8.01  In keeping with the Prospectus Regulation’s¹ aim of providing investors with any necessary information that is material for making an informed assessment of, among other things, the assets and liabilities, profits and losses, financial position, and prospects of the issuer,² financial information is a key element of the prospectus information package.

(p. 168) 8.02  Nevertheless, the Prospectus Regulation does not provide a clear definition of what financial information exactly means for the purposes of the prospectus, nor does it draw a clear distinction between financial information and non-financial information. However, it is possible to conclude that financial information consists of all accounting-related information (i.e. all information, directly or indirectly extracted from or based on issuer’s financial statements) that must be included in the prospectus. Hence, for the purposes of drafting the prospectus, financial information means all information concerning the issuer’s assets and liabilities, financial position, and profits and losses mentioned by section 18 of Annex I (and related sections of other annexes) of the Commission Delegated Regulation supplementing the Prospectus Regulation.³ On the other hand, any information concerning, for example, the history of the issuer, business overview, organizational structure, issuer corporate governance, or related-party transactions is classified as non-financial information and falls beyond the scope of the following analysis.⁴

8.03  Although under EU law, the content and the format of a prospectus both depend on a variety of factors, such as the type of issuer, security, and issuance; the prospectus must always provide detailed information concerning the issuers’ assets and liabilities, financial position, and profits or losses.

8.04  Specifically, the prospectus must incorporate (by reference⁵) audited financial statements covering a varying number of financial years, depending on the type of security or issuance. Moreover, where the issuer has published quarterly or half-yearly financial information since the date of its last audited financial statements, these must normally be included in the registration document.⁶

8.05  In addition, in order to ensure that financial statements included (by reference) in the prospectus represent the issuer’s undertaking accurately, and to avoid any potential inaccuracy within the information provided from affecting the ability of investors to make an informed assessment, equity security issuers with a complex financial history, or who have made a significant financial commitment, are required to provide additional information showing the impact of a relevant transaction or financial commitment on the issuer’s historical financial information, which should be incorporated into the prospectus.⁷

8.06  However, as a security’s value to investors depends on issuer’s future results, historical financial information may be relatively unhelpful for investors and not enough to allow (p. 169) them to make a sound investment decision. Hence, given that ‘information relevant to the issuer’s likely future performance is of much greater interest to investors’,⁸ issuers are also required or allowed (depending on the type of the security and offering) to include in the prospectus profit forecasts or profit estimates that are still outstanding and valid.⁹

8.07  Against this backdrop, and with a view to developing a comprehensive analysis of the rules for financial information set out by the EU prospectus regime, this chapter proceeds as follows: section II ‘The Legal Background: Prospectus Regulation, Delegated Regulation, ESMA Recommendations, and Q&A’ (para. 8.08) provides an overview of relevant rules concerning the financial information that must be included in the prospectus; section III ‘Historical Financial Information’ (para. 8.14) examines historical financial information; section IV ‘Pro Forma Financial Information’ (para. 8.34) deals with some specific issues concerning pro forma financial information; and finally, section V ‘Profit Forecasts and Estimates’ (para. 8.64) analyses the definition of profit forecasts and estimates along with related audit and disclosure requirements. Section VI ‘Conclusions’ (8.85) sets out some concluding remarks.

8.08  In line with the overall structure of the EU prospectus regime, the rules on the financial information that must be included in the prospectus are ‘multi-layered, composed of three elements’:¹⁰ first, the Prospectus Regulation; second, the Delegated Regulation as regards the format, content, scrutiny, and approval of the prospectus; and, third, the European Securities and Markets Authority (ESMA) Prospectus Recommendations (updating the existing Committee of European Securities Regulators (CESR) recommendations)¹¹ and the ESMA Q&A Prospectus.¹²

8.09  The Prospectus Regulation only provides rules on the key financial information that must be included in the summary, as well as the incorporation of information by (p. 170) reference to previously or simultaneously published documents. Indeed, according to Article 13, Prospectus Regulation, the European Commission is empowered to adopt delegated acts in accordance with Article 44 to supplement this Regulation regarding, among other things, the format of the prospectus and the schedules defining the specific information to be included in a prospectus. Hence, prospectus contents are mainly regulated by the CDR.

8.10  Article 13, Prospectus Regulation states that the delegated acts shall be based on the standards in the field of financial and non-financial information set out by international securities commission organizations, in particular by the International Organization of Securities Commissions (IOSCO) and, more generally, that information requirements shall be appropriate, taking into account the information needs of the investors concerned, depending on the type of the security and offering concerned.¹³

8.11  In keeping with such general principles, the CDR accepts a flexible and modular approach (so-called ‘building block approach’) according to which the prospectus shall be drawn up through a combination of schedules and building blocks,¹⁴ as appropriate for the type of issuer and security concerned.¹⁵

8.12  The Delegated Regulation largely enacts ESMA’s technical advice,¹⁶ apart from a few changes that do not have any substantial impact.¹⁷ Moreover, in many respects, it reproduces provisions of the Council Regulation (EC) 809/2004. This is in keeping with the contents of the formal mandate from the Commission seeking technical advice from ESMA in relation to, amongst other things, the format and content of the prospectus. In particular, with regard to the schedules defining the specific information that must be included in a prospectus, the EU Commission invited ESMA to carry forward the disclosure items required by the Council Regulation (EC) 809/2004 into the new schedules only after verifying that they strike an appropriate balance between investor protection and cost to the issuers.¹⁸ Nevertheless, with the aim of simplifying contents (p. 171) of the prospectus, ESMA was also asked to explore ways of streamlining schedules in order to reduce the overall number of annexes.¹⁹

8.13  Finally, the ESMA Prospectus Recommendations and Q&A Prospectus represent the third layer of the EU prospectus regime. Although they aim to promote common supervisory approaches and practices,²⁰ the ESMA Prospectus Recommendations and Prospectus Q&A are also meant to provide market participants with an indication of what constitutes proper implementation of the prospectus rules.²¹ This is especially true for the financial information that must be included in the prospectus. Indeed, the ESMA Prospectus Recommendations and Q&A Prospectus provide relevant guidance on several practical issues concerning historical information, pro forma financial information, and profit forecasts and estimates.

