The new EU non-financial reporting requirements, while a step in the right direction, lack the scope and the necessary verification requirements to be a real game-changer writes Beate Sjåfjell.
Beate Sjåfjell is a professor at the University of Oslo. She is the coordinator of the H2020-funded project Sustainable Market Actors for Responsible Trade (SMART).
The convergence of crises that we face as a global society, with its grand challenge of how to achieve social progress for all without destroying the very basis of our existence, emphasises the importance of discussing the role of business. One thing is for sure: ‘business as usual’ is a very certain path towards a very uncertain future.
We know that there is a strong will in the EU to ensure the contribution of business to sustainability – environmental, social and economic. However, the regulatory tool of choice for the EU and national legislators around the globe – to ask companies to report on their performance – does not have the intended effect. This is the compromise result between those who wish to regulate companies’ environmental and social performance more strictly and those who do not.
In spite of much hard work in this area, reporting requirements are strikingly insufficient in influencing companies and their investors. Reporting requirements often fail from the beginning. Much reporting is left to voluntary and discretionary measures, which increases the risk of corporate capture, lack of comparability, lack of consistency and uncertainty in benchmarking.
The new EU non-financial reporting requirements, while a step in the right direction, still lack the scope and the necessary verification requirements to be a real game-changer. The new EU rules start out well with requirements to report on the business model of the company. Companies are told to report on environmental matters, social and employee-related matters, respect for human rights, anti-corruption and bribery matters. Notably, they also have to report on the due diligence processes implemented by the company. This is a key mechanism to integrate environmental and social matters across supply chains.
While the EU sees reporting as vital to managing change towards a sustainable global economy, its efforts are bound to fail because of the narrow scope of the rules and the lack of verification and enforcement of reporting. Only the largest companies are covered by the new EU rules and it is up to the companies to decide whether they wish to have policies on these ‘non-financial’ issues. If not, they can simply explain why not. If they do report, there are no enforceable requirements for verification of the content. Empirical studies have shown that non-financial reporting is often neither reliable nor relevant. The ugliest companies use the most make-up.
The EU rules leave too much leeway to the member states and by extension to companies. Member states could choose to implement the EU rules in a way that firms up the requirements. This would mean requiring verification and enforcement in such a way that it actually has the intended effect of internalising the environmental, social and economic externalities of business in corporate boards. However, the overall trend across member states is to do the minimum – they implement the EU rules with same vagueness and lack of verification and enforcement.
It is possible to make the reporting rules a vital part of the transformation to sustainable business that the EU wishes to see.
We have to start with bridging the chasm between what boards perceive as their main duty and what they are required to report on. The legal myth that boards have a duty to maximise shareholder returns, rather than ensuring the long-term sustainability of the business, is an important driver for unsustainable corporate behaviour.
To mitigate this shareholder primacy drive, we need a corporate law reform which redefines the purpose of the company and the role and duties of the board. The aim would be to ensure life-cycle based creation of sustainable value within the planetary limits.
A key requirement of such reform should be a duty for each corporate board to create a sustainable business plan for the company. A requirement for such a sustainable business plan, designed thoughtfully, would involve the standardisation of a process that companies wishing to achieve long-term sustainable value would need to go through anyway. The standardisation would contribute to lowering costs and establishing a level playing field. The sustainable business plan should include key environmental performance indicators in so far as impacts are quantifiable.
Such a reform would bridge the gap between internal decision-making in the company and its reporting – giving businesses a clear duty on which to report and actual content to the non-financial reporting requirements.
The internal motivations are there: the EU is increasingly focusing on the circular economy and sees itself as a front-runner in the fight against climate change. Ensuring that the new reporting rules become a game-changer would undoubtedly strengthen the EU’s position as a leading global actor for sustainability.