Comments on the proposed DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Directive 2013/34/EU, Directive 2004/109/EC, Directive 2006/43/EC and Regulation (EU) No 537/2014, as regards corporate sustainability reporting
The current activity at EU level on requirements for financial actors and private companies to disclose on extra-financial sustainability issues must be seen as a realization that, in order for EU Member States (MSs) to live up to their international obligations, they need to focus on the activities of economic actors which - perhaps until relatively recently - were seen more as subjects of general legislations governing business, and obviously criminal legislation or legislation on e.g. social contributions, health care etc. within each MS, and not so much as a group for which specific sustainability legislation and attention was directed. This proposal consists of one Directive that would amend four existing pieces of legislation. In the first place, it would amend the Accounting Directive, revising some existing provisions and adding certain new provisions about sustainability reporting. In addition, it would amend the Audit Directive and the Audit Regulation, to cover the audit of sustainability information. Finally, it would amend the Transparency Directive to extend the scope of the sustainability reporting requirements to companies with securities listed on regulated markets, and to clarify the supervisory regime for sustainability reporting by these companies.
The EU (along with many other countries) is aiming to become net zero by 2050 and has also agreed a 55% reduction on 1990 levels of greenhouse gases by 2030. In order to reach these targets, vast amounts of capital (in particular private capital) need to be redirected towards greener, more sustainable activities. Which means investors need more and better information on which to base their investment decisions - not just on climate change, but also on a much wider range of other sustainability issues including diversity and inclusion. One interesting point of the proposed Directive is that there is a clear realization not only that the sustainability aspects of business need to be better and more clearly addressed, but also that such effect cannot be considered “NON financial” – that sustainability (or lack thereof) is a financial aspect even if not quantifiable in the old fashioned way. Many stakeholders have expressed their belief that the term ‘non-financial’ is inaccurate, in particular because it implies that the information in question has no financial relevance. It is recognized with the current proposal that the information in question does increasingly have financial relevance. Since many organisations, initiatives and practitioners in this field refer to “sustainability” information, the proposal suggests that it is preferable to use the term “sustainability information” instead of “non-financial information”. This is also in line with using ESG measurements and strategies and investment as a way of working towards the implementation of the SDGs in a way that considers “sustainability” as a 360* issue. The Proposal is thus that Directive 2013/34/EU should be amended to take account of this change in terminology.
The Green Deal also aims to protect, conserve and enhance the Union's natural capital, and protect the health and well-being of citizens from environment-related risks and impacts. The European Green Deal aims at decoupling economic growth from resource use, and ensuring that all regions and citizens of the Union participate in a socially just transition to a sustainable economic system.
The Green Deal is presented as a framework that will contribute to the objective of building an economy that works for the people, strengthening the EU’s social market economy, helping to ensure that it is future-ready and that it delivers stability, jobs, growth and investment. These goals are especially important considering the socio-economic damage caused by the COVID-19 pandemic and the need for a sustainable, inclusive and fair recovery.
It is paramount to note how the EU in its reasoning is clearly linking sustainability (understood not only as environmental sustainability but also as social sustainability and governance in line with the SDGs) to what has always been at the core of the EU: strengthening the social market economy and helping the guarantee that the Union is capable of ensuring stability, jobs, growth and investment on a long-term basis. The fact that COVID-19 exposed the dangers of social inequality and lack of respect for basic rights including in the Global North may well have sped up the process of focusing more on social issues of sustainability and not so exclusively on the environment as hitherto. The need for a “fair” recovery is mentioned in the reasoning for this legislative initiative.
In its Action Plan on Financing Sustainable Growth the Commission set out measures to achieve the following objectives: reorient capital flows towards sustainable investment in order to achieve sustainable and inclusive growth, manage financial risks stemming from climate change, resource depletion, environmental degradation and social issues, and foster transparency and long-termism in financial and economic activity. The proposed Directive is aiming at making the disclosure of relevant, comparable and reliable sustainability information a tool, since such disclosure has to be considered a prerequisite for meeting those objectives. The European Parliament and the Council adopted a number of legislative acts as part of the implementation of the Action Plan on Financing Sustainable Growth already.
Asset managers and financial advisers are being required to report on a wide range of sustainability issues under new requirements in the Sustainable Finance Disclosure Regulation (SFDR), since March 2021. Besides requiring entities to understand the scope, severity, probability of occurrence and potentially irremediable character of the negative impact on the E that has been caused, compounded by or directly linked to its investment decisions and advice performed, the adverse sustainability impact set forth in the SFDR – mandatory for large entities and large holdings – requires considering the negative, material or likely to be material effects also on the S and the G, including requiring the publication of a statement on the entity’s website describing its due diligence policies in respect of these adverse impacts. The SFDR defines mandatory and voluntary adverse sustainability indicators and metrics in relation to social and employee matters, respect for human rights, anti-corruption and anti-bribery. If Asset Managers are to report on these issues, they in turn will need access to the required data and information.
The primary users of sustainability information disclosed in companies’ annual reports are investors and non-governmental organisations, social partners and other stakeholders. Investors, including asset managers, want to better understand the risks of, and opportunities afforded by, sustainability issues for their investments, as well as the impacts of those investments on people and the environment. They not only want this to attract Asset Owners and respond to increased societal pressure in the Global North where many Asset Owners are based, but they also need this information to be available in order to live up to their reporting requirements. Non-governmental organisations, social partners and other stakeholders want to hold undertakings to greater account for the impacts of their activities on people and the environment, and the better the information they can get, the better the companies and entities they are holding accountable either legally or in the public opinion can engage in a meaningful and transparent way which will aid them in maintaining their licence – legal or social – to operate.
