The quality of financial reporting is gradually improving, but there is still room for further improvement. Investors have a greater need for relevant and comparable information and the company’s ‘own story’ in the disclosures attached to the financial statements. Review by the Netherlands Authority for the Financial Markets (AFM) shows that the disclosures can be improved.
In addition to its regular supervision, the AFM carried out four thematic reviews of the 2013 financial reporting in 2014, which are described together in the report ‘In Balans 2014’. These reviews focused on the disclosures attached to the financial statements, the disclosure of remuneration of management boards, compliance with the reporting standards with respect to pensions and the risk paragraph.
Board member Gerben Everts of the AFM: “Investors are looking for timely, relevant and reliable information on listed companies. This is an important condition for confidence in the operation of the financial markets and reducing the costs of capital. Relevant and comparable financial information, together with a real account of the company’s ‘own story’, should be the priorities in the notes to the financial reporting.
Companies and their auditors are becoming increasingly more confident with the application of IFRS and the quality of financial reporting has increased further in some respects. This is a good thing. However, it appears that investors are still not always getting the information that they really need in our opinion. Companies and auditors need to be more critical. A justified and sustainable return of confidence has to be earned.”
Disclosure per theme:
The company’s ‘own story’ seems to be getting lost
Internationally, attention is increasingly focusing on the simplicity, readability and accessibility of financial reporting. Specific and relevant information on a company is important, because this enables investors to make decisions on a sounder basis.
Looking at the disclosures however, it turns out that companies can make significant improvements when it comes to telling their own story. Drafting or reviewing a financial report simply as a compliance document is not enough. The story of reporting companies seems to be getting lost as a result of simply following a checklist or illustrative financial statements. The information in the financial statements needs to be more specific. In other words, it should present information that can influence an investor’s decision.
More information needed on remuneration of the management board
The social debate on remuneration of management boards is still ongoing. There are more and more rules in place to prevent excessive remuneration and over-generous severance packages. This means that the disclosure of the remuneration of managers in key positions is a source of relevant information for decisions by investors and supervisors. The AFM reviewed the disclosure of remuneration of management boards in 2013 financial statements of 119 listed companies this year.
Too many of the disclosures on remuneration of management boards are not transparent enough. Depending on the remuneration component, the actual costs are not stated by 7 per cent to 39 per cent of the companies. For another quarter to one third of the companies, it is not clear whether the actual costs or other amounts are disclosed.
The remuneration structure is generally reasonably well described, however it is frequently not clear whether the bonus targets were achieved. Two thirds of the companies did not state whether the targets set had been achieved. The AFM’s view is that companies must provide this mandatory disclosure in their financial reporting. Moreover, information on remuneration is not easy to find. More or less all the companies presented this information piecemeal in various places in their financial reporting.
Poor compliance with the new disclosure requirements for pensions
Reporting of pension liabilities (and expenses) is socially relevant. Transparent presentation of the real costs of the current pension schemes has contributed to a wide social debate on the substance and continuity of pension systems, in the Netherlands and elsewhere. Furthermore, the pension liabilities are of such size that they have a direct effect on strategic policy and can materially affect the value of the individual company.
The review showed that companies did not comply satisfactorily with most of the new disclosure requirements for pensions. These requirements include a description of the statutory framework and governance of the pension fund, a description of the risk appetite of the pension fund and the provision of a sensitivity analysis with respect to the key assumptions.
The AFM also notes that companies audited by the same audit firm with the same industry pension scheme and the same administrator do not consistently qualify. For users, this causes confusion as to how to qualify the scheme and the associated risks.
Risks are neither good nor bad, as long as they are recognised and well managed. For users, it is important that companies report transparently on relevant risks and their risk appetite. Moreover, there recently have been a number of incidents that clearly demonstrate that too often, risk management and internal controls leave much to be desired, which creates uncertainty.
Only a limited number of companies explicitly stated which risks were the most important to them. There is also room for improvement with respect to the disclosure of the risk appetite, and more attention needs to be devoted to quantifying risks and providing information in the form of sensitivity analyses.
Thematic reviews in 2015
In 2015 the AFM’s supervision of financial reporting will focus on whether the new reporting standards for consolidation, joint arrangements and the accompanying disclosures are properly applied.
The AFM will also focus on the transparency provided by Dutch banks on any material changes arising from the recent Asset Quality Review by the European Central Bank, such as system changes, changes in accounting estimates, correction of prior period errors and changes to capital requirements. Remuneration of management boards, and specifically the disclosure of severance packages, will also be a focus of attention for the AFM next year.
The AFM also notes that companies do not provide a clear representation of bank covenants they have concluded. This is important information for users. Lastly, in 2015 the AFM will monitor developments with respect to integrated reporting and will strive to increase further awareness of this issue among the various parties interested in financial reporting.
In terms of theme, the reviews will correspond to the reviews that will be coordinated by ESMA in the European context.
The AFM is committed to promoting fair and transparent financial markets.
As an independent market conduct authority, we contribute to a sustainable financial system and prosperity in the Netherlands.