8.14  According to section 18 of Annex I (and related sections of other annexes) of the CDR, issuers are required to incorporate into the prospectus audited historical—consolidated²²—financial information covering a number of financial years,²³ which varies depending on a variety of factors, such as the type of issuer, security, or issuance. For example, while the equity registration document includes audited historical financial information covering the past three financial years,²⁴ the retail non-equity registration document must include two years of audited historical financial information.²⁵

(p. 172) 8.15  As far as issuers that have been in operation for a shorter period than the requisite duration of historical financial information are concerned, item 18.1 of Annex I (and related items of other annexes) of the CDR states that they shall disclose audited financial information covering that shorter period.²⁶ Moreover, according to item 18.1.7 of Annex I (and related items of other annexes), the balance sheet date of the last year of audited financial information may not be older than: (i) eighteen months from the date of the registration document if the issuer includes audited interim financial statements in the registration document; (ii) sixteen months from the date of the registration document if the issuer includes unaudited interim financial statements in the registration document. The maximum sixteen-month period is consistent with the requirement, set forth by Article 4, Transparency Directive, to make a public annual financial report at the latest four months after the end of each financial year. As ESMA notes:

The 18 month maximum period for the age of the annual financial statements is included where an issuer does not fall within the requirements of the Transparency Directive²⁷ (for example where it makes an offer to the public but its securities are not admitted to trading) and may therefore not be required to produce audited accounts four months after its year end.²⁸

8.16  In keeping with item 18.2.1 of Annex I (and related items of other annexes) issuers are also required to incorporate into the prospectus quarterly or half-yearly financial information published since the date of their last audited financial statements. In order to avoid duplicating information, ESMA has made it clear that, if at the time of prospectus filing (say 30 June), both half-yearly financial information and information on the first quarter are available, the prospectus shall include only half-yearly financial information, as it covers also the information for the first quarter. On the other hand, if at the time of prospectus filing (say 30 October) half-yearly financial information and information on the third quarter are available, both the half-yearly and the quarterly financial report must be included in the prospectus, as there is no duplication of information.²⁹

8.17  The ESMA Q&A must be read in conjunction with item 18.2.1 of Annex I (and related items of other annexes) of the CDR according to which, if the registration document is dated more than nine months after the date of the last audited financial statements, it must contain interim financial information—which may be unaudited—covering at least the first six months of the financial year. Hence, in keeping with the CDR, where the prospectus is filed more than nine months after the date of the last audited financial (p. 173) statements, the incorporation of interim financial information covering the first six months of the year seems to be sufficient.

8.18  However, the abovementioned requirement set out by item 18.2.1 of Annex I does not clash with the ESMA Q&A. Indeed, while the CDR does not require the issuer to prepare a quarterly financial report if the registration document is dated more than nine months after the date of the last audited financial statements, item 18.2.1 of Annex I does not preclude the incorporation—required by the ESMA Q&A Prospectus—of financial information covering the third quarter of the year, if it has been already published. Put differently, in order to alleviate the prospectus-related burden, the CDR does not oblige the issuer to produce a quarterly financial report simply for the purposes of the prospectus.

8.19  Annual financial historical information must be independently audited in accordance with Directive 2014/56/EU and Regulation (EU) 537/2014, and the prospectus must contain the audit report in respect of each year.³⁰ By contrast, the audit requirement does not apply to interim financial reports,³¹ although the issuer’s auditor is required to perform a review of interim financial information in accordance with the International Standard on Review Engagements (ISRE) 2410.³² A review of interim financial information conducted in accordance with the ISRE 2410 differs significantly from an audit conducted in accordance with the International Standards on Auditing. Pursuant to the ISRE 2410, a limited review of interim financial information ‘does not provide a basis for expressing an opinion whether the financial information gives a true and fair view, or is presented fairly, in all material respects, in accordance with an applicable financial reporting framework’.³³

8.20  Where the EU audit regime does not apply, as in the case of third-country issuers, the historical annual financial information must be audited or reported on in order to establish whether or not, for the purposes of the registration document, it gives a true and fair view in accordance with auditing standards applicable in a Member State or an equivalent standard.³⁴ In addition, if audit reports for the historical financial information have been rejected by the statutory auditors or if they contain qualifications, modifications of opinion, disclaimers, or an emphasis of matter, such qualifications and elements of the audit report must be reproduced in full in the prospectus, along with the reasons given.³⁵

8.21  As stated in item 18.1.3 of Annex I (and related items of other annexes), both annual and interim financial information must be prepared according to International Financial Reporting Standards (IAS/IFRS) as endorsed in the EU based on Regulation (EC) 1606/2002.³⁶ This requirement is generally unproblematic for European issuers. In keeping with item 18.1.6 of Annex I (and related items of other annexes), European issuers are required to include at least the consolidated financial statements in the registration document and, pursuant to Article 4, IAS Regulation, must prepare their consolidated accounts in accordance with IAS/IFRS.³⁷

8.22  On the other hand, accounting standards requirements are, in theory, more burdensome for third-country issuers as they must present financial information according to an ‘equivalent’ accounting system³⁸ or, absent such an equivalent system, restate their historical financial information in accordance with IAS/IFRS as endorsed in the EU.³⁹ However, given that the requirement for restatement entails significant costs and could make prospectus requirements very expensive for third-country issuers,⁴⁰ in 2008, based on the preventive ESMA’s (and previously CESR’s) assessment,⁴¹ the European Commission recognized the equivalence—for the purposes of the prospectus regime—of Japanese and US accounting standards.⁴² Moreover, from 1 January 2012, Generally Accepted Accounting Principles of the People’s Republic of China, Canada, and the Republic of Korea are also deemed to be equivalent to IAS/IFRS.⁴³ Hence, the incorporation of historical financial information into the prospectus is not burdensome for third-country issuers adopting ‘equivalent’ accounting standards as a basis for their statutory consolidated financial statements.⁴⁴

8.23  As under the EU law, issuers are obliged to adopt IAS/IFRS as a basis for their consolidated accounts, issuers accessing financial markets for the first time may have to change their set of accounting standards if they used local generally accepted accounting principles (GAAP) until they prepared and filed the initial listing prospectus.⁴⁵

8.24  In such cases, in order to render the historical financial information incorporated in the prospectus comparable with the financial information provided by the issuer once it is listed, item 18.1.4 of Annex I (and related items of other annexes) of the CDR requires that, ‘The last audited historical financial information, containing comparative information for the previous year, must be presented and prepared in a form consistent with the accounting standards framework that will be adopted in the issuer’s next published annual financial statements.’ Therefore, in keeping with this rule, the last annual report incorporated into the prospectus must be restated in accordance with IAS/IFRS. Given that the last financial statements also contain comparative information for the previous year, the restatement implies that the prospectus must include IAS/IFRS-compliant figures for the last two years prior to the offering.

