The EU consultation on the Non-Financial Reporting Directive has now closed and the proposed revisions together with EU taxonomy will classify industries on how ‘green’ they are, changing how companies report on ESG issues and how investors consider these.
And given its commitment to green finance, it seems unlikely that the UK government will end up going in a radically different direction to the EU. Even if it did, the global nature of investment – and of the ESG ratings agencies that evaluate corporate reporting – means that companies and investors will probably fall into line anyway.
It is worth considering, therefore, what the impact of this revised legislation might be. While it is too early to know for sure what the requirements will look like, we do know something about the broad areas that will be impacted.
A New Measure of "Greenness"
Firstly, the Taxonomy regulation. This will classify activities on the basis of how “green” they are. Initially this was just investment products, but will now apply to any company that has to publish a non-financial statement under the Non-Financial Reporting Directive; that is companies with over 500 employees and, in some member states, smaller companies too.
While the framework for the classification of how “greenness” will be assessed has been set, detailed screening criteria are still missing for many sectors. Key environmental objectives outlined as the key focus of the legislation include climate change mitigation, adaption, sustainable water use, transition to a circular economy, pollution prevention and control and the protection of biodiversity. Companies will have to specify to what extent their activities contribute to achieving these objectives, or not, as well as how they are adhering to minimum safeguards from a human rights and health and safety perspective.
A Technical Expert Group has suggested screening criteria for sectors such as the manufacturing of aluminium fertilizers, plastics or chemicals, production of gas, electricity, biogas or biofuels, transport, construction, data processing etc. This could change however during the period between now and the likely date from which the taxonomy will be fully applicable, which is the end of 2022.
Higher Standards of Non-Financial Reporting
Turning to the NFRD, one of the criticisms of current EU legislation is that it leaves too much room for manoeuvre for companies on how to report. So the EU will look to more standardisation, including a clearer definition of materiality. It has already recognised certain standards, such as the reporting framework created by the Taskforce on Climate Related Financial Disclosures (TCFD) which was included in the updated guidance on climate reporting last year
There will also be additional measures to improve the integration of financial and non-financial reporting too. This is an area where Teneo spends a lot of time working with clients and changing traditional reporting processes can be a real challenge but doing this effectively will be absolutely key going forward.
Other expected changes include the introduction of an obligation for non-financial information to be subject to audit, increased digitalisation of reporting and the possible expansion of the scope of businesses included in the directive to cover non-listed companies.
Change Could Happen Fast
Finally, two points worth noting are that some elements of the directive could be turned into regulation, meaning that they will automatically become part of legislation in member states.
Secondly, the Commission plans to present the proposed NFRD in the first quarter of 2021, which means that these rules could be in place much sooner than anyone is expecting.
As a result, it makes sense for companies to consider today how their ESG disclosures will need to change to comply with the directive and meet investor needs. That's as true for UK companies as it is for companies across the EU.
