Starting from the top: why non-financial reporting needs strong corporate governance

As debates on the need for corporate governance proposals at EU level flourished, the event took a sober look at the connection between non-financial reporting and corporate governance reforms. The event gathered complementary perspectives from various speakers who provided the audience with food for thoughts around the role of corporate boards, the development of sustainability strategies, targets and transition plans as well as the need for high quality non-financial reporting. 

Non-financial reporting as a key element to make sure that businesses consider environmental risks and opportunities

The event was introduced by Mardi McBrien, CDSB Managing Director, who emphasized the role non-financial reporting can play to ensure more responsible and transparent corporate behaviours. She urged policymakers and companies to steer and get ready for ambitious reforms as 2021 will be a turning point on these issues within the EU with a new sustainable finance strategy, but also at international level, with the COP26 and CBD 15 which are due to happen later this year.

As part of the NFRD review, the EU is due to develop non-financial reporting standards, on which EFRAG is currently finalising recommendations, as part of the preparatory work it has been requested to perform by the European Commission in early 2020. On that timely policy matter, Mardi McBrien stated that CDSB remains convinced that there is no need to choose between existing standards used by businesses operating at global level and the rise of EU standards to answer to specific EU needs.

What to expect from EU in 2021 on coporate governance and non-financial reporting?

In its opening keynote speech, European Commissioner for Justice Didier Reynders shed light on the upcoming policy initiatives the European Commission has in mind to reach the ambitions of the European Green Deal. 

After recalling the link between non-financial reporting and corporate governance reforms, Commissioner Reynders echoed CDSB's call for action, saying that “we are facing a sustainability crisis of an unprecedented scale and urgency. We also have the challenge of ensuring a sustainable recovery from the COVID-19 crisis. In these circumstances we should do our utmost to ensure that all companies can contribute to this broader sustainable recovery.” 

Commissioner Reynders explained the objectives of the upcoming reforms and the benefits they will bring to both companies and the EU economy, as “environmental degradation and climate change are creating risks to business and their supply chains. The transition creates big opportunities. Companies that are ahead in the game will benefit most.” 

The reforms will focus on two major areas of corporate governance:

• Clarify directors’ duties to act on the best interests of the company and make informed decisions on various environmental matters, based on the necessary assessment of risks and opportunities and due diligence processes and their reflection within corporate strategies, target setting and the design of transition plans. 
• Strengthen the transparency of companies supply chains by introducing mandatory due diligence legislation to consider adverse sustainability impacts throughout supply chains. 

Commissioner Reynders also showed the firm commitment and ambition of the European Commission to ensure that “corporate decision making changes to a sustainability mindset at all levels”  and become aligned with agreed sustainability objectives to improve “the sustainability, competitiveness and resilience of the EU economy.”

Academic views on what is needed to clarify directors' duty of care

Richard Howitt took part in the debates and brought his decades of experience working on non-financial reporting and corporate governance in the European Parliament, advising companies or leading one of the international standard setters. 

He held a discussion with Professor Andrew Johnston, coauthor, together with 75 senior company law scholars of a statement on “Corporate Governance for Sustainability” published by the Harvard Law School. 

According to the statement, based on existing directors’ discretion and the lack of success of previously chosen policy options, the EU reforms should focus on procedure law changes at board- level rather than on outcomes to ensure that companies make sustainability a corporate priority. 

The board should therefore have the duty to: 

• Develop and monitor, based on sound due diligence processes, a forward-looking sustainability strategy addressing risks and impacts connected to the company business model, operations, and supply chains; and 
• Report and sign off on the implementation of the strategy on an annual basis in the company non-financial report. 

Such changes should be complemented by a national and an EU wide regulation on due diligence obligations “in a two-pronged approach” that the statement presents as the most effective policy option going forward. 

Professor Johnston highlighted that these proposals do not require directors to balance competing interests and do not create new accountability mechanisms as they rely on existing corporate governance rules. He nonetheless stated that “simple encouragements will not suffice. Obligations are needed” with enforcement mechanisms, management incentives linked to Key Performance Indicators (KPI) identified in the sustainability strategy or the setup of a non-executive board level committee to monitor and review content and implementation of the strategy. 

He concluded with an additional call for actions to the European Commission as “time has come to introduce board level procedures that complement due diligence processes and harness the power of corporate governance to make sustainability a reality.”

From theory to practice: perspectives from businesses, investors, and civil society on the direction of travel

The panel discussion of the event aimed to put the ideas provided by policymakers and scholars to the test to ensure that such reforms help the sustainability transition. 