8.25  For example, if the issuer files the prospectus in January 2019, its next published annual financial statements will be those for 2018, which must be approved at the latest four months after the end of the previous financial year. In such cases, the issuer is required to restate the 2017 financial statements—containing comparative information for 2016—in accordance with IAS/IFRS. Consequently, the prospectus will incorporate: the 2017 restated financial statements prepared according to IAS/IFRS and financial statements covering 2016 and 2015 prepared according to the previous GAAP, as previously published. This is consistent with the so-called bridge approach recommended by ESMA, according to which the middle period (2016) is used as a bridge between the first year (2015) and the third year (2017).⁴⁶ Indeed, the prospectus will incorporate 2016 figures drafted according both to IAS/IFRS (as included in the restated 2017 financial statements) and national GAAP (as included in the 2016 financial statements).

8.26  On the contrary, where the issuer adopted IAS/IFRS as the basis for its statutory consolidated accounts before it was listed, item 18.1.4 of Annex I (and related items of other annexes) of CDR states that changes within the accounting framework applicable to an issuer do not require the audited financial statements to be restated solely for the purposes of the prospectus. Nevertheless, if after the offering an issuer changes an accounting policy⁴⁷ in its consolidated financial statements (e.g. upon the initial application of a new standard or interpretation issued by IASB or IFRIC or a voluntary change (p. 176) in accounting policies⁴⁸), IAS 8 then applies. In this case, IAS 8 requires the retrospective application of changes of accounting policies, unless this is impracticable.⁴⁹ Thus, the new accounting policy must be applied as if that policy had always been applied.⁵⁰

8.27  Nevertheless, ESMA made it clear that no additional IAS 8 requirements should be applicable in a prospectus.⁵¹ For example, if the issuer incorporates into the prospectus the annual financial statements for 2017, 2016, and 2015, and then starts to apply a new accounting policy in 2017, according to the IAS 8 the issuer is required to restate only the set of financial statements for the year 2017 (including the comparative information included therein). Hence, according to the IAS 8, the restatement only concerns the comparative information (for 2016) included in the financial statements for 2017, whereas the 2016 and 2015 financial statements need not be restated and can be incorporated into the prospectus as they were published.⁵²

8.28  The historical information requirement can make the prospectus excessively long and complex, and lead to an increase in prospectus-related costs borne by issuers.⁵³ In order to prevent such potential drawbacks, issuers are allowed to incorporate by reference some documents containing the information that must be disclosed in a prospectus. According to Article 17, Prospectus Regulation, information may be incorporated by reference into a prospectus where it has been previously or simultaneously published electronically and has been drawn up in a language fulfilling the requirements of Article 27.⁵⁴

8.29  Therefore, information that may be incorporated by reference includes, inter alia, annual and interim financial reports, audit reports, and management reports as referred to in Chapter 5 of Directive 2013/34/EU.⁵⁵ In order to ensure that the information remains accessible, a cross-reference list must be provided in the prospectus in order to enable investors to identify easily specific items of information.⁵⁶ For the same purpose, the prospectus must also contain hyperlinks to all documents containing information that is incorporated by reference.⁵⁷

8.30  In line with the aim of limiting prospectus complexity, the CDR aligns the operating and financial review (OFR) requirement with the management reports required under the Accounting Directive. According to item 7.1.2 of Annex I (and related items of other annexes) of the CDR, OFR requirements may be satisfied by the inclusion of the management report referred to in Articles 19 and 29, Directive 2013/34/EU. This is in keeping with Article 19, Prospectus Regulation, which includes the management report among the documents that can be incorporated into the prospectus by reference.⁵⁸

8.31  As noted by ESMA,⁵⁹ the management report also contains information that can be found elsewhere in the prospectus. For example, the description of the principal risks required by Article 19, Directive 2013/34/EU partially overlaps with the section of the prospectus dedicated to the risk factors. Although this can lead to some duplication of information, the solution adopted by the CDR has considerable advantages. First, it can significantly reduce costs for issuers. Second, as the yearly management report must include the information required under Articles 19 and 29, Accounting Directive, its incorporation by reference can enhance the comparability of the information disclosed for the financial years covered by historical financial information.⁶⁰

8.32  As recommended by the ESMA technical advice, the EU Commission has removed the requirement⁶¹ for issuers of equity and retail non-equity to include a section in the prospectus containing selected financial information. ESMA clarified that the removal of this requirement does not conflict with the provisions of Annex I of the Prospectus Regulation, on which the Commission is obliged to base its delegated (p. 178) acts. In particular, the Commission highlights that ‘selected financial data’, as referred to in Annex I, ‘is not a defined term and its inclusion in a prospectus can be achieved through the requirement to disclose a selection of historical key financial information in the summary’.⁶²

8.33  The removal of the requirement for selected financial information is primarily aimed at avoiding the duplication of information and reducing prospectus-related costs. Nevertheless, as the primary purpose of including selected historical financial information in a prospectus is to summarize the key information originating from the historical financial information of the issuer,⁶³ the removal of this requirement does not deprive investors of relevant information. First, the prospectus summary includes a selection of historical key financial information. Second, selected financial information is extracted from historical financial information that is incorporated into the prospectus in full by reference.⁶⁴ Third, the management report (which can be incorporated into the prospectus by reference) must include references to, and additional explanations of amounts reported in, the annual financial statements insofar as it is necessary for an understanding of the issuer’s development, performance, or position.⁶⁵

