Enforcement of the 2022 annual reports published by issuers subject to the Transparency Law

Pursuant to the Law of 11 January 2008 on Transparency requirements for issuers (the "Transparency Law"), the CSSF is monitoring that financial and non-financial information published by issuers is drawn up in compliance with the applicable reporting frameworks.

As issuers are now preparing their reporting for the 2022 financial year, the CSSF wishes to draw the attention of those issuers preparing their financial statements in accordance with IFRS and/or their non-financial report in accordance with the Law of 23 July 2016¹, as well as of their auditors, to a number of topics and issues that will be the subject of a specific monitoring during the CSSF's enforcement campaign planned for 2023.

European Common Enforcement Priorities

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 2022 annual reports to which particular attention will be paid when monitoring and assessing the application of the relevant reporting requirements. ESMA issued on 28 October 2022 a public statement which presents these 2022 ECEPs. That document is available on the CSSF website under Enforcement of financial information.

The 2022 ECEPs related to IFRS financial statements focus on the following topics:

This ECEP is articulated around four areas of focus: i) consistency between IFRS financial statements and non-financial information; ii) impairment of non-financial assets; iii) provisions, contingent liabilities and contingent assets; and iv) power purchase agreements.

As climate-related matters were already identified as an ECEP for the 2022 campaign, the CSSF carried out focused examinations of the 2021 financial and non-financial information of issuers for which significant climate-related risks were identified.

The results of this review highlighted that this priority remains particularly relevant for 2022 annual reports. Therefore, in order to address this first priority, the CSSF will tailor its review procedures in view of addressing both the aspects covered by this ECEP and the follow-up of the observations made during its 2022 campaign thereon.

The CSSF recalls that, in the given context, boilerplate disclosures on climate related topics are not what is needed by users of the financial statements. They require specific and relevant information on how climate risks have been factored in the financial statements.

It goes without saying that the CSSF supports the ESMA recommendation to group these disclosures into one single note or, at least, to make this information easily accessible by providing a mapping of where different notes address climate-related matters.

In its statement on implications of Russia's invasion on half-yearly financial reports published in May 2022, ESMA reminds issuers of the following requirements and/or points of attention: i) presentation of the impacts of Russia's invasion in the financial statements; ii) loss of control, joint control or the ability to exercise significant influence; iii) discontinued operations, non-current assets and disposal groups held for sale; and iv) impairment of non-financial assets.

For issuers affected by this issue, it is absolutely necessary to present clear and detailed qualitative and quantitative information on the financial impacts, both at the balance sheet and comprehensive income levels, as well as the judgments and assumptions made.

ESMA and the national enforcers observe that the current macroeconomic environment pose significant challenges to issuers and their operations. As indicated in the ECEP statement, the main elements to be considered cover the increase in inflation, interest rates and energy costs, due to the fact that all such issues have an effect on the current business climate and present risks to the activity and financial situation of issuers.

Therefore, issuers are required to assess and reflect the impacts that the macroeconomic environment and uncertainties will have on their financial statements, and provide clear and detailed disclosures to ensure that investors obtain relevant, accurate and timely information.

In that context, four areas were identified on which national enforcers will focus for the enforcement of 2022 IFRS financial statements: i) impairment of non-financial assets; ii) employee benefits; iii) revenue from contracts with customers; and iv) financial instruments.

When reviewing these areas, the CSSF will pay particular attention on how the following subjects have been considered by issuers:

Discount rate

Considering the environment of high inflation in Europe for the first time since 2011, the European Central Bank's Governing Council increased interest rates in July 2022. This rise has been followed by three subsequent increases in September, November and December 2022. These decisions have a significant impact for issuers notably regarding a potential impairment of non-financial assets. Indeed, when the recoverable amount is based on discounted cash flows to determine either the value in use or the fair value less costs of disposal, one of the major assumptions is the discount rate which determines the present value of future cash flows.

The rise in interest rates will impact the long-term risk-free rates. All other things being equal, an increase in the risk-free rate and, by implication, the discount rate, leads to a decrease in the recoverable amount and, consequently, an increased risk that individual assets (or cash-generating units) are impaired.

Inflation

Harmonised Index of Consumer Prices (HICP) increased to 10.1% in November 2022 in the euro area and inflation reached records. This high level of inflation affects issuers in different ways.

Indeed, depending on the price elasticity of demand for issuers' products and services, some companies can pass along the increased costs to customers while others must absorb the higher costs of energy and raw materials. Moreover, even if issuers can increase their prices, the volume of sales and activity could nonetheless be affected by the decrease in purchasing power of their customers.

In these circumstances, the CSSF asks issuers to disclose, in their management report or financial statements, sufficient information explaining how inflation affects their business. This means that issuers should present the impact of inflation on their profits, margins, liquidity as well as on their overall level of activity and explain how the forecasts have been revised to take into consideration the surge in prices.

