On Friday the Division of Corporation Finance issued informal disclosure guidance related to financial institutions with direct and indirect exposure to European sovereign debt.
Intending to encourage greater clarity and comparability within and across filings, the guidance makes note of disclosures that the staff found to be inconsistent and of the type of comments issued in response, such as requests that for each country of concern an issuer provide:
- disclosure of gross sovereign, financial institution and non-financial corporation exposure, separately by county;
- quantified disclosure explaining how gross exposures are hedged; and
- disclosure of the circumstances under which losses may not be covered by purchased credit protection.
The guidance also addresses some of the disclosure requirements that may trigger the need to discuss sovereign debt exposure, such as in risk factor and market risk disclosures and in MD&A disclosures regarding known trends, demands or uncertainties that may affect liquidity or results of operations. It also refers to further guidance available in Industry Guide 3, regarding bank holding company disclosure requirements.
In determining which countries the guidance applies to — a determination which is expected to change over time — issuers are advised to focus on those countries that are “experiencing significant economic, fiscal and/or political strains such that the likelihood of default would be higher than would be anticipated when such factors do not exist” and to disclose the basis of their determination.
The guidance also advises that disclosure “be provided separately by country, segregated between sovereign and non-sovereign exposures, and by financial statement category, to arrive at gross funded exposure, as appropriate.” And, that issuers should “consider separately providing disclosure of the gross unfunded commitments made … [and] provide information regarding hedges in order to present an amount of net funded exposure.”
Finally, the guidance outlines a number of considerations (reproduced below in their entirety) that an issuer should take into account when determining what disclosure is relevant and appropriate.
I. Gross Funded Exposure
i. The basis for the countries selected for disclosure.
ii. The basis for determining the domicile of the exposure.
b. Type of Counterparty
i. Separate categories of exposure to sovereign and non-sovereign counterparties.
1. Sovereign exposures consist of financial instruments entered into with sovereign and local governments.
2. Non-sovereign exposures comprise exposure to corporations and financial institutions. To the extent material, separate disclosure may be required between financial and non-financial institutions.
c. Categories of Financial Instruments
i. Categories to be considered for disclosure include loans and leases, held-to-maturity securities, available-for-sale securities, trading securities, derivatives, and other financial exposures to arrive at a gross funded exposure.
1. For loans and leases, the gross amount prior to the deduction of the impairment provision and the net amount after impairment provision.
2. For held-to-maturity securities, the amortized cost basis and the fair value.
3. For available-for-sale securities, the fair value, and if material, the amortized cost basis.
4. For trading securities, the fair value.
5. For derivative assets, the fair value, except that amount could be offset by the amount of cash collateral applied if separate footnote disclosure quantifying the amount of the offset is provided.
6. For credit default contracts sold, the fair value and notional value of protection sold, along with a description of the events that would trigger payout under the contracts.
7. For other financial exposures, to the extent carried at fair value, the fair value. To the extent carried at amortized cost, the gross amount prior to the deduction of impairment and the net amount after impairment.
II. Unfunded Exposure
a. The amount of unfunded commitments by type of counterparty and by country.
b. The key terms and any potential limitations of the counterparty being able to draw down on the facilities.
III. Total Gross Exposure (Funded and Unfunded)
a. The effect of gross funded exposure and total unfunded exposure should be subtotaled to arrive at total gross exposure as of the balance sheet date, separated between type of counterparty and by country.
b. Appropriate footnote disclosure may be provided highlighting additional key details, such as maturity information for the exposures.
IV. Effects of Credit Default Protection to Arrive at Net Exposure
a. The effects of credit default protection purchased separately by counterparty and country.
b. The fair value and notional value of the purchased credit protection.
c. The nature of payout or trigger events under the purchased credit protection contracts.
d. The types of counterparties that the credit protection was purchased from and an indication of the counterparty’s credit quality.
e. Whether credit protection purchased has a shorter maturity date than the bonds or other exposure against which the protection was purchased. If so, clarifying disclosure about this fact and the risks presented by the mismatch of maturity.
V. Other Risk Management Disclosures
a. How management is monitoring and/or mitigating exposures to the selected countries, including any stress testing performed.
b. How management is monitoring and/or mitigating the effects of indirect exposure in the analysis of risk. Disclosure should explain how the registrant identifies their indirect exposures, examples of the identified indirect exposures, along with the level of the indirect exposures.
c. Current developments (rating downgrades, financial relief plans for impacted countries, widening credit spreads, etc) of the identified countries, and how those developments, or changes to them, could impact the registrant’s financial condition, results of operations, liquidity or capital resources.
VI. Post-Reporting Date Events
a. Significant developments since the reporting date and the effects of those events on the reported amounts.