Richard Howitt, was the rapporteur for the Non-Financial Reporting Directive, he recalls the hurdles he faced to bring the directive forward – not too dissimilar to discussions currently taking place in the trialogue for the CSRD. Interview by Vincent Huck.
You were the rapporteur for the NFRD – can you tell us how you got involved in the first place?
I was a long-standing member of the European Parliament and in Europe, MEP's are specialized in their roles to be a bridge between the technical level and the political level.
I came partly from an international development perspective, and from the 1990s I was interested in how European companies were impacting the fight against world poverty and how their operations in developing countries were bringing genuine local benefit to local communities and to the country.
I organized a series of parliamentary hearings about that, working with specific companies to explore it. But it became increasingly clear to me that it needed a systematic response and the European Union at that time didn't have any policies whatsoever towards corporate responsibility.
I wrote a report that was agreed in parliament in 1999. That essentially made the case and got agreement for the European Union to open up a policy programme across many fields in relation to responsible business conduct, what at the time we called Corporate Social Responsibility.
One of my recommendations was that we should reform the accountancy directives to bring in social environmental reporting. It wasn't well received at that time. It was it was ahead of its time.
But there were people out there, not just me, who could see the virtue in doing that. And so, I was involved in advocacy and campaigning over the next decade to actually make the case for this to happen.
I got involved in work with the Global Reporting Initiative (GRI), with the Organisation for Economic Co-operation and Development (OECD), I represented the European Parliament through six years of development of the UN guiding principles on business and human rights. And all of that led me to the conclusion for myself personally – that reporting, and transparency had a key role to play.
It's not enough on its own and I've never suggested that. But I became more and more convinced that reporting was a crucial driver if we are really to get change, and more and more people within business, within the accountancy profession, within wider stakeholder groups were coming to the same conclusion at the same time.
So, the policy environment for that to be a non-financial reporting directive was much changed in those 10 years. I do have to give great credit to the European Commission, I had very good colleagues, some of whom are still there who understood these arguments, and in particular to then Commissioner Michel Barnier who in the end showed the political courage to bring forward the initiative.
I'll always be very grateful to him.
All of that led to the directive which again was still not well received. Particularly the business community, some individual business and leaders were very supportive, but still the mainstream business associations and Federations were cautious at that time.
But one of the things I'm proudest of is that there was a survey by Eurostat after NFRD had been implemented, and it found the directive was the most popular initiative, also by businesses, that had come from Europe on corporate governance.
It showed that it helped change business attitudes and to some extent, investor attitudes, I think, towards the case for reporting, transparency and sustainability issues by business.
There are obviously different stakeholders in that environment you describe between the policymakers, the businesses, the accountancy profession, and civil society through NGOs' initiatives. Who was the main opponent of the idea at the start? Just businesses? Or policymakers as well?
Oh, policymakers as well! The idea was ahead of its time and you have to build support for these things, and I stress that I was part of a network of people it's by no means myself alone.
But yes, there are many policymakers who thought it was dangerous regulation. There were many stakeholders who were supportive, but perhaps didn't think it would make the difference at the local level in reality.
And there were other debates going on as always in policy. In public policy, you're always competing for attention and competing for priority. We're talking about the period just after the global financial crisis; regulators, businesses, and many were looking elsewhere, like the issues of financial prudence, liquidity, and Basel reform.
Because of the nature of policymaking, you had to compromise, what aspect of NFRD didn't come out that you wished you could have pushed for?
There were many things, but you are right to start your question by saying that every single piece of European legislation is a compromise. It's the very nature of European politics, and this was no different. And so, getting the regulation was important.
The fact that the scope was substantially applied, we think, to around 12,000 companies for whom the vast majority (90%) were not doing sustainability reporting beforehand, so were going to be doing it for the first time; the fact that we got supply chain in; the fact that we got due diligence in.Before I answer what didn't go in, there are lots of things that I hope were groundbreaking, and have really led to what's followed since.
And what didn't get in?
We didn't manage to get public interest companies within the scope. I think that got out-voted at the last minute. So, it was it was limited to listed companies, which restricted its scope.
We had to compromise around prescription, should it have been a bit more prescriptive? Probably. We had to enable companies to comply with it through using many different frameworks, all of which were said to be acceptable. That was a key flaw in that it didn't enable comparability. That's the difference, between then and now. We got companies to report to do what I hope was meaningful reporting. It certainly changed thinking within companies, helped change the debate and the atmosphere overall on the subject, but we didn't end up with open comparable and consistent reporting by companies, and that particularly failed the investor test and most of the reports that companies produced were not used or well regarded by investors.
But we did what we could when we could, it was impossible to go further in 2012/2014. It's led to what has happened since in some great measure. So, I would defend what we did on that ground.
Would you say that CSRD is addressing some of those points the way that you wanted to address them?
Yes, indeed. I'm excited by the CSRD. I've written and spoken that it is time for an update, I'm completely non-defensive about changing the directive that I helped author.
