How will latest changes to Volcker Rule affect non-US banks?
Kathleen A. Scott discusses the final Volcker Rule, focusing on some of the issues raised by non-US banks in their comments.
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On November 5, 2018, the Code Committee of the Takeover Panel issued Public Consultation Paper 2018/2 (PCP) setting out proposed amendments to the Takeover Code in relation to the withdrawal of the UK from the EU.
The Takeovers Directive (Directive 2004/25/EC) will cease to apply in the UK on exit day and section 943(1) Companies Act 2006 (CA 2006), which requires the Takeover Panel to make rules giving effect to certain Articles of the Takeovers Directive, will be amended to require the Takeover Panel to make rules in accordance with the new Schedule 1C to the CA 2006 (which will replicate the relevant requirements of the Takeovers Directive, other than those relating to the shared jurisdiction regime, discussed below). This amendment, and certain other amendments to the CA 2006, will be made by the Takeovers (Amendment) (EU Exit) Regulations 2019 (2019 Regulations).
Key changes to the Takeover Code
Upon the new section 943(1) CA 2006 coming into force, the Takeover Panel will no longer have a statutory obligation to give effect to Article 4.2 of the Takeovers Directive which sets out a system of shared jurisdiction if a takeover bid is made for a company which has its registered office in one EEA member state and its securities admitted to trading on a regulated market in another EEA member state (but not also on a regulated market in the EEA member state in which the company has its registered office) (the shared jurisdiction regime). Section 3 of the PCP proposes that, upon the new section 943(1) CA 2006 coming into force, section 3(a)(iii) of the Introduction to the Takeover Code, which implements the shared jurisdiction regime in the UK, should be deleted. Upon the deletion of section 3(a)(iii) of the Introduction, the Takeover Code would no longer apply to an offer for:
The Takeover Code would, however, apply in full to an offer for a company which has its registered office in the UK and whose securities are admitted to trading on a regulated market in an EEA member state (but not on a regulated market in the UK) if that company satisfies the residency test in section 3(a)(ii) of the Introduction to the Takeover Code.
Minor amendments are proposed to be made to the General Principles of the Takeover Code which would be the same as the general principles in Schedule 1C of the CA 2006. A few amendments are also proposed to be made to other Rules and Appendices, including the proposal that the requirement of Rule 30.4 that documents, announcements and information should be made available to shareholders and employees in the EEA should be amended so as to refer to shareholders and employees in the UK, the Channel Islands and the Isle of Man.
The Panel Executive will also withdraw Practice Statement No. 18 (Cross-Border Mergers) once it will no longer be possible to effect a statutory merger between a UK company and an EEA member state company under the Companies (Cross-Border Mergers) Regulations 2007.
Comments on the amendments to the Takeover Code proposed in the PCP are requested by December 17, 2018.
The PCP notes that if a transition period is agreed in the final version of the Withdrawal Agreement currently being negotiated between the EU and the UK (and the Withdrawal Agreement receives the necessary Parliamentary approvals), then, subject to any other arrangements agreed between the EU and the UK during the transition period, the amendments to the Takeover Code set out in the PCP will come into effect following the end of the transition period. However, if the UK withdraws from the EU in a “no deal” scenario, then the amendments to the Takeover Code set out in the PCP will come into effect at 11:00pm on March 29, 2019, in accordance with the notification under Article 50 of the Treaty on European Union of the UK’s decision to withdraw from the EU dated March 29, 2017.
In the case of an offer for a shared jurisdiction company to which the Takeover Code initially applies but to which it will not apply when the Takeovers Directive ceases to apply in the UK the Code Committee considers that the Takeover Panel’s regulation of that offer should cease when the shared jurisdiction provisions are deleted from the Takeover Code as an offer for the company would cease to be subject to the Takeover Code from that time. The Code Committee would expect the documentation in relation to an offer for such a shared jurisdiction company to make clear that the Takeover Panel’s regulation of the offer would cease on that date. However, in the case of offers for shared jurisdiction companies to which the Takeover Code will apply in full once the Takeovers Directive ceases to apply in the UK, then the Code Committee considers that the full requirements of the Takeover Code should be applied to the company and to the transaction with effect from that time (except where to do so would give those requirements retrospective effect) and this should also be made clear in the offer documentation.
