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EU Directive: disclosure of non-financial information and diversity information

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EU Directive: disclosure of non-financial information and diversity information

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Tangible assets Intangible assets

From reporting year 2017, the legal requirements for transparency on non-financial information in management reports of large public interest entities (PIEs) will be stricter. In this paper, we will explain the background and content of this legislation. In addition, we will offer you tools to determine how compliant you are and which steps you can take to comply with the new legislation.

Why new legislation?With this directive, the largest organizations in Europe will be obliged by the European Union (EU) to be open about non-financial information such as their environmental and social policies and diversity on their boards of directors. The EU has adopted this directive for several reasons. First, transparency engenders confidence, both among investors as among consumers and other stakeholders. In addition, investors can better assess the opportunities and risks of their future investment if they are provided with insight into the policies and performance of non-financial aspects of the business. Research has shown that transparency also leads to better performance. It has become clear over the years that voluntary transparency has reached its limit. Given the increasing importance of non-financial information, the EU has therefore decided to legislate what is expected in terms of transparency. This will also promote the consistency and comparability of this information in the EU.

How does the new legislation tie in with market development?For investors and other stakeholders, it is important that an organization’s management report gives a realistic picture of its financial position, development, and performance. They not only look at the figures in the financial statements, but also at the non-financial information in the management report. Increasingly, importance is being attached to information about the business model, developments in the value chain and risks and opportunities, to obtain a comprehensive view of business performance and its sustainability. Aspects of sustainability and corporate social responsibility are facets of this. Improved transparency on non-financial company information will reduce the information gap between managers and stakeholders.

The importance of a comprehensive view on the financial position and performance of the organization, revolving around value creation in multiple domains (i.e. social, environmental, economic), is also reflected in the new Dutch Corporate Governance Code. The new Code focuses more on long-term value creation than previous versions. The committee that worked out the proposal for revision of the Corporate Governance Code sees corporate social responsibility as something that is no longer a separate goal, but an integral part of the daily operations of an organization focused on long-term value creation. This focus requires the executive board and the supervisory board to act sustainably, by focusing on long-term value creation, while paying attention to opportunities and risks, in the exercise of their tasks. In addition, the interests of relevant stakeholders should also be taken into consideration. The revised Dutch Code was published in December 2016.

The non-financial aspects of organizations are becoming an ever-greater factor in how the total value of organizations is determined. The following illustration shows that intangibles increasingly determine the market value of organizations. Valuation methods have begun to take more account of aspects which are not included in the financial statements.

Market value structure of the S&P 500

EU Directive on disclosure of non-financial information and diversity information

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Legislative developmentThe EU Directive on disclosure of non-financial information and diversity information (2014/95/EU) was published at the end of 2014. The European Member States were given two years to transpose the EU Directive into national legislation.

This transposition into Dutch legislation took place at the end of 2016. The Dutch legislation covers reporting on financial years beginning on or after 1 January 2017. Thus, organizations must report on non-financial information for the first time in 2018, in the management report covering the year 2017.

The transposition of the Directive has resulted in two separate decrees: “Disclosure of non-financial information” (Bekendmaking niet-financiële informatie) and “Disclosure of diversity policy” (Bekendmaking diversiteitsbeleid). The decrees are embedded in Dutch legislation in Section 391(5) of Book 2 of the Dutch Civil Code.

Who does it apply to?Disclosure of non-financial information applies to large public interest entities (PIEs). PIEs are listed companies, banks, insurance companies, and other organizations designated as public interest entities by the government. 12 “Large” PIEs means that the organization must have at least 500 employees. In addition, an organization must have either a balance sheet total of more than €20 million or a net turnover of more than €40 million.

Disclosure of diversity policy only applies to large listed companies. A large listed company meets at least two of the three following criteria: balance sheet total of more than €20 million; a net turnover of more than €40 million; An average number of employees for the year of more than 250.

For parent organizations, the consolidated figures of the whole group are looked at to determine whether there is an obligation to disclose non-financial information. This large parent organization is then also obliged to provide insight into the non-financial information of the entire group. A subsidiary organization is exempt from this reporting requirement. This applies even if the subsidiary is a holding company and the parent organization reports.

