Enforcement of the 2018 financial information published by issuers subject to the Transparency Law
Press release 19/02
Pursuant to the law of 11 January 2008 on transparency requirements for issuers (the “Transparency Law”), the CSSF is monitoring that financial information published by issuers, in particular their consolidated and non-consolidated financial statements, is drawn up in compliance with the applicable accounting standards.
In this context, the CSSF draws the attention of issuers and auditors on identified financial reporting topics they should particularly consider when preparing and auditing, respectively, the IFRS financial statements for the 2018 year-end (the “2018 financial statements”).
As in previous years, the European Securities and Markets Authority (“ESMA”), together with the European national accounting enforcers, including the CSSF, identified European common enforcement priorities (the “ECEPs”) for the 2018 financial statements to which particular attention will be paid when monitoring and assessing the application of IFRS requirements.
In its communication, ESMA also underlines specific requirements relating to the sections of the annual financial report other than financial statements, for instance particular disclosures of non-financial information and specific aspects of the ESMA Guidelines on Alternative Performance Measures (the “Guidelines on APMs”).
ESMA’s detailed press release on common enforcement priorities is available under the section: Supervision > Securities markets > Enforcement of financial information > ESMA News of the CSSF website and on ESMA’s website.
When establishing its enforcement campaign, the CSSF has assessed how to monitor these common priorities defined at European level and communicated by ESMA and considered the need to identify further items of interest. The underlying analysis is based on the following criteria:
- the importance and relevance of these topics for issuers under the CSSF’s direct supervision;
- the importance of judgements and assumptions to be made by issuers in dealing with these topics; and
- the experience and issues encountered by the CSSF during previous campaigns.
The CSSF’s campaign will thus be governed by the following priorities:
Application of IFRS 15 Revenue from Contracts with Customers
As the application of IFRS 15 is mandatory for annual reporting periods beginning on or after 1 January 2018, issuers shall recognise revenue following the requirements set forth by the standard and provide relevant disclosures in their 2018 annual financial statements.
Indeed, as foreseen by ESMA’s common enforcement priorities on IFRS 15, the CSSF will monitor specific issues related to the standard’s application as well as issuers’ overall first-time application process. As such, the CSSF will not only monitor that information will be disclosed in conformity with IFRS 15 disclosure requirements but will also examine measurement and presentation aspects, for issuers selected for an examination.
Paragraph 110 of IFRS 15 requires issuers to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash-flows arising from contracts with customers. In order to assess the disclosures made, the CSSF will ensure, amongst others, that issuers have properly applied the five-step model framework.
As the core principle of IFRS 15 is delivered by the five-step model framework, the CSSF will assess specifically how selected issuers have identified their contracts with customers and the related performance obligations in these contracts. For some issuers, the identification process may be relatively straightforward, but others have to reassess the criteria contained in their contracts and to consider whether contracts should be combined for accounting purposes.
Judgement is crucial for the so-called “unbundling” process of the issuers’ performance obligations. The identification of the deliverables (products or services) determines the accounting treatment to be applied and issuers recognise revenue when or as they satisfy a performance obligation by transferring control of goods or services to a customer. Control may be transferred either at a point in time (as with point-of-sale transactions) or over time (as with many service contracts). It is of crucial importance to assess the possible change of timing for revenue recognition. To do so, issuers need to begin by assessing whether control is transferred over time, i.e. if one out of the three criteria set forth by paragraph 35 of IFRS 15 is met. If none is met, then the transfer of control occurs at a point in time but further analysis is required to determine such point in time from when revenue can be recognised.
When determining whether revenue should be recognised over time, one of the criteria is whether the issuer’s performance does not create an asset with an alternative use to the issuer and whether there is an enforceable right to payment. It is important to keep in mind that for this particular “over-time” criterion, both aspects must be met. In assessing whether an asset has an alternative use, issuers need to consider both the practical limitations and contractual restrictions on redirecting the asset for another use. For an enforceable right to payment to exist, issuers must be entitled at all times during the contract to compensation for performance completed to date. Such
compensation should approximate the selling prices for the goods or services transferred to date. Additional judgement is required in this respect.
Also, in some cases, issuers need to assess whether they are acting as a principal or an agent. This will be important as it affects the amount of revenue issuers recognise. Control is vital to the presumption that the issuer will be considered as principal.
