Commentary on the EU Commission's new guidelines on climate reporting
The experience with the implementation of the Non-Financial Reporting Directive (NFRD) and the analysis of the current status of companies’ sustainability reporting indicates that without clearer legal requirements, no guidance, no matter how good, will have substantial effect on the quality of companies reporting.
The research of the Alliance for Corporate Transparency project demonstrates the need for specification: 79% out of 105 companies reported on their climate change policy, but merely 50% clearly specified what the policy was designed to achieve specifically and how. The latest TCFD survey also concluded that only 3% of companies are disclosing enough information on their resilience to climate-related risks. Furthermore, the disclosures in the social area are equally relevant to understand companies’ development and impact. Notably, there is currently a lack of human rights due diligence and supply chains disclosure which hinders the EU Commission objective for a just and sustainable transition.
Investors keep calling for the improvement of corporate reporting (see CDP’s Non-Disclosure Campaign or the petition to the SEC in the U.S.). ESMA has also called on the EU Commission for the specification of reporting requirements as proper monitoring and enforcement in case of not compliance will be otherwise practically impossible (thus creating an uneven playing field among leaders and laggards).
The urgency of climate change requires effective policy-making in the EU as individual Member States leadership will not suffice. This situation puts the achievement of the Sustainable Finance Action Plan in jeopardy as investments will be misallocated without appropriate and comparable insights from companies.
We expect that the result of the Fitness Check carried out by DG Fisma and the mounting evidence and calls for the review of the NFRD will prompt the next EU Commission to take the needed steps.
Specific comments on the guidelines for climate-related information:
The guidelines are welcome as they provide clear indications for companies on which concrete climate-related information is relevant and material. However, these guidelines represent only half of what needs to be done as there will not be significant improvement in corporate disclosure until the European Commission establishes minimum mandatory requirements in the legislation itself.
At general level, the guidelines do a very good job of explaining the double materiality standard, which is required by the EU NFRD, that is that companies have to report both on risks of negative impact on the company as well as risks of negative impacts on the climate, what these risks may be and how they interact.
The guidelines, however, follow on this general definition only half-heartedly when it comes to concrete instructions for disclosure. They recommend a description of climate-related targets and how they relate to the Paris Agreement, and encourage companies to consider risks under different global warming scenarios in different time horizons, which companies should define for themselves.
While this may be in line with the TCFD Recommendations, it is not with the IPCC 2018 report and the EU's commitments. A much clearer guidance is required in terms of what are adequate targets and time horizons to be reported against, taking into account the need to achieve carbon neutrality before the mid century.The integration of TCFD recommendations in the European Commission guidance (and potentially in future regulation) will help companies to consider climate-related issues that are financially material for their business. However, TCFD recommendations alone are not sufficient to capture companies’ impact on climate change mitigation.
This gap, alongside a mere encouragement for companies to consider a 1.5°C scenario, highlights insufficient understanding of the consequences of global warming spinning out of control if it exceeds 2°C and risks of aiming for the grey zone between 1.5° and 2°C. As a result, it is to be expected that most companies will continue to report on arbitrary targets and time horizons, which will not allow a clear assessment of their true risks and impacts.
The guidelines also clearly describe KPIs, including financial (but not impact) indicators regarding Products and Services that contribute to climate change mitigation, and Green Finance. Specific guidance and clearer requirements on sector-specific KPIs are also required to enable effective disclosure and comparability.
In March 2018 the Commission published the Action Plan on Financing Sustainable Growth, with the aim of reorienting capital towards sustainable investment, managing financial risks that arise from climate change and other environmental and social problems, and fostering transparency and long-termism in financial and economic activity.
As part of that Action Plan the Commission committed to update the Non-Binding Guidelines on Non-Financial Reporting, specifically with regard to the reporting of climate-related information.