Impact on organizationsLarge public interest entities (PIEs) are required to disclose non-financial information. There are estimated to be 115 of such entities in the Netherlands. Especially the “stragglers” must get a move on to provide insight into non-financial aspects that are necessary for gaining an understanding of the development, financial position or performance of their organization. But many organizations that already provide extensive non-financial information will also have to verify whether they meet all the requirements of the new legislation. The great variety of topics in and degree of depth of the new legislation requires organizations to have adequate data management and reporting systems. We therefore recommend that you make a detailed inventory of the impact of the new legislation on your external and internal reporting and their underlying processes. A pilot study of 12 Dutch frontrunners has shown that none of these organizations report on everything that is required under the new legislation, when looking at their reporting for the year 2015. We therefore expect that most organizations covered by this legislation will have to take steps in the coming period to ensure full compliance in the reporting year 2017.

• For more research results, please refer to the section “To what extent are Dutch companies already compliant?”.

• For a structured approach to determining the degree of compliance of your organization, please refer to the section “Ensuring you are compliant”.

The Corporate Governance Code applies to Dutch listed companies and contains principles and best practices for the governance of listed companies and reporting on this to shareholders. Each year, Dutch listed companies check their governance against the principles and best practice of the Code and report on their level of compliance.

What exactly does this new legislation entail?

1 For the definition of a “PIE”, see the “Richtlijn jaarrekening” (Directive on Financial Statements), in Section 398(7) of Book 2 of the Dutch Civil Code.

2 Currently, no other organisations have been designated as public interest entities (PIEs) in the legislation on financial statements apart from listed companies, banks and insurance companies.

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The expectation is that it will be relevant for organizations who are not required to report this information, to also acknowledge these legislative requirements in their reports. By including non-financial information and diversity information in their reporting, organizations can engender good governance and social responsibility. In addition, stakeholders in the chain may ask for this information. What must be reported?An organization should at least provide insight into how it deals with environmental, social and personnel matters, respect for human rights and the fight against corruption and bribery in its own business and value chain. In relation to these issues, concrete insight should be given into the:

• Policy pursued (if present, including implemented diligence procedures).

• Results of the policy pursued.• Principal risks and their management.• Non-financial performance indicators.

Insight into the company’s business model is important when it comes to placing the above information in the correct context. Therefore, a description of the company’s business model is one of the statutory requirements.

In addition to the above, large listed organizations must also provide insight into their diversity policy as it relates to their executive board and supervisory board. Little diversity can lead to groupthink, which can stand in the way of innovation and growth. In addition to the policy itself, the report must provide insight into on how the policy is implemented. Furthermore, objectives and results must be described. A description of the company’s diversity policy could extend to multiple forms of diversity, such as age, gender, geographical origin, training, and professional experience.

Disclosure of non-financial information

Disclosure of diversity information

Large public interest entities (PIEs) Large listed companies

Large public interest entities (PIEs) meeting at least two of the following criteria:

• An average number of employees for the year > 500.

• Balance sheet total > 20 million or net turnover > 40 million.

Large listed companies meeting at least two of the three following criteria:

• An average number of employees for the > 250.

• Balance sheet total > €20 million.

• A net turnover > €40 million.

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How to report?The non-financial statement must be included in the management report as a whole, for example in a separate section. An organization providing insight into the non-financial information in the form of a separate report would not meet the new reporting requirement. The Dutch legislation requires the non-financial statement in the management report to form a coherent whole with the other information in the management report.

Although the guidelines provide for a broadening of the reporting obligation, they do not aim to ask organizations to report on irrelevant matters. Only information that is needed to understand the company’s developments, performance and financial position should be included in the management report. To be compliant, any environmental, social, personnel, human rights, corruption and bribery matters that are relevant to the organization should be discussed.

Should an organization not have a policy in place for one the aspects referred to in the directive, it must include a clear and substantiated account of why this is the case. If reporting the requested information could cause serious damage to the commercial position of an organization, it can choose not to include certain information, again providing an account of its reasons for doing so. Such an exemption may only be made use of in exceptional cases. Whether such a case exists must be determined by the organization’s board.

Business modelYou should provide at least a general description of the core processes and activities of your organization in order to place further non-financial information in the correct context.

