17 January 2012

FRC's Update responding to increased country and currency risk in financial reports

The Update is designed to be relevant to annual and half-yearly financial reports issued by companies in the UK listed on a regulated market in the coming months. It aims to draw together Directors’ attention to some of the more significant issues they may need to consider in order to provide a balanced and understandable assessment of the company’s position and prospects in the context of increased country and currency risk.

The issues Directors could consider include, where relevant:

• the company’s exposure to country risk, direct or to the extent practical indirect, through financial instruments but 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 examples referred to in this Update are not intended to be comprehensive but to provide a stimulus to Directors and Audit Committees, who are better able to judge the relevance of these and other related issues to the company’s particular circumstances.

Similar guidance has also been issued by other regulators in recent months, including ESMA’s November 2011 public statement, “Sovereign Debt in IFRS Financial Statements”, which Directors may also want to consider.

Country and/or currency risks have seen significant change in the last year. Of particular note are the risks arising from regime changes in the Middle East, the funding pressures on certain European countries, and curtailment of capital spending programmes. The outcome of these events remains uncertain. However, the austerity measures being widely adopted in Europe will likely mean significant changes to growth rates and demand for consumer products in those countries. Similarly, to the extent relevant, consideration could also be given to outcomes such as one or more euro area country being forced to exit the euro area.

These conditions may give rise to delays or other defaults on contracts with customers and other trading partners exposed to, or based in, countries experiencing difficulties, and/or may affect expectations of future business volumes and margins.

Analysts and investors are likely to pay particular attention to these risks over the next few months given the very high level of uncertainty about further developments. Thus, it is particularly important at this time that Directors focus sufficient attention on the 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 these country and/or currency risks.

Companies have the opportunity to manage the risk that markets misunderstand their exposures by ensuring that they explain clearly their relevant material risks and how management is mitigating them, and keep the market up to date as further developments arise.

The various reporting requirements of Laws and Regulations set out in the Update are derived from different sources, and relevant disclosures may often appear in different parts of an annual or interim report. However, it may be helpful to investors and other users if they are brought together in one section of an annual or interim report, so that all of the effects and risks of the most recent crisis can be more easily understood.

Full paper

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