Wednesday, 22 October 2014

New EU human rights reporting requirements for companies: One step beyond the current UK rules



Anil Yilmaz (Lecturer in Law, University of Brighton) and Rachel Chambers (PhD candidate, University of Essex)  

Background

Among the core objectives of the EU set out in Article 3(3) of the Treaty on the European Union is the creation of an internal market and sustainable development of Europe “based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment.” The Single Market Act 2011 fleshed out the features of a “highly competitive social market economy” and provided that it called for new business models where environmental and social concerns “take precedence over the exclusive objective of financial profit.” In this respect, the Act outlined the allocation of tasks for achieving this goal between itself and the industry. While the European asset management industry was asked to use their leverage to promote socially and environmentally responsible businesses, the EU would take action, inter alia, to ensure a level playing field by introducing new rules on environmental and social reporting. Stemming from the Act was also the adoption of the Commission’s 2011-2014 Corporate Social Responsibility Strategy, which reaffirmed the objective of establishing EU rules on social and environmental reporting.  Although CSR has been on the EU agenda for a decade, the 2011-2014 Strategy put forward a more rigorous definition of CSR and demanded better alignment with global approaches to CSR, including implementation of the UN Guiding Principles (UNGPs).  Within the Strategy, the Commission announced its intention to build on the existing reporting requirements for companies.

Prior to the adoption of the recent amendments to Directive 2013/34/EU on company reporting, EU law made the following requirement on companies, not necessarily including small and medium‐sized enterprises (SMEs): “To the extent necessary for an understanding of the company’s development, performance or position, the analysis [in the annual review] shall include both financial and, where appropriate, nonfinancial key performance indicators relevant to the particular business, including information relating to environmental and employee matters.” In November 2010, the European Commission had launched an online public consultation to gather views on the disclosure of non-financial information by enterprises. The consultation had sought both to expand the subjects of such disclosure and to make the requirements more effective.

In January 2013, following the adoption of the 2011-2014 CSR Strategy, the European Parliament adopted two resolutions reiterating the importance of company transparency on environmental and social matters and calling for specific measures to combat misleading and false information regarding commitments to CSR and relating to the environmental and social impact of products and services.   The resolutions expressly acknowledged the role of the UNGPs in improving standards of corporate practice. The European Commission went one step further in its proposal of 16 April 2013, by suggesting an amendment to existing accounting legislation to improve the transparency of certain large companies on social and environmental issues, in particular with regard to human rights impacts.  The European Parliament and the Council reached an agreement on 26 February 2014; the European Parliament adopted the amendments to Annual Financial Statements Directive 2013/34/EU on 15 April 2014; this was adopted by the Council of the European Union on 29 September 2014.

The Reforms

The amendments introduce compulsory reporting of non-financial information by certain large undertakings. Under the new Article 19a certain large undertakings governed by the law of a member state are required to include a non-financial statement in their annual management report, ‘to the extent necessary for an understanding of the undertaking’s development, performance and position and of the impact of its activity.’ Recital 14 determines the personal scope of the reporting requirement based on the number of employees, balance-sheet total and the net turnover. ‘Certain large undertakings’ within the meaning of Article 19a are public-interest entities which have 500+ employees (in the case of a group of companies with the parent governed by a member state law, number of employees will be calculated on a consolidated basis). Public interest entities are defined in Article 2(1) of the Directive as including listed companies, credit institutions, insurance companies and any other entity designated by member states as a public interest entity due to the nature or size of their business.  The press release announcing the adoption of the Directive by the Council says that some 6,000 public interest entities in the EU will fall under its scope.

 Non-financial information encompasses “as a minimum, environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters”.  The statement will contain a brief description of the company’s business model, a description of the company policy in those areas and its outcome, main risks faced by the company, including those arising from its business relationships, and how these are managed and the due diligence processes it employs to identify, prevent and mitigate adverse impact. Companies can avoid reporting on one or more of these issues if they do not pursue policies on those issues and provide a ‘clear and reasoned’ explanation of this choice. There is an additional exemption from reporting in exceptional cases where disclosure of such information would seriously harm the commercial position of the company and non-disclosure does not prevent a fair assessment of company’s impact and risk.

Recitals provide some examples of what should be included in the report for each item and refer to a selection of national and international frameworks for further guidance that companies can rely on. In the meantime, the Commission will prepare general and sectoral non-binding guidelines for non-financial reporting.  Member states will have two years to incorporate the new provisions into domestic law, which will be applicable in 2017.  In terms of enforcement of these obligations, Recital 10 requires member states to establish effective national procedures to ensure compliance with non-financial reporting requirements. Finally, it is up to the member state implementing the directive to require independent verification of the non-financial information contained in the report.

Analysis

The adoption of this Directive was hard fought for, and can be seen as a major achievement –both in terms of the content of the reforms but also the symbolic step which their adoption represents.   These are a broad set of reporting requirements, wider than comparable UK law as they include anti-bribery and corruption as well as environmental, social and employee matters and human rights.  By requiring reporting “of the impact of [a company’s] activities” and of the “principal risks related to those matters linked to the undertaking's operations” these provisions focus effort on what is important – reporting the actual human rights risks/impacts to/on society of a company’s operations and prioritising the most severe risks.  This compares favourably to UK non-financial reporting which, as explained below, is focused essentially on providing information to shareholders on which they can assess the financial performance of the company.  The requirement for group reporting of these issues in consolidated statements will allow stakeholders to be informed about the impacts of subsidiaries as well as their parent companies. Business partners are also covered but reporting on risks from supply chains and business relationships is only required “if relevant and proportionate”. The inclusion of risk management processes such as due diligence is useful when trying to understand how companies are tackling the issues which they face in this realm.

However, there are a number of shortcomings in the new Directive.  It does not cover many companies: the original Commission proposal was for it to apply to around 18,000 companies – listed and non-listed – that were of a certain financial size and had 500 employees or more.  As stated above, the adopted proposal only covers around 6,000 “public interest” companies.  The failure to include listed SMEs (although member states can choose to include them) is particularly difficult to understand given that these companies already have to file annual reports, and that despite their size, these companies can have significant human rights impacts.  The methods for enforcement of the obligations and independent verification of the reports are left to member state discretion, which can create inconsistencies in the application of these rules, and ultimately a lack of “teeth” if companies fail to comply.

Does it improve existing UK requirements?
 
The new UK requirement to compile a strategic report which must, to the extent necessary for an understanding of the development, performance or position of the company’s business, include, amongst other requirements, information about social, community and human rights issues came into force in October 2013.  The inclusion of a test of materiality in the statutory guidance on the new statutory regime was controversial.  Under the heading of “Materiality” the guidance recommends that companies include human rights-related information “if its omission from or misrepresentation in the strategic report might reasonably be expected to influence the economic decisions shareholders make on the basis of the annual report as a whole” – as noted above the new European requirement takes a different, and from a human rights protection point of view better, stance by looking at impact on society.

Enforcement of the UK law is weak, a situation which will not be changed by the new EU law. In the UK, the Conduct Committee of the Financial Reporting Council is responsible for monitoring the compliance of the strategic report with the Strategic Report Regulations. It may investigate cases where it appears that required information has not been provided, and has the power to apply to the court for a declaration that a strategic report does not comply with the requirements and for an order requiring the directors to prepare a revised strategic report.  The equivalent powers under the previous statutory regime were seldom used.  Since compliance with the new EU non-financial reporting requirements will be overseen by member state regulators, it is crucial that they have qualified staff with the appropriate human rights expertise to draw on when assessing whether the information required has been provided.
 
 
Barnard & Peers: chapter 9, chapter 14

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