8.34  In order to ensure that financial statements incorporated (by reference) into the prospectus represent the issuer’s undertaking accurately, and to avoid the potential inaccuracy of the information provided affecting the ability of investors to make an informed assessment, equity issuers with a complex financial history or that have made a significant financial commitment are required to provide additional information showing the impact of a relevant transaction or financial commitment on the company’s historical financial information included in the prospectus.⁶⁶

8.35  Specifically, according to Article 18(1), additional information relating to an entity other than the issuer must be included in the registration document and in the securities note. Moreover, Article 18(2) states that information relating to an entity other than the issuer must contain all information referred to in Annexes 1 and 20 that investors need to make an informed assessment as referred to in Article 6(1) and Article 14(2), Regulation (EU) 2017/1129, as if that entity were the issuer of the equity security.

8.36  Additional financial information relating to an entity other than the issuer must be included in the registration document and in the securities note when the issuer (i) has a complex financial history; or (ii) has made a significant financial commitment.

8.37  As far as the latter hypothesis is concerned, Article 18(4), CDR states that ‘a significant financial commitment is a binding agreement to undertake a transaction that is likely to give rise to a variation of more than 25% relative to one or more indicators of the size of the issuer’s business’. For these purposes, indicators of size include total assets, revenues, profits, or losses.⁶⁷ In addition, since historical financial information must contain the cash flow statement, cash flows can arguably also be regarded as a relevant indicator of size.

8.38  The ESMA Recommendations help to clarify the definition of financial commitment. First, a transaction is deemed to involve a significant financial commitment even where an agreement renders the completion of the transaction subject to certain conditions, including approval by a regulatory authority, if it is reasonably certain that those conditions will be fulfilled.⁶⁸ Second, an agreement should be treated as binding:

where it makes the completion of the transaction conditional on the outcome of the offer of the securities that are the subject matter of the prospectus or, in the case of a proposed takeover, if the offer of securities that are the subject matter of the prospectus has the objective of funding that takeover.⁶⁹

8.39  According to Article 17(3), CDR, an issuer is considered as having a complex financial history where all of the conditions indicated therein are fulfilled. First, at the time of drawing up the prospectus, the information contained therein does not represent the issuer’s undertaking accurately; second, the inaccuracy of information contained in the prospectus affects the ability of investors to make an informed assessment; third, additional information, including financial information, relating to an entity other than the issuer is needed for investors to make an informed assessment.

8.40  In line with this definition, additional information relating to an entity other than the issuer is required when the issuer’s business undertaking underwent a significant change during the period covered by historical financial information incorporated into the prospectus. Hence, an issuer will be considered as having a complex financial history, for example, where it acquired a business that makes up a significant portion of its size or was incorporated during the period covered by historical financial information. (p. 180) In such cases, additional information concerning the business acquired is required in order to allow investors to make an informed assessment.

8.41  Although the Delegated Regulation does not provide any explicit recommendation concerning this matter, it is apparent that ‘the larger an acquired business undertaking is, the more likely it is that separate financial information will be required’.⁷⁰ Therefore, issuers can use size indicators that must be taken into account in order to assess whether a binding agreement to execute a transaction constitutes a significant financial commitment for the purposes of Article 18(1) also in order to consider whether a transaction is of such significance as to give rise to a complex financial history. This approach is consistent with the UK Listing Rules requirement for the admission of securities to the premium-listing segment of the London Stock Exchange. Listing Rule 6.1.3BR(1) states that historical financial information covering the past three years must represent at least 75 per cent of the new applicant’s business for the full period.

8.42  As mentioned in paragraph 8.35 above, according to Article 18(2), CDR, the additional information relating to an entity other than the issuer that must be included in the prospectus must contain all relevant information referred to in Annexes 1 and 20 that would be relevant in order to allow investors to make an informed assessment as referred to in Article 6(1) and Article 14(2), Regulation (EU) 2017/1129, as if that entity were the issuer of the equity security.

8.43  According to Article 17(2), draft CDR, the additional information relating to an entity other than that issuer would have to contain ‘(a) all relevant information items referred to in Annex 19 and (b) all relevant information referred to in the Annexes that would be relevant for that entity if it were the issuer of the equity security’. A number of participants in the public consultation on the draft CDR noted that this requirement would have imposed a significant burden on issuers. In fact, the draft CDR significantly extended the scope of information concerning the target that may be required. While Article 4a, Council Regulation (EC) 809/ 2004 required the registration document to include only certain items of financial information relating to an entity other than the issuer, the requirement set out by Article 17 of the draft CDR went well beyond financial information.⁷¹ Hence, the issuer seemed to be required to include in the prospectus (p. 181) risk factors, a business description, and other disclosures as if that acquired business were a stand-alone issuer.⁷²

8.44  In line with the ESMA technical advice,⁷³ several participants to the public consultation on the draft CDR also recommended that, when defining the information to be provided in accordance with Article 18(2), CDR, the competent authority should also take into account (alongside the other elements mentioned by Article 36, CDR) the ability of the issuer to obtain financial or other information relating to another entity with reasonable effort.⁷⁴ Moreover, other participants asked for the reinstatement of the status quo as set out in Commission Delegated Regulation 809/2004,⁷⁵ under which it was clear that only financial information of a company other than that of the issuer must be included in the prospectus.⁷⁶

8.45  In the light of criticisms raised during the the public consultation on the draft CDR, the final version of the CDR significantly limits the information requirement relating to an entity other than the issuer, and essentially reinstates the previous regime. In fact, according to Article 18(2), CDR, with respect to an entity other than the issuer, a prospectus must only include all information referred to in Annexes 1 and 20 that are needed to allow investors to make an informed assessment as referred to in Article 6(1) and Article 14(2), Regulation (EU) 2017/1129, as if that entity were the issuer of the equity security. Hence, based on the reference to Article 6(1), Regulation (EU) 2017/1129, the additional information relating to an entity other than the issuer must only include the necessary information which is material to an investor for making an informed assessment of: the assets and liabilities, profits and losses, financial position, and prospects of the issuer and of any guarantor; the rights attaching to the securities; the reasons for the issuance, and its impact on the issuer. Therefore, if compared to the wording of Article 17 of the draft CDR, the final rule of Article 18, CDR significantly reduces the scope of the information concerning an entity other than the issuer that equity issuers having a complex financial history are required to include in the prospectus.

