Doubts surround corporate ethics on new ‘comply or explain’ regime

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This article is part of our special report Corporate Governance.

SPECIAL REPORT / Those for and against proposals launched this week to tighten corporate social responsibility reporting (CSR) are both suspicious of its “comply or explain” enforcement regime.

The proposed new CSR regime would amend three accounting directives that require larger companies to report nonfinancial information, such as their diversity and environmental policies and to explain why they have not done so where necessary.

Companies failing to do so would be required to explain why they have not included such information, in the first attempt to legally impose such a “comply or explain” regime on larger companies.

Groups that believe that the CSR proposals do not go far enough generally feel that the enforcement mechanism will be lax, and fail to hold companies to account, whilst business interests say that the Commission has proposed a “comply or explain” system different in nature from previous examples (see background).

A surprising choice of enforcement

“It’s slightly surprising that the Commission has decided to implement comply or explain into the legislation, since it is usually used for voluntary codes,” said John Davies, the head of technical issues at the Association of Chartered Certified Accountants.

“Indeed where 'comply or explain' is currently used in European rules, the Commission itself has acknowledged that these procedures can be unsatisfactory because they can produce sketchy results and be uninformative,” Davies added.

The enforcement mechanism came in for heavy fire from the European Coalition for Corporate Justice (ECCJ), an NGO, in response to the proposals.

A statement from the group said that “comply or explain” leaves excessive discretion to companies to decide what they report on, and how they report, adding: “We don’t believe such approach will make the legislative reform achieve its objectives.”

“The 'comply or explain' approach won’t ensure robust reporting, true identification of significant risks and impacts companies have on society, comparability of the information and enforcement,” said Jérôme Chaplier, the ECCJ coordinator.

Industry fears the new approach

But businesses believe that the new regime would offer a different kind of “comply or explain,” one that goes further than before.

A source close to major European companies, who preferred to remain anonymous, said that in Denmark – one of the countries that uses such an enforcement regime – there is a broad understanding of what it means: businesses can explain where they do have policies but prefer not to disclose them.

“In the Commission proposal the issue is much more prescriptive. Companies that have policies but do not want to report them in respect of certain areas – like human rights or anti-corruption – ought to be able to explain why. If you have a policy under the Commission proposals, you have to comply and disclose,” said the industry source.

The Danish example

For the ECCJ’s Chaplier, Denmark is not a shining example. “Danish companies don’t address difficult human rights or environmental dilemmas and supply chain issues – for which they are desperately seeking to avoid responsibility,” he said. 

Ironing out the fine print on how the “comply or explain” system works is likely to be one of thornier issues as the draft rule changes make their way through the Parliament and the Council.

The Commission itself acknowledged in presenting the proposals that: “Different stakeholders have different views on what 'comply or explain' legislation should look like. Jurisdictions claiming that they have a “comply or explain” approach to transparency often have very different legislation.”

The EU executive insists that its “comply or explain” system will be clear and flexible, but others are less convinced.

“Further guidance is necessary to reduce any misinterpretation of the new requirements… The EU now needs to provide information as to how such measures will be enforced, and what would be the consequences of non-compliance,” said Rachel Jackson, ACCA’s head of sustainability.

Jackson said there needs to be a debate on the issue, and it will be discussed at a round-table in the Parliament on 4 June by members of the Corporate Sustainability Reporting Coalition (CSRC).

Parliament will debate “comply or explain”

The CRSC represents financial institutions, professional bodies, NGOs and investors, and will be co-hosted at the round table by MEPs Raffaele Baldassarre (Italy; European People’s Party) and Richard Howitt (UK; Socialists and Democrats).

It will be the first time the issue is aired in Parliament, where all sides of the argument debate what the “comply or explain” regime might look.

“Although Commissioner Barnier has indicated that he favours a flexible and unburdensome regime, the Parliament may look to strengthen the requirements regarding the explanations companies must give if they do not comply,” ACCA’s Davies said.

“Some questions that really matter to consumers, workers and communities may be ignored by companies under a “comply or explain” regulation: How are the suppliers of famous European retailers treating their workers throughout their supply chain? What is the impact of a mining project on the neighbouring communities? What are the responsibilities of a European holding in the explosion of an industrial plant belonging to its subsidiary?” said Jérôme Chaplier, the coordinator the European Coalition for Corporate Justice (ECCJ), an NGO.

“It is now time for public debate. In order to raise awareness and discuss the new measures, Aviva, ACCA and Eurosif - all members of the Corporate Sustainability Reporting Coalition (CSRC) -  are  organising a high level multistakeholder roundtable entitled ”Non-financial information disclosure: towards a more sustainable and comparable corporate reporting regime?” which will be co-hosted by  MEPs Raffaele Baldassarre and Richard Howitt, on the 4th June 2013 at the European Parliament in Brussels,” said Rachel Jackson, the head of sustainability at the Association of Chartered Certified Accountants (ACCA).

Britain first introduced a code setting out best practice in corporate governance – known as the Cadbury Code – which introduced a new regulatory concept known as “comply or explain”, in 1992.

This gave companies the option either to follow the best practices or to explain to their shareholders why they considered that they were not appropriate in the company’s particular circumstances.

Although the Cadbury Code has now been superseded, “comply or explain” mechanism remains an important part of the system of corporate governance in the United Kingdom, and in other European countries such as Germany and Denmark.

In 2006 it was enshrined in the EU directive requiring  all companies listed on EU-regulated markets to comply with the relevant corporate governance codes or explain why they have not done so.

The proposed changes to the accounting directives announced this week would require larger EU companies to report on specific corporate social responsibility issues for the first time at EU level.

  • 4 June 2013: Round Table in Parliament to discuss: “Non-financial information disclosure: towards a more sustainable and comparable corporate reporting regime?”

European Institutions

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