S&P Global recently submitted its response to the European Commission's consultation on the Non-Financial Reporting Directive (NFRD) review. As a user of non-financial information, here we outline the key thoughts in our response as it relates to our Ratings division. The Commission's consultation is an important opportunity for a wider range of users of non-financial information, beyond investors and preparers, to make their voices heard.

At S&P Global Ratings, we incorporate non-financial risks, opportunities, and data into our credit ratings, as well as our non-rating products, including our ESG and Green Evaluations, if we believe that these factors are relevant and material to our analysis.

Specifically, in our credit rating analysis, we evaluate the impact of material and known ESG credit factors that could influence the obligor's creditworthiness. ESG risks and opportunities can affect the capacity and willingness of an entity to meet its financial commitments in many ways. We incorporate these considerations into our ratings methodology and analytics, which enables analysts to factor in short-, medium-, and long-term impacts--both qualitative and financial--during multiple steps in their credit analysis.

Such factors have gained prominence, primarily driven by the need to understand and assess the effects of climate change and other environmental and social matters, and more recently the COVID-19 pandemic, on the sustainability of corporate business models.

Both the quantity and quality of corporate non-financial disclosures have increased in line with investor demand. Often, however, these disclosures are not sufficiently comprehensive, comparable, consistently provided, and reliable. In our opinion, this is still the main limiting factor for market participants undertaking a rigorous and comparable company performance analysis using non-financial disclosures. We therefore welcome the European Commission's efforts to enhance the NFRD.

However, the main challenges when trying to evaluate ESG credit factors can be insufficient disclosure generally and--where there is disclosure--inconsistent disclosure across peers. Improved, more standardized, and more meaningful risk-based non-financial data from companies will enable us to better identify non-financial risks and opportunities.

Standardization

We believe that the numerous and sometimes overlapping reporting frameworks can make navigation and information extraction difficult for analysts and preparers alike. Being voluntary, such frameworks introduce a high degree of subjectivity in disclosing relevant matters--and can thereby reduce transparency. Credit analysis, ESG evaluations, and arguably the wider financial markets could benefit from a single standardized disclosure framework that would enhance comparability and consistency. That said, we acknowledge that different reporting standards exist to solve different data needs. It is therefore important to ensure that any new EU reporting standard would not limit or prevent supplementary disclosures to which a company or sector may wish to adhere, nor limit the ability of data users to request additional disclosures that are not required by a revised NFRD.

Furthermore, S&P Global Ratings believes that the creation of a core set of ESG metrics providing standardized minimum disclosure, for all companies subject to the NFRD, would enhance the analysis of ESG factors. A set of general but common ESG key performance indicators (KPIs) would enable greater comparability across sectors and could take the form of a short list of ESG disclosures that all companies must publish. New reporting standards would also benefit from being tailored to sectors, thereby allowing and encouraging sector-specific KPIs, because a one-size-fits-all approach might risk distorting, rendering less useful, or discouraging the disclosure of data points that a company might otherwise volunteer.

Non-financial disclosures should not be made in isolation, but should directly connect to the information included in financial statements. This approach, in turn, would help to tell a comprehensive story about the entity's exposure to non-financial risks and opportunities--and management's actions in response to those--including a quantitative analysis of potential financial impacts such as projected cash-flow changes.

Non-financial risk reporting has been around for several years but has only gained prominence recently. As collective understanding of these matters improves over time and consensus builds about the underlying factors affecting non-financial risk, disclosures should and will improve. It is crucial that standardization does not stifle innovation in ESG analysis.

Quality and scope of non-financial information to be disclosed

The current NFRD requires scoped-in entities to disclose matters relating to a number of sustainability issues. However, due to the high-level nature of the existing requirements, what information companies are required to disclose, and in how much detail, remains unclear.

Aligning future disclosure requirements with investors' data needs, and those of intermediaries who produce assessments used by investors, is well worth pursuing and in our view would facilitate more detailed and comparable analysis of ESG factors.

In our opinion, the revised requirements should be extended to the following non-financial matters and data:

Climate change:  While the existing NFRD refers to environmental matters, it does not explicitly require climate-related disclosures. Standardized, comparable, credit-risk-relevant climate disclosures would enhance our assessments of climate-related risks and opportunities and their potential impact on a company's creditworthiness. This would also support our analysis of the relative standing of companies regarding climate risk, including adaptation and mitigation factors, compared to competitors and peers. Revised disclosure requirements could also provide an opportunity to align with international reporting standards, which are particularly useful in assessing risks associated with climate change. For example, disclosures aligned to the Financial Stability Board's recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) are helpful in understanding the liability, climate-transition, and climate-physical risks of a specific company as well as a company's strategy to manage or mitigate those risks.

Corporate governance disclosures specific to the management of non-financial risks and opportunities:  Better, clearer, comparable disclosure of (a) the oversight, process, and outcome of the company's evolving ESG strategy and how this relates to its business-model adaptation; (b) entity-wide non-financial risk management systems and their integration into financial risk management; and (c) policy, metrics, and targets related to board and executive remuneration, and how these link to the company's broader ESG goals.

Governance of supply chain management:  Governance matters arising from supply chain management, including oversight, risk management, metrics and how these interlink. We would view as beneficial a company having to disclose metrics about the top-three suppliers to which it is exposed.

Forward-looking information:  Our credit rating on an issuer is our forward-looking opinion about an obligor's overall creditworthiness, and our credit analysis therefore incorporates forward-looking information. Historical information is useful to understand the impact of non-financial risks on the entity's historical and current financial position, performance, and cash flows, and it gives us some indication of a company's future direction. However, forward-looking information that explains the entity's own assessment of such non-financial risks and opportunities on its business model could notably enhance the understanding of credit-relevant risks and, in turn, their likely effect on the entity's ability to repay debt. Forward-looking information would ideally be both qualitative and quantitative. The potential financial consequences of non-financial risks and opportunities are often barely visible in today's corporate reporting. However, enhanced reporting would help us assess the impact on future cash flow generation and, in turn, an entity's creditworthiness. Separate from our credit rating, in our ESG Evaluation product we assess an entity's long-term Preparedness, reflecting our qualitative view of an entity's capacity to anticipate and adapt to a variety of plausible long-term disruptions. Better, more-detailed disclosure on forward-looking matters would enable enhanced analysis of how management is planning to mitigate and manage emerging risks and capitalize on opportunities to support the entity's long-term sustainability.

Related Research

• The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis, Sept. 12, 2019
• Environmental, Social, And Governance Evaluation Analytical Approach, June 17, 2020