WhereThe information must be published in the management report.

ThemesProvide information on:• Environmental matters.• Social and personnel

matters.• Respect for human rights.• Anti-corruption and bribery.

AspectsThe following aspects must be addressed for each theme:• ➢The policy pursued.• ➢Outcomes of the policy pursued.• ➢The principal risks and their

management.• ➢Non-financial performance

indicators.

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1. Identifying gaps

2. Drafting policy

3. Measuring re

sults

4. Reporting

5. A

ssur

ance

EY has developed a five-step approach helping you align the legislative requirements with your current policy and reporting processes.

Five-step plan

1. Identifying ‘gaps’We recommend that you start by performing a gap analysis to determine the extent to which you may already be compliant. This will help you ascertain for

which relevant themes your organization already has policy in place and where it is still lacking. You can then identify whether, in addition to information on policy, you are already collecting and publishing information relating to performance, risks and key performance indicators (KPIs) with respect to the four themes (social, environmental, human rights, anti-corruption & bribery). Within each theme, you can determine the factors that are most important to you, and which you

Ensuring you are compliant

will use to manage the theme. This inventory will clarify the extent to which the four central themes of this legislation are already embedded in your reporting processes.

Risk inventoryIf your organization does not report on the main risks regarding social, environmental, human rights and anti-corruption and bribery aspects in its own operations and in the value chain, these must be included in the reports. Moreover, these must be included in existing risk management processes and activities, while appropriate measures should be established to manage or mitigate these risks.

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Call for action How can EY provide support in this process?

Identify the requirements of the EU Directive (2014/95/EU) and design policy, data management and reporting framework accordingly.

Compliance gap analyses, data management support, data quality checks, KPI definition, readiness reviews, and assurance engagements.

The EU will publish a guide in the spring of 2017 to support organizations to comply with this new legislation. The guide will help organizations design their reporting processes by providing a method that will simplify the disclosure of relevant, useful, and comparable non-financial information.

2. Drafting policyFor relevant topics for which no policy has yet been formulated it must be determined whether policy will be developed or it is to be explained why there is no policy

for that item. Subsequently, policy must be developed, if necessary. For topics on which you are not yet including information in the management report you must determine which relevant information you wish to provide and how it will be internalized in your current data systems and reporting processes.

3. Measuring resultsMeasure the progress in your business and value chain with respect to the relevant themes for which policy has been formulated. Measure the progress based on quantitative

performance indicators, which are comparable over time. If not present, these must be formulated and included in the data management processes.

4. ReportingAs required by the legislation, the information must be included in the management report. If certain information is omitted, this must be mentioned with a note in accordance

with the so-called “comply or explain” principle. Merely mentioning that a topic is not relevant and therefore has not been included in the report is not enough to comply with the legislation. In such a situation, it is also important that you explain why a particular topic is not relevant, based on a clearly substantiated account.

5. AssuranceOnce your data systems and reporting standards are sufficiently in order you may also choose to have the reported information verified by an external auditor.

An assurance engagement is aimed at obtaining evidence to provide assurance that the management report, which includes the non-financial statement, is free from any material misstatements. Such an assurance engagement may be aimed at obtaining a reasonable level of assurance or a limited level of assurance. If the latter, the work entailed will be less extensive.

The work following the adaptation of ISA 720 and the consistency assessment of the decree ‘disclosure of non-financial information’, are not an assurance engagement. Such an assessment only looks at whether the information in the management report is consistent with the financial statements and whether the management report contains any material misstatements based on the knowledge and understanding of the organization and its environment already obtained during the audit of the financial statements. For more information about this, see the section “Monitoring compliance and the role of the auditor”.

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In the new legislation, using internationally recognized frameworks and standards to prepare and publish the requested information is allowed. Below you will find several international standards that are often used in the context of reporting. Below we will explain their connections regarding content and where the international frameworks overlap with the new legislation.

GRI G4The Global Reporting Initiative (GRI) has published the G4 Guidelines (and further to these, the GRI Standards3) to stimulate improvement in sustainability reporting. The goal of the Global Reporting Initiative is to offer a worldwide framework allowing a standard approach to transparent and consistent sustainability reporting. To facilitate implementation of the EU Directive, the GRI has created an overview of how the requirements in the EU Directive can be linked to the G4 guidelines (or G4 standards)4.

