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The Path From Non-Financial to Sustainable Reporting

The Path From Non-Financial to Sustainable Reporting

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Until 2014, less than 10 percent of the largest companies in the European Union regularly disclosed non-financial information about their operations as part of reports that supplement annual financial consolidated reports. Although they were obliged to do so by the then-current Directive of the European Union, the requirements of the existing legislation proved to need to be more transparent and more effective.

Some countries have previously, on their initiative, tightened non-financial reporting. For example, the United Kingdom introduced non-financial reporting into its local legislation in 2006, requiring large companies to disclose non-financial information (and diversity information). Similar laws were adopted by Sweden (2007), Spain and Denmark (2011), and France a year later.

And while most countries didn’t have the proper legislation regarding this matter, the practices of the United Kingdom and the mentioned countries showed exceptional effects. Everything led to the fact that the existing Directive on accounting (Directive 2013/34/EU) was about to be supplemented by the Directive on non-financial reporting (Directive 2014/95/EU, NFRD) as an amendment, which was adopted in 2014.

The EU Non-Financial Reporting Directive – from Amendment to Law

The NFRD began a new non-financial reporting process, coming into force in December 2014, as part of a general strategy to promote corporate social responsibility in the European Union. The primary purpose of the new Directive was to encourage transparency and accountability by requiring companies to publish information on corporate responsibility regularly.

The introduced norm was aimed to make companies disclose relevant policies in their management reports, as well as the outcomes and risks, including non-financial key performance indicators related to social and employee issues, respect for human rights, anti-corruption and bribery issues, and diversity in management boards.

For example, EU rules require large companies to publish regular reports on the social and environmental risks they face, that is, how their activities affect people and the environment. The reporting referred to companies with more than 500 employees. They were required to integrate into their reports numerous data that are of general social importance but also of importance to the market itself. For instance, issuers of securities had to disclose certain key information to ensure transparency for investors.

Even though the NFRD was not fully standardized for all countries, it turned out that it contributed to an exceptional extent to the general trend of non-financial reporting in the EU. With this regulation, the EU encouraged each member state to apply general rules but allowed each state to set requirements as it desires. Austria, Belgium, Bulgaria, Cyprus, Finland, Germany, Ireland, Italy, Portugal, and Spain are postal countries where NFRD requirements are strictly observed. On the other hand, France is considered the country that has implemented the most regulations. What has been a general benefit is that companies across the EU have started to create different methods in the way they report details about their business with much greater intensity.

Sweden and Luxembourg, for example, have exceeded the requirement regarding companies with more than 500 employees. These two countries required all companies with over 250 employees to comply with the reporting requirements under the NFRD. Finally, Greece went the furthest, establishing that every company with more than ten employees with an income of 700,000.00 euros must submit non-financial reports.

The aim of the Directive – to increase the transparency and performance of EU companies concerning environmental and social issues and effectively contribute to long-term economic growth, has been fulfilled. A Global Insights report from 2013 to 2018 shows a 72% increase in reported non-financial disclosures. Sufficient grounds have emerged to legislate the NFRD.

The Directive on Non-Financial Reporting began to be applied in all member states as national law in 2018. All 28 EU member states are now expected to comply with the law if their companies meet the conditions for participation in the NFRD.

Next Stage – Evolution of the NFRD into the CSRD

The need for non-financial disclosure is snowballing, and the reason is that the price of non-financial risk for companies is enormous. According to the Greenly platform, only in the past four years have ten of the world’s most famous banks lost almost 200 billion dollars due to fraudulent claims and operational misunderstandings. In contrast, countries across the EU following the NFRD have benefited because they have introduced it as a preventative measure requiring companies to understand how financial risk can be mitigated. However, now they are going one step further.

The original idea of the NFRD was to expand and supplement the annual financial reporting of companies. This regulation establishes a set of standards for companies based on which they should disclose their approach to managing environmental and social challenges. In recent years, Europe has set several other norms that have extended the effect of the NFRD, mainly meaning the methodologies for measuring and disclosing ESG information. The goal is to realistically show (measure) the activities of companies that, according to previous management reports, were matched with a corporate approach. In other words, corporate approach and values are one thing, and actual activities and results are entirely different.

In this way, a new branch of reporting is being profiled, which should also represent sustainability reporting in addition to financial and non-financial reporting. In light of the mentioned, in April 2021, the European Commission published a proposal for a Corporate Sustainability Reporting Directive (CSRD), which, in the outcome, should replace the Non-Financial Reporting Directive.

The proposed CSRD will include reporting all large companies – with 250 employees or more- and will establish binding sustainability reporting standards, where all data should be harmonized according to the taxonomy. In particular, all companies that fall under the European Reporting regime established by the NFRD (and, in the future, the CSRD) must make publicly available information related to the environmental sustainability of their operations. Among other things, a third party, in the sense of the participants themselves, will have to verify the sustainability data reported by the company, which represents an additional check of the correctness of the conduct.

The CSRD, in an ideal scenario, should establish collective, active management responsibility for sustainability reporting and demonstrate the real power of a company’s sustainable operations. Taking everything into account, we emphasize that the proposed CSRD brings the area of complete corporate transparency to the fore.

The article was written on the occasion of the publication of the special annual edition The Power of Sustainable Business, which is published within BeRiskProtected platform – where the extended, Serbian version can be found. A special topic that the text deals with is Sustainability and Regulation.

By Mina Milaković, Associate, Petar Protić, Business Development Manager, SOG Law Firm