Risk disclosure demands rise as European Parliament adopts new directive

The directive demands that companies disclose information on policies, risks and results pertaining to environmental matters, social and employee-related aspects, respect for human rights, anti-corruption and bribery issues and diversity on boards of directors. Following this week's adoption by the European Parliament, the Council is expected to formally adopt the proposal in the coming weeks. The directive adds to rising pressure on board directors from regional and national legislators and regulators to properly identify risks faced by the companies that they manage, ensure that these risks are managed in a proactive way and are transparently reported.hideIn the UK, for example, The Financial Reporting Council (FRC) carried out a consultation late last year on changes to the UK Corporate Governance Code, guidance for boards of listed companies and standards for auditors covering risk management and reporting that it plans to implement later this year. The FRC said that the proposals aim to raise the bar for risk management by boards. These proposals set out how the FRC will implement the recommendations of Lord Sharman's 2012 inquiry: Going Concern and Liquidity Risks: Lessons for companies and auditors. This inquiry looked at the corporate governance and reporting lessons to be learnt from the failure of ostensibly healthy businesses in the financial crisis. When the consultation was launched, Melanie McLaren, Executive Director, Codes and Standards at the FRC said: "Risk management is one of the most important responsibilities of the board. Understanding the principal risks facing the company is essential for the development of strategic objectives, and the ability to seize new opportunities. For investors, as providers of risk capital, knowing how the board is managing and mitigating risks is an important indicator when judging whether the company will be able to deliver the value that investors seek." "The new guidance, and the proposed changes to the Code, highlight the issues that boards need to consider when assessing and managing risk, crucially including risks to solvency and liquidity. We have placed considerable emphasis on the need for robust assessment by boards and on the important role of auditors in ensuring reliable communication to investors," she added. In a parallel development, Europe is ramping up its corporate governance and risk management requirements, not least through the new directive. Earlier this week the European Commission said that it welcomed the adoption by the European Parliament of the directive on disclosure of non-financial and diversity information by large companies and groups. Internal Market and Services Commissioner Michel Barnier said: "I am pleased that the European Parliament has adopted this directive modernising the disclosure of relevant and useful non-financial information by large companies and groups. Companies, investors and society at large will benefit from this increased transparency. Companies that already publish information on their financial and non-financial performances take a longer-term perspective in their decision-making. They often have lower financing costs, attract and retain talented employees and ultimately are more successful. This is important for Europe's competitiveness and the creation of more jobs. Best practices should become the norm." The EC explained that the new rules will only apply to large companies with more than 500 employees. It recognises that the cost of applying the rules to small and medium-sized enterprises (SMEs) could outweigh the benefits. The EC believes that some 6,000 large companies and groups across the EU will have to apply the directive. The EC stresses that it is trying to ensure that the administrative burden is kept to a minimum. "Companies will be required to disclose concise, useful information necessary for an understanding of their development, performance, position and impact of their activity, rather than a fully-fledged and detailed report. Furthermore, disclosures may be provided at group level, rather than by each individual affiliate within a group," stated the EC this week. It added that the directive also gives companies 'significant flexibility' to disclose relevant information in the way that they consider most useful. Companies will be allowed to use international, European or national guidelines that they consider appropriate such as the UN Global Compact, ISO 26000 or the German Sustainability Code. On the tricky matter of diversity within company boards, large listed companies will be required to provide information on their diversity policy. This will include age, gender and educational and professional background. Disclosures will set out the objectives of the policy, how it has been implemented and the results achieved. Companies that do not have a diversity policy will have to explain why not. This approach is in line with the general EU corporate governance framework, the so-called 'comply or explain' approach. The EC also explained that the directive represents a first step towards the implementation of the European Council conclusions of 22 May 2013 on the need for further transparency on tax matters and for ensuring country-by-country reporting by large companies and groups. "The Commission supports this objective and will endeavour to deliver effectively on the review clause included in this legislation," stated the EC. Country-by-country reporting is the requirement for large companies to produce certain information, notably on taxes paid, by each country in which they have operations. "With more transparency, tax evasion and fraud will become more difficult. Transparency is complementary with other measures, such as strengthening international cooperation," stated the EC this week. The disclosure directive requests that the Commission examines and reports back by July 2018 on the possibility of the introduction of an obligation that would demand large undertakings produce a country-by-country report that contains information on, as a minimum, profits made, taxes paid on profits and public subsidies received on an annual basis. The European risk management community has not formally responded to the new directive on non-financial disclosure yet. But Ferma's public affairs manager Julien Bedhouche did publish a note at the start of this month on transparency and financial disclosure that specifically referred to the country-by-country reporting element of this and other related proposals. Mr Bedhouche pointed out that for over a year now there has been a 'strong politicalwill' to greatly increase transparency over corporate financial transactions. He said that several amendments from members of the European Parliament (MEPs) requesting the introduction of some country-by-country reporting provisions were added to the original proposal from the European Commission on the non-financial reporting directive. Ferma asked why this trend has emerged and what pressure is being applied to adopt formal and annual country-by-country reporting by 2018. It identified two key 'protagonists'. First, the member states of the European Union. "Because of budget issues and sensitive public opinions, country-by-country reporting is partly connected with the fight against tax evasion," stated Mr Bedhouche. Second, NGOs are lobbying 'really hard' to put financial transparency at the top of MEPs' agendas, encouraging them to introduce amendments in several different EU draft laws, he added. And Mr Bedhouche pointed out that country-by-country reporting has also been considered in the Anti-Money Laundering Directive, which has also received amendments from MEPs to include 'aggressive tax planning' disclosures. The European Parliament adopted those amendments on 11 March, 2014 during a plenary session in Strasbourg. So what does it mean for risk managers and their companies? "Pressure for financial transparency can be now considered as a regulatory risk for several reasons. The possible full implementation of country-by-country reporting provisions for large companies and for every sector of activity will have an internal cost in terms of time and resources. It could also take unprepared firms by surprise and lead to possible fines for some cases," said Mr Bedhouche. Moreover in two to three years from now Ferma believes that country-by-country reporting will become a reputation risk. "Again, unprepared or unaware organisations could face a risk of public naming and shaming for some lack of scrupulous country-by-country financial disclosure. Several companies have already suffered negative media coverage after being singled out for 'aggressive tax planning," pointed out Mr Bedhouche. Only this week, for example, Coffee retailer Starbucks announced its decision to relocate its headquarters from the Netherlands to the UK, where it will pay more tax, in response to intense media and political pressure over its corporate tax policy. For Ferma the message is clear for individual risk managers. "Risk managers must be aware of the possible impact of such financial transparency over their corporate structure and so need to be knowledgeable about the financial flows of their organisation. They should regularly inform their upper management (board, C-suite, audit committees...) of the possible consequences of such new regulation on competiveness and also reputation," stated Mr Bedhouche. "There is still time to adjust and adapt to comply with the future financial transparency standards. Here, risk managers have a role to play as an early warning function," he added. "By being leaders in financial transparency, European companies could also suffer temporarily from a competitive disadvantage compared to other regions of the world with less stringent regulations on the matter. Public authorities must think globally on this issue," concluded Mr Bedhouche.

Risk disclosure demands rise as European Parliament adopts new directive

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