The Perfect Storm: How ESEF and COVID will increase scrutiny

By Russell Gammon, Chief Innovation Officer, Tax Systems

Annual company reports are incredibly important in conveying the financial robustness of the business – it’s why finance teams dedicate significant time and resources every year-end to crafting a narrative around the figures – but the next raft of annual reports will be scrutinised like never before due to two factors: COVID-19 and a new reporting regulation in the form of the European Single Electronic Format (ESEF).

The ramifications for reporting

The COVID-19 crisis has seen a small handful of businesses such as online retailers’ profit, yet the vast majority have seen severe disruption, with their workforce, supply chain and customer base all under threat. Estimates suggest that up to 250,000 businesses could go into receivership as a result, with over nine million employees being furloughed at the peak of the crisis.

The annual reports currently in production, through to the peak of the reports (for the year to 31 December 2020), will all have a significant focus on COVID-19. Right across all businesses, there will be material impacts not only on the figures in tables, but the narrative that goes alongside them. Amongst other things, the annual report is a chance for a business to ‘tell its story’. Every listed business this year will have a story to tell about how they responded to the crisis. More than ever, the annual report is not just about the figures, the narrative is of huge importance too.

While dedicated sections will cover the business’ response to the crisis, there will also be changes throughout the entire document to reflect the fact that COVID-19 has impacted on pretty much every aspect of performance. And, even in areas where performance hasn’t been affected, it will be useful to explain why not.

For these reasons, this year’s annual consolidated report is likely to be of crucial importance. It will devote significant airtime to COVID-19 in a bid to reassure stakeholders, investors and analysts that the business is on top of the situation.

How will ESEF change financial reporting?

Main-market listed businesses will also have to comply with ESEF this year, a new regulation that essentially standardises the creation of a digital version of the annual report and which, despite its acronym, will continue to apply even after Brexit.

ESEF requires large corporates to produce a report in XHTML format and to tag all primary statements, such as the Income Statement, Balance Sheet, Cashflow statement and Statement of Charges in Equity (SOCIE) using iXBRL to create a human and machine-readable report.

Unlike HMRC documents that are currently iXBRL tagged, the ESEF report will need to comply with a different rulebook. The ESMA ESEF taxonomy, based on the EU IFRS taxonomy issued by the IFRS Foundation, will require issuers to map the primary statements directly to the taxonomy. Where no direct match can be made, the tag will need to be extended and anchored, requiring some customisation.

After 2022, tagging requirements will increase to cover things such as block tagging of the notes associated with the primary statements. So, in the future, ESEF reporting is likely to become more complex and in doing so will see more company data laid open to analysis.

A possible delay to ESEF?

In July, the FCA published a Consultation Paper which looks to postpone the introduction of ESEF by a year so that it would apply to December 2021 year-ends rather than December 2020.

Whilst that process is ongoing, affected businesses cannot take it as a given that this will happen. Firstly, should there be any delay to the transitional arrangement in Brexit, the FCA would not be able to postpone the introduction. Secondly, and perhaps even more importantly, the Consultation will not close until later in the year, giving firms precious little time to prepare between now and early 2021. It is definitely in the ‘one to watch’ category, but firms should press on with preparations and the work done in 2020 will not go to waste even in the event of a delay.

Why will scrutiny increase?

As well as being audited and made available to regulators, the ESEF document must also be published online. This means it can be widely scrutinised across markets, allowing analysts to compare companies by size, sector or geography. Technology already readily exists that allows quick analysis of XBRL data, which is in use already in countries such as the USA where XBRL has been required for annual reporting for some time now.

As soon as the first ESEF reports are filed, analysts will be able to pick up the data, ingest it and compare across industry and geography. This means that the iXBRL data behind the filing must be correct, as errors can be glaring. For example, if a company gets the scale of the figures wrong, it will be very noticeable when comparing figures across firms.

ESEF effectively standardises reporting so that analysts are no longer comparing apples with oranges. It means that previous barriers, such as language, will no longer apply, allowing the direct comparison of businesses.

Regulators will also seek to use the transparency afforded by ESEF to identify any issues or irregularities. They may well compare results in order to help justify investigations, for instance, by looking for unusual activity among businesses in the same sector.

What are the implications for this year?

ESEF applies to businesses for year-ends starting on or after 1 January 2020. In practical terms, this means that the first batch of reports to be affected by the regulation will be 31 December 2020. This does, of course, mean that many will be reporting on their trading during the COVID-19 crisis and as such will be producing and publishing information that charts the most tumultuous time in the company’s history. Such information has the power to invigorate or debilitate because many companies are still highly susceptible to the perception of the market. Without public confidence, share prices will suffer, and the viability of the company will come under doubt.

For these reasons it’s essential that the business seeks to control the narrative and implement ESEF requirements in a way that’s sympathetic to the business. When tagging the report, the issuer needs to label the data with the appropriate descriptors and determine where and how to apply custom tags. XBRL descriptors control how tags will be read by a machine and thus determine how the data will be consumed. Get this right and you can help control how data is interpreted.

How can you mitigate risk?

There are a number of ways you can comply with the ESEF. A recent policy document published by the UK Government states that tagging requirements can be carried out after the directors have satisfied themselves that the accounts are true and fair by creating “a single filing, a parallel tagged document, or the creation of a tagged document once the annual report has been completed in paper format”. This means you can continue to produce your usual annual report and then create the ESEF report afterwards if desired.

The problem many face is that ESEF will add to finance teams’ workloads at a time of year when they are already under strain. To produce the report, the team will need to get up to speed with the ESMA taxonomy, learn how to apply the tags using new technology and to do so in a way that is favourable to the business. Plus, they will need to liaise with internal and external parties to verify and validate results.

Alternatively, the business can look to outsource ESEF reporting. This not only reduces the pressure on resources but can also ensure tagging is applied correctly with review processes that ensure no mistakes are made: an essential consideration given the sensitivity of the information contained in the report.

COVID-19 will make this year’s annual financial report the most important report businesses have ever compiled. Shareholders will want to know how companies have responded and the measures they have taken to protect cashflows. Annual reporting will also be more pressurised as companies seek to get to grips with the new reporting requirements. The question is whether businesses will realise the importance of getting both the narrative and the technical tagging right given how extensively this data will be pored over.