I broadly like the draft put forward by the European Commission. The aspect of making it really useful for investors by making it comparable. There's going to be a digital tagging, which is going to make them much more accessible. And key, instead of a myriad of different frameworks that could be used to report, there is this unprecedented, really an astonishingly, interesting, exercise that the Commission has mandated to EFRAG to develop standards.
Those standards, like any other standards, will be changed over time, will be more malleable and flexible than legislation can ever be, but will give far more guidance and direction to companies on what they need to report and how they need to report it.
The working papers that have been produced by EFRAG suggests that the standards that will come through will be extremely detailed. There's going to be a lot of water to flow under the bridge and a lot of argument about them and there will still be many people who say, 'what is being brought forward by EFRAG is over prescriptive'. But nevertheless, it's going to be at an entirely different level, and it will be comparable to large measure.
This is a huge change, and the commissioner has been steadfast really in putting that forward. And we all wondered whether the member states in the European Council would go for it, but they have – and there are still arguments going on, for example about scope, but I'm confident CSRD will advance and the standards will come.
It's quite remarkable that the things you had to compromise on, like scope, are the same sort of key battlegrounds of compromise that are ongoing with CSRD...
It is fascinating, but there are two things about that: the fact that that's the main argument shows that many of the other issues there is consensus around, and that is a very good sign.
And then on scope, I am persuaded by the argument that SMEs in key risk sectors should be included, and I hope it will be. But even without that the European Commission's proposal will apply to, we think, 50,000 companies, so four times plus the directive that I advocated and campaigned for. That's an unbelievable scale of change.
Even though we should acknowledge the arguments that are going on, let's not lose the weight of truth that this is now spreading like wildfire across the business community, and it is becoming part of the norm.
Beyond scope, what are the areas where the CSRD proposal will be challenged on in the trialogue?
There's a danger that one of the compromises is to delay implementation and I would be very, very worried about that. And there are suggestions that simplified reporting requirements for SMEs, that do exist within the proposal, may take longer, but we need to measure that against the impact. We need to make to move to a sustainable financial system, to move to net-zero, in time, to make a sizable impact on the sustainable development goals (SDGs). And if we delay too long, I think that's a concern.
A third one would be the issue about the balance between the risk-based approach and the more prescriptive box ticking approach and that's a huge debate always amongst companies. I'm myself more comfortable with the risk-based approach but the right balance for how materiality is determined, how companies say materiality is determined and published, there is still a lot of detail in that, that we still have to get right.
One aspect you haven't mentioned yet is the auditability of that information, which CSRD introduces. It is quite remarkable that today you hear this sort of unanimous acceptance that this information is not only going to be disclosed, it is going to be audited. Five or six years ago, auditors themselves didn't want anything to do with 'sustainable information auditing'... have we just witnessed a giant leap in that regard?
Yes, we have. Back in 2012/2014, we couldn't keep it in and that's one of the areas we had to compromise on because one country blocked NFRD at the Council if we didn't take out auditing. But gradually the number of companies using audit and verification of different methods and levels has crept up, and they are asking of their auditors to provide those audits.
But what has really drove this sea of change in the audit world is the investors' demand, this has really changed the landscape.
Now you won't find amongst the major audit and accountancy companies anyone suggesting they don't want to be doing it. And I praise the Commission for including it in CSRD and going as far as actually determining what is a good audit and what isn't.
It remains a threat to the traditional audit firms that others could come in and fulfil those criteria. There's a challenge to those firms to step up to the task, not just in their willingness to do it, but in also meeting the standards that have been set for them to do it.
Going back to the standards we are seeing the development of international standards under the IFRS Foundation and EU standard under EFRAG, is that beneficial on the long run to have two sets of standards, and how should they interconnect?
If you look across the whole standard setting arena, it's not unusual to have European standards and global standards and for there to be an interface between the two. So, this is not a unique challenge whatsoever and companies in terms of standards for product and service regulation, are completely used to having both European and global standards and this is just part of the norm. Let's not build up the differences more than we have to.
I really do believe that over time, they will converge and should converge.
The exact relationship between the two I accept isn't easy, especially at this point. The different definition of materiality is often cited as the main difference between the two and I do think there's some fundamental issues there that I wouldn't want to cover over. But in the end, what's driving this is the pressure of the challenges of climate change of social breakdown. And so that outside pressure, will cause these two systems to work together coherently.
One of the key differentiators between what the IFRS Foundation is doing and what the European Union is doing, and you mentioned it, is the question of materiality. The European Union's sustainability agenda, including CSRD, is very much rooted in the idea of double materiality. Whereas the IFRS foundation is criticized because they haven't fully embraced double materiality, even if its first two standards released earlier this year mention "dynamic materiality". How do you feel about this?
This is why I'm an optimist on that question. First of all, the enterprise value creation approach is really important in demonstrating that this really matters to business.
