ESMA’s 2020 report – pump that action rate!

The European Securities and Markets Authority (ESMA) recently issued a report on its 2020 corporate reporting enforcement and regulatory activities

Here’s an extract from the summary:

  • Enforcers undertook 711 examinations (729 in 2020) of financial statements drawn up in accordance with International Financial Reporting Standards (IFRS), constituting an examination rate of 17% of issuers listed on European regulated markets preparing financial statements in accordance with IFRS (the 2020 examination rate was also 17%).
  • Of the 711 examinations undertaken, 619 were undertaken as ex-post examinations (689 in 2020) and, based on these examinations, European enforcers took enforcement actions against 250 issuers (265 in 2020) in order to address material departures from IFRS. This represents an action rate of 40% (the 2020 action rate was 38%). As in the past, most shortcomings were identified in the areas of accounting for financial instruments, impairment of non-financial assets, presentation of financial statements and revenue recognition. The material departures from IFRS related to recognition, measurement and/or disclosure issues since the concept of materiality is pervasive to the financial statements as a whole. In particular, omitting, obscuring, or misstating material information in the notes could reasonably be expected to influence decisions that primary users of the financial statements make on the basis of those financial statement.

Unsurprisingly, Covid-19 comes up a lot in the report, for example in the context of impairment testing:

  • Regarding the impact of COVID-19, only 41% of issuers provided explanations on what time horizon was considered in terms of returning to pre-covid cash flows or normal activity. Only one third of issuers which included cash flows from government grants received in relation to the pandemic in recoverable amounts (around 10% of all issuers in the sample) disclosed the assumptions on which the consideration of these cashflows is based.

Sometimes the report confirms that potential concerns identified earlier in the pandemic didn’t really come to pass:

  • In the 2020 (statement of priorities), ESMA emphasized that a separate presentation of COVID-19 impacts in the profit or loss statement may not faithfully represent an issuer’s current and future overall financial performance and be misleading due to the pervasiveness of the impacts of the pandemic. ESMA noted positively that very few (5%) of the issuers reported separate line items with regard to the impacts of the COVID-19 pandemic in their profit and loss statements.

On the non-financial side, among other things, enforcers “assessed the extent to which European issuers had taken account of ESMA’s considerations on non-financial disclosures in the 2020 ECEP Statement (notably relating to social and employee matters, business model and value creation, risk relating to climate change, and impact of the COVID-19 pandemic on non-financial matters). To this end, the non-financial statements of 116 issuers were examined, leading to enforcement actions towards issuers who did not comply with (requirements) relating to 19 infringements.”

Such reports always provide a good reference point and much food for thought. As always, some of the content feels like a stretch, for instance:

  • Around 40% of issuers that provided insufficient information (the information was disclosed only partly, or the description was boilerplate) on the management of employees working during the pandemic provided a sufficient description for their own employees but not for the employees in their supply chains.
  • Only 26% of issuers included disclosures on whether the policies put in place in the context of COVID-19 are permanent (e.g. a new right for employees to work remotely for a certain part of the time). 57% did not provide this information, and for a further 17% this disclosure was not relevant. About half of the issuers provided information on how those policies were implemented. One-third of the issuers did not provide details on the implementation and for the remaining issuers, there was no relevance.

That might all be interesting enough as sociological fodder, but as written there, it’s impossible to discern how such omissions might be material to decision-making. A right to work remotely, for instance, might depending on the circumstances be a good thing (happier employees; cost savings from maintaining less physical space), or a bad thing (because it’s harder to maintain a sense of shared purpose and culture, and to train new employees) or most likely a mixture of both. Whichever of those applies in a particular case (and the entity might not even know itself), it will likely be harder again to assess whether that net good or bad thing has a quantifiable effect on financial performance (compared to a theoretical alternative state in which Covid had never happened), or over what period of time that effect might evidence itself. In other words, although it’s easy enough to lecture issuers on how they should have said more about this or that, it’s much harder to articulate on why it really matters. After all, we’re all also supposed to be concerned about disclosure overload. Typical though of the perpetual waxing and waning of issues, that seems to have slipped a bit recently in the collective priority….

The opinions expressed are solely those of the author

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