With climate change warnings ever more severe, it is important now more than ever to make our industries sustainable and in tune with climate risks. At the Climate Disclosure Standards Board (CDSB), we advocate for making it mandatory for companies to report on climate and environmental information affecting their business within their mainstream reports, because we strongly believe that it is in their interest to do so.
There is overwhelming evidence that the inclusion of this information is a key part of the structure that will not only enable investors to make informed capital allocations, but also help businesses manage these risks and opportunities more effectively. This will ultimately contribute to building a more sustainable financial system.
The EU’s Non-Financial Reporting Directive (NFRD) provides a first step in the right direction, requiring large companies to publish regular reports on their management of social and environmental matters. Our newest publication ‘First Steps’, launched last month and published jointly by CDSB and CDP, analyses the annual reports of the 80 biggest publicly listed companies in Europe based on five reporting demands in the NFRD.
This review comes out at an opportune time following the first year of reporting under the NFR Directive. Ultimately, it provides the European Commission, Parliament and Council with evidence to understand the role of the NFR Directive in shaping the environmental and climate reporting landscape.
It could also serve as a baseline for measuring changes in reporting practices and in future assessments on the state of European corporate reporting of non-financial information. The review also considered what was recommended in the reporting methodology of the non-binding guidelines to the Directive, produced in 2017 as a Communication from the Commission.
The main analysis focused on the top 80 companies in Europe, from 12 countries, representing $3.7 trillion in market capitalization. A further high-level analysis of disclosures by the top 500 by market capitalization is also included. The review also analyses how far current reporting practices align with the recommendations of the G20 Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), which represents a new best practice in climate change reporting and is endorsed by the European Commission. Aligning these recommendations with the Non-Financial Reporting Directive presents an opportunity to streamline the EU corporate reporting landscape.
Our report found that, whilst there is a good foundation of disclosure on environmental matters emerging, it is evident that company management reports are found lacking key environmental and climate information. Of the sample, 30 companies (38%) make reference to the TCFD in their annual report, showing that implementation is already underway, but while 60% of companies disclose that responsibility for environmental issues sits with a board member, only 15% mention climate change specifically, which is a key TCFD recommendation. The UK (31%) and France (21%) lead in this aspect, while some firms now link environmental or climate targets to management remuneration.
In terms of regional differences within Europe, all French and UK company reports include current emissions, compared to just 56% in Germany and 81% EU-wide. Only 41% of annual reports include targets to reduce emissions. Where such reporting was mandatory before the NFR Directive, like the UK and France, companies seem to perform better.
The review also reveals a large gap between companies’ stated risks and the actions to address them. With the NFR Directive asking for information on environmental risks, 79% of company reports identify at least one climate or environmental risk. However, 80% do not prepare a specific climate change strategy to mitigate these risks.
Other findings include that only 41% of company reports disclose risks associated with the transition to a low-carbon economy, such as future regulation and policy changes, which are likely to have material business impacts. Three in four company reports include a business model description that falls short of EU guidelines and fewer than one in four include a clear statement that climate or environment is part of their overall due diligence processes.
Drawing from this evidence, our review proposes clear actions for regulators and companies to take to provide better quality information to investors and markets. Specifically, we have seven key recommendations for the Commission including amendments to the Directive.
So why do we see these shortcomings in the quantity and quality of information? One aspect is the fact that the Directive isn’t as clear as it should be, but it isn’t the only reason. In our work with businesses we have seen that ESG information is often prepared in a silo by sustainability teams, which we believe to be a missed opportunity. It is important to remember that, according to both the Directive and the TCFD recommendations, the primary location of such information should be the mainstream financial filing of a business.
Disclosure in mainstream financial filings should foster shareholder engagement and broader use of climate-related financial disclosures, thus promoting a more informed understanding of climate-related risks and opportunities by investors and others. The publication of climate-related financial information in mainstream annual financial filings should also ensure that appropriate controls govern the production and disclosure of the required information.
Financial Directors and their teams have a wealth of experience of consolidating and communicating information to a high standard and this rigour could only benefit ESG reporting. I therefore encourage you, if you haven’t already, to speak to your sustainability teams and see if there are ways you can support them. The result can only be a better annual report that will benefit your Board and your investors.