Businesses have a major impact on the society and environment that go beyond just economics. However, there is no concrete way to measure their positive and negative impact within the existing frameworks, most of which focus only on the financial aspects of operations. To address this gap, the EU came up with the Non-Financial Reporting Directive (NFRD), which focuses on environmentally and socially sustainable economic growth.
From an organization’s standpoint, complying with this directive can be challenging. In this article, we talk about the challenges and what organizations can do to comply with the NFRD.
What is NFRD?
The NFRD, adopted by the European Union (EU), mandates that large public-interest companies disclose non-financial information related to their operations, particularly concerning environmental and social responsibilities. This requirement aligns with the European Green Deal’s goals of achieving sustainable growth and climate neutrality by 2050.
The main objectives of NFRD are:
- To provide investors and stakeholders with relevant and comparable non-financial information.
- To hold companies accountable for their impact on society and the environment.
- To encourage companies to adopt sustainable business practices.
This push for improved non-financial reporting stems from growing demands from stakeholders, including investors and civil society, who seek greater transparency regarding companies’ sustainability practices and their effects on society.
The NFRD applies to companies with more than 500 employees, including listed companies, banks, and insurance companies. Under this directive, these entities must disclose non-financial information in their management reports, covering aspects such as:
- Environmental impact – Companies must report on their policies and outcomes concerning the environmental effects of their operations, including resource use and waste management.
- Social responsibility and treatment of employees – This includes how companies manage their relationships with employees, respect labor rights, and promote workplace diversity.
- Human rights – Organizations are required to disclose how they address and mitigate human rights risks in their operations and supply chains.
- Anti-corruption and bribery – Companies must outline their policies to prevent corruption and bribery within their operations.
- Diversity in governance – This includes information about the diversity of company boards, highlighting efforts to promote gender equality and inclusivity.
Understanding these requirements is the first step for organizations to implement a successful compliance program.
Challenges in Implementing Compliance Programs
While the NFRD’s goals are commendable, it is also challenging for organizations due to the following reasons.
Lack of Clarity and Guidance
NFRD allows companies to choose their reporting framework, and this could lead to inconsistencies in how information is presented, thereby making comparison challenging. Without clear guidelines, companies may struggle to determine what to report and how to ensure that their reports meet necessary standards.
Resource Constraints
For many organizations, particularly small and medium-sized enterprises, the financial and human resources required to comply with the NFRD can be a big burden. Gathering non-financial data, analyzing it, and producing reports can strain limited resources.
Integration with Existing Reporting Frameworks
The overlap of the NFRD with other EU regulations, such as the Capital Requirements Regulation (CRR) and the Sustainable Finance Disclosure Regulation (SFDR), complicates compliance efforts. Companies must ensure that their non-financial reporting aligns with multiple regulations, leading to potential duplication of effort and confusion.
Ensuring Data Accuracy and Reliability
A major concern for users of non-financial information is the reliability and comparability of the data disclosed. Companies must establish robust processes to ensure the accuracy of their non-financial reporting, often requiring detailed data collection and analysis.
While there are no clear solutions, the best practices mentioned below can help.
Best Practices for Implementing NFRD Compliance Programs
To navigate these challenges, companies can adopt several best practices for implementing effective compliance programs under the NFRD:
Conduct a Gap Analysis
Before implementing a compliance program, conduct a thorough gap analysis to identify areas that fall short of NFRD requirements. This comprehensive analysis must review existing reporting practices, data collection processes, and governance structures.
Establish Clear Reporting Frameworks
Select a reporting framework that aligns with the NFRD and other relevant regulations. Popular frameworks include the Global Reporting Initiative (GRI), the Task Force on Climate-related Financial Disclosures (TCFD), and the UN Guiding Principles on Business and Human Rights. Establishing a clear framework ensures consistency in reporting and facilitates stakeholder understanding of non-financial performance.
Engage Stakeholders
Involve stakeholders in the reporting process, as this eases the process of gathering relevant information and ensuring transparency. Engage investors, employees, customers, and local communities to understand their expectations and concerns. This stakeholder engagement helps shape the content of the non-financial report and improves its relevance.
Implement Robust Data Collection Processes
Accurate non-financial reporting relies on solid data collection and analysis processes. Make sure to develop efficient systems for collecting, managing, and analyzing non-financial data, ensuring integration with existing financial reporting processes. This may involve using technology solutions that facilitate data collection and reporting.
Invest in Training and Capacity Building
Train the employees involved in non-financial reporting, helping them better understand the NFRD’s requirements and the importance of accurate data collection. Also, consider investing in capacity-building initiatives to enhance their workforce’s skills in sustainability reporting and compliance.
Create Strong Governance and Oversight
Effective governance is non-negotiable for successful compliance with the NFRD. To achieve this, establish oversight mechanisms, such as a dedicated compliance committee, to monitor reporting practices and ensure accountability. Regular audits of non-financial reporting can also help identify areas for improvement and enhance the reliability of disclosed information.
Build a Culture of Transparency
Promote a culture of transparency within the organization to boost compliance with the NFRD. As a part of this plan, encourage open discussions about social and environmental issues, emphasizing that non-financial performance is a priority for the organization. This cultural shift can lead to more accurate reporting and improved stakeholder trust.
Thus, these best practices can help you to better comply with NFRD.
Final Thoughts
To conclude, implementing compliance programs for the Non-Financial Reporting Directive is a critical undertaking for companies operating in the EU. While challenges exist, adopting best practices can help navigate the complexities of non-financial reporting. By understanding the key provisions of the NFRD, addressing potential challenges, and implementing effective compliance measures, organizations can contribute to a more sustainable and accountable business environment. Ultimately, embracing transparency and accountability can increase a company’s reputation and build trust among stakeholders, paving the way for long-term success.