For all the years I was at the IIRC, the danger was that sustainability reporting could be polished and perfected all we liked, but if it wasn't really translated into business strategy business model if it wasn't an issue for the board, if they didn't believe that it would also have a financial consequence, then it wasn't really effective, it wasn't going to do the job.
Using the enterprise value creation approach, I think, has been an essential part of businesses understanding that this is integral to them and their sustainability.
And so I don't apologise, there'll be some in the stakeholder world who won't like this, but I don't apologise for the enterprise value creation approach. Because that's been absolutely essential to show that the risks that are there for business are real to their financial books.
So, then you come to the impact side of the equation, which people criticize the IFRS foundation over. What I think is not understood about double materiality is that it is moving fast. And while there is more confidence and security in the business world around enterprise value creation at the moment, if you look at the work of the impact management project now platform, if you look at the rise of impact investing, not just ESG investing, you've got rapidly improved understanding of how we measure and understand and make an impact from a business point of view. And that's going to carry on accelerating very fast so that all of those questions about impact on whether the data is reliable, consistent and comparable will be answered.
The second reason that makes me optimistic about that question is that investors are increasingly saying they want this to happen, so you watch that investor demand make that difference over the next years.
What do you like about the EFRAG standards and perhaps don't like?
They've got a good orientation towards what should be generic, what should be sector specific, what should be entity specific, and not trying to put the wrong questions in the wrong boxes. And understanding that in terms of viability in the reporting make it really workable, a lot of the detail on the sector specific standards is still to come, but that's rooted in their entire approach. So that's something I like about them.
I like the fact that they've got good people involved in detailed work. The quality of the standards, results from the quality of the people that they've had doing it. And I hope and believe that that will continue. And I do like the fact that they're looking across the board not to climate first, they're anticipating all of the ESG issues that impact the company. That's essential, all these issues are connected, I've always argued for that
The EFRAG standards are going to be immediately connected to implementation because they're going to be connected to the directive. And so, we're not just talking about another framework which may or may not be successful over how many years, but it will mount to something that really is going to happen, and that companies will have to implement.
If I had a criticism, the speed is breathtaking so to take it all in and meaningfully, and being able to respond to that it's hard, particularly for people in business.
Businesses are always going to be worried about over-prescriptiveness and perhaps that is part of the debate. But people are worried about it in this instance, because if they haven't been involved intimately in the debates, they read it for the first time, and they find it quite scary and off putting.
What about the global standards?
We know less about the global standards because we've only got general requirements and climate. What I would say about climate in particular is it's pretty good. From my point of view, it's really robust and impactful – if I can use that word – piece of work.
I do think the attempt to bridge the gap on double materiality by calling it dynamic materiality doesn't really answer the question. It's a neat way of answering the criticisms and give the appearance of being consistent with the enterprise value creation approach. But in the end, if the dynamic materiality only means it comes into the finance books too late, that doesn't answer the question at all. that's a bit of a worry. And the attempt to have a focus on climate first is understandable. I worry about that, because I believe that there's interconnectivity between all of the different societal and environmental influences on the company and I would like them to have a timetable that takes a broader approach sooner, though, we don't have a firm timetable.
I still worry, and I would say this because of my work on integrated reporting, about connectivity. Everyone is for the principle of that happening. But the detail of how it should happen, there's still a lot of work to be done. And so, the danger is that it fails that test and we would still be stuck where we were 10 years ago, with good sustainability reporting that doesn't actually affect what business decisions business or investment decisions had.
You mentioned your role at the IIRC. One thing you tried to do there was to bridge the gap between the different reporting initiatives and cut through the alphabet soup of initiatives. Although as an observer one could see you were really trying, it's fair to say you didn't manage to do it back then. But it seems it is happening now, the value reporting foundation has been created, and these initiatives seem to regroup under broader umbrellas. Do you see that as a real movement, or do you still see them trying to fight their corner?
You're partly right and partly wrong. Having a multiplicity of different frameworks and standard setters was the problem. And each of those would say at the time 'just to talk me, I'm the best one' that was not a forward looking.
When I went to the IIRC I put great emphasis on getting cooperation and alignment between the different frameworks. We ran the corporate reporting dialogue, we sponsored the TCFD, we ran a 1.5 million project to get alignment between different frameworks around TCFD recommendations, and to lay the path for what would happen next.
I have to say again, I'm proud I think that was the essential step, which has helped us to get to where we are.
One of the big question marks on getting convergence globally is what is going to happen in the US?
A huge challenge to the global standards is what happens with America and it's the same challenge that the IFRS standards faced. They never gained traction in the states and what happens with the sustainability standards in relation to the States is absolutely crucial as well.
I'm very interested by the detail of the SEC's proposed climate reporting standards, but there's a huge diplomacy and negotiation operation that needs to happen with the US. There are lots of supporters there, but we've got to try and find a way to make sure that for the global standards to be truly global they apply to the states too.