As part of its activities, the European Securities and Markets Authority (ESMA) organizes a forum of enforcers from 38 different European jurisdictions, all of whom carry out monitoring and review programs similar to those carried out here by the Canadian Securities Administrators. ESMA a while ago published some extracts from its confidential database of enforcement decisions on financial statements, covering eight cases arising in the period from December 2021 to December 2023, with the aim of “strengthening supervisory convergence and providing issuers and users of financial statements with relevant information on the appropriate application of IFRS.” There’s no way of knowing whether these are purely one-off issues or more widespread, but some of them certainly have some relevance to matters discussed within Canadian entities once in a while. Here’s one:

• The issuer, a real estate company, holds investment property as its core business, with a geographical distribution spread across multiple cities and regions in the country of incorporation. A small percentage of the portfolio (15%) was located internationally. The issuer applied the fair value model of IAS 40 Investment Property for the subsequent measurement of the properties (based on a model using Level 3 inputs).
• In its annual report, outside the financial statements, the issuer provided quantitative and qualitative information for 15 different geographical markets. In addition, the issuer commented on risks and opportunities by different market segments and by different types of use of properties (i.e., offices, warehouse/logistics, residential, government buildings).
• When providing disclosures regarding the valuation techniques used to determine the fair value of the real estate properties in the financial statements, the issuer described that the valuation was based on (i) future developments in the wider market and in the immediate vicinity, and (ii) the conditions and location of the real estate properties. Furthermore, the issuer provided rental yields by ranges in two separate dimensions: (i) geography or location (divided in six classes), and (ii) type of use (divided in four classes). The ranges used in the different classes varied between 200 to 550 basis points.

The enforcer (as ESMA likes to term it) disagreed with the issuer’s determination of classes of investment properties included in the financial statements, concluding that the disclosures related to the input data used failed to provide sufficient information regarding the fair value measurement as required by paragraphs 91 to 94 of IFRS 13. In particular, given the wide ranges of rental yields applied by the issuer, the enforcer considered that the level of detail and aggregation in the disclosures regarding unobservable inputs was insufficient to meet the objectives set out in IFRS 13.91; it required the issuer to include a higher degree of disaggregation of classes based on geography, and for each class of geography, the rental yields by type of use. Here’s more explanation on that:

• The enforcer agreed with the issuer that, in the case at hand, the key factors affecting the rental yields and consequently the fair value measurement of real estate assets were the location and the type of use.
• With regards to the geographical/location dimension, the enforcer noted that, among other factors, in urban areas there are often alternative lessors, vacancy risk is lower, and rents are generally higher. In rural areas competition as well as rental levels are lower, and the risk of vacancy is higher.
• With regards to the type of use (nature and characteristics) the enforcer noted that, in the case at hand, there was a growing demand for logistics and residential areas, whereas retail and office buildings were regarded as properties with higher risk. Government buildings, by contrast, represented a low risk.
• Considering the wide range in the rental yields applied by the issuer, resulting from significant differences in the characteristics and risks of the issuer’s properties, the enforcer concluded that a combination of geographical location and type of use would be an appropriate basis for the determination of the issuer’s relevant asset classes. Therefore, the enforcer requested the issuer to provide a matrix combining the real estate rental yields by geographical location broken down by type of use.

The argument there isn’t dissimilar to one that might be made in arguing that two operating segments don’t share similar economic characteristics and therefore require separate disclosure. In this case, based on the information provided, the enforcer seems to have made a good case that the issuer stopped short of identifying “appropriate classes of assets and liabilities” for which input-related information should be disclosed, trying to get by instead with providing a broader survey of input data, and limiting a user’s ability to constructively engage with the limitations of and possible ranges of variability surrounding the fair value measures in the balance sheet. What we don’t know, as so often in such case studies, is why the issuer thought such an approach would be in their own, or anyone else’s, best interests…

The opinions expressed are solely those of the author.