The CSSF will also specifically pay attention to the determination of the transaction price and the allocation of such transaction price to the performance obligations. As IFRS 15 typically bases revenue on the amount to which issuers expect to be entitled rather than the amounts that they ultimately expect to collect, adjustments to revenue such as discounts, rebates or similar items have to be considered when measuring total revenue. Key considerations in determining the transaction price are the effects of any variable consideration, the time value of money, non-cash consideration and any consideration payable to customers. The CSSF will ensure that issuers have taken into account any possible consideration which could have a significant impact on the transaction price. The allocation of the transaction price could potentially be a significant area for issuers which have multiple performance obligations identified as the transaction price should be allocated to each separate performance obligation on the basis of relative stand-alone selling prices.
Application of IFRS 9 Financial instruments
With regards to the initial application of IFRS 9, ESMA highlights that IFRS 7 Financial instruments: Disclosures contains a detailed set of disclosure requirements for the period that includes the date of initial application of IFRS 9 in order to meet the objectives of IFRS 7. These include the requirements to disclose:
- reclassifications of financial assets and financial liabilities upon the initial application of IFRS 9; and
- reconciliation of the closing impairment allowances under IAS 39 Financial Instruments: Recognition and Measurement to the opening impairment allowances under IFRS 9 disaggregated by measurement category.
Disclosure of further disaggregation of such reconciliations, together with a narrative explanation of the main drivers of the impact, including the impact on performance, may be relevant depending on the circumstances.
ESMA and the CSSF expect issuers to provide relevant, material and entity-specific disclosures, by taking into account the importance of financial instruments in their business operations.
During the year, the CSSF has performed a desktop review of the 2018 interim financial statements of a sample of financial institutions, focused on the disclosures relating to the implementation of IFRS 9. Based on the findings of this review and on top of other ECEPs related to IFRS 9, the CSSF expects issuers:
- to include in their disclosure explanations about the assessment of significant increase in credit risk (“SICR”) on a collective basis, if any, the factors taken into account in assessing the reversal of SICR and the definitions of default, including the reasons for selecting those definitions. When describing the models used to determine expected credit losses (“ECL”), issuers that use regulatory models as a basis for ECL calculation are expected to explain the adjustments between the regulatory models and ECL; and
- to disclose not only a reconciliation from the opening to the closing balance of loss allowance for each impairment stage, but also an explanation of how significant changes in the gross carrying amount of financial instruments during the period contributed to changes in the loss allowance. Besides, the effect of collateral and other credit enhancements on the ECL, as well as the effect of modifications of contractual cash flows on restructured assets, should be presented and explained.
In this context, the CSSF wants to highlight that the disclosures related to the ECL determination and SICR assessment should avoid the use of boilerplate descriptions and should be entity-specific.
Impact of the implementation of IFRS 16 Leases
IFRS 16 sets out the principles and requirements for the recognition, measurement, presentation and disclosure of leases. The standard provides a single lessee accounting model which requires lessees to recognise assets and liabilities for leases unless the lease term is 12 months or less or the underlying asset is of low value. Application of the standard will be mandatory for annual reporting periods beginning on or after 1 January 2019. IFRS 16 will replace the requirements in IAS 17 Leases. Considering the date of first-time application of the standard, implementation of IFRS 16 has to be made by issuers when they publish their 2018 financial information.
In its 2018 common enforcement priorities, ESMA highlights the need for high-quality implementation of IFRS 16 and communication of its expected impact on the financial statements. Issuers should provide entity-specific quantitative and qualitative disclosures about the application of IFRS 16 in accordance with paragraphs 30 and 31 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
When providing information on the impact of the implementation of IFRS 16 on the issuers’ financial statements, the disclosures should be provided with enough granularity in order for the users of the financial statements to assess the effect that the new standard has on the statement of financial position, the statement of profit and loss and the statement of cash flows.
In order to do so, the CSSF reminds issuers to pay particular attention to the key aspects of the standard when determining the impact on their financial statements. On first phase of judgement, issuers should ensure to properly assess whether a contract is, or contains, a lease and whether the contract conveys the issuer the right to control the use of an identified asset. The determination of the lease term will be another phase of significant judgement and therefore of crucial importance for issuers to quantify the impact on their financial statements. In that context, the CSSF encourages issuers to consider guidance presented in IFRS IC educational materials (e.g. the “lease term Q&A” dated October 2017).
Another aspect to be cautiously considered will be the discount rate used at initial measurement of the lease liability. Paragraph 26 of IFRS 16 requires lessees to measure the lease liability at the present value of the lease payments that are not paid at the commencement date. The lease payments should be discounted using the interest rate implicit in the lease. If the interest rate would not be readily determined, the lessee should use its incremental borrowing rate. Paragraph BC161 of IFRS 16 highlights that as the interest rate implicit to the lease is generally affected by a lessor’s estimate of the residual value of the underlying asset at the end of the lease and may also be affected by other factors only known to the lessor, it is likely to be difficult to determine such implicit interest rate by lessees. Accordingly, when
the discount rate cannot be readily determined, lessees should use its incremental borrowing rate taking into account the terms and conditions of the lease.
