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.
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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