The conversion included:

• Theo Jaekel, Corporate Responsibly Expert at Ericsson; 
• Steve Waygood, Chief Responsible Investment Officer at Aviva; 
• Caroline Avan, Advocacy Officer at Oxfam; and 
• George Dallas, Policy Director at the International Corporate Governance Network. 

The four panellists highlighted the following key elements: 

• The relevance of the sustainable corporate governance initiative to address the sustainability crisis and the ability to ensure long term shareholder value creation and overcome short term perspectives within the financial sector;
• The support from leading businesses for the introduction of due diligence requirements to be an opportunity rather than an additional burden on companies (Ericsson was among the supporters of a statement published last September calling for an EU framework on mandatory human rights and environmental due diligence); 
• The need to move beyond disclosure requirements on due diligence as disclosure is only the last step of a proper due diligence process;
• A sound due diligence process should not be a box ticking exercise; it should ensure the involvement of the company board and management, be linked to target-setting and stakeholder engagement, and follow existing international standards; 
• The demand for legal certainty and policy coherence between the various initiatives of the sustainable finance agenda in the EU in a systemic vision of disclosures across legislations; and 
• Discussions highlighted the need to address issues related to sustainability expertise within boards, target setting and remuneration incentives. 

As summarised by Richard Howitt, the panel discussion touched upon the different issues the European Commission aims to address in the upcoming legislative package (expected for June 2021) with debates on where to put measures into hard law and how to make boards and investors consider all issues even when they cannot be monetised (such as in the case of human rights due diligence).

Upcoming reforms: an evolution or a revolution?  

Alberto Carrillo Pineda from the Science-Based Target Initiative shared with the audience the progress and the development of the initiative since its inception, as a concreate example of what good corporate governance practice can look like. 

He explained how the targets help companies translate long term climate commitments, such as the Paris Agreement, into internal climate targets within an appropriate timeframe to drive action and, more importantly, accountability. 

He also argued that the regulatory framework as well as demands by investors to create the enabling conditions for the adoption of strategies and targets aligned with planetary boundaries, before arguing that “much more progress is needed.” 

This suggests that both an evolution as well as a revolution in current corporate practices is needed going forward – a view shared by the final speaker, MEP Heidi Hautala. 

Even though it has been 10 years since the release of the UN Guiding Principles on Business and Human Rights, the EU must “rethink and revise corporate law” so that sustainability becomes “an essential part of the corporate culture.”

Ms Hautala highlighted the ambition from both the European Parliament and the European Commission to “lead the transition to a healthy planet” and ensure that corporate governance plays its role to make the EU deliver on its objectives as part of the EU Green Deal. 

She strongly supported  a review of corporate law with a shift in paradigm as “the tide had turned, and companies see that they need to incorporate sustainability in their processes and decision making.” 

There is therefore a key role for policymakers first and then for companies to make that transition happen based on a “common language” to be able to “speak sustainability.” 

Echoing the discussions throughout the event, Ms Hautala was confident that the EU can develop a consistent and concreate policy framework on due diligence for companies to report but also to act. She also stated that companies board and audit committees have already the capacities to meet the expectations of various stakeholders as they become obligations. 

Ms Hautala concluded the event by a double request :

• To the European Commission, which needs to “make sure that the metrics and KPIs for the ESG are as strong and clear as the KPIs for the financial performance.”
• To companies themselves to “make sure that you have robust future-fit sustainability strategy” and whose “directors, CEOs, CFOs, the company board and audit committee” must “lead and oversee not just financial but also sustainability performance”, “because in the future they cannot be separated.” 

Useful resources:

To go one step further after the discussion, we invite you to have a look at the following resources:

• The Alliance for Corporate Transparency website, which includes 2019 and 2020 research reports and public databases

• CDSB analysis of environmental disclosure under the EU Non-Financial Reporting Directive, looking at annual reports of EU's 50 largest companies by market capitalisation, with further recommendations for companies and policymakers

• CDSB response to the public consultation on sustainable corporate governance 
  

• Free e-learning course "Governance of climate-related risks and opportunities"
• The complete recording of the event is available here. 

We should now wait for the release of the EU legislative proposals. The NFRD review is expected for mid-April whereas the sustainable corporate governance initiative, together with the renewed sustainable finance strategy, is due to be published in June.

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Written by Axelle Blanchard, Policy Manager, CDSB

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