8.46  In addition to the abovementioned information concerning the entity other than the issuer, in the event of a significant gross change, item 18.4 of Annex I (and related (p. 182) items of other annexes) of the CDR requires pro forma financial information to be prepared in order to describe how the transaction might have affected the assets, liabilities, and earnings of the issuer, had the transaction taken place at the commencement of the period being reported on or at the date reported.⁷⁷ Hence, pro forma financial information complements the historical financial information of the issuer by ‘acting as a bridge to guide investors to an indication of the totality of what it is they are investing’.⁷⁸

8.47  Based on the definition set out by Article 1(e), CDR, a significant gross change means a variation by more than 25 per cent of one or more of the indicators of the size of the issuer’s business.⁷⁹ Moreover, ESMA clarified that the reference made to ‘transaction’ covers both transactions that have already occurred and transactions that have not yet taken place, but where the issuer has made a significant firm commitment.⁸⁰

8.48  In addition, significant gross change transactions only include acquisitions and disposals, whereas equity or debt raisings are not in themselves significant gross changes, since they do not have a significant impact on issuer’s assets, liabilities, and earnings.⁸¹ Nevertheless, the effects of equity or debt raisings are reflected in the pro forma financial information where they are closely related to a transaction involving a significant firm commitment.⁸² For example, the Institute of Chartered Accountants in England and Wales (ICAEW) recognizes that:

where a proposed acquisition is to be funded in part from the proceeds of an equity issue made subsequent to the last year-end, but prior to the proposed acquisition, it would be appropriate to present as an adjustment in a pro forma net assets statement the receipt of the proceeds from the equity issue.⁸³

(p. 183) 8.49  Although in most cases the provision of pro forma financial information is the best way of describing the effect of a significant gross change, item 18.4.1of Annex I (and related items of other annexes), CDR recognizes (implicitly⁸⁴) that sometimes the inclusion of pro forma information in the prospectus is not feasible or might not be a fair way of describing the effects of the transaction.⁸⁵ In such cases, a narrative description of the transaction’s impact on issuer’s earnings or assets and liabilities is enough to comply with the information requirement for gross change transactions.⁸⁶

8.50  Pro forma financial information must be presented as set out in Annex 20 of the CDR and must be accompanied by a report prepared by independent accountants or auditors.⁸⁷ In particular, item 1.1 of Annex 20 states that pro forma financial information shall consist of: (i) an introduction illustrating the purpose of the pro forma financial information, the period or date covered, and the effects of the transaction as if it had been undertaken at an earlier date; (ii) a profit-and-loss account, a balance sheet or both, depending on the circumstances presented in a columnar format; (iii) accompanying notes explaining, among other things, the sources from which the unadjusted financial information has been extracted, the basis upon which the pro forma financial information is prepared, source and explanation for each adjustment, and whether each adjustment in respect of a pro forma profit-and-loss statement is expected to have a continuing impact on the issuer or not.⁸⁸

8.51  As, in keeping with item 18.4.1 of Annex I (and related items of other annexes), pro forma financial information aims to illustrate the effects of the transaction as if had it been undertaken at the commencement of the period being reported on or at the date reported;⁸⁹ the profit-and-loss account and (if needed) the balance sheet included in the pro forma financial information must be presented in a columnar format composed of (i) historical unadjusted information; (ii) accounting policy adjustments, where necessary; (iii) pro forma adjustments; (iii) the results of the pro forma financial information.⁹⁰

(p. 184) 8.52  Pro forma financial information may be published in respect of the last completed annual financial period or the most recent interim period for which relevant unadjusted information has been published or are included in the prospectus.⁹¹ The specific period that is covered by pro forma financial information and whether it is necessary to present also a pro forma balance sheet are questions that depend on when the relevant transaction took place and when the prospectus is filed. In this regard, ESMA provides a detailed recommendation by distinguishing between four different cases.⁹²

8.53  If the transaction occurred during the previous financial year and the prospectus is filed during the first half of the current year, a pro forma balance sheet is not required, since the transaction is already reflected in the balance sheet of the previous year financial statements. On the other hand, as the transaction is not reflected in the profit-and-loss account for the full previous year, a pro forma profit-and-loss account illustrating the transaction as if it had happened on 1 January of the previous year is required.⁹³ The pro forma profit-and-loss account can be prepared according to two alternative approaches. First, it is possible to subtract the partially consolidated target financial information and then add the target’s latest full-year financial information to that of the issuer through separate adjustment columns for the pro forma profit-and-loss account. Otherwise, adjustments can only cover the pre-acquisition period.⁹⁴

8.54  Where the transaction occurred during the previous financial year and the prospectus is filed during the second half of the current year, no pro forma balance sheet and profit-and-loss account is required, since the transaction’s effects are already reflected in the published half-yearly financial report. As has been confirmed by ESMA,⁹⁵ this implies that a period of six months is generally sufficient in order to illustrate the profit-and-loss effect of the transaction, unless in the specific case a longer period of time is required, for example where the issuer’s business is affected by seasonal factors.⁹⁶

8.55  The position is in part different if the relevant transaction takes place during the current financial year. In this case, where the prospectus is issued during the first half-year after the transaction and contains audited annual financial statements for the previous year, then both a pro forma balance sheet and a pro forma profit-and-loss account for the previous financial year are required. On the other hand, where the prospectus is issued during the second half-year, there are two possible scenarios. If the issuer has already published the half-yearly financial report, a pro forma balance sheet is not needed, as the transaction is already reflected in the balance sheet within the half-yearly financial (p. 185) information. Alternatively, if the half-yearly financial report is not yet available, the issuer must also prepare a pro forma balance sheet covering the previous financial year.

