The legal framework for public corporate reporting in the EU has been progressively adopted. In 2018, the European Commission initiated a fitness check, accompanied by a wide-ranging stakeholder consultation, to assess whether existing legal rules were still achieving their intended aim.
Published with little fanfare, alongside the proposals for a new Corporate Sustainability Reporting Directive (CSRD), the outcome of the fitness check focuses on the application of the IAS Regulation as well as the Accounting, Transparency and Non-Financial Reporting Directives. It is accompanied by a review of specific legislative requirements, including those relating to micro-entities, country-by-country reporting (CBCR) and the removal of quarterly reporting obligations.
The current EU legal framework
The IAS Regulation applies to all limited companies that have securities listed on EU regulated markets and requires them to prepare consolidated financial statements according to IFRS standards as endorsed by the EU. IFRS standards can only be incorporated into EU law if they meet the criteria for endorsement laid down by the IAS Regulation. The Transparency Directive applies to all companies that have securities listed on EU regulated markets and requires the publication of an annual and semi-annual financial report.
The Accounting Directive sets rules on the preparation, presentation, publication and audit of annual financial statements for all limited liability companies established in the EU. Large and listed companies in the extractive and logging industries must also disclose their payments to local governments according to CBCR requirements. The Non-Financial Reporting Directive, to be revised according to the draft CSRD, requires large public interest entities to include a non-financial statement in their management report.
IFRS in the EU
Overall, the Commission assesses that the IAS Regulation has been an effective instrument in ensuring high-quality and comparable public financial information across the EU. Indeed, the Commission could consider engaging further with stakeholders and undertaking a more comprehensive cost-benefit analysis to assess whether more entities should be required to use IFRS standards. This could include all companies listed on regulated markets, all SMEs that plan to issue securities (as a company option) and larger non-listed companies.
Looking at the EU endorsement process for IFRS standards, the Commission suggests that while there is an argument to introduce greater flexibility in the procedure, to date the EU has been able to deal with any specific situations requiring a more nuanced approach through existing ‘carve-out’ and ‘top-up’ powers. Given that this possibility has been used only twice since 2003, the current procedure is probably flexible enough. Some changes may be needed, however, to clarify the endorsement criteria in the IAS Regulation to account for the growing importance of sustainability considerations for investment decisions.
Quarterly reporting requirements
Changes to the Transparency Directive in 2013 removed the requirement to publish quarterly financial information for listed companies to reduce administrative burdens and encourage longer-term investments. The changes have been proportionate for smaller and medium-sized issuers, without having adversely impacted investor protection. But the overall impact has been limited with many issuers still disclosing quarterly reporting, whether on a voluntary basis or because it is still required by their respective EU country or regulated market.
The Commission highlights some shortcomings when it comes to the Accounting Directive, particularly in relation to the relevance and comparability of information. On the relevance point, the lack of standard accounting treatment of leases is highlighted as an example. Some of these gaps have been addressed through national GAAP or by expanding the scope of companies using IFRS. Comparability is a concern for companies with cross-border activities, given the numerous options in relation to substance embedded in the Accounting Directive. Such companies, however, are estimated to be only 2% of all EU limited liability companies.
Publication deadlines also vary significantly across the EU, with nine countries granting companies more than 10 months before publications. Citing evidence of some companies delaying publication beyond the legal deadlines, the Commission queries whether sufficiently dissuasive penalties are being applied at country level.
The Commission is unconvinced that EU reporting requirements are relevant to the over 14 million micro-entities in the EU. Although most EU countries have taken advantage since 2016 of the legislative option enabling the introduction of a simplified reporting regime for micro-entities, results have been mixed. The majority of EU countries have alleviated the reporting regime, with 8.6 million companies now being recognised as micros. Only six countries (Cyprus, Spain, Croatia, Luxembourg, Malta and Sweden) do not recognise micro-entities specifically for corporate reporting.
However, the degree of simplification varies greatly. About half of EU countries have implemented a fairly simple regime for micros, with the most popular features including fewer notes and simplified layouts for the balance sheet and profit and loss accounts. But the other half have not fully implemented the simplified regime. In addition, many micros do not seem to be aware of the new regime or have not put it into practice leading the Commission to question whether accountants have played a full enough role in raising awareness and putting simplification in motion.
SME size criteria
The Commission is required to regularly review and, if necessary, adjust the size criteria (balance sheet and turnover thresholds) in the Accounting Directive to take account of the effects of inflation. Although cumulated inflation in the eurozone between 2013 and 2019 reached 6.4 percent (7.5 percent for the EU27), the Commission has concluded that there is not a pressing case to make any changes now.
Large EU companies in logging or extractive sectors have been required to comply with CBCR requiring annual disclosure on payments to governments since the financial year 2016. The Commission notes good compliance in the extractive industry with a considerable amount of reporting undertaken, although less so in the logging sector. Overall, CBCR rules are thought to have been effective in increasing transparency over payments with the information provided being used primarily by civil society to raise awareness and hold companies to account.
There has been no significant impact, to date, on government accountability in other parts of the world. Fears that competitors from non-EU countries might gain significant advantages by not being obliged to report on payments have not materialised. Nor have the operations of EU companies been limited in other countries due to EU reporting requirements. But the Commission stresses the need for a global level playing field to ensure full reporting coverage and to enhance transparency over payments to governments. In addition, some adjustments could be foreseen to improve reporting on joint ventures as well as to enhance the accessibility and electronic usability of reports. Broader legislative proposals for public CBCR for multinationals are currently being negotiated between the European Parliament and Council.
Focusing on another area where the legal framework is already being revisited, the fitness check stresses the need for greater use of digital tools to structure, re-use, secure, disseminate and enable easier access to both financial and non-financial information. The adoption of the ESEF Regulation, requiring machine-readable consolidated IFRS financial statements is seen as an important step forward, alongside proposals for the establishment of a European Single Access Point.
The reliability of financial information disclosed by listed companies is good overall. But the fitness check has also raised questions over the enforcement practices of national supervisors across the EU requiring priority action. As highlighted by the Wirecard collapse, there are significant differences in how supervisory powers are defined and applied across EU countries. ESMA has already identified potential improvements in this area, including strengthening the independence of competent authorities, enhancing cooperation between competent authorities and better harmonising the supervision of financial and non-financial information.
Fitness Check on the EU Framework for public reporting by companies EUR-Lex – 52021SC0081 – EN – EUR-Lex (europa.eu)
Commission report on review clauses in the Accounting, Non-Financial Reporting and Transparency Directives – EUR-Lex – 52021DC0199 – EN – EUR-Lex (europa.eu)