The adoption of the EU Non-Financial Directive in Germany

Posted
30 July, 2015

The German Federal Ministry of Justice and Consumer Protection has issued a concept paper on the adoption of the EU non-financial directive on disclosure of non-financial and diversity information by certain large undertakings and groups. Currently, there is a lively debate going on in Germany about the pros and cons of “non-financial” information in financial reports.

For instance, it is being discussed whether non-financial information is at all useful for the management reports’ audience, especially providers of financial capital. According to the directive, management reports should contain certain “non-financial” information “to the extent necessary for an understanding of the undertaking’s development, performance, position and impact of its activity.”

An integrated approach is essential for providers of financial capital to be able to use such material information on what drives corporate value. Only if it is made clear how these value drivers impact the company’s position, now or in the future, will its inclusion in reports be useful. Therefore, this information should be connected to contents on the company’s organizational environment, business model, strategy, performance, position, future outlook including risks and opportunities, remuneration and governance report.

The information needs to be integrated into the management report. A combined report in a chapter ‘non-financial statement’ within the management report, or a separated report from the management report, is not sufficient. Without connectivity of information, providers of financial capital would most probably not use this information, even though it is material for an understanding of the company’s future development – especially the viability of its business model.

The adoption of the EU non-financial directive could provide for integrated, combined or separated reporting. There is legitimate interest not to raise the reporting burden too high, thus allowing for combined or separated reporting. However, non-financial information seems to be most useful when it is connected to the company’s financial position. Therefore, many argue the adoption should be carried out in the spirit of <IR>. Not only did the FAQs to the directive make explicit reference to <IR> (“Integrated Reporting is a step ahead”), several German organizations emphasized that conceptually only Integrated Reporting makes sense. This includes financial capital markets and corporate governance expert and IIRC board member, Prof. Christian Strenger; the German <IR> Roundtable  which includes BASF, Deutsche Bank, Deutsche Börse, EnBW, Flughafen München and SAP; and Institut der Wirtschaftsprüfer in Deutschland. Furthermore, Econsense the Forum for Sustainable Development of German Business, argued that separated reporting would be a step backwards from current reporting requirements.

Some organizations welcome the idea of emphasizing the relevance of “non-financial” issues for a company’s financial position, but also emphasize possible barriers for businesses to apply such requirements. Many of these issues in question were also discussed in the IIRC’s International <IR> Framework consultation period, such as technological developments and need for internal controls and systems, assurance, defining materiality and the definition of “impact of its activity”. The IIRC is currently working proactively with partners and engaging with the market on developments in these areas.

A first draft of the requirements is expected to be published in late 2015. The directive shall be adopted until 06 December 2016 and shall be applied for financial years starting on 01 January 2017 or during the calendar year 2017.

In my view, the success of the adoption of the EU non-financial directive in Germany – just as in every other EU member state – will depend on whether legislation provides for integrated, combined or separated reporting. Only through connectivity of information can non-financial matters add value for management reports’ audience (especially providers of financial capital), thus providing for financial capital market stability and sustainable development, benefitting companies, providers of financial capital and other stakeholders.