During the current Coronavirus crisis, publicly listed corporations are facing particular challenges with regard to their obligations applying to ongoing financial reporting.
The « Law for the Mitigation of the COVID-19 pandemic’s impact on civil, insolvency and criminal proceedings law of 27 March 2020 » does not contain any regulations on financial reporting. However, the Federal Financial Supervisory Authority (BaFin) and the European Securities and Markets Authority (ESMA) have issued recommendations on some select questions, which at least offer some practical indications for issuers. The Institute of Public Auditors (Institut der Wirtschaftsprüfer – IDW) in Germany also offered several valuable hints in « two technical notes » regarding the handling of these obligations during the crisis.
We would like to highlight a few particularly relevant issues as follows.
1. Impact on ongoing financial reporting
In a « public statement of 25 March 2020 » on ongoing financial reporting, the ESMA urges issuers to disclose any actual and possible impact of the COVID-19 pandemic in their financial reports as transparently as possible. This concerns the annual financial statements (provided that they have not been issued yet), as well as upcoming quarterly and half-year statements. Therein, the issuer should disclose all information necessary for investors to understand the overall impact of the Coronavirus crisis on the issuer’s assets, financial situation and results. In addition, any risks resulting from the COVID-19 pandemic are to be disclosed in an adequate manner.
This requires that in a first step, the issuer’s executive board assesses the current and possible future impacts of the COVID-19 pandemic (and any potential measures ordered by public authorities to stop its spread) on the issuer’s operations. Additionally, the executive board must consider measures to mitigate any negative effects. As the situation is still developing in an extremely dynamic way, the executive board will naturally have difficulties in making a reliable assessment of the concrete impact on supply chains and production processes or in accurately predicting customers’ changing demands. The same applies to the crisis’ impact on key performance indicators.
At the same time, this current uncertainty also leaves a wide scope of discretion for executive boards. As a rule of thumb, in case of doubt, the executive board should approach its assessment rather carefully – at least the capital markets should now accept a negative forecast more willingly than before the crisis.
When preparing financial reports, a balance must be found between the transparency requested by ESMA on the one hand and the substantial uncertainty on the other hand. When preparing annual financial statements with as of 31 December 2019, any expected financial impact must be stated in a supplementary report as a non-adjusting events (in comparison to a value-adjusting event), as it was only in 2020 that the COVID-19 pandemic occurred on a material scale on a material scale. In addition, possible risks (and opportunities) related to the impact of the COVID-19 pandemic must be described in a sufficiently concrete manner in the management report. Finally, the impact of the Coronavirus pandemic must be outlined in the forecast report.
Moreover, issuers face practical obstacles that are currently causing difficulties for the preparation of financial reports, as the restrictions on work processes due to contact restrictions and employees working from home are currently causing many delays in the drafting of financial reports. IDW at least notes in a « statement of 25 March 2020 » that most cases of a delay may, depending on the underlying reasons, probably be considered as a delay without the company’s own fault. Therefore, it may be possible in cases of a delayed disclosure to apply for reinstatement to the previous status with the Federal Office of Justice, should the proceedings to impose a fine actually be initiated.
2. Obligation for ad hoc reporting of significant deviation from announced forecasts
Due to the impact of the COVID-19 pandemic, there will often be (negative) deviations regarding the issuer’s financial indicators as stated in the forecasts previously communicated to the capital markets. Significant deviations can principally constitute inside information, leading to the issuer’s obligation to issue an ad hoc announcement. Accordingly, in their statement of 25 March 2020, ESMA reminds issuers explicitly of their possible disclosure obligations pursuant to the Market Abuse Regulation.
During ongoing financial reporting, it must therefore be determined in each individual case whether a deviation may constitute inside information. At the moment, such a determination is admittedly connected to considerable uncertainty.
Firstly, the deviation must be sufficiently likely. Luckily, the Federal Financial Supervisory Authority clarified in its « FAQs on the COVID-19 situation (last changed on 31 March 2020) » that an issuer may maintain its previous forecast if the impact of the COVID-19 pandemic on society cannot be sufficiently predicted yet. That being said, as soon as it can be assumed with sufficient probability that results will fall short of the existing forecast in a material manner, it can be assumed (subject to any significant potential to influence share prices, see below) that this constitutes inside information, even if a new detailed forecast cannot be issued at that time. In that case, it would be too late to issue an ad hoc announcement at the time at which the issuer gains detailed knowledge of the specific effects. Therefore, the existing forecast should be withdrawn without offering detailed new guidance at the same time.
Secondly, it will often be difficult to determine whether the deviation actually has significant potential to influence the stock price, as the stock exchanges have proven to be extremely nervous and volatile during the last weeks. Accordingly, a deviation can only be considered inside information if the financial figures’ deviation from the previously communicated figures is significant. Here, the Federal Financial Supervisory Authority believes that given the current circumstances, stricter criteria need to be applied to such a “significant” deviation in individual cases. It remains to be seen what this means exactly – yet it can be assumed that a deviation corresponding to the scope of other competitor’s deviations in the market will not be considered as inside information. On the contrary, a significant potential to influence the stock price may likely be presumed if the shortfall of the issuer’s results regarding its forecasts is even more dramatic than the one of other competitors in the current market environment, whereas any “normal” deviation may usually be considered “priced in” by the markets.
The current situation is an enormous challenge for management. The executive board of an issuer should thoroughly consider the impact of the Coronavirus crisis on the business operations with regard to financial reporting. Top priority of financial reporting should be transparency, especially as the capital markets will be prepared for bad news anyhow. At the same time, there should be a continuous review of whether and, as the case may be, at what time there is a significant deviation from previously stated forecasts, resulting in the obligation for an ad hoc announcement. Where necessary, the previous forecast should be withdrawn without issuing any new guidance.