At first-time application of IFRS 16, issuers are permitted to either apply the full retrospective approach or the modified retrospective approach. Appendix C of IFRS 16 sets out the disclosure requirements related to the initial application and the method of transition applied.
Disclosure of non-financial and diversity information in the management report
Since 1 January 2017, the requirements of the Law of 23 July 2016 on disclosure of non-financial and diversity information for certain large undertakings and groups, implementing the Directive 2014/95/EU (“the Law”), entered into force and require some issuers to provide additional disclosures including:
- a non-financial statement containing information on environmental, social and employee matters, respect for human rights, anti-corruption and bribery matters; and
- a description of the diversity policy applied in relation to an entity’s administrative, management and supervisory bodies with regard to aspects such as, for instance, age, gender, or educational and professional backgrounds.
During its 2018 enforcement campaign, the CSSF has carried out an examination of the relevant non-financial information for 2017 published by issuers within the scope of the Law. Overall, the CSSF has noted that most issuers effectively published information on the referred matters. Nevertheless, further improvements are expected in order for issuers to fully comply with the Law (the results of this examination is available on the CSSF website under the section Enforcement of financial information publications).
The CSSF will continue to monitor the non-financial information published throughout the year 2019 and how concerned issuers adapt consistently to this new legislation. In this way, the CSSF will ensure that these issuers provide useful and meaningful information for users of financial statements, covering in particular the results of their policies and focusing on the main risks they are facing.
Alternative Performance Measures
The 2018 common enforcement priorities will also cover specific aspects of the ESMA Guidelines on APMs. As well as ESMA, the CSSF remind issuers that whenever APMs are used throughout financial information published outside the financial statements, they should define them and their components as well as the basis for calculation adopted in conformity with the requirements set forth by paragraph 20 of the Guidelines on APMs.
Following the introduction of new accounting standards, notably IFRS 9, IFRS 15 and IFRS 16, as well as ESMA, the CSSF expect issuers to review and amend accordingly their disclosures regarding APMs used. In accordance with paragraphs 41 to 44 of the Guidelines on APMs, consistency should be adopted when defining or calculating APMs. The CSSF specifically reminds issuers that whenever they need to redefine, replace or even stop using a certain APM, they should explain the changes which occurred, the reasons why these changes result in reliable and more relevant information and provide restated comparative figures.
The CSSF will continue to closely monitor how issuers comply with the Guidelines on APMs in their future financial information published. In this context, the CSSF reminds issuers that the Guidelines on APMs apply to prospectuses and regulated information, including management reports disclosed to the market in accordance with the Transparency Directive1 and disclosures issued under the requirements of article 17 of the Market Abuse Regulation2, for example ad-hoc disclosures including financial earnings results.
Hyperinflationary economy - Argentina
Issuers having business operations and/or subsidiaries in Argentina need to assess the impact on their financial statements of the country’s classification as hyperinflationary economy as of 1 July 2018.
The CSSF reminds issuers that, when having subsidiaries whose functional currency is the Argentine peso, they need to consider paragraph 43 of IAS 21 The Effects of Changes in Foreign Exchange Rates before including their subsidiaries’ financial statements into their consolidated financial statements. Indeed, the subsidiaries’ financial statements shall be restated in accordance with IAS 29 Financial Reporting in Hyperinflationary Economies.
On 29 March 2019, the United Kingdom is expected to leave the European Union. When preparing their year-end financial statements, further details on the Brexit agreement may be available and issuers should ensure that these will be reflected in their 2018 annual financial statements.
Issuers will have to carefully and closely monitor the reporting consequences that the Brexit agreement will have on their future financial performance. As a matter of high uncertainty is remaining when preparing year-end financial information, issuers should ensure to disclose:
- the impact that Brexit will have on their activities and operations, notably for issuers having material existing trades with UK-based counterparties; and
- an entity-specific description of the sources of estimation uncertainty based on the specific facts and circumstances applying.
More information on inspections and findings by the CSSF within the framework of its mission under Article 22 (1) of the Transparency Law are given under the section Enforcement of financial information of the CSSF website and in its annual report.
1 Directive 2004/109/EC of the European Parliament and of the Council of 15 December 2004 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market and amending Directive 2001/34/EC3
2 Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014 on Market abuse