Through its new European Green Deal, the European Commission is putting sustainability at the heart of Europe’s real economy and financial system. Europe’s leaders are reinforcing this ambition by looking to ensure a green recovery from COVID-19.
Companies are instrumental in the transition to a resilient, sustainable economy. Disclosing the right non-financial data is key to getting support from investors and capital markets.
The benefits of environmental transparency are clear; and strengthening the regulations is key
Driving sustainable investments is critical to meeting Europe's goals. The Non-Financial Reporting Directive (NFRD) helps achieve this. The NFRD is the main regulation of the European Union (EU) obliging companies to report environmental, social and governance (ESG) information. Applying to the 6,000 biggest companies in Europe, the law sets out the minimum level of climate and environmental information that major European companies should include in their annual reports.
For businesses leading on environmental transparency, it’s important that investors can access information on their actions in the most comparable, complete way.
With the current review of the NFRD, there is a major opportunity to ensure the right information gets reported, and to firmly embed environmental matters into the financial reporting mainstream.
Companies and investors can help strengthen the directive and its impact by responding to the European Commission’s public consultation by 11 June.
CDP Europe’s five key recommendations for the new law
- Require companies to disclose long-term plans and targets to align with the latest climate and environmental science and outline how they will achieve climate and resource neutrality.
- Specify that ‘environmental matters’ include, at minimum, climate change mitigation and adaptation, water security, land use and commodity-driven deforestation. The new EU taxonomy, which defines sustainable business activities, could be referenced in support.
- Apply the TCFD’s recommendations to a broader perspective of natural capital and make companies include disclosures on climate- and natural capital-related governance as part of their corporate governance statement and non-financial statement.
- Include TCFD-recommended disclosures on strategy, risk management, metrics, and targets, to make the links between non-financial and financial information stronger.
- Oblige companies to report the mandatory information in their annual reports, by removing the exemption currently allowing non-financial statements to be issued separately.
Revising the NFRD will help deliver the data investors need
As the EU rolls out new sustainable finance policies, financial actors must increasingly integrate evidence-based sustainability and risk criteria into decisions.
But the disclosure requirements of the NFRD in current form do not give them complete data. Last week, a report published by the Climate Disclosure Standards Board found that the 50 biggest companies in Europe report data which lacks quality, comparability and coherence.
To be of value, corporate data must show companies' long-term value creation and exposure to risks. Only with this level of information – across the entire investment and lending chain – can investors engage company boards on sustainability issues, as increasing numbers want to do.
The NFRD must also better reflect the latest Intergovernmental Panel on Climate Change (IPCC) science. It should incorporate the new developments in non-financial reporting since its introduction in 2014, such as the new EU taxonomy and upcoming European non-financial standards. Revising the NFRD is therefore key for Europe to have a science-based, harmonized reporting framework.
To drive capital to firms leading the transition, environmental risks and impacts must be fully reflected in the law. It should therefore expand the minimum types of information companies must report.
For example, companies must currently disclose information on four non-financial matters: environment, social and employment, human rights, and corruption and bribery.
But the rules should also specify that companies report information on deforestation, climate adaptation and mitigation, and water security. Transparency into these risk areas is the foundation for driving the urgent action demanded by the science and the EU’s long-term ambitions. And it is key for companies to understand their risks and build resilience.
On issues related to forests, this tighter regulation can drive companies to be more be transparent – which they need to be. Less than 30% of firms with a high deforestation impact disclosed any data through CDP last year.
Updating the directive in this way would bring disclosures more in line with the information many firms readily – and voluntarily – disclose through CDP. For example, companies reporting to CDP report over €392 billion in business risks relating to water, and nearly €2 trillion in climate-related business opportunities. Yet these topics are not well included in the current law, making it hard for investors to compare them.
Accountability for companies, usability for investors: Guiding principles for revising the NFRD
Achieving an urgent transition to a resource-secure economy depends on companies being accountable for their impact, and investors having usable information. Yet the scope of the directive as it stands falls short on both principles. A much-needed change to the NFRD is to clarify the meaning of ‘materiality’ for non-financial information.
The NFRD includes both financial materiality and environmental/social materiality. These complementary concepts are both needed in order for disclosures to provide insight into the environmental as well as financial markets.
But currently, many impacts and risks are currently judged to be environmentally material because they carry financial risk. It should be vice-versa.
To enable financial market actors to play their role in financing the transition to a sustainable economy, the logic of materiality in the NFRD must change. What is financially material for a firm actually stems from its impact on the environment (known as inside out materiality).
As the regulatory framework of the European Green Deal comes into play, companies will face higher regulatory risks if they do not reduce their environmental impact. The NFRD should reflect this to help companies and investors more accurately reflect financial risks and opportunities linked to climate and the environment when they report or use data.
We also suggest that the NFRD is significantly broadened in scope to give investors data on the whole market. All companies listed in EU markets, regardless of size or origin, should be included. As should all large non-listed companies, plus large companies established in the EU but listed elsewhere.
The last pieces of the reporting puzzle
The consultation and revision of the NFRD is not the end of the road for building a fit-for-purpose corporate reporting framework. The next steps will be for the new European non-financial standards to be built.
The European Commission is right to be proactive in its proposal to clearly define what information companies should report. A public standard is important for ensuring that complex and systemic non-financial risks are well-priced by the market, and for uncovering and seizing the societal benefits of mitigation and adaptation.
Civil society and academics must also play their part in this process to ensure it reflects public interest and to promote science-based expert opinions across the range of issues.
2020 was set to be the start of a super decade for climate and environmental action. This ambition can be achieved. The NFRD consultation presents a major opportunity to support the European Commission in building the stronger basis for sustainable investment we urgently need.
CDP therefore encourages all companies and investors to submit their responses by June 11 to help strengthen the foundations for effective corporate climate and environmental transparency.