The SFDR governs how financial market participants (including asset managers and financial advisers) should disclose sustainability information to end-investors and asset owners. To be able to fulfil the requirements of the SFDR – and therefore ultimately to be able to meet the needs of end investors – financial actors need adequate information from investee companies.
The current legal framework does not ensure that the information needs of Asset Managers - who are obliged under the SFDR as well as under pressure from Asset Owner as mentioned above - are met. This is because some companies from which sustainability information is necessary do not report such information, while many that do report sustainability information do not report all the information that is relevant. When information is reported, it is often neither sufficiently reliable, nor sufficiently comparable between companies. Information on intangibles, including internally generated intangibles, is under-reported. The growing awareness of investors that sustainability issues can put the financial performance of companies at risk, the growing market for investment products that explicitly seek to conform to certain sustainability standards or achieve certain sustainability objectives is requiring such information to be available. The COVID-19 pandemic is likely to further accelerate the growth in demand for sustainability information from companies, such as regarding the vulnerability of workers and the resilience of supply chains.
The proposed Directive therefore compliments the SFDR in order to ensure that companies from whom investors need sustainability information report this, and that reported information is relevant, comparable, reliable, and easy to access and use. It also aims to reduce unnecessary costs for preparers. By enabling investors to better evaluate the sustainability risks and impacts of investments, it will mobilise private finance in support of the European Green Deal. It will also reinforce the social contract between companies and society, which is becoming ever more demanding on these issues, by making companies more accountable for their impact on society and the environment.
Asset Managers will benefit from better access to comparable, relevant and reliable sustainability information from more companies. This will reduce the risks of investing in the financial system, increase financial flows to companies with positive social and environmental impacts, and make companies more accountable. Accountability and transparency is and will be a major part of being sustainable, and of showing sustainability in both direct and supply chain operations.
There is no doubt that business enterprises can impact the entire range of human rights positively or negatively, including discrimination, health, access to education, labour exploitation, freedom of association and to form unions, freedom of expression, privacy, adequate standard of living (not in poverty), food and water, housing. So, what does it mean to “respect” human rights when one is a private enterprise? It means taking active steps to be in line with human rights obligations, often even if not always enshrined in national laws and regulations. A State has an obligation to exercise due diligence under its obligation to protect. A non-state actor has such an obligation in order to respect rights. That means first of all having internal policies which from an internal governance perspective sets up a regulatory framework safeguarding workers, communities and environment – all the way down the supply chain – as well as the more extended communities in which the enterprise operates. Being accountable does not mean never having any issues or any problems – but having processes in place that address these issues, provide possibility for redress, and ensure participation and transparency in those processes.
The growth in the number of investment products that aim to pursue sustainability objectives means that good sustainability reporting can enhance an undertaking’s access to financial capital. Sustainability reporting can help undertakings to identify and manage their own risks and opportunities related to sustainability matters. It can provide a basis for better dialogue and communication between undertakings and their stakeholders, and it can help undertakings improve their reputation.
Up until now available evidence indicates that existing non-binding guidelines did not have a significant impact on the quality of non-financial reporting by undertakings under current Directive 2013/34/EU. There is a need for mandatory common reporting standards to ensure that information is comparable, and that all relevant information is disclosed. Building on the double-materiality principle, standards should cover all information that is material to users. Common reporting standards are also necessary to enable the audit and digitalisation of sustainability reporting and to facilitate its supervision and enforcement. The development of mandatory common sustainability reporting standards is necessary to progress to a situation in which sustainability information has a status comparable to that of financial information.
The fact that sustainability information is taking on the same importance as financial information may seem a given to those who see the respect for national, regional and thus international law on societal sustainability issues as a given, but it is true that this has up until now not been the case. And that only recently have the benefits of sustainability reporting from financial and private actors come to the attention of those who are responsible for the effective implementation of laws. This has happened due to the need to create new and innovative regulations and reporting requirements for environmental sustainability, and this has shown that creating such requirements based on long-standing rules and standards on societal sustainability will have enormous benefits and assist those responsible for ensuring compliance with laws to actually act when laws are violated, as well as promote understanding and compliance based on clear guidance.
Article 5 requires Member States to transpose Articles 1 to 3 of the Directive by 1 December 2022, and to ensure that its provisions apply to companies for the financial year starting on 1 January 2023 or during calendar year 2023.
What do Member States need to do?
The draft directive provides that each Member State should designate one or more competent authorities to be responsible for the supervision of the directive. The competent authorities will have the power to carry out investigations to ensure that undertakings comply with their obligations. The competent authority will be authorised to carry out checks on company and interviews with affected or potentially affected stakeholders or their representatives.
Competent national authorities are required to put in place proportionate sanctions and are given the authority to impose proportionate fines calculated on the basis of an company’s turnover. Member States are to ensure that they have a liability regime in place under which company can be held liable, and remediation can be provided for any harm arising out of potential or adverse impacts on human rights, the environment or good governance where they have caused or contributed to the harm. This responsibility extends to companies under the control of Member States.
Liability is prevented if the company can prove that they took all due care in line with the directive.