On November 6, 2018 the Financial Reporting Council (FRC) published a report setting out findings from its thematic review of smaller listed and AIM company disclosures in their annual reports and accounts. The review, which was conducted by the FRC’s Corporate Reporting Review, considered the annual reports and accounts of 22 listed companies outside the FTSE 350 and 18 AIM quoted companies with year ends ranging from December 31, 2017 to March 31, 21018.
The main objective of the report is to encourage better quality reporting that better enables users to assess the quality of management’s decisions and to provide preparers with examples of better disclosure. The report covers the following topics:
Alternative performance measures (APMs) and strategic reports
The FRC has noted improvements in the presentation of APMs but most of the improvements identified involved incremental changes to existing disclosures (for example, clarifying narrative elements, providing a better balance between APMs and IFRS measures and explaining the calculation of APMs), rather than major redrafting of the report and accounts. However, it has also noted several inconsistencies with the reporting requirements and comments that companies should not use labels that are likely to be confused with terminology defined by IFRS or normally used in the context of IFRS reporting. In addition, only a few companies provided specific, rather than general disclosures to explain their rationale for excluding certain items from an APM. The FRC does expect companies to explain why individual items have been excluded from an APM.
In considering the overall comprehensiveness of strategic reports, the FRC notes that the quality of the discussion in relation to cash flow matters varied significantly, with weaker narrative failing to present a comprehensive view of the cash position or showing inconsistencies with the financial statement. Better examples specifically address the effect on cash flows of individually significant transactions separately from ongoing trends and provide supplemental information to support the analysis where required.
While there were improvements in previously reported information, and most companies, for example, disclosed key pension valuation assumptions, they did not always provide the required sensitivity analyses. The FRC also expects companies to explain any judgement made when assessing pension trustees’ rights and this assessment should be made both when there is a pension surplus, as well as when total committed contributions under a minimum funding requirement exceed the net defined benefit liability.
Accounting policies, including critical judgements and estimates
The FRC notes that there were markedly fewer judgements than estimates reported. It comments that companies should differentiate between judgements that do not involve estimation uncertainty and those that do, as there are different reporting requirements. It also notes that there were cases where the auditor’s report included commentary on matters involving significant judgement or estimation by management that had not been disclosed as such in the accounts.
Cash flow statements
The FRC notes that companies should explain key cash flows and their cash position in the strategic report. In some cases, the classification of cash flows appear to be inconsistent with IAS 7 requirements and while the FRC understands that reverse factoring/supplier financing arrangements are common, these were only referred to by one company reviewed.
A number of the companies reviewed presented their effective tax rate reconciliation clearly. However, the FRC did challenge companies where significant movements in the tax charge were labelled “other”, potentially reducing the usefulness of the analysis of the charge, or credit, for the period or the reconciliation to a standard applicable rate. The FRC comments that better tax disclosures provide a clear explanation of the matters requiring estimation, the amounts in question and sources of uncertainty affecting them.
Table of reminders
A table in section 8 of the report sets out the FRC’s expectations in each of the areas above and provides guidance on what should be included so as to assist companies in considering the requirements of the Companies Act 2006 and relevant IFRSs.
On November 7, 2018, the Financial Reporting Council’s Financial Reporting Lab (Lab) published a report providing guidance for companies on the presentation of performance metrics in their reporting.
The Lab notes that performance metrics presented in a fair, balanced and understandable way are key to the communication between companies and investors. The report includes examples of how companies can apply the five principles outlined in the Lab’s June 2018 Report on performance metrics which focused on investors’ views. That report highlighted that when trying to understand performance, investors utilise whatever information they think is likely to be useful, regardless of its type. Investors will, however, be seeking different metrics, or using them in different ways, depending on their position in the investment chain and investment focus.
In relation to each of the five principles, the report sets out questions that the management and board should ask in relation to each principle and it provides examples of good practice:
Aligned to strategy - It is important for companies to report those metrics that are being monitored and managed internally, and explain how and why they are used, including how they link to the company’s strategy. Means of demonstrating that metrics are aligned to strategy include explaining what the metrics are and why they are important.
