The European Commission has proposed a new Directive requiring larger corporates in the EU to disclose non-financial and diversity information in annual reports (the “Proposed Directive”). The key objectives are threefold:

  1. enhance transparency and increase the relevance, consistency and comparability of non-financial information;  
  2. increase diversity on boards; and  
  3. increase companies’ accountability and performance.

The European Commission believes that these objectives will enhance management by larger corporations of non–financial risks and opportunities, and improve their non-financial performance (without undue administrative burden and cost).

Key proposals:

  • Companies with over 500 employees that also meet certain financial thresholds will be required to disclose environment and social information in their annual reports; and  
  • Large listed companies will additionally be required to include information on their diversity policies, and implementation and results of such policies, in their corporate governance statement.

Currently the legislative framework (namely the Fourth and Seventh Accounting Directives on Annual and Consolidated Accounts, the “Accounting Directives”) regulate the information provided in the financial statements of all limited liability companies which are incorporated under the law of a Member State or European Economic Area. The amendments introduced by the Proposed Directive will apply to companies listed on an EU regulated market, even if they are registered in a third country.

Current Legislative Framework – it’s “ineffective”

The current Accounting Directives provide that a company’s annual report or a group’s consolidated annual report must contain non-financial information relating to environment and employee matters as appropriate and to the extent necessary for an understanding of the company’s development, performance and position.

The European Commission has taken the view that these current Directives have been ineffective in terms of ensuring transparency of companies’ non-financial information. The European Commission makes the point that fewer than 10% (around 2,500) of the largest EU companies regularly disclose environment and social information. Further the European Commission is critical of the quantity and quality of the information that is disclosed.

Another driver appears to be the disparity in application by the Member States of the Accounting Directives. This, the European Commission says, has led to legislative fragmentation across the EU, with some Member States doing more than currently required (the UK being one), whilst others lag behind. The European Commission takes the view that the lack of conformity and legal certainty has made it difficult for investors and stakeholders to analyse and compare companies’ positions and performances.

In the UK, regulations which go beyond the obligations of the Accounting Directives are due to come into force in October 2013. These regulations will amend the Companies Act 2006, and make changes to the way companies report their environment, employee and human rights-related information. Under these planned changes, there will be an additional obligation on quoted companies to disclose information about gender (only) diversity of their boards and organisation as a whole for the first time. However, the Proposed Directive will go further than this (see below).

With regard to diversity, the European Commission states that its consultations and impact assessments have identified that a continuing lack of diversity on boards may be exacerbating so-called ‘group think’, which its says can stifle innovative ideas and cause detrimental impacts on company performance. The European Commission believes that there is a need for increased pressure to diversify boards.

The Proposed Directive (which technically amends Articles 46 and 36 of the Fourth and Seventh Accounting Directives) is being introduced to address these issues and to provide easier and more widespread access for investors to important useful information.

Key Elements of the Proposals

Large companies to disclose non-financial information

  • Article 1(a) of the Proposed Directive requires large companies to include a statement in their annual report describing their policies, results and risk-related aspects relating to (at least) environment, social, anti-corruption, bribery and employee-related matters, and respect for human rights.  
  • These disclosure requirements will only apply to companies with over 500 employees, and either a balance sheet total in excess of €20 million or a net turnover in excess of €40 million. The European Commission estimates that this will apply to around 18,000 companies across the EU.  
  • The disclosure obligations may be fulfilled at group level in a consolidated annual report.  
  • A company may be exempt from the disclosure requirements if it prepares a comprehensive report corresponding to the same financial year relying on national, EU-based or international frameworks, provided that report covers the information required by Article 1(a) and it is annexed to the annual report.  
  • A company may rely on national, EU or international frameworks, but should disclose which framework it has relied on.

Large listed companies to provide information on diversity

  • Large listed companies will also be required to provide information on their diversity policy. This information will need to include the diversity policy objectives, implementation and results. In terms of diversity this must include aspects concerning age, gender, geographical diversity, and educational and professional background. This diversity information is to be included in the company’s corporate governance statement in its annual report.

Comply or Explain

  • Companies which do not apply specific policies for any of the matters above will be required to explain why this is the case.

Costs

The European Commission estimates that the additional direct costs for large companies will be less than €5,000 per year. The European Commission also takes the view that this expenditure should be seen as an investment rather than a cost.

Next steps

It is anticipated that the Proposed Directive will be adopted by the European Council and the European Parliament, and transposed into Members States’ domestic legislation by 2016. First reports will be expected to appear from 2017, however Member States will have the option to allow non-listed companies an additional year. Member States will also be free to introduce more stringent requirements.

The Proposed Directive, Press Release and FAQs can be found here