8.56  As far as the profit-and-loss account is concerned, the ESMA guidance is not entirely clear.⁹⁷ Nevertheless, based on the general criteria according to which a period of six months is generally sufficient in order to illustrate the profit-and-loss effect of a gross change transaction, a pro forma profit and loss for the half-yearly financial information as if the transaction had occurred on 1 January would appear to be sufficient.

8.57  In order to render pro forma financial information comparable with the historical financial information included in the prospectus, item 2.1. of Annex 20 specifies that ‘the pro forma financial information must be prepared in a manner consistent with the accounting policies adopted by the issuer in its last or next financial statements’. Therefore, pro forma financial information must be based on accounting policies adopted in the historical financial information.⁹⁸ Nevertheless, as the ICAEW notes, this requirement does not preclude simplified presentation, ‘where such simplification assists in a clear reading of the pro forma financial information and is consistent with the specific purpose of the pro forma information’.⁹⁹

8.58  As pro forma financial information amounts to a hypothetical illustration of the impact of a transaction on the issuer’s assets and liabilities or earnings as if it had been undertaken at an earlier date selected for purposes of the illustration, adjustments are the key element of pro forma financial information. Item 2.3 of Annex 20 sets out the criteria that issuers must apply when considering which adjustments to make in order to illustrate the pro forma effect of a transaction. Specifically, item 2.3. states that pro forma adjustments must (i) be clearly shown and explained; (ii) present all significant effects directly attributable to the transaction; and (iii) be factually supportable.

8.59  As far as the presentation of adjustments is concerned, it is crucial that the issuer provides a clear and comprehensive illustration of each adjustment in order to make it comprehensible to investors. For these purposes, according to the CDR, accompanying notes comprised in the pro forma financial information must provide the source and an explanation for each adjustment, and explain whether each adjustment in respect of a pro forma profit-and-loss statement is expected to have a continuing (p. 186) impact on the issuer or not.¹⁰⁰ In addition, adjustments must be clearly stated in the pro forma balance sheet and profit-and-loss account, usually by using a columnar presentation.¹⁰¹

8.60  However, although having a separate column for each adjustment may be desirable, an excessive number of columns can make pro forma financial information too complex and unclear. Therefore, in order to avoid this potential drawback, the ICAEW recognizes that ‘it is normal for the adjustment columns to contain information, with varying degrees of aggregation, reflecting more than one adjustment’.¹⁰² Moreover, where appropriate, two or more adjustments can be presented on an aggregated basis.¹⁰³ In such cases, additional details on adjustment indicated in the pro forma balance sheet and/or profit-and-loss account can be included in the notes.¹⁰⁴

8.61  According to item 2.3 of Annex 20, adjustments must present all significant effects that are directly attributable to the transaction. Although its wording is not entirely clear, this rule seeks to prevent pro forma financial information from reflecting matters that are not an integral part of the transaction described in the prospectus, and also in particular any effects of the transaction that are dependent on the company’s future actions, regardless of whether such effects are central to the issuer’s purpose in entering into the transaction.¹⁰⁵ For example, the EU Commission notes that, ‘the issuer should not include deferred or contingent consideration in its pro forma if such consideration is not directly attributable to the transaction at hand but to a future event and may result in unduly inflating the net assets figures’.¹⁰⁶ Along the same lines, synergy benefits resulting from the transaction cannot be reflected in the pro forma financial information, since they depend on the future actions of the issuer, which must be taken once the transaction has been completed.¹⁰⁷

8.62  In order to provide an adequate level of assurance as to the reliability of pro forma financial information, item 2.3 of Annex 20 also requires adjustments to be factually sustainable. This requirement implies that adjustments must be backed up by facts that ‘are expected to be capable of some reasonable degree of objective determination’.¹⁰⁸ Normally, support may be provided by published accounts, management accounts, other financial information, and valuations contained in the document, purchase, and sale agreements and other agreements to the transaction covered by the prospectus.¹⁰⁹ Consequently, given the trade-off between the relevance and reliability of financial (p. 187) information depending on the availability of appropriate support, an issuer need not include in the prospectus any adjustments that may be relevant when sufficiently reliable supporting facts are lacking.¹¹⁰

8.63  Pro forma financial information must be accompanied by a report prepared by an independent accountant or auditor.¹¹¹ In line with the International Standard on Assurance Engagements 3420,¹¹² accountants or auditors are required to state that ‘the pro forma financial information has been properly compiled on the basis stated’ and ‘this basis is consistent with the accounting policies of the issuer’. ESMA recommends that the auditor’s statement concerning pro forma information includes the exact wording as set out by the CDR and should not include qualifications or emphasis-of-matter paragraphs, as these are considered to reduce the clarity of the auditor’s or accountant’s statement.¹¹³ Nevertheless, it is questionable whether this position is correct, taking into account paragraph 34, ISAE 3420, according to which an auditor may consider it necessary to include an emphasis-of-matter paragraph where, in the practitioner’s opinion, the matter is of such importance that it is fundamental to users’ understanding of whether the pro forma financial information has been compiled, in all material respects, on the basis of the applicable criteria.¹¹⁴

8.64  Profit forecasts and estimates are a crucial element of the prospectus since the issuer’s likely future performance is of much greater interest to investors than historical financial information.¹¹⁵ However, since information relating to future events is more sensitive to assumptions than historical financial information and can thus be presented in an over-optimistic manner,¹¹⁶ some concerns are associated with the inclusion of forward-looking information in the prospectus. Therefore, in order to prevent issuers from presenting profit forecasts and profit estimates conveying unreliable predictions, (p. 188) estimates, and in particular the presentation of forecasts, are both tightly regulated under the EU prospectus regime.¹¹⁷

8.65  Although profit forecasts and estimates are generally supposed to be of great interest for investors, their relevance varies depending upon the type of financial instrument. In particular, as recognized by ESMA, in some cases profit forecasts and profit estimates are not deemed to be relevant for non-equity investors, since they focus mainly on the issuer’s solvency.¹¹⁸ Hence, as item 8.1, Annex 6 (and related items of other annexes) of the CDR clarifies,¹¹⁹ profit estimates or profit forecasts can be included in a prospectus for non-equity securities on a voluntary basis. Nevertheless, as ESMA correctly notes, an issuer of non-equity securities is required to assess whether or not an outstanding profit forecast is material for investors. If so, such information must be included in the prospectus in accordance with Article 6, Prospectus Regulation.¹²⁰

