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This article was first published in the June 2016 international edition of Accounting and Business magazine.

In December 2014, a new European directive came into force on disclosure of non-financial and diversity information. The requirements apply only to companies designated as public interest entities (PIEs) – large undertakings with more than 500 employees, including listed companies plus certain unlisted companies, such as banks, insurance companies and other companies so designated by member states because of their activities, size or number of employees. PIEs are generally those with securities admitted to a regulated market in the European Union (EU). 

The directive does not apply to unlisted companies unless they are designated PIEs for other reasons, but there is an option for member states to extend the scope to any entity. They have until December 2016 to introduce the directive into national law, with a view to applying the regulations to reporting periods beginning on or after 1 January 2017. 

Investors are increasingly looking to assess not just the financial performance of companies, but also their environmental, social and governance (ESG) performance. The European Commission has stated that only 2,500 large companies in the EU currently prepare some form of separate non-financial report. It is estimated that approximately 6,000 public interest entities in the EU will be affected by the new requirements. 

The directive will require qualifying entities to issue a non-financial statement that sets out the entity’s development, position and performance, and the impact of its policies and outcomes relating to, as a minimum, environmental, social and employee matters, respect for human rights, and anti-corruption and bribery matters. The report should also include a brief description of the business model and the principal risks related to the above matters, including how its business model could cause adverse impacts in those areas. 

The entity should also disclose how the company manages these risks and any relevant non-financial key performance indicators (KPIs). Non-financial KPIs are other measures that an entity feels are important to the achievement of its strategic objectives. Typical examples include measures that relate to customer relationships, employees, operations, quality, cycle-time and the organisation’s supply chain. Entities may choose not to disclose information relating to impending developments or matters in negotiation if it is deemed that disclosure would be seriously prejudicial to the company’s commercial position. This non-disclosure must not affect the view given by the report and must be approved by the administrative, management and supervisory bodies. 

What to disclose

Examples of areas to be disclosed are:

  • Environmental matters, which may include greenhouse gas emissions, current and foreseeable impacts of the entity’s operations on the environment and, as appropriate, on health and safety, the use of renewable and/or non-renewable energy, water use and air pollution.
  • Social matters, which may include actions taken to ensure gender equality, implementation of fundamental conventions of the International Labour Organization, working conditions, social dialogue, respect for the right of workers to be informed and consulted, respect for trade union rights, health and safety at work and the dialogue with local communities, and/or actions taken to ensure the protection and development of those communities.
  • Human rights matters which may stem from the undertaking’s own activities or may be linked to its operations, and, where relevant and proportionate, its products, services and business relationships, including its supply and subcontracting chains.

All large PIEs that are traded companies will be required to disclose their diversity policy, as part of their corporate governance statement. The disclosure must describe such things as age, gender, educational and professional background, the objectives of the policy, how it has been implemented and the results in the reporting period. The non-financial statement must include references to and explanations of amounts in the financial accounts, where this is appropriate. 

The directive includes an option for member states to allow entities either to include the disclosures in the management report or to prepare a separate report on non-financial information. 

One issue arising is the threat of having to prepare and publish non-financial information to the same deadline as financial statements. However, the directive allows companies to publish the non-financial statement separately on the company’s website up to six months after the end of the company’s financial year, but reference must be made to it in the management report. 

If a separate report is prepared, there is an issue over the auditor’s interaction with it. Further thought will need to be given to this to determine the degree of scrutiny to be applied to this report.

Entities normally have internal processes for validating the non-financial information disclosed in the annual report. However, when the directive is adopted by member states, they can require the non-financial statement to be verified independently by an assurance services provider. If member states adopt this clause, there will be additional costs for entities, and this may increase the burden of compliance. In addition, the directive specifies that the statutory auditor should check whether the relevant statements have been made in the non-financial statement.

Many countries already require quoted companies to report on their greenhouse gas emissions. The EU directive does not require qualifying entities to report this information although they will be required to supply information on environmental matters, which may contain information on the use of renewable and non-renewable energy and greenhouse gas emissions.

It is generally felt that appropriate flexibility should be given to companies to decide on the material issues to be included in the non-financial disclosure. It is difficult for legislation to provide an exhaustive list of topics and therefore legislation should focus on the principles which may include a description of the relevant non-financial policies and the entity’s related performances, as well as forward-looking strategies and risk management policies. 

Risk management covers broader issues than other non-financial elements as it also includes business and competitive risks. Disclosure should not only include information on risks, but also on the related opportunities, and should contain an explanation of the methods used to assess performance. The content of the non-financial disclosure should be consistent with the existing international frameworks, such as the United Nations Global Compact, the Organisation for Economic Co-operation and Development (OECD)Guidelines for Multinational Enterprises, and ISO 26000, Social responsibility. 

The directive requires that companies choosing to use a recognised international framework to prepare their non-financial statement disclose which framework they have used. Entities may have to introduce new systems or practices, or existing processes may have to change in order to comply.

In June 2013, Eurosif (the leading pan-European sustainable and responsible investment membership organisation) and ACCA surveyed investors, analysts and other stakeholders, to gather views and opinions on the use of ESG information. It was found that the key sources of non-financial information for investors were corporate social responsibility (CSR) reports and annual reports. The respondents felt that current non-financial information published by companies is linked to CSR policy, but disagreed that current reporting is linked to business strategy and risk. 

Respondents also felt that insufficient information is provided to assess financial materiality and that non-financial reporting is not sufficiently comparable across companies. There was also a feeling that non-financial information should be better integrated with financial information and that non-financial reporting should be subject to scrutiny, either by the board or by third-party assurance and/or shareholder approval at annual general meetings. 

Public consultation

The European Commission launched a public consultation on the directive in January 2016. ACCA has responded to this, stating that it feels the non-financial disclosures required under the directive should be placed within the annual report, as part of the management report. ACCA’s view is that the International Integrated Reporting Framework provides the best framework for demonstrating the connectivity between non-financial and financial information. 

Integrated reporting provides entities with the vehicle through which they can ‘tell their story’ and gives investors a source of reference. In applying the directive, the concept of materiality should be applied to non-financial reporting requirements, such that only information that is of strategic importance should be disclosed. ACCA also believes that specific independent assurance on non-financial reporting should be market-led, rather than mandated and that further guidance is required on diversity disclosures. 

The consultation presents a useful opportunity to discuss current and ongoing issues in corporate reporting. The commission is seeking views on whether receiving non-financial information solely in electronic format, for example via a company’s website, would be beneficial, or raise concerns for users; and on whether the non-financial information should be validated by an independent assurance adviser?

The disclosure of information outside of the annual report is a recurring theme, while the future of digital reporting and the role assurance can play needs to be debated by all key stakeholders. Corporate reporting should be ready to respond to the opportunities that technology brings, while ensuring that there is accountability over information disclosed.

Graham Holt is director of professional studies at the accounting, finance and economics department at Manchester Metropolitan Business School