Can the EU Directive on nonfinancial reporting give you a competitive advantage? April campaign 2017 The better the question. The better the answer. The better the world works.
Contents 1 2 Can the EU Directive on nonfinancial reporting give you a competitive advantage? About EY Page 2
Can the EU Directive on nonfinancial reporting give you a competitive advantage? Page 3
Expanding the concept of capital Nonfinancial elements of organizations are becoming an ever-greater factor in how the total value of companies is determined. Intangibles increasingly determine the market value of organizations, and valuation methods are increasingly taking into account aspects that are not included in the financial statements. This trend is pushing the concept of capital beyond the solely financial, to encompass the myriad other ways companies affect, and are affected by, the world around them. This shift has spurred demands from investors for new and different kinds of disclosures, helping shareholders to make better informed decisions. Page 4
Demanding more from nonfinancial reporting What we hear investors say (based on EY¹ and Association of Chartered Certified Accountants (ACCA) investor surveys) What we hear CEOs and CFOs say (based on EY² and International Integrated Reporting Council (IIRC) surveys) Investors are facing an information deficit they do not receive enough accurate, standardized, industry-specific information relevant to risk and performance assessment. A link is missing among current reporting, business strategy and risk. Current nonfinancial reporting is not sufficiently relevant, and nonfinancial information should be better integrated with financial information. Quantitative key performance indicators (KPIs) are viewed as essential to assess financial materiality. Financial information is considered to be critical, but not sufficient. C-suite executives state it is important that they can effectively explain how their business creates value through their corporate reporting. Bringing together financial and nonfinancial information to explain value creation helps to strengthen relationships with investors and creditors. Only a quarter of C-suite executives feel that their current reporting very much meets the information needs of investors and other external stakeholders. Many corporate reports cover CSR, sustainability and integrated reporting. In three years time, CFOs expect that almost all reports will cover those aspects. ¹ Is your nonfinancial performance revealing the true value of your business to investors?, EYGM Limited, 2017. ² Connected reporting: responding to complexity and rising stakeholder demands, EYGM Limited, 2014. Page 5
How reporting can become a competitive advantage Corporate reporting may be used as an effective management tool to achieve the broader corporate goals: Goals Improve access to capital markets Improve the dialogue with key stakeholders Support corporate reporting as a management and decision-making tool Target audience Investors All relevant stakeholders Internal Advantage Executives know the importance of their companies reputations to investors. The market often believes that companies with a good reputation will deliver sustained earnings and future growth and that they have higher price-earnings multiples, market values and lower costs of capital. Companies with positive reputations tend to attract more loyal customers. The increased interactions from customers buying a broader range of products and services and repeat purchases provide more opportunities to communicate. In an economy where around 80% of market value comes from intangible assets, it is important that management monitors and measures how those assets impact on the organization s operations and reputation. Source: Harvard Business Review, Reputation and its Risks by Robert Eccles, Scott Newquist and Roland Schatz, Feb 07 Page 6
Why nonfinancial reporting matters The following key questions can help you assess whether your management of nonfinancial information is organized to reliably and efficiently deliver the right information to investors, stakeholders and your internal audiences. Question Are you concerned about brand reputation, stranded assets, business resiliency or license to operate? Do you get sufficient business value from nonfinancial reporting? What is the current state of nonfinancial information management in your organization? What information matters most, and who is most likely to use the business information that is reported publicly? Do investors use nonfinancial information to assess risk and the outlook for your organization? Are you confident that nonfinancial information governance, processes and definitions are sufficiently reliable? Is the finance function involved in nonfinancial information management? Do you use technology effectively to support credible reporting and use resources efficiently? To what extent do you plan to integrate nonfinancial reporting with annual financial reporting? Can you gain efficiencies by obtaining nonfinancial report assurance and financial auditing from the same provider? EY can help you on your journey to improved nonfinancial reporting. Page 7
The introduction of the EU Directive on nonfinancial reporting From reporting year 2017, beginning 1 January 2017, the legal requirements for transparency on nonfinancial information in management reports of large public interest entities (PIEs) will be tightened and require additional disclosures. These disclosures will cover policies, nonfinancial performance indicators, main risks and outcomes relating to at least five areas including environmental matters, social and employee aspects, respect for human rights, anticorruption and bribery issues, and diversity in their board of directors. EY can help you address information needs for the board, the management team and the market, and support your actions toward a much more real-time, digital and interactive dialogue with your stakeholders and investors. Page 8
The EU Directive Who is impacted by the legislation? What companies are impacted by the legislation? All sectors are affected by the legislation. Nonfinancial information will have to be disclosed by all large PIEs in the EU including companies listed in the EU markets plus some unlisted companies such as banks, insurance companies and others designated by the country governments. The definition of large varies by EU country, but in most cases this means companies with at least 500 employees and annual revenues of more than 40m, or at least 20m in assets. Some countries, like Denmark and Sweden, have lowered the threshold to 250 employees, therefore requiring also medium-sized companies to report on nonfinancial matters. Will companies have to file a report in each EU country they operate? No, a subsidiary organization is exempt from this reporting requirement as it should be included in the parent company s management report. The parent organization is obliged to report the nonfinancial information for the entire group. Page 9
