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ESMA’s IFRS Report Highlights “Room for Improvement” in Fair Value Data Disclosure

The European Securities and Markets Authority’s (ESMA) recent report on the application of International Financial Reporting Standards (IFRS) across the European region highlights that firms are still falling short in their data provision for fair value hierarchy and qualitative disclosures on risks arising from financial instruments. Although the European level regulator notes that progress has been made in the application of standards since IFRS were first applied back in 2005, it indicates that the number of enforcement actions required last year indicate that there is still “room for improvement.”

In the report ESMA states that firms’ disclosures around risk have improved over the last five years, but that there are still issuers that have “not achieved a satisfactory level of transparency.” The regulator attributes this lack of transparency to the fact that firms are continuing to use “boiler-plate disclosures rather than attempting to accurately describe facts specific to the issuer and/or transaction.” It is in this lack of specificity and granularity of data in which the regulator finds fault and suggests further improvement is needed.

Moreover, although it notes “significant improvements” in the level of compliance of disclosures related to: valuation techniques, own credit risk, credit risk, day one profit or losses and special purposes entities, it suggests that fair value and valuation risk are areas in most need of development. The classification and identification of instruments that require the application of fair value methodologies is an area of particular concern to ESMA, especially with regards to impairment of assets.

Data transparency around inputs into fair value calculations are also highlighted: “The fair value hierarchy, as defined under IFRS 7 paragraph 27A focuses on the methods used to determine fair value and the inputs used in valuation techniques. Valuation techniques are affected by the availability of inputs used for valuation, requiring judgment and consideration of factors specific to the asset or liability being measured. Enforcers identified cases where the level of fair value hierarchy disclosed did not accurately reflect the nature of the inputs used.”

On the subject of valuation risk and risk disclosures, ESMA states: “IFRS 7 identifies qualitative and quantitative disclosures to be provided by an entity regarding the nature of the risks to which the entity is exposed. There were cases where disclosures provided by the issuer tended to be boiler-plate, minimal in nature, and of limited usefulness to users of the financial statements other than shareholders. For example, financial statements did not adequately include information related to price risk, sensitivity analysis and counterparty risk disclosures.”

In order to highlight the scale of the problem, the regulator examines the number of enforcement actions required over 2010 and breaks them down into three categories. It lists: 22 actions requiring issuance of revised IFRS statements (compared to 19 in 2009); around 220 actions requiring public corrective notes or other public announcements (compared to 160 the previous year); and around 380 actions requiring corrections to future financial statements (compared to 560 in 2009). Further to this, it also states that a number of actions were not publically recorded such as notices to issuers, thus indicating that data standardisation problems persist in the financial reporting process.

As for follow ups to this report, no doubt ESMA will continue to raise the data transparency issue and ensure it is adequately tackled within upcoming regulation and accounting standard rule changes in cooperation with key global partners. On the latter note, ESMA also indicates it is working with the US Securities and Exchange Commission on the work plan first set up by its predecessor back in 2006.

The report also provides more fodder for the valuations and pricing community to call for investment in both data management frameworks and additional vendor feeds.

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