A note on EU rule-making and expedience of informed policy decisions

Playing alone: excluding expert communities from decision-making

GUBERNA highlighted the exclusive character of consultations back in 2020. The European Commission DG Justice and Consumers assigned the “Study on directors’ duties and sustainable corporate governance” to the EY. The resulting report received wide criticism from the governance professionals. GUBERNA had expressed its concerns not only with the way the corporate governance landscape had been simplistically treated and portrayed, but also with the methodology of the study and the data used to support the highly demanding claims of the report.

Namely, the chosen theoretical model was arbitrary, as well as the selected statistical indicators. The latter supported the report’s main claim, but did not represent the whole situation which was objectively complicated and thus required careful and detailed examination. Besides, both sampling procedure and sample size raised questions too, given the expected impact of the study.

However, the main point of criticism in relation to this report was its key message. It offered a skewed, rather negative, portrait of the existing corporate governance (CG) practices. In particular, it neglected sustainability efforts and initiatives undertaken by many companies. Such attitude was counterproductive for the joint effort needed for the successful transition towards sustainable economy, one of the key EU priorities.

Besides, the study focused solely on classic regulatory policies. It omitted such policy options as self-regulation, in particular under the form of corporate governance codes. The latter were a widespread CG practice, whose effectiveness in promoting long-term value creation was generally accepted.

GUBERNA warned then about the risk of falling into regulatory excess with clear negative consequences for all parties involved. On the one hand, business needs a stable and a clear regulatory framework as guidance for its operations. On the other hand, when regulation becomes disproportionate, it encourages formal attitude, i.e. box-ticking, and thus does not serve its original intentions anymore.

GUBERNA believes that the initial push for more regulation resulted from excluding the professional community from the decision-making process. The EY Report 2020 cast the first stone at cooperation between regulators and business community.

Tightening the screws: calling for a judge before the rules are set

Another major startling episode for GUBERNA was the assurance of sustainability reporting back in 2022. The Institute immediately commented the initiative, pointing out that common standards and clear methodology would have 1) facilitated organisation and preparation of reporting by companies, and 2) allowed for consistent interpretation by readers of reports.

One of the requirements that the Non-Financial Reporting Directive (NFRD) imposed, was the check by the statutory auditor whether the requested non-financial information had been provided (Article 19(a) paragraph 52). Besides, while transposing the NFRD into national legislation, Member States had an option to require the companies to have their non-financial information verified by an independent assurance services provider (Article 19(a) paragraph 63). Thus, the third parties were brought into play, implying additional costs for the companies.

GUBERNA had observed the criticism expressed in relation to assurance providers due to ethical issues in their business: e.g., commercialism in sustainable assurance, symbolism of verification process, the interdependency between assurance and consulting services, and the familiarity with clients.

The application of the reporting standards suggested by NFRD revealed inconsistencies, including a lack of comparability, reliability and relevance of the non-financial information provided. With the launch of the European Green Deal, NFRD was widely revised resulting in Corporate Sustainability Reporting Directive (CSRD). CSRD required an independent and certified auditor or service provider, to provide limited assurance around a company’s reported sustainability information. In other words, the obligation to verify externally the reported information was strengthened.

At the same time, the standards for non-financial reporting had not been set yet, meaning that neither companies nor assurance service providers were capable to ensure that the sustainability reporting was credible and trustworthy. In fact, both sides needed time and experimentation to develop the necessary practices. Given the innovative character of the requested information, that was not an easy task.

It is not surprising that many assurance statements were disclosing the same information on a few conventional items and appeared largely distant from important sustainability matters and stakeholder concerns. In other words, the reporting turned out to be formal. However, the regulation pushed the companies to report, and thus they sought external advice to comply.

As a consequence, these reporting and assurance measures, which were meant to identify the benchmarks for sustainability risks and vulnerabilities,

• were launched too rapidly,

• resulted in massive complaints over excessive regulation and its high costs.

GUBERNA continues to remind that issuing regulation before shared standards have been established resembles putting the cart before the horse. Such practices decrease the acceptance of innovation and the overall willingness to cooperate. This is especially true when the additional parties and thus additional costs are imposed, complicating the unclear case further as it happened with the assurance of sustainability reporting.

Taking people on board: ideas for the next steps

Massive legislative revision foreseen for the near future opens immense opportunities for integrating the lessons learnt into the renewed EU legal framework.

There is a wide consensus: ineffective decision-making practices cost time, efforts and resources. The most crucial risk though is the loss of trust in the agenda behind the legislation. The European Union cannot afford such a loss.

Consider the example of Sustainability Omnibus. The urge to fight recent regulation resulted from a haste in launching pioneering practices. As any innovation, new initiatives had to be tested and accepted before being imposed. However, the rush for the results led not only to a large confusion, but also to disappointment and the overall rejection of the necessary shift. As a result, red tape replaced innovation; change was postponed; readiness to accept the necessary transformation of the existing business practices decreased.

Even the best legislative initiatives remain unclear if underdeveloped and thus lose their original purpose. Instead of supporting the desired change, they impose vague formal rules; moreover, they necessitate the third parties’ input, yet their involvement allegedly creates additional costs and obfuscates the policy-making agenda.

One can understand the urge to put things right from the very beginning, but without the shared understanding among concerned parties and without consensus among at least certain actors, the good intentions could pave the way to undesired outcomes.

When legislative initiatives minimise preparatory work and limit external consultations, they are later perceived as undesired burden and are widely fought against. Earlier attention to the warnings previously raised by GUBERNA, would have saved considerable amounts of time, resources and dedication to change for both regulators and market actors.

GUBERNA believes that effective rule making requires gradual adaptation to new requirements, sound scientific rationales and wide consultation processes with a wide range of stakeholders. These principles guarantee wide acceptance of rules that aim to prepare markets for a new era of competitiveness and growth. Mutual trust between the parties involved ensures competitiveness of European economy and forward-looking focus of its enterprises.

Conclusions

GUBERNA wants to ensure that EU rulebook will integrate these lessons, and the measures proposed by the European Union should:

• rely on high quality information (especially when supported by external providers),
• enable wide stakeholders’ participation prior to policy decisions being adopted,
• integrate soft law tools more frequently to stimulate wide acceptance of the desired change and only adopt hard law instruments at a later stage.

GUBERNA believes in participative processes at the core of the EU and trusts that the above formulated principles will guide the measures addressing the corporate sector of the united Europe.