international regulatory enforcement
EU Ratcheting Up The Heat on Sustainability Reporting
On 21 April 2021, the EU Commission adopted a proposal for a Corporate Sustainability Reporting Directive, which would amend the existing reporting requirements of the Non-Financial Reporting Directive (Directive 2014/95/EU, the “NFRD”). The Commission proposal:
- extends the scope of the NFRD to all large companies and all companies listed on regulated markets (except listed micro-enterprises),
- requires the audit (assurance) of reported information,
- introduces more detailed reporting requirements, and a requirement to report according to mandatory EU sustainability reporting standards, and
- requires companies to digitally ‘tag’ the reported information, so it is machine-readable and feeds into the European single access point envisaged in the capital markets union action plan.
The current NFRD reporting rules apply to “public interest entities” -- that is, listed companies, banks, and insurance companies having more than 500 employees. In finding that the current non-binding reporting guidelines “have not sufficiently improved the quality of information companies disclose pursuant to the NFRD,” the EU Commission issued this proposal that would extend the scope of these requirements to include all large companies regardless of whether they are listed, or the number of employees. In addition, the Commission proposes to extend the scope to include listed SMEs, with the exception of listed micro-enterprises. This would increase the number of covered entities from approximately 11,000 to approximately 50,000.
The European Financial Reporting Advisory Group (“EFRAG”) – a private association majority-financed by the EU - will be responsible for developing draft standards. At the request of the Commission, EFRAG recently published technical recommendations and a road map for the development of EU sustainability reporting standards.
With respect to other existing standards, including the proposals of the International Financial Reporting Standards (“IFRS”) Foundation to create a new Sustainability Standards Board, the Commission noted that its “proposed EU sustainability reporting standards would build on and contribute to standardisation initiatives at the global level. This will require constructive two-way cooperation between EFRAG and relevant international initiatives.” It is now for the European Parliament, and the Member States in the Council, to negotiate final legislative text of the Directive based on the Commission's proposal. In parallel, EFRAG expects to have the first set of draft sustainability standards ready by mid-2022.
The final timetable will depend on how the Parliament and Council progress in their negotiations on the Directive, which will, in turn, require agreement between the European Parliament and the European Council as to the final text, likely to take some time. According to the Commission, if the Parliament and the Council reach agreement in the first half of 2022, then the Commission should be able to adopt the first set of reporting standards under the new legislation by the end of 2022. That would mean that companies would apply the standards for the first time to reports published in 2024, covering financial year 2023.
This new proposal should be read in conjunction with two other EU initiatives:
- First, the EU Sustainable Corporate Governance initiative, which launched on 30 July 2020, aims to improve the EU regulatory framework on company law and corporate governance. According to the Commission, this initiative “would enable companies to focus on long-term sustainable value creation rather than short-term benefits. It aims to better align the interests of companies, their shareholders, managers, stakeholders and society. It would help companies to better manage sustainability-related matters in their own operations and value chains as regards social and human rights, climate change, environment, etc.” The Commission was expected to submit a proposal for an EU Directive in the second quarter of 2021 but it is unclear if that target date will be met.
- Second, the EU ongoing work on the Corporate Due Diligence and Corporate Accountability Directive for which a Commission proposal is now expected to be tabled in July 2021. If adopted, this Directive would impose sweeping obligations on companies as to the ESG and human rights risks in their own operations as well as in their business relationships.
European companies, as well as companies operating in the EU and/or working with EU companies, should take note of these developments and what potential implications for them. In particular, U.S. publicly listed companies that are cross-listed on EU exchanges should be cognizant of the potential public sustainability reporting obligations, and how those may impact their U.S.-related disclosures and statements.