8.66  On the other hand, there is a general presumption that an outstanding forecast is material for equity issuances.¹²¹ Thus, a profit estimate or profit forecast must be included in a prospectus for equity securities unless it is no longer outstanding and valid. Moreover, if a profit forecast or a profit estimate has been published and is still outstanding, but no longer valid, an explanation as to why such a forecast or estimate is no longer valid must be provided.¹²²

8.67  However, in order to alleviate the burden on issuers, the ESMA recognizes that, despite the (apparently binding) requirement to include outstanding profit forecasts and profit estimates, previously published profit forecasts and profit estimates need only be disclosed within the context of an equity issuance where they are material and valid.¹²³ (p. 189) A profit forecast cannot be considered (still) to be valid where, due to changes since the time when the forecast was made, the actual profits or losses are expected to be materially different from those forecast and such changes give rise to material differences between the currently expected profits or losses and those previously forecast.¹²⁴ For example, a profit forecast made several months before an acquisition is announced is more likely to be no longer valid once the acquisition has been announced.¹²⁵ In addition, where the profit forecast covers more than one year, the validity of profit forecasts for each year must be assessed. Therefore, it may be the case that the first year of a profit forecast is deemed to be valid, whereas later years are considered invalid.¹²⁶

8.68  Article 1(c) and (d), CDR defines profit forecasts and profit estimates and draws a clear distinction between forecasts and estimates. A profit forecast is:

On the other hand, a profit estimate is ‘a profit forecast for a financial period which has expired and for which results have not yet been published’.

8.69  Based on these definitions, it is apparent that, while forecasts are future-oriented predictions, estimates can qualify as past-oriented since they refer to a period that has expired (and for which results are not yet available).¹²⁷ Hence, profit estimates are not expected to be that assumption-sensitive¹²⁸ and, normally, the financial information published after estimates would confirm the status of previously published data as an estimate.

8.70  In spite of the clear definition set out by Article 1, CDR, in practice it is problematic determining whether or not a profit forecast has been made. In order to tackle such a practical issue, in 2018 ESMA published a Q&A Prospectus with the aim of clarifying what a profit forecast is.¹²⁹ Although it relies on the wording of Article 1, CDR, ESMA’s (p. 190) recommendation embraces the substance-over-form approach in order to determine which data or financial indicators may, under certain circumstances, be considered to constitute a profit forecast.¹³⁰

8.71  In keeping with the substance-over-form approach, ESMA states that a profit forecast can refer, either directly or indirectly, to a precise figure or a range of figures, especially when a minimum or maximum figure is mentioned or implied.¹³¹ Moreover, the phrase ‘the likely level of profits or losses’—included in the definition of profit forecast—is deemed to refer not to the profit or loss for the year but also to other measures of profitability conveying an expectation of a future performance. Hence, financial ratios derived from the profit-and-loss account such as, for example, earnings before interest, taxes, depreciation, and amortization (EBITDA), earnings before interest and taxes (EBIT), and earnings before taxes (EBT), are considered to be a profit forecast.¹³²

8.72  In view of the above, in line with the substance-over-form approach and the definition of profit forecast,¹³³ the wording of the statements made by the issuers is not crucial: also information that, when combined with other information in the prospectus, makes it possible to calculate a figure or a minimum or a maximum for the likely levels of future profit or loss may be considered as a profit forecast. For example, ESMA concludes that the statement, ‘We are expecting this year’s turnover to remain the same and this year’s EBITDA margin to rise by 5%’ is a profit forecast.¹³⁴ Moreover, also information relating to one or more segments of the issuer’s business must be classified as a profit forecast where these segments generate the vast majority of the issuer’s profits or losses. Likewise, if the issuer is involved in an acquisition project, predictions concerning the level of the target’s profits or losses are deemed to constitute a profit forecast where they are included in the prospectus and the proposed acquisition is expected to generate the vast majority of the issuer’s profits or losses.¹³⁵

8.73  In addition, ESMA also provides some insights into how to distinguish between profit forecasts and trend information required under item 10 of Annex 1 (and related items of other annexes) of the CDR. While a general discussion of the future prospects of the issuer under trend information does not normally constitute a profit forecast, a statement may have to be considered as a profit forecast if it is ‘specific with respect to (i) level of profit/loss or other measure of profitability (a number/range/floor/ceiling) and (ii) a specific financial period’.¹³⁶ That said, however, in keeping with the substance-over-form approach, a case-by-case analysis is required; thus for example, the statement (p. 191) announcing a certain dividend per share or describing the issuer’s dividend policy will not be considered as a profit forecast.¹³⁷

8.74  As pointed out by ESMA, persons responsible for the prospectus must ensure that profit forecasts or estimates are not misleading for investors.¹³⁸ In line with this general principle, profit forecasts and profit estimates should be:

Understandable, i.e. Profit forecasts or estimates should contain disclosure that is not too complex or extensive for investors to understand; reliable, i.e. Profit forecasts should be supported by a thorough analysis of the issuer’s business and should represent factual and not hypothetical strategies, plans and risk analysis; Comparable, i.e. Profit forecasts or estimates should be capable of justification by comparison with outcomes in the form of historical financial information; relevant, i.e. Profit forecasts or estimates must have an ability to influence economic decisions of investors and be provided on a timely basis so as to influence such decisions and assist in confirming or correcting past evaluations or assessments.¹³⁹

8.75  That said, it is worth noting that item 11.2 of Annex I (and related items of other annexes), CDR pays particular attention to the assumptions on which the issuer has based its forecast or estimate. In particular, according to the abovementioned item, the prospectus must specifically distinguish between assumptions about factors that the members of the administrative, management, or supervisory bodies can influence and assumptions about factors that fall exclusively outside the influence of the members of the administrative, management, or supervisory bodies. Moreover, the assumptions must be reasonable, readily understandable by investors, specific and precise, and not relate to the general accuracy of the estimates underlying the forecast.