Integrated Reporting Framework (IIRC)The Integrated Reporting Framework of the IIRC provides organizations with a framework for integrated reporting on such matters as their strategy, financial position, and performance. To this end, both financial and non-financial aspects are considered, by looking at six different forms of capital: financial, manufactured, human, intellectual, social & relationship, and natural. The Integrated Reporting Framework has been designed to provide investors and other stakeholders with information on how an organization can create value in various domains (i.e. social, environmental, economic). Application of the principles of integrated reporting makes a management report more meaningful. The themes discussed in the new legislation can be linked to the various forms of capital of the framework. In this way, your organization can provide insight into how the themes: environmental, social and employee issues, respect for human rights, and the fight against corruption & bribery are part of the value creation process. The new legislation also asks organizations to provide a description of their business model. By revealing their value creation model in their reporting, this legal requirement is also met.

OECD guidelinesThe OECD guidelines provide tools for organizations to deal with issues such as supply chain responsibility, human rights, employment and labor relations, the environment and corruption. The four themes discussed in the new legislation thus overlap with the OECD guidelines. The OECD guidelines contain principles and standards for good behavior, in accordance with the applicable legislation and internationally recognized standards. Organizations are free to comply with the guidelines (which are not legally enforceable) on a voluntary basis. With the advent of this European legislation it will become mandatory for large European public interest entities (PIEs) to report on some of the topics covered by the OECD guidelines.

Global CompactThrough the Global Compact, the UN seeks to link up companies, UN organizations, trade unions and civil society organizations. The idea is that together these parties will contribute to international corporate social responsibility. Parties which have joined the Global Compact endorse the ten principles of this UN initiative. These principles address the same themes in the new legislation, namely: human rights, working conditions, environmental protection, and the fight against corruption. The Global Compact seeks to uphold the fundamental responsibilities that organizations have with respect to people and the environment by integrating the 10 principles into strategy, policy, and organizational culture. The Global Compact also considers these principles to be essential to long-term commercial success. With the advent of the new European legislation it will become mandatory for large European public interest entities (PIEs) to report on the four main themes of the Global Compact.

International frameworks

3 MAKING HEADWAY IN EUROPE – Linking GRI’s G4 Guidelines and the European directive on non-financial and diversity disclosure” (2016) – This document can be downloaded at: www.globalreporting.com

4 The G4 Standards will become effective for all users on July 1, 2018, where an earlier application is recommended.

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Previous involvement of the auditor in the management report

Current involvement of the auditor in the management report after amendment of the EU Directive 2014/95/EU and adjustments of ISA 720

Presence check: Does the management report contain all legally required elements?

Presence check: Does the management report (including non-financial statement) contain all legally required elements?

Consistency assessment: Is the information in the financial statements and in the management report consistent with each other?

Consistency assessment: Is the information in the financial statement and in the management report (including non-financial statement) consistent with each other?

Be careful to notice any indications of material misstatements in the management report:Does the content of the management report (including the non-financial statement) correspond to the knowledge obtained about the organization during the financial statement audit?

For organizations that fall under the scope of the new legislation, the auditor should assess whether all aspects of the non-financial statement have been included (aanwezigheidstoets, i.e., presence check). In addition, the auditor must assess whether this statement is consistent with the financial statements and does not contain any material misstatements considering the knowledge obtained during inspection of the financial statements (consistency assessment).

The consistency assessment and the presence check were already present in previous legislation but now that the duty of disclosure has been extended much further, these checks have become more relevant. Under the new legislation, the non-financial statement must now be published as part of the management statement and thus be included in the auditor’s checks.

Internationally speaking, auditors tasked with auditing financial statements are now also responsible for the other information in documents containing financial statements. The International Auditing and Assurance Standards Board (IAASB) has amended “International Standard on Auditing 720 – “The Auditor’s Responsibilities Relating to Other Information”. This deals with the auditor’s responsibilities relating to the other information included in an entity’s annual report. The auditor is now expected to read the other information and, in doing so to consider whether there is a material inconsistency between the other information and the financial statements and consider whether there is a material inconsistency between the other information and the auditor’s knowledge obtained in the financial statement audit. While reading the other information, the auditor shall remain alert for indications that the other information appears to be materially misstated. If the auditor encounters any material inconsistencies, further investigation will be required.

