level under the NFRD and/or large non-listed companies?

EU non-financial reporting standard: EFRAG to commence work shortly

As mentioned, the Commission has made it clear that it supports the development of EU-wide non-financial reporting standards and that it will be inviting, soon, the European Financial Reporting Advisory Group (EFRAG) to begin preparatory work for those standards as quickly as possible.6

The Commission intends to use the “best and most widely accepted elements” of existing international non-financial/ESG reporting standards (such as the GRI, SASB, TCFD, etc) as their starting point. The second NFRD consultation seeks views on which elements of these existing standards should be incorporated into an EU standard.

The indications so far are that the Commission does not believe simple adoption of an existing standard on its own would be sufficient to meet the EU’s needs, particularly in light of the level of additional information about sustainability that will be required under the new Disclosure Regulation and Taxonomy Regulation. This is borne out by a report published by the European Securities and Markets Authority (ESMA), published in December 2019, on undue short-term pressure on corporations7 and the Council’s conclusions on the Capital Markets Union.8 It is clear that it is not just the Commission’s view that the current non-financial reporting regime is insufficient; that view is shared by member states and the European supervisory authorities.

In parallel, the Commission has said it will continue to engage with international efforts to develop a standardised global reporting standard. However, as the development of a global standard is still some way off, the EU intends to forge ahead with its own standard in the meantime.

Next steps

  • 27 February - first NFRD consultation closed.
  • 14 May - second NFRD consultation closes.
  • February to May - the Commission will send out surveys to SMEs and companies outside the scope of the NFRD to gather their views.
  • Shortly – the Commission will consult on a Renewed Sustainable Finance Strategy.
  • Shortly – the Commission will invite EFRAG to begin preparatory work for a EU-wide non-financial standard.
  • Shortly – the Taxonomy Regulation will be formally adopted and published in the Official Journal of the European Communities.
  • Q4 – the Commission will publish draft legislation to give effect to the changes to the NFRD.