On 17 January 2012, the Financial Reporting Council (FRC) published an update for directors of listed companies to draw to their attention some of the more important issues they may need to consider so as provide a balanced and understandable assessment of a company’s position and prospects in the context of increased country and currency risk. The Update identifies some of the more significant annual and interim reporting requirements that directors of listed companies could consider if a company has a material exposure to country and/or currency risk and is designed to be relevant to annual and half-yearly financial reports.
Country and/or currency risks have seen a significant change in the last year and the FRC points out that consideration needs to be given to the risks arising from regime changes in countries, the impact of austerity measures and the possibility of one or more countries leaving the Eurozone. The FRC notes that analysts and investors are likely to pay particular attention to these risks in the near future, given the very high level of uncertainty about further developments. As a result, the FRC suggests that directors highlight relevant strategic and operational risks and that companies make clear the nature and scope of their direct, and to the extent practical, indirect exposures to countries experiencing difficulties and/or currency risks. The FRC argues that companies can manage the risk that markets misunderstand their exposures by ensuring that they explain clearly the relevant material risks and how management is mitigating them, and keep the market up to date as further developments arise.
Issues that directors could consider include, where relevant:
- The company’s exposure to country risk, direct or to the extent practical indirect, through financial instruments and also in terms of exposure to trading counterparties (customers and suppliers);
- The impact of austerity measures being adopted in a number of countries on the company’s forecasts, impairment testing, going concern considerations etc;
- Possible consequences of currency events that are not factored into forecasts but may impact reported exposures and sensitivity testing of impairment or going concern considerations; and
- A post balance sheet date event requiring enhanced disclosures to avoid misleading investors.
The FRC stresses that the examples referred to in its Update are not intended to be exhaustive but to provide a stimulus to directors and audit committees, who will be better able to judge the relevance of these and other related issues to a company’s particular circumstances.
The Update summarises specific reporting requirements that are relevant in this area and suggests that it might be helpful if the relevant disclosures are brought together in one section of the annual or interim report so that all of the effects and risks of the most recent crisis can be easily understood. In relation to these reporting requirements, the Update makes the following points:
- There is a general requirement that financial statements give a true and fair view. Directors may, therefore, need to provide additional disclosures in financial statements where an issue is not explicitly addressed by the law or relevant accounting standards.
- The UK Corporate Governance Code requires directors to provide a balanced and understandable assessment of a company’s position and prospects. A company that has significant trading relationships with businesses or governments facing increased uncertainty should explain how its business model and financial position might be affected by a default or other significant event.
- When preparing annual and interim accounts and reports, directors may need to give enhanced disclosures in relation to going concern under Listing Rule 9.8.6R(3) and IFRS, as well as the principal risks and uncertainties under section 417(3)(a) Companies Act 2006, should the company in question be significantly exposed to increased country and currency risk. Such a disclosure needs to include how these risks and uncertainties are mitigated.
- If a company is materially exposed to adverse developments in a country and/or currency risk, this is likely to trigger an impairment assessment (IAS39.58) for material non-financial assets that carry that exposure at each annual and interim reporting date.
- Directors need to consider the impact of economic conditions on detailed disclosures relating to credit risk, liquidity risk and other market risks required under IFRS7. So far as the concentration of risk is concerned, directors should consider changes to significant concentrations in the context of requirements under IFRS7.
- Proper disclosure in relation to the carrying amount of assets and liabilities will require an assessment of each material country and/or currency risk, reconsidering the underlying assumptions about a reasonable range of possible outcomes and estimating how such different circumstances may affect the value of the relevant assets and liabilities.
(FRC, Update for directors of listed companies - Responding to increased country and currency risk in financial reports, 17.01.12)