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Non-financial reporting – Rising importance in the context of sustainable finance

Non-financial reporting is growing in importance in the public perception of annual reporting by companies. The coronavirus pandemic and climate change are increasingly widening the focus on social and regulatory aspects, too. There is less tolerance for non-sustainable operations than ever before.

Sustainable finance

Concept of sustainable finance

‘Sustainable finance’ is generally understood as a ‘sustainable financial industry’ and ‘sustainable funding’ that are not guided solely by quantitative economic criteria, but instead, increasingly also by different sustainability aspects. This includes reducing damage to the environment and the climate, promoting social participation and sustainable corporate governance. Based on these aspects it is possible to discern that the term ‘sustainable finance’ is a metaconcept that encapsulates related terms such as ‘green finance’, ‘climate finance’ and ‘carbon finance’.

The EU’s endeavours

While the evolution of corporate reporting requirements has indeed also embraced NGO activities, however, it does particularly track the current endeavours by the EU to guide substantial financial assets into sustainable investments. The EU is thus attempting to increasingly include in its guidance those high-profile issues that are being discussed on which it is discernible that future generations will place higher importance.

An explanation of ESG factors

The so-called ESG factors make it possible to differentiate between a corporation’s sustainability-related business areas as follows:

  • Environmental – this refers to those factors that stand for the prevention of environmental pollution or environmental risk as well as for energy efficiency targets.
  • Social – the spheres that fall within this category include ones such as occupational safety, health protection, social engagement and diversity.
  • Governance – this term is understood to mean sustainable corporate governance that combines, in particular, related individual fields such as determining company values as well as management and monitoring processes.

Influences on reporting in corporations

External reporting by corporations is increasingly moving away from pure financial reporting towards more comprehensive reporting that likewise places special emphasis on the consideration of ESG factors within the scope of non-financial reporting.

This therefore takes into account the current development whereby the various target readers of external corporate reports (stakeholders) have a growing interest in corporations that are managed transparently and sustainably.

There is demand for information on the effects that arise in the corporations when complying with the ecological, social and regulatory requirements.

Corporations should thus expand their reporting to include the direct and indirect effects of such requirements on the corporation and its environment. The starting points for the respective non-financial reporting are the existing concepts at the corporation and the established processes as well as their implementation.

Please note: In the context of reporting, corporations should pay particular attention to the reputational impact. For example,

  • business activities in certain regions and with particular contractual partners, or
  • products or services that are considered to be problematic from a sustainability perspective

could negatively affect the reputation of a corporation.

The measures that have to be taken in respect of non-financial reporting thus result from the imperative to forge positions in future markets, whether directly vis-à-vis environmentally conscious customers, or indirectly in relation to investors and shareholders who are increasingly measuring the value and/or future performance of a global corporation on the basis of ESG criteria. For example,

  • enhancing transparency through sustainability reporting can help to improve the competitive position and
  • expanding non-financial reporting can increase the attractiveness of the respective corporations as employers or as business partners.

For this reason, voluntary non-financial reporting, or going above and beyond the legal requirements should also be considered here.

CSR Reporting

The EU had already responded to this paradigm shift in reporting in 2014 and with its CSR Directive (Corporate Social Responsibility) had obliged certain capital market-oriented companies and large financial service providers to prepare non-financial reports. Germany transposed the Directive into national law with the CSR Directive Implementation Act (CSR-Richtlinien-Umsetzungsgesetz, CSR-RUG). This has been applicable to management reports since the 2017 financial year.

The CSR-RUG affects capital market-oriented companies (Section 264d of the Commercial Code [Handelsgesetzbuch, HGB]) and corporate groups (Section 293 HGB) averaging more than 500 employees during the financial year (Art.19a and Art. 29a CSR Directive) as well as financial service providers; these entities now have to include non-financial issues, such as the environment, employees, social matters, human rights, anti-corruption/bribery as well as diversity, in their reports.

The reporting on these issues can be either integrated into the management report at various points, or presented in a separate section, or published in a self-contained non-financial report in the Federal Gazette (Bundesanzeiger), or on the company’s website.

However, internationally there is a lack sufficient comparability as there is no standard criteria catalogue that could provide guidance on the content and nature of the reporting. International institutions such as, e.g., the IIRC (International Integrated Reporting Council) have already recognised this and it can thus be assumed that there will be other regulations in this area.

Please note: Empirical studies have indeed shown that those responsible for preparing a company’s annual financial statements are increasingly focusing on the non-financial reporting. Yet, this part of the reporting frequently falls short of the expectations of many investors because little information is included on, for example, CO2 emissions, the issue of inclusion or the appropriateness of wages and salaries.

Important for the Mittelstand sector, too

Currently, the statutory obligation to prepare a non-financial report admittedly only directly affects the above-mentioned (few) large capital market-oriented companies as well as financial service providers. While medium-sized enterprises have thus hitherto not been directly affected by CSR reporting, nevertheless, the respective reporting done on a voluntary basis could have a positive impact on investors’ perceptions.

It should also be noted that for medium-sized enterprises that have been integrated into group structures, if a statutory obligation exists for their parent companies then this will extend to such enterprises because non-financial information will then be internally requested.

Given that strong sustainability is anyway very frequently already a distinguishing feature of the organisational culture of medium-sized enterprises in particular – especially in the case of family enterprises that wish to ensure the continued existence and growth for future generations in this way -, in many cases, the basis for expanding the reporting activities will accordingly already be present.

Recommendation: Therefore, for medium-sized enterprises it could be a perfectly sensible course of action to veer from a traditionally cautious information policy and take an in-depth look into CSR issues even without being legally obliged to do so. Furthermore, capital providers are increasingly attaching importance to the respective information.

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