As NGOs working on sustainable corporate transparency and responsibility, we have been supportive of the EU Commission’s plans to reform the EU Non-Financial Reporting Directive (NFRD) and the development of mandatory European sustainability standards.

The European Commission has presented its legislative proposal for a Directive as regards sustainability disclosures by certain companies.

The proposal presents several major improvements which are essential to help companies focus and report on meaningful information and channel finance to activities and projects needed to meet the objectives of the European Green Deal and make the European economy sustainable.

Positive developments

1. The extension of the scope of the Directive to include all large companies, which is important for the success of the sustainable finance strategy, because a vast majority of large European companies are not publicly traded but rely instead on bank financing; and for public accountability, because both private and publicly-traded companies may have severe impacts on people and the environment.
2. A requirement to develop European generic and sector specific mandatory sustainability reporting standards. This is essential to ensure relevance, clarity and comparability of disclosed information and to address the specificities of high-risk sectors.
3. Clarification of the main reporting areas and the categories of information that companies should disclose is specified in greater detail. The principle of “double materiality” is also clarified and properly enshrined in the draft proposal. Double materiality is key so that investors, other finance providers, supervisors and citizens and rights- and other stakeholders can understand risks and opportunities stemming from sustainability matters that companies face, as well as the actual and potential adverse impacts of corporate business models and operations on people and planet. This will provide a clear framework for the development of the above-mentioned standards.
4. The proposal provides a clear mandate to report on plans to ensure the compatibility of company business models and strategies with the transition towards a sustainable economy and with the limiting of global warming to 1.5 °C in line with the Paris Agreement. However, this requirement is not reflected in the provisions on mandatory sustainability standards. They only refer to standards that should address climate change mitigation and adaptation, without further qualifications. The transition will generate risks and opportunities that will have major implications for companies’ business models and strategies. This requires a clear framework specifying what needs to be reported. EU standards need to provide clarification by addressing interim objectives and related timelines, publication of carbon footprints at all scope levels and capital alignment. As time is of the essence especially with regards to the climate transition, we need sustainability reporting standards to be ambitious, with the first set adopted by October 2022.

Shortcomings

However, the proposal also falls short on several important points, which significantly limit its desired impact.

1. Private companies, which don’t meet the threshold of a large undertaking, are left out of the scope of the proposed Directive in contradiction to the EU Parliament’s clear call for the integration of all companies from high-risk sectors. Similarly, SMEs listed on SME Growth Markets and other MTFs are excluded. This will create a two tiered system and is problematic on two accounts. First, investors and relevant stakeholders would not receive sustainability information on medium-sized companies with high actual or potential negative impacts, such as in the energy and mining sectors or agri-business that is linked to deforestation and land grabbing.Second, this exclusion risks leaving smaller companies behind in the reallocation of capital to support transition to a sustainable economy, thus undermining the competition for the benefit of dominating companies. The Directive will specify disclosure of critical data which will influence access to loans and investments for transition. Even a slight delay in the ability to collect and present the relevant data by companies not included in the scope, will put them (as well as national economies) at a competitive disadvantage. Similarly, data disclosed by companies is critical to CSOs and rights-holders working to hold companies to account for their impact on people and the planet.

   The exemption for large companies, which are part of corporate groups, is problematic. The proposed exemption is different from the rules for financial reporting, which do not exempt companies from publishing statutory financial accounts because they are also integrated into consolidated financial accounts. Throughout the EU, some sectors (such as the financial industry) are highly concentrated. Making disclosures subject to the determination of materiality at the group level may lead to non-disclosure of specific information on resilience and significant impacts of subsidiaries of such EU groups, resulting in lack of accountability at national level as well as to investors and stakeholders needing these insights.

2. The proposal includes the requirement for companies to report on sustainability due diligence, and actual and potential adverse impacts connected with the company’s value chain, though the information about value chain should be provided only ‘where appropriate’. In this respect, the proposal fails to specify the essential aspects that EU standards need to address in particular with regard to reporting on human rights, including disclosure of salient human rights issues, key elements for supply chains disclosures, and quality criteria for KPIs. The lack of clear directions would significantly hamper the development of the reporting standard given unsatisfactory level of reporting in this area and lower maturity of existing standards compared to the environmental area.
3. The proposal outlines the need to describe targets related to sustainability matters set by the undertaking, and disclose their progress against those targets and milestones. However, to ensure target setting is relevant and connected to the company’s impacts and risks, it is essential to specify that such targets must be linked to the outcomes of the company’s double materiality determination. Likewise, requiring companies to report on actions taken, and the result of such actions, to address adverse impacts must be linked to targets and progress against set targets. These connections are not made explicit in the proposal. Correcting it requires only minor changes, which however are critical to ensure meaningful information allowing understanding of how companies manage their risks and impacts.

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