Finally, we also ask issuers to assess the effect of this new environment, in combination with the rise in interest rates, when applying notably the following standards (in addition to those mentioned in the ESMA statement):

• IAS 1 Presentation of Financial Statements (notably when reviewing judgments and estimates, going concern assessment…)
• IAS 2 Inventories (notably when assessing the net realisable value)
• IAS 10 Events after the Reporting Period (as high inflation could lead to major events after the reporting period);
• IAS 12 Income Taxes (when assessing deferred tax assets for instance);
• IAS 37 Provisions, Contingent Liabilities and Contingent Assets (notably when assessing the risk of contracts becoming onerous);
• IFRS 2 Share-based Payment (as risk-free rates and volatility are assumptions used in pricing models);
• IFRS 13 Fair Value Measurement (impacts where models consider inflation and interests rates);
• IFRS 16 Leases (notably for incremental borrowing rate, exercise of lease extension, variable lease payment based on consumer price index…).

ESMA recalls that beyond the consistency of financial and non-financial information and further to the IFRS requirements as described in priority 1.1, non-financial statements shall include information on the impact of climate change in application of the NFRD and in anticipation of the requirements of the future European Sustainability Reporting Standards that will apply with the forthcoming Corporate Sustainability Reporting Directive (the "CSRD").

In 2021, the CSSF carried out a thematic review to examine the status of climate-related information reported by issuers. That review was based on the recommendations made by the guidance on non-financial reporting as issued by the European Union for companies on how to report the impacts of their business on the climate and the impacts of climate change on their business.

As the review largely covered the different disclosure requirements of the Law of 23 July 2016, it confirms that the current areas of attention pointed out by the ECEP for the 2023 campaign are largely justified. Therefore, the CSSF expects significant progress to be made on this topic in the 2022 non-financial information.

2023 marks a major step for the reporting under Article 8 of the Taxonomy Regulation. Indeed, the financial year 2022 is the first year for which non-financial undertakings are required to disclose not only the taxonomy eligibility, but also the alignment of their economic activities with climate change mitigation and adaptation objectives as provided by the Taxonomy Regulation.

As mentioned in its report released on 26 October 2022, the CSSF will continue to examine the information published under Article 8 of the Taxonomy Regulation by issuers that are covered by that regulation, and will also challenge issuers on the outstanding issues and recommendations made in the above-mentioned report and resulting from the observations made by the CSSF in 2022.

Further to the guidance already released on this topic, the CSSF would like to inform issuers on new FAQs published by the EU Commission in December 2022. These FAQs provide further guidance on the application of Article 8.

Supply chains are often the main source of a company's carbon emissions and are therefore central to the fight against climate change. An entity's environmental and social footprint extends well beyond its own walls: it includes indirect emissions that occur throughout the company's value chain, such as emissions embedded in purchased goods and services, employee travels, and the use and end-of-life treatment of products sold. It may therefore be appropriate for entities to effectively measure their environmental and social scopes across their entire chain.

Indeed, benchmarking ESG performance across the entire cycle against competitors and players in other sectors is useful and can not only reveal hidden ESG strengths within the value chain, but can also show companies where they need to improve in order to match or exceed industry standards.

Furthermore, issuers are encouraged to provide transparency on the robustness of their data collection processes in order to ensure that quality data are used when preparing non-financial reporting.

As ESMA priorities highlight, APMs remain an important topic for the 2023 campaign, especially as issuers use them a lot in their communications. Based on the examination of the 2021 annual reports, the CSSF has decided to focus, in addition to those points mentioned in the ECEP statement, on the following topics in the context of its future examinations of the application of ESMA Guidelines on APMs:

First of all, APM labels should be meaningful and clear in order to avoid confusing or misleading the users of these measures.

Then, issuers should identify every APM presented in management reports or press releases. Indeed, we noted that issuers, once having correctly identified measures as APMs, respect most of the principles of the Guidelines.

Moreover, disclosure of APMs should not be more prominent than other measures that stem directly from the financial statements. Prominence is judged not only by the number of APMs given in comparison to other IFRS measures, but also by the presentation and place given to them in issuers communications.

The CSSF will pay particular attention to the respect of these requirements during its 2023 campaign.

Finally, we recommend that issuers, if concerned, use caution when making adjustments to APMs used and/or when including new APMs solely with the objective of depicting the impacts that macro-economic environment, such as inflation or increase in discount rates, may have on their performance and cash flows.

As from the financial year 2021, issuers' Annual Financial Reports (AFRs) have to be prepared in compliance with ESEF. A first requirement from the Regulatory Technical Standard (RTS) on ESEF was to publish all AFRs in xHTML and to mark-up IFRS consolidated financial statements using XBRL tags foreseen by Annex II of this RTS.

Issuers are now reminded that for their 2022 AFRs, further mandatory elements will have to be marked up if they are present in the consolidated financial statements. Whereas the first mandatory mark-up elements were defined as simple text elements, the consolidated Table in Annex II of the RTS now comprises a number of elements defined as, amongst others, "text block" and which are expected to be used for marking up larger pieces of information contained in the consolidated financial statements, such as explanatory notes and accounting policies.

Different levels of granularity are expected and specific attention should be brought to the existence of multiple block tags. While using multiple block tags and nested block tags, issuers will have to pay attention that narrative blocks extracted from the XBRL instance will be properly formatted and human readable. Common noticed issues are, amongst others, lost table structures, inconsistencies in applied styles, or different line breaks.

Issuers are encouraged to refer to the dedicated page on the ESMA website to consult supplementary and detailed guidance material on the block tagging approach.

Issuers may address their questions and remarks in this respect to [email protected].