EU Financial Transparency

EU reporting requirements set to enhance financial transparency in the extractive sector

By Steffen van der Velde LL.M. Researcher, T.M.C. Asser Instituut

Large companies active in the extractive sector dealing with oil, gas and minerals and loggers of primary forests have recently been subjected to new EU-rules on disclosure of payments made to national governments for projects they operate. The new rules, introduced as an amendment to the pre-existing ‘Accounting-Directives’, aim to make companies dealing with strategic resources and governments more accountable. Especially developing countries, rich in mineral raw material, are expected to benefit greatly from the new rules.

Many developing countries, experience difficulties in maximizing the benefits of the exploitation of their mineral wealth, since they lack the governance frameworks necessary to ensure a sustainable contribution of the mining industry to their development as a whole. To illustrate, over 50% of the major known mineral reserves is located in countries whit a per capita gross national income of $ 10 per day or less.[2] Mining is thus of particular relevance to these countries, for it can catalyse broad-based economic development and reduce poverty. In short, mining activities should maximize social and economic benefits, for present and future generations, as well as effectively address negative environmental and social impacts, while any regulatory framework should aim for improvement of accountability and transparency to prevent illicit financial flows from mining activities.[3]

The scope of the new rules

So far, the foreign extractive industry has benefitted from the regulatory vacuum in developing countries and flourished in the absence of strong regulations on fiscal, social and environmental matters. To counter this development, and in line with earlier adopted legislation by the US Government, more specifically Section 1504 Dodd-Frank Act,[4] the European Union established its own new transparency rules. Combined, the US and EU legislation encompasses a majority of the world’s largest mining companies. In brief, the new Directive,[5] adopted on 26 June 2013 after a long and hard-fought battle between Commission, Parliament, NGO’s and industry lobby groups, requires large undertakings and all public interest entities active in the extractive industry or the logging of primary forest to prepare an annual report on payments made to governments. A ‘large undertaking’ is defined as a company which exceeds at least two of the following three criteria: a balance sheet total of € 20 million; a net turnover of € 40 million; and an average number of employees during the financial year of 250.[6] Any taxes, royalties, dividends, bonuses, licence fees or payments for infrastructure improvement exceeding € 100,000.-, aimed at engaging in the exploration, prospecting, discovery, development and extraction of natural resources would constitute a ‘payment’ under the Directive.[7] The Report should include the total amount of payments made to each government; and if specifiable, the total amount per type of payment attributable to separate projects.[8]

NGO’s vs. industry

According to Global Witness, a strong proponent of the EU’s enhanced transparency legislation, ‘countries will be able to see where the money generated from their natural resources is going, and therefore ensure it is better used for their benefit’. Furthermore, the NGO commented that the new legislation ‘represents a defeat for […] industry lobbyists in their attempts to stifle the establishment of a global transparency standard in the extractives sector’.[9] Quite contrarily, Business Europe, a lobbyist which represents more than 20 million companies from 35 countries, is not convinced of the effectiveness of the Directive’s new transparency rules. The organisation believes that ‘this proposal will create red tape and further disadvantage for a large number of European businesses in international markets, running counter to the urgent necessity of re-establishing the conditions for confidence and competitiveness in Europe’. Furthermore, they claim that the EU is ‘running the risk of demotivating all companies that have embarked on genuine Corporate Social Responsibility activities on their own’.[10] NGO’s have countered this last argument by claiming that, so far, voluntary reporting standards have not delivered the desired results or were able to enhance the contribution of the mining sector to sustainable development in developing countries.

Will the new rules work?

Enhancing financial transparency in the extractive sector is a necessary prerequisite to create a more sustainable contribution of the mining sector to general economic performance, especially in developing countries. Still, the new transparency rules solve only one part of the puzzle. For more inclusive sustainable development of resource-rich developing countries to be realized, attention should also be paid to non-financial performance indicators. Here, the Directive still displays shortcomings, and only requires inclusion of such other performance indicators relating to environmental and employee matters ‘to the extent necessary for an understanding of the undertaking’s development, performance or position’.[11] It is not specified in the Directive when this is the case. Another matter of concern is that the new rules only apply to ‘large undertakings’, often listed on one or more stock exchanges.

Such companies are accountable to their shareholders, lenders, and generally attract more publicity and attention from the media and NGO’s, resulting in a tendency to conform better to internationally agreed principles or sustainable development standards than smaller, non-listed, mining companies.[12] Their exclusion from the scope of the transparency rules will have to be reflected upon by the European Commission in its first implementation report, to be submitted in 2018. Nevertheless, the new reporting requirements represent a major first step in binding EU extractive companies active in developing countries to stricter sustainable development standards, albeit primarily focussed on enhancing financial transparency. The first reports on payments to governments are expected to be filed in 2017, after the Directive has been transposed into national law by the Member States.