U.S. regulators ponder Brexit plans, disclosure demands

The Securities and Exchange Commission is among the agencies keeping a close eye on potential Brexit fallout. During a March 15 speech in London, at the 18th Annual Institute on Securities Regulation in Europe, William Hinman, director of the Division of Corporation Finance, spoke on “Applying a Principles-Based Approach to Disclosing Complex, Uncertain and Evolving Risks.”

“Sounds like Brexit might fit that description, and I don’t think I could come to London this week without spending some time discussing it,” he said. “I realize that you all may be worn out on the subject, and the U.S. regulatory perspective on this topic may seem of secondary or tertiary interest to those of you living through these events. However, I would note that over half of the world’s largest companies have their primary listing in the U.S. and a larger proportion trade and report in compliance with our requirements. Given that these companies typically have extensive international operations, including in the U.K. and EU, we have a keen interest in the quality of disclosure that is being provided by the many issuers for which Brexit may have a material impact.”

While the U.S. disclosure regime emphasizes materiality, principles-based disclosure requirements, including Management’s Discussion and Analysis and Risk Factors, “are examples of such disclosure requirements and are well-suited to elicit disclosure about complex and evolving areas,” Hinman said. “Ideally, MD&A allows investors to see a company’s results and prospects through the eyes of management. A well-written MD&A allows investors to understand how management is positioning the company in the face of uncertainties, like those associated with rapidly evolving topics such as Brexit.”

For several months, Hinman and SEC Chairman Jay Clayton have highlighted the need for more robust public company disclosure about how companies are considering Brexit and its possible impact on their business and operations.

“What did we find? We saw a wide range of disclosures, even within the same industry,” Hinman said. “Some companies provided generic disclosure, merely stating that Brexit presents a risk, that the outcome is uncertain and that it could materially and adversely impact the business and its operations. In my opinion, this type of disclosure does little to explain to investors the potential specific impact of Brexit on a company’s business and operations and is insufficient to guide investors in a meaningful manner.” On a more positive note, the Division has also seen the companies likely impacted most directly “providing tailored disclosure at a higher rate than U.S. domestic registrants.”

“We anticipate that there will be international effects that non-U.K. and non-EU issuers will not escape,” Hinman said. “As Brexit becomes more imminent, and perhaps in response to our public requests for more robust disclosure, we are encouraged to observe that a higher percentage of companies appear to be including tailored Brexit disclosures in their 2018 annual reports. While this is encouraging, we believe there is room for continued improvement.”

At the time Hinman delivered his remarks, there remained tremendous uncertainty associated with Brexit, including whether it will be delayed beyond March 29 to permit further negotiations or whether it will be reversed or sharply modified through a second referendum or other arrangements.

“In addition, there is a lack of clarity on what the actual effects of Brexit will be on companies, their investors, and on global financial markets,” he added. “Despite this uncertainty, the reality for many companies is that Brexit is already here. I would think that management and boards have not thrown up their hands in light of the uncertainties and declared that ‘nothing can be done.’ They have been preparing for the variety of outcomes well in advance of March 29. Businesses have not been able to take a wait-and-see approach. Rather, they’ve had to prepare for a range of outcomes.”

“Given the differences across industries and companies, there is no one specific data point or prescriptive piece of information that all companies could provide to disclose material information relating to their Brexit-related risks,” he added. “Investors are better served by understanding the lens through which each company’s management looks at its exposure. … Banking and financial services are obviously not the only industries subject to regulatory risk in light of Brexit. Biopharmaceutical companies with substantial U.K. operations face risks concerning how their products and clinical trials will be regulated. Airlines face risks that potential restrictions on flying rights or changes in administration of antitrust laws may negatively impact their joint ventures. For companies in these industries and others affected by regulatory risk, we would expect tailored disclosure explaining these risks where appropriate.”

Among the questions Hinman suggested to help steer disclosure discussions:

• How does management assess and analyze Brexit-related risks and the potential impacts on the company and its operations?
• Is the business exposed to new regulatory risk given the uncertainty of which set of laws and regulations will apply and whether transition agreements will be in place?
• Are there significant supply chain risks due to the potential disruption to the U.K.’s access to free trade agreements with other nations and any resulting changes in tariffs on exports and imports?
• Will potential changes to customs administrations and delays materially impact a company’s business, particularly if the business relies on just-in-time supply chains?
• Does the company face a material risk of losing customers, a decrease in sales or revenues or an increase in costs due to tariffs or other factors?
• Is demand for the company’s products especially sensitive to exchange rates or changes in tariffs?
• What is the company’s exposure to contractual risk in the face of Brexit? Has the company undertaken a review of its existing contracts with counterparties in the United Kingdom or the European Union to determine whether renegotiation or termination is necessary in light of contractual obligations?
• Do Brexit-related issues affect financial statement recognition, measurement, or disclosure items, such as inventory writedowns, long-lived asset impairments, collectability of receivables, assumptions underlying fair-value measurements, foreign currency matters, hedge accounting, or income taxes?
• Does the company have exposure to currency devaluation, foreign currency exchange rate risk, or other market risk?
• What is management doing to mitigate and manage these risks?
• What is the nature of the board’s role in overseeing the management of these risks?

“One analytical tool to evaluate disclosure in this context is to consider how management discusses Brexit-related risks with its board of directors,” Hinman said. “Obviously, not all discussions between management and the board are appropriate for disclosure in public filings, but there should not be material gaps between how the board is briefed and how shareholders are informed.”

For those involved in crafting disclosure documents, Hinman suggested another question: “Would these disclosures satisfy the curiosity of a thoughtful, deliberative board member considering the potential impact of Brexit on the company’s business, operations, and strategic plans?”

“We have seen useful, tailored disclosure by some financial institutions that addresses the regulatory risks associated with the potential loss of passporting arrangements that currently permit U.K. entities to provide services to businesses and customers throughout the EU. Similarly, some firms have provided disclosure explaining specific efforts undertaken to re-locate their U.K. operations, or to merge with or acquire EU subsidiaries, to mitigate the regulatory risks of Brexit,” he said.

In general, the SEC expects to see a wide range of disclosures about Brexit.

“However, to the extent material, each company’s Brexit disclosure should provide tailored insight into how management views the risks posed to the business and operations and what actions they are taking to address these risks,” Hinman said.