Transparent – Performance metrics must be meaningful, and users must be able to understand what the metric attempts to measure and how it does so. Providing an explanation for the use of metrics and a full breakdown of GAAP to no-GAAP metrics is one of the means listed of presenting metrics in a transparent way.
In context - In understanding performance, investors want to understand what is achieved in the context of the company’s aims. Companies can provide context by disclosing targets for metrics, showing whether performance has achieved its target or not, referencing a relevant industry benchmark and/or providing a market context that is linked to how that context affects the company.
Reliable - Investors require the metrics being disclosed to be calculated appropriately, and there must be sufficient governance and oversight over their use and reporting. Making governance and oversight over metrics clear and explaining the levels of scrutiny to which metrics have been subjected will help I the presentation of the reliability of metrics.
Consistent - Consistent reporting across time, and across reporting formats, helps build credibility, as investors feel that they are getting a consistent and solid view of the state of the company. A five year track record and performance with reference to industry benchmarks or standards will help companies show their reporting is consistent.
On November 5, 2018 the Financial Reporting Council (FRC) published a report summarising the key findings of a thematic review it has conducted in relation to IFRS 9 “Financial Instruments” which became effective on January 1, 2018. The thematic review considered disclosures in 2018 interim accounts of banking entities relating to the implementation of IFRS 9 since it is the banking sector that is most significantly affected by IFRS 9.
The FRC noted certain good examples of disclosure and it has highlighted some of these in the thematic review. However, the thematic review also identified a number of areas where disclosure could be improved, and some areas where no disclosure had been provided at all. While the FRC accepts that interim disclosure requirements are less extensive than those for full-year accounts, it does feel that some companies, particularly smaller banks, did not sufficiently explain the impact of adopting IFRS 9 and it hopes companies will provide more comprehensive disclosure in their upcoming annual reports and accounts.
The report notes that in particular, the following disclosures could be improved:
On November 5, 2018 the Financial Reporting Council (FRC) published a thematic review of interim disclosures about the implementation of IFRS 15 “Revenue from Contracts with Customers” which became effective on January 1, 2018.
The report notes that for some industries (such as telecommunications, aerospace and defence and software), the initial impact of applying IFRS 15 is particularly significant and so the purpose of the thematic review is to assess the adequacy of interim disclosures of a sample of companies in high-impact industries in the first year of adoption with the aim of producing useful guidance for companies when considering the completeness of their upcoming year-end disclosures.
The FRC feels that some companies did not sufficiently explain the impact of adopting IFRS 15 and it notes that the following disclosures in particular could be improved:
The report notes that the best disclosures were those that were specific to the company and provided additional detail for the benefit of providing a relevant robust explanation of the impact of IFRS 15. The report highlights some good examples of disclosure and the FRC will expect companies to use these examples to benchmark the quality of their own disclosures in their upcoming annual reports and accounts.
On November 6, 2018 the Department for Business, Energy and Industrial Strategy (BEIS) published the draft Statutory Auditors and Third Country Auditors (Amendment) (EU Exit) Regulations 2018. The draft Regulations are intended to address deficiencies arising from the UK’s exit from the EU in relation to the regulatory oversight and professional recognition of statutory auditors and third country auditors in the UK.
In summary, the draft Regulations make amendments to the Statutory Auditors and Third Country Auditors Regulations 2016 (SI 2016/649), the legislation that implements the Audit Directive, and to the retained UK version of the Audit Regulation. The draft Regulations also transfer powers, previously held by the European Commission, to the Secretary of State and to the Financial Reporting Council (FRC).
The draft Regulations include amendments to the Companies Act 2006, the Companies (Audit Investigations and Community Enterprise) Act 2004, the Limited Liability Partnerships Act 2000 and the European Communities Act 1972 to provide:
for the recognition of EEA auditors and EEA audit firms as being eligible for appointment as statutory auditors after the UK's exit from the EU.
The draft Regulations also include amendments to the Statutory Auditors and Third Country Auditors Regulations 2016 to provide the FRC with further powers. These new powers supplement the FRC's existing powers to set standards in the UK and allow them to adopt International Standards on Auditing.
Kathleen A. Scott discusses the final Volcker Rule, focusing on some of the issues raised by non-US banks in their comments.
OFAC published a final rule that modifies the Cuban Assets Control Regulations to revoke the so-called "U-turn" authorization.