8.76  As far as profit forecasts are concerned, the assumptions must draw the investor’s attention to factors that are uncertain and could materially alter the outcome of the forecast. This requirement does not apply to profit estimates as they relate to a financial period that has expired and for which results have not yet been published. Consequently, it is possible to assume that estimates are reasonably certain and should not include any uncertain facts that could materially change the estimate.¹⁴⁰

8.77  Finally, as regards the basis on which profit forecasts or estimates must be prepared, paragraph 47 of the ESMA recommendations states that the forecast or estimate should (p. 192) normally be of profit before tax and that the tax effect should be clearly explained. If the forecast or estimate is not of profit before tax, the issuer is required to explain the reasons for presenting another figure from the profit-and-loss account. In addition, when financial statements relating to a period covered by a forecast or estimate are published, they must disclose the relevant figure so as to enable the forecast and actual results to be directly compared.¹⁴¹

8.78  Based on the technical advice provided by ESMA,¹⁴² the CDR repeals audit requirements—previously set out by the Council Regulation (EC) 809/2004—on profit forecasts and estimates for equity and retail non-equity issuers. To be sure, this is one of the most relevant changes introduced by the new prospectus regime, and, probably, the most controversial.

8.79  Under the previous regime, when an issuer chose to disclose a profit forecast or a profit estimate, the prospectus would have included:

8.80  In the opinion of ESMA, the rationale of the audit requirements’ deletion is straightforward.¹⁴⁴ First, such requirements come with additional costs for the issuer without the added-value to investors being clear.¹⁴⁵ Second, as far as profit forecasts are concerned, audit requirements provide limited comfort to investors, since such requirement—as formulated by the repealed Council Regulation (EC) 809/2004—simply asks the accountant or auditor to state that it has been properly compiled on the basis stated and that the basis of accounting used is consistent with the issuer’s accounting policies.¹⁴⁶ ESMA’s opinion seems to be in line with relevant auditing standards providing guidance on engagements to examine and report on prospective financial information according to which ‘when reporting on the reasonableness of management’s assumptions the auditor provides only a moderate level of assurance’.¹⁴⁷ In addition, the same auditing standards correctly recognize that, as far as prospective financial information (p. 193) is concerned, the auditor is not ‘in a position to express an opinion as to whether the results shown in the prospective financial information will be achieved’.¹⁴⁸ Therefore, it is reasonable to assume that the longer the forecasts’ time horizon is, the lesser is the safeguard provided by the audit report.¹⁴⁹

8.81  Nevertheless, the merit of the audit requirements’ deletion is forcefully contested. The majority of participants in the public consultation on the draft CDR was against the deletion of the abovementioned requirements and claimed that the audit report on profit forecasts and estimates provides investors with not inconsequential protection and comes with limited costs that, usually, are not significant if compared to the total issue costs.¹⁵⁰ Moreover, several participants pointed out that widened disclosure obligations set out by item 11.2 of Annex I of the CDR—concerning, inter alia, uncertain factors that could materially alter the outcome of the forecast—‘would not fill the potential gap left by the audit report and would be an excessive burden for the issue’.¹⁵¹ ESMA’s Securities and Markets Stakeholders Group (SMSG) raised criticism against the deletion of audit requirements as well. In particular, the SMSG remarked that having some form of third-party oversight of these matters provides an important safeguard for investors.¹⁵²

8.82  In the light of these arguments, the potential effects of the audit requirements’ deletion remains controversial, especially as far as profit forecasts are concerned.¹⁵³ On the one hand, such a deletion eliminates the risk of not finding an auditor available to provide a report, especially in the case of longer-term forecasts, and of preventing an issuer issuing a prospectus due to the impossibility of complying with the profit forecasts audit requirement.¹⁵⁴ On the other hand, even if one leaves aside the general question as to whether disclosure can be an adequate substitute for audit requirements and provide an effective safeguard for investors, to be sure the widened disclosure obligations concerning profit forecasts will make prospectuses longer and more complex. Thus, it seems apparent that such an outcome is not in line with the objective (which is at the core of the new Prospectus regime) of making prospectuses simpler and of increasing their readability.

8.83  At this stage, also taking into accounting the opposing argumentations raised during the public consultation on the draft CDR, it seems premature to draw definitive (p. 194) conclusions. Indeed, only the actual application of the modified prospectus regime will confirm whether it will pass the market test, or the deletion of the audit requirements will impair investors’ confidence and issuers will decide to regularly provide the audit report on profit forecasts and estimates on a voluntary basis. Nevertheless, if the latter is the case, it is worth mentioning that, as noted by ESMA, the issuer will be entitled to include the audit report on forecasts in the prospectus, where a report has been prepared on a voluntary basis or for other purposes (e.g. a due diligence¹⁵⁵ ) and it is deemed to be material information.¹⁵⁶

8.84  Having said that, if we consider the situation de lege ferenda, ESMA could weigh up the opportunity to require an audit report only on short-term profit forecast pointing to the current or next financial year. In this way, the report would be more reliable and, perhaps, ‘investors will place more weight on such an estimate/forecast given the relatively short period being forecast and its proximity to the time at which the prospectus is published’.¹⁵⁷

8.85  As far as financial information is concerned, the reformed EU prospectus regime is in line with the objectives of the European Commission to reduce the administrative burden for issuers when drawing up a prospectus, and to make the prospectus a more relevant disclosure tool for potential investors. For example, the removal of the requirement for issuers of equity and retail non-equity to include selected financial information in the prospectus and the alignment of the Operating and Financial Review requirement with the management reports required under the Accounting Directive clearly go in this direction.

8.86  Nevertheless, in spite of such simplifications, the fact remains that financial information is one of the most technical elements of the prospectus contents and, as such, is primarily addressed to sophisticated investors. In particular, pro forma financial information and profit estimates and forecast are deemed to be of limited use for unsophisticated investors. Therefore, in this regard, it is particularly important that (as recommended by the European Commission¹⁵⁸) the information included in the prospectus summary and primarily addressed to retail investors should not be a mere compilation of excerpts from the prospectus.