Listed companies across Europe are now required by law to deliver their annual financial reports in a new standardized electronic format, as ESEF – European Single Electronic Format. But what does this mean exactly? What do businesses need to do to be compliant? And how will this affect the accounting profession?
What is the ESEF?
The European Single Electronic Format (ESEF) is a regulatory framework containing a new technical standard for statutory securities reporting, issued by the European Securities and Markets Authority (ESMA). All companies with securities (including both shares and bonds) that are listed on EU (and EEA) regulated markets must use this new digital format for the preparation of their annual financial report for financial years beginning on or after 1 January 2020.
The new format was imposed with an EU Regulation supplementing the Transparency Directive; therefore, its requirements are entirely and directly applicable in all Member States (and have EEA relevance).
When will the preparation of ESEF annual reports become mandatory?
ESEF has been in force since the 1st of January 2020. Depending on the length of the financial year, most companies’ reports in ESEF will be published for the first time in early 2021 – in relation to annual financial statements of the fiscal year 2020.
What does the ESEF mean for EU-listed companies and their auditors?
The new ESMA guidelines establish two essential requirements:
- All AFRs (annual financial reports) must be prepared entirely in web-based format (XHTML). This means moving from the current annual report in PDF (or printed versions) to a more modern representation of the same information as a “website page”, viewable with any standard web browser.
- Listed companies that prepare IFRS consolidated financial statements (approximately 5,300 EU organizations) will also have to mark certain information using the iXBRL tags (Inline eXtensible Business Reporting Language) according to the IFRS Taxonomy.
The IFRS (International Financial Reporting Standards) Taxonomy is a set of definitions and classifications of all concepts that are applied in financial reporting endorsed by the EU and updated annually by the IAASB (International Auditing and Assurance Standards Board) of the IFAC (International Federation of Accountants).
In plain English, ESEF is nothing more than a technical format: it doesn’t prompt to produce new information; it’s just about making existing information not only human-readable but also machine-readable to enable and improve its interpretation and scrutiny.
Looking for further guidance to understand the regulatory requirements?
To help companies prepare their ESEF-compliant annual financial reports, ESMA makes available on its website the ESEF Reporting Manual, which will be updated in the case of technical amendments to the ESEF Regulation. The ESEF taxonomy files are available on ESMA’s website in all EU languages and will be amended every year to reflect possible updates made by the International Accounting Standards Board (IASB) in the IFRS Taxonomy.
Why did the European Commission introduce ESEF?
ESEF is a fundamental step towards the EU’s stated ambition for a Single Digital Market, fit for the information age, and to keep up with the rest of the world. Such a goal requires the removal of national markets’ regulatory barriers to achieving an EU-wide harmonization of laws and processes. Included as part of this broader action plan is indeed the digitization of EU listed companies’ financial information through a common structured electronic format, a milestone that was long in coming considering how digital reporting is an increasing trend both within Europe and globally.
What are the benefits of ESEF? What’s in it for companies and shareholders?
A single electronic reporting format contributes to the accelerating digital maturity of the EU Market but brings forth further benefits for issuers, investors, and other stakeholders.
ESEF makes reporting easier and improves access, analysis, and comparability of financial statements. Digitizing reports according to the same standards means enabling more comprehensive usability of company data and making such financial information freely available and discoverable in the public domain.
Moreover, it will strengthen investors’ confidence and provide a better basis for all the stakeholders to make informed financial decisions – as they’ll be able to select and view relevant information such as percentage changes from previous years, currency, or even graphs. All this, in turn, will contribute to creating well-functioning capital markets and enhance their transparency.
Furthermore, a number of academic studies have documented positive impacts of the introduction of iXBRL-based tagging of financial reports in a range of jurisdictions, including some EU Member States, on the cost of equity capital and stock liquidity, access to bank funding, the timeliness of audit reports, and reduced audit fees.
What else is the EU doing to further support the digitization of financial information?
The EU Commission is exploring the role of digitalization in making information more accessible and more usable for users and investors. ESEF is only a part of the wide-ranging EU strategy for the promotion of digitization in both governments and businesses. Other initiatives – such as the activation of a European Electronic Access Point (EEAP) – are currently considered to complement ESEF in the digitalization of public corporate reporting.
What’s the impact of ESEF requirements on auditing firms’ work?
As the new digital tagging becomes part of the financial report, the European Commission indicated that they are expecting it to be audited as well. Most companies will ask their auditors to provide assurance on the high quality and compliance of their reports. According to initial recommendations published by the Committee of European Auditing Oversight Bodies (CEAOB), the main focal points auditors will need to focus on will be accuracy and completeness in the use of tags and taxonomy.
Put simply, the ESEF boils down to one thing: all companies whose shares are traded on the stock markets have a new requirement to comply with – meaning another task for their auditors that must adapt to legislative changes and evolve their traditional working methods. After all, keeping up with new legislative requirements is one of the main challenges the profession faces historically – as auditors not only need to incorporate those changes into their own activities but also figure out how they impact their clients.
It is, therefore, not unlikely that ESEF will cause new inefficiencies, lengthen the reporting process, and produce additional costs. So, the reporting format adds up to the many drivers that are increasing the need for auditors to embrace digitization to meet customer needs. Good review tools, expertise, and software with built-in compliance will help auditors and their clients avoid additional audit work and lengthy delays right before the intended publication date.
Given the approaching deadline, this regulatory change is becoming a hot topic for those responsible for annual reports, as it will doubtlessly disrupt current processes and the supplier landscape. Ultimately, the way ahead towards ESEF readiness comes down to a regulatory compliance exercise, for which the following steps are recommended:
1. Become familiar with the ESEF rules and taxonomy
Start by getting acquainted with this new set of rules. Before making any updates to the current report process, the first step should be understanding the requirements and evaluating how they may affect your company. This phase can involve tasking someone in the organization to assess ESEF rules, entering into discussions with current and potential service providers, go through the options, and devise a plan.
2. Review your current annual report preparation process
Once the Regulation cornerstones have been understood, it’s time to make changes to the annual report process, align it with the new rules, and get ready for first quarter deadlines. Being required this year for the first time, ESEF can understandably become a complex project, whereby preventive planning is crucial. But it should also be seen as a great opportunity to work out how to improve data governance and information flows within the company.
3. Get ready to select and deploy new software
Identify a partner or software that can support you in the process of creating the tags and converting the report to XHTML.
At Penneo, we have compliance and security at heart. We can provide you with a wall-to-wall solution for document management and process automation that can be easily integrated with other tailor-made accounting software. You’ll have a single, dedicated place to collect and handle all the documents, information, and digital signatures needed to complete the audit report process.