Monitoring compliance & the role of the auditor

How does the legislation in other EU countries compare?The EU Directive contains several Member State options that gives Member States the option of implementing the legislation in national legislation as they see fit within certain parameters. For example, in Sweden the scope is broader than in the Netherlands and organizations with over 250 employees already qualify. Furthermore, compliance with the new legislation can be checked in various ways. In some countries, the auditor only has to check whether the information is present (the “presence check”). In other countries, the member State option is implemented that prescribes that the non-financial statement is subject to assurance by an external auditor. Italy, for example, will likely make use of this option.

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Transparency BenchmarkThe Dutch government has been making efforts for some time already to encourage large enterprises to be transparent about the non-financial side of their operations. For example, since 2004 the Transparency Benchmark has aimed to stimulate the 500 largest organizations to be transparent about non-financial performance. The organizations that fall under the new legislation are also part of the group of organizations under review in the context of the Transparency Benchmark, and are therefore already familiar with a significant portion of the contents of the legislation. And yet, several organizations with a high score on the Transparency Benchmark do not comply with all aspects affected by the new legislation. The Transparency Benchmark may be used in the future to monitor the new legislation via a set of custom criteria.

Pilot among Dutch organizations EY carried out a pilot study on twelve front-runners in the Dutch Transparency Benchmark on the degree to which the reporting of these organizations (PIEs) already meets the requirements under the new legislation. The study showed that none of the front-runners from the pilot group report on everything that is required under the new legislation, when looking at their reporting for the year 2015. This means that even the front-runners in reporting will have to take steps in the coming period if they want to become fully compliant in 2017.

Principal findings • ➢All organizations in the pilot group provided a description of their

business model.

• ➢Seventy-five per cent of the organizations provided insight into their diversity policy (including implementation, goals, and results) as it relates to their Executive Board and Supervisory Board.

• ➢Over 50% of the organizations report fully on the matters stipulated by the requirements on social and environmental matters.

• ➢Only a few organizations report fully on the themes respect for human rights, and anti-corruption & bribery. Most organizations do provide insight into their policies regarding these two themes, but information on performance indicators and risks is often missing.

• ➢Half the organizations in the pilot group publish the complete non-financial statement as part of the management report. The other half place the non-financial statement in a separate report, or include parts of the information in an attachment to supplement the management report.

The above radar chart shows the number of organizations in the pilot group that meet the requirements in the various areas.

Management report component12

10

8

6

4

2

0

Combating corruption and bribery

Diversity

Business model

Respect for human rights

Social and personnel matters

Environmental matters

To what extent are Dutch organizations already compliant?

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Call for action How can EY provide support in this process?

Gain insight into the content of this legislation and the opportunities it creates through greater transparency and better governance in non-financial issues.

EY can provide you with further details and answer any questions that you may have. For more information, contact please one of the persons below. The new legislation is an important step towards greater transparency and accountability for overall business performance and its impact on society.

This legislation has important implications for large enterprises and the external auditors. Because the impact of the required transparency is expected to extend through the chain, the scope of this legislation will reach further than just the 115 Dutch organizations for whom the legislation was drafted. The pilot study carried out on the front-runners of the target group revealed that none of the organizations is fully compliant with the new legislation based on their 2015 annual reports. We therefore expect that many organizations will need to act if they are to fully report on the requested information. We therefore recommend that organizations study the new legislation carefully and make an inventory of compliance therewith to mitigate potential social, reputation and compliance risks, and above all seize the opportunities offered by this integrated approach.

In conclusion

Jan Niewold Tel: +31 (0)6 21 25 16 64Email: [email protected]

Remco BleijsTel: +31 (0)6 29 08 31 18Email: [email protected]

Stefan van SabbenTel: +31 (0)6 55 44 26 40Email: [email protected]

Nancy Kamp-RoelandsTel: +31 (0)6 29 08 45 29Email: [email protected]

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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.

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