In less than two years, new rules are set to require all companies listed on fully regulated European exchanges (including the FTSE*) to change the way they file their annual reports.
The European Securities and Markets Authority (ESMA) intends to require annual reports to be filed using what it calls the European Single Electronic Format (ESEF). The critical word here is ‘electronic’. Not only will the annual report have to be filed digitally, the key financial data must be machine-readable – in other words, each piece of data will need to be invisibly tagged so that computers will be able to identify the crucial numbers.
The chosen vehicle for the ESEF is XHTML with iXBRL tags included, two technologies that you might well never have heard of. And here’s the kicker: this reform is imminent. The EU is scheduled to legislate this summer, with the current plan being to implement ESEF for 2020 year-end annual reports. In other words, for many firms that means the next-but-one report.
The annual report filed using the ESEF will be available as a web page (or pages) which can be read and understood by both humans and computers. Humans see words and numbers, and hidden tags coded using iXBRL (Inline eXtensible Business Reporting Language) allow computers to swiftly identify and extract the primary financial data and narratives.
In the UK, since 2011 company accounts submitted to HMRC for tax purposes have been filed using iXBRL tags. Many smaller companies file their accounts using HMRC’s Online Filing software, which automatically generates an iXBRL document; others rely on their accounting packages to deliver an iXBRL export of their financial accounts. Some companies prefer to render their tax accounts using Microsoft Word or Excel, and then use a commercial tagging system to tag the key data and create an iXBRL document. In contrast, listed companies’ annual reports are often delivered to stock exchanges, investors and analysts on paper, and/or via a high-quality designed PDF without any tagging at all.
If the legislation passes as ESMA has recommended, then the adoption of the ESEF would require the following changes:
- The ESEF filing must be an XHTML document with iXBRL tags (or multiple XHTML documents if a single file is too big for a web browser to open), including all notes, explanations and narratives required to understand the financial data.
- An ESEF filing cannot be via PDF (although some bodies consulted by ESMA fought hard for PDFs with iXBRL tags added). ESMA also ruled out filing both an XHTML/iXBRL file and a designed PDF version.
- The ESEF will, to start with, require iXBRL tagging for the primary financial numbers only. In due course, virtually all the data in the annual financial report may end up being tagged as well.
Until the final legislation emerges, there are several critical questions left unanswered.
The ESMA consultation exercise recommended that ‘all annual financial reports’ issued by listed companies should be delivered via XHTML, viewable only online using a web browser. Does this mean that, once companies have filed a compliant ESEF for their stock exchange, they will be banned from producing paper or PDF versions for their investors?
Can you separate your annual financial report from other aspects of annual reporting? In other words, can you create a second annual report that deals with all the non-financial aspects, such as company mission and values, and send it to your investors in a beautifully-designed paper or PDF format? Or will the legislation really require all annual reporting to be in a single document via ESEF?
The XHTML/iXBRL file type allows the company to create a designed online annual report, but not at a great level of sophistication; the tagging format is not yet compliant with HTML5, the latest standard for web page design, and a complex design will likely not render well (you can see a sample file created by the Financial Reporting Lab here – click on any of the financial data and you should see the iXBRL format). Quite a few listed companies might feel pretty unhappy about rolling back the look and feel of their annual reports to an online-only and dated design, and might seek to separate financials from their ‘mission and values’ publishing, if the finalised rules allow such a thing.
ESMA’s aim is to make financial discovery and assessment transparent and efficient. It is hoped that tagging will allow exchanges and analysts to create sector-wide comparisons of companies’ performance on the key data, improving and speeding up the ability of investors to spot underrated companies.
The Financial Reporting Council (FRC) has warned that, for ESMA’s hopes to be achieved, regulators across Europe must align their reporting requirements, definitions and tagging taxonomies, as well as creating or encouraging easy access by analysts and investors to new comparative databases. There is little sign at the moment that this is happening. It also frets that gaining true visibility of company performance requires more comprehensive tagging than is envisaged for ESEF’s launch, and wonders whether sufficient thought is being given to assurance via audit and the danger of online hacking of annual reports by bad actors.
The FRC also raises how well companies will cope as they try to get to grips with adding a new technical tagging requirement to what is already a time-pressed process, especially if their current annual report designers do not have web design capabilities. Given that we are less than two years from launch and have yet to see the finalised rules of what could be a very disruptive change, the FRC’s concerns seem entirely sensible.
We are watching this closely, and will update clients on their communications and potential changes to their reporting strategies once the final legislation is revealed.
*PS: UK readers who think that Brexit might just come in time to dodge these new rules, think again; indeed, as a country looking to retain as much European business as possible – and as an early adopter of iXBRL – it seems likely that the UK will seek to synchronise its reporting regime with that used by the rest of Europe, even if we have already formally left the EU by 2020.