Enforcement of Corporate Reporting

Background

In 2014, ESMA published its Guidelines on Enforcement of Financial Information (the Guidelines/GLEFI), aimed at strengthening supervisory convergence in the enforcement practices amongst the national competent authorities (NCA) designated in each EEA country. In 2022, a revised version of the Guidelines became effective.

Enforcers are required to confirm in writing to ESMA whether they comply, intend to comply, or do not (intend to) comply with the Guidelines. Currently, 26 of 30 EEA countries have indicated to ESMA that they comply with the revised version of the Guidelines, while one NCA has declared that it intends to comply in the near future.

Key definitions and concepts

“Enforcement” refers to examining compliance of financial information with the applicable financial reporting framework as well as taking appropriate measures when infringements are identified.

Enforcers identify the most effective way for enforcement of financial information. Each enforcer’s selection of issuers for examination is based on a mixed model whereby a risk-based approach is combined with random sampling and rotation. A risk-based approach considers the risk of a misstatement as well as the impact of a misstatement on the financial markets. Enforcers can use either unlimited scope examinations or a combination of unlimited scope and focused examinations of financial information of issuers selected for enforcement. Depending on the enforcer’s interaction with issuers, examinations are classified as interactive or desktop examinations. 

An unlimited scope examination entails the evaluation of the entire content of the financial information to identify issues or areas which require further analysis, while a focused examination refers to the evaluation of pre-defined issues / areas in the financial information. Both entail an assessment of whether this information is compliant with the relevant financial reporting framework. However, the depth and scope of an examination as prescribed in GLEFI cannot be equated with those of an audit of financial statements.

According to Guideline 7, when a material misstatement is detected, enforcers should, in a timely manner, take at least one of the following actions: 

• Require a reissuance of the financial statements: This action leads the issuer to publish revised financial statements which may be subject to a new audit opinion,
• Require a corrective note: This action entails that either the issuer or the enforcer itself publishes a note in relation to a material misstatement with respect to the particular item(s) included in already published financial information generally together with the corrected information (unless impracticable), or
• Require correction in future financial statements with restatement of comparatives, where relevant: When an enforcer takes this action, the issuer either adopts an acceptable treatment in the next financial statements and, where relevant, corrects the prior year by restating the comparative amounts or includes additional disclosures which may not require the restatement of comparatives.

The assessment of whether a departure from the standards is material is made in accordance with the relevant financial reporting framework. In relation to financial reports prepared in accordance with IFRS, paragraph 7 of IAS 1 Presentation of Financial Statements states that information is considered material if omitting, misstating, or obscuring it could reasonably be expected to influence decisions that the primary users of financial statements make on the basis of those financial statements. 

Depending on the nature of the items to which the identified departure from the standards relates, enforcers consider quantitative and/or qualitative factors to determine whether a departure could reasonably be expected to influence the decisions of users. As the assessment of materiality of disclosures involves qualitative considerations to a greater extent, for enforcers it is key that the disclosures provided in financial statements are informative, comprehensive and clear to enable an understanding of the transactions or events having occurred in a given year and how the principles of recognition, measurement and presentation have been applied by issuers.

The assessment of materiality often requires judgement and depends on entity-specific facts and circumstances. Therefore, the decision regarding which specific quantitative thresholds and qualitative criteria are to be applied in the context of an individual issuer's financial statements is made by the enforcer conducting the examination of those financial statements.

The IFRS Practice Statement 2 Making Materiality Judgements published by the International Accounting Standards Board (IASB) in 2017, which includes an overview of the general characteristics of materiality and presents a four-step materiality assessment process, provides helpful guidance on how to make materiality judgements in specific circumstances.

When deciding which type of action to apply, enforcers should consider (subject to the existing powers of the enforcer) that the final objective is that investors are provided with the best possible information. Therefore, an assessment should be made as to whether the original financial statements and a corrective note provide users with sufficient clarity for taking decisions or whether a reissuance of the financial statements is more appropriate. Other factors should also be considered, namely timing, the nature of the decision and the surrounding circumstances. For instance, a correction in future financial statements might be appropriate when (i) the decision is very close to the date of the publication of the next financial statements (which could also be the interim financial statements of the issuer), (ii) the market is sufficiently informed at the moment the decision is taken or (iii) the decision relates merely to the way information was presented in the financial statements rather than to the substance (e.g., material information is clearly presented in the notes or elsewhere in the financial report, for instance in the management report, whereas the relevant accounting framework requires the presentation on the face of the primary financial statements or in the notes).

Furthermore, enforcers seek to improve the quality of future financial statements by engaging in activities designed to provide helpful guidance to issuers, such as defining enforcement priorities and / or a pre-clearance procedure. Even when no enforcement actions are required, enforcers often make recommendations during the examination process on how certain disclosures could be improved by issuers.

ESMA Guidelines on Alternative Performance Measures (APMs) 

ESMA’s Guidelines on APMs were published on the basis of Article 16 of the ESMA Regulation and became effective in 2016. The Guidelines on APMs set out principles for the presentation and disclosure of performance measures outside financial statements, such as labels, reconciliations, and definitions, to ensure that issuers comply with the “true and fair view” principle when publishing APMs.

The Guidelines on APMs are addressed to issuers whose securities are admitted to trading on a regulated market and who are required to publish regulated information as defined by the Transparency Directive, as well as to persons responsible for the prospectus under Article 11(1) of the Prospectus Regulation. They are aimed at promoting the usefulness and transparency of APMs included in prospectuses or regulated information such as management reports or ad-hoc disclosures published to market pursuant Article 17 of MAR. Adherence to the Guidelines improves the comparability, reliability, and/or comprehensibility of APMs. Issuers or persons responsible for the prospectus who comply with these Guidelines provide a true and fair view of the APMs disclosed in a prospectus.

ESMA has published several questions and answers on the Guidelines on APMs to promote common supervisory approaches and practices in their implementation (retrievable in the Q&A tool).