The EU Directive What must be reported? The legislation sets out that companies should at a minimum produce information on: Environmental matters Social and employee aspects Respect of human rights Anti-corruption and bribery issues Current and foreseeable environmental impacts Health and safety impacts Use of renewable energy and nonrenewable energy Greenhouse gas emissions Water use Actions taken to ensure gender equality Implementation of fundamental conventions of the International Labor Organization Working conditions Social dialogue Respect for the rights of workers and trade unions Information on the prevention of human rights abuses, including aspects such as supply chain transparency Information on mechanisms in place to fight corruption and bribery Air pollution Health and safety at work Dialogue and initiatives with local communities In relation to the above aspects, the legislation expressly addresses the following elements: The business model The policy pursued (including due diligence process) The result of the policy pursued The principal risks and the management of these risks Nonfinancial key performance indicators In addition, the board diversity policy may include: Stressing the roles of non-executive directors as well as the importance of independence of the board Emphasizing the significance of balancing skills and experience of the board members Taking into account aspects such as age, gender, educational and professional backgrounds Page 10
How EY can help EY can support you in most stages related and leading to the disclosure of nonfinancial and diversity information. We tailor our support to your specific context and your organization s maturity regarding the requirements of the Directive and national laws. Depending on your needs, our support may include: Providing assistance to define your nonfinancial and sustainability strategy Undertaking a compliance gap analysis, industry comparisons or readiness review Supporting your team during the stakeholder engagement process Helping you to develop a data management system, supporting data quality checks and defining key performance indicators Assisting in the development of the report Helping you while you implement sustainability and nonfinancial management and reporting processes Page 11
How EY can help Providing tailored support to your business Your level of maturity Starter Middle of the pack Front-runner As your assurance provider, we may: Perform a criteria assessment to identify any potential gaps against internal or external reporting standards Perform assurance-readiness on selected material nonfinancial information disclosures Assess the efficiency of your process and data flow documentation Perform a gap assessment to identify any potential areas of improvements against selected reporting frameworks (e.g., G4) Perform assurance assessment on nonfinancial information disclosures Perform assurance assessment on nonfinancial information disclosures Assess current reporting of nonfinancial information against innovative standards for integration (e.g., integrated reporting standard) As your advisor, we may: Provide advice on how to draft definitions for the nonfinancial information disclosures that are available and suitable Provide support on governance setup Help identify and define the scope and boundaries for nonfinancial information disclosures following the different reporting frameworks Help develop standard operating procedures and data flows to increase data accuracy as well as reporting efficiency Provide advice on how to design the processes, identify risks and implement controls Create a road map to prepare for third-party assurance Assess technology for nonfinancial information reporting, including data conversion and definition of process and controls Support data gathering (and audit trail) for nonfinancial information disclosures to prepare for an assurance engagement not performed by EY Assist internal audit through procedures or co-sourcing of internal audit activities Provide internal audit training on nonfinancial information Provide advice on the reporting process and controls for Scope 3 or other complex disclosures Help prepare the organization for the journey toward integrated reporting Provide advice and support on impact measurement and reporting Provide advice and support on measuring and valuing your stock of capitals Page 12
Our approach for compliance with the EU Directive EY has developed a five-step approach to help companies align their current policies and reporting processes with the new EU Directive. 1. Identifying gaps We recommend you start by performing a gap analysis to determine the extent to which you may already be compliant. This inventory will clarify which of the five central themes of this legislation are already embedded in your reporting processes. 2. Drafting policies For topics where no policy exists, you should determine whether a policy will be developed or explain why there is no relevant policy. For topics not yet included in the management report, you should determine which relevant information you wish to provide and how it will be integrated within the existing data systems and reporting processes. Page 13
Our approach for compliance with the EU Directive (continued) 3. Measuring results The legislation requires that you measure the progress made within your business and value chain with respect to the relevant themes for which a policy has been formulated. Progress should be measured based on quantitative performance indicators, which are comparable over time, and included in the data management processes. 4. Reporting The legislation requires you to consolidate information in the nonfinancial statement. If certain information is omitted, you need to explain why a particular topic is not relevant, based on a clearly substantiated account. 5. Assurance Once the data systems and reporting standards are in place, you may wish to consider engaging an external auditor to examine your nonfinancial information, which can provide assurance to your stakeholders. Page 14
Why EY The EU Directive is just one signal, among many, that companies are experiencing a shift in what constitutes meaningful corporate reporting for the 21st century, and it is indicative of a more general rethink of what, and how, companies communicate about their activities. EY can assist you as you implement the EU Directive s requirements so that your disclosures meet the regulatory requirements and provide a more holistic perspective to your business, adding value for you and your investors alike. Used effectively, your corporate reporting can be utilized as a management tool to achieve broader corporate goals like improve access to capital markets, improve the dialogue with key stakeholders or support corporate reporting as a management and decision-making tool. EY has experience that can help you as you transition to these new ways of communicating your nonfinancial performance in line with the EU Directive. Certain services and tools may be restricted for EY audit clients and their affiliates to comply with applicable independence standards. Please ask your EY contact for further information. Page 15
About EY Page 16
Financial Accounting Advisory Services EY contacts Americas Jeanna Doherty jeanna.doherty@ey.com +1 860 725 3835 Europe, Middle East, India, Africa (EMEIA) Christophe Schmeitzky christophe.schmeitzky@fr.ey.com +33 1 46 93 75 48 Asia-Pacific Mathew Nelson mathew.nelson@au.ey.com +61 3 9288 8121 Japan Keiichi Ushijima keiichi.ushijima@jp.ey.com +81 3 3503 1100 Nonfinancial Reporting Solution Leader Matt Bell matthew.bell@au.ey.com +61 2 9248 4216 Page 17
EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. 2017 EYGM Limited. All Rights Reserved. EYG no. 01878-173GBL BMC Agency GA xxxxx ED None In line with EY s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com