European Union Supplemental Guidance on Climate-Related Disclosures
In June 2019, the European Commission published its Guidelines on Non-Financial Reporting: Supplement on Reporting Climate-Related Information (the Supplement). While not binding, the Supplement was designed to assist companies in complying with the European Union’s (EU) Non-Financial Reporting Directive (NFRD). The Supplement also considered a variety of existing standards and frameworks; however, it particularly underscores its integration of the recommendations from the Task-Force on Climate-related Financial Disclosure (TCFD). Despite the Supplement’s lack of new legal obligations, companies can benefit from the consolidated guidance for complying with both the TCFD recommendations and the EU’s NFRD requirements.
Overview of the NFRD
Adopted in October 2014, the NFRD required EU member states to adopt legal requirements for large companies to provide disclosures on various non-financial matters, ranging from anti-corruption to the environment to human rights. Since the NFRD’s entry into force in 2017, companies are expected to have policies related to all of these areas or to provide a “clear and reasoned explanation” for a policy’s absence. Moreover, the disclosures are expected to cover at least five main areas: (1) business model; (2) policies and due diligence; (3) outcome of policies; (4) principal risks and risk management; and (5) key performance indicators.
Non-binding Guidelines on Non-Financial Reporting were published in 2017, providing further detail on the types of information expected for all of a company’s non-financial disclosures. Of particular importance, the guidelines emphasize that companies “should focus on information needs of stakeholders as a collective group, rather than on the needs or preferences of individual or atypical stakeholders, or those with unreasonable information demands.” A list of potential stakeholders is provided, including, among others, investors, workers, customers, communities, vulnerable groups, and public authorities. Moreover, company policies are to include, “where relevant and proportionate,” review of their supply and subcontracting chains.
Shortly after the final TCFD report was published in June 2017, the European Commission announced its action plan on sustainable finance, including development of more detailed standards and guidelines for climate-related disclosure. However, several member states have moved independently of the EU’s directive, making clear to regulated companies their expectations specifically regarding climate change disclosures. For example, in 2015, France had adopted a law requiring disclosure of climate risks in a similar comply-or-explain approach. More recently, the United Kingdom (UK) announced in its Green Finance Strategy, a consideration of mandatory climate reporting. This followed the UK Prudential Regulation Authority’s April 2019 Supervisory Statement (discussed here) detailing expectations for financial institutions to include climate change disclosures that incorporate stress testing and scenario analyses.
The Supplement provides further guidance on how climate disclosures should be made under the NFRD, explicitly stating that climate is already covered under the existing language of the NFRD. While recognizing that the field of climate-related reporting is quickly evolving, the Supplement focuses on guidance in two main areas: (1) assessment of materiality and (2) disclosures under the NFRD’s five main areas.
The Supplement discusses a “Double Materiality” perspective for climate change. It provides that climate information should be reported not only if it is necessary to understand the company’s development, performance and position but also if it is necessary to understand the impacts of the company on the climate. Building from this, the Supplement suggests disclosures look at climate-related dependencies and opportunities in addition to climate-related risks. However, for all of these, it underscores that materiality for climate change should involve a longer time horizon, advising companies against “prematurely conclud[ing] that climate is not a material issue just because some climate-related risks are perceived to be long-term in nature.”
To address this, the Supplement contains lists of climate-related disclosures that may be expected under the NFRD, cross-referencing the TCFD recommendations where appropriate. These lists contain several recommended disclosures for each of the five required areas under the NFRD, and they are followed by more detailed topics that companies may consider including as part of these disclosures. The recommended disclosures include information that meets the baseline for both the NFRD requirements and the TCFD recommendations. Many of the further disclosures describe information that would be used in developing the recommended disclosures, such as the methodology behind certain analyses, description of natural capital and risks by business location and activity, and related quantification of carbon flow in the business.
The Supplement is an example of how quickly expectations for climate change disclosures have evolved in Europe. This stands in stark context to the U.S. regulatory environment where the SEC has taken no action on climate change disclosures since its 2010 guidance. The SEC’s 2010 guidance makes clear that certain climate issues, including potential regulations and physical impacts of climate change could rise to the level of materiality (meaning they would be important to the decision-making of an ordinary investor or shareholder), but do not impose any specific requirements for disclosure that are akin to the type of scenario analysis being called for in Europe. As ESG investor expectations continue to evolve—driven at least in part by the types of information they are receiving from companies subject to the NFRD—they are likely to continue to demand similar disclosures from U.S.-based companies, even though such disclosures may not be legally required in the U.S.