On 9 December, CFA Institute took part in a roundtable on financial institutions risk disclosure that attracted more than 70 participants and observers from constituencies considered pivotal in shaping observed financial reporting practices. They included accounting and audit standard setters, regulators, key monetary institutions, financial institutions, investors, and the Big 4 audit firms.
The Basel meeting was convened by the Financial Stability Board, the international body established by the G-20 to coordinate international financial regulation and standards setting. Several themes were covered during engaging panel discussions, including:
- The importance of risk disclosures especially as a basis of enabling investors to exercise their market discipline mandate
- Establishing a process of identifying and monitoring emergent risk factors for financial institutions
- Improving risk disclosures
- Determining the level of audit assurance required for risk disclosures
A recurrent point made by various speakers was the need to focus disclosures on communicating key information to investors and not merely complying with mandatory risk disclosure requirements, such as IFRS 7 and Basel Pillar 3.
The significant areas of risk exposures faced by financial institutions include liquidity and funding, asset encumbrance, sovereign, loan forbearance, counterparty, and derivatives exposure. In addition, the opacity of the methods used for determining risk-weighted assets was repeatedly raised, as was the limited understanding by investors of the Basel Pillar 3 disclosures.
Unsurprisingly, a number of the financial institution representatives pointed to the voluminous and ever-growing annual reports, positing that these must be burdensome for users to read. However, several other speakers pointed out that the volume of disclosures should not be assumed to be synonymous with providing comprehensive information required by investors. The below excerpts from the slide presentation of the Office of the Superintendent of Financial Institutions Canada (OSFI) aptly point out considerations that anchor disclosure improvements around the interests of investors:
Companies say there is too much disclosure now and providing more is not useful — but is anyone doing anything about ensuring disclosures are useful?
A big question for all involved in disclosures is — what is useful disclosure? And who is it useful for? Is it the bank? The insurer? The investor?
The deliberations also highlighted a number of competing considerations, including:
- The desirability of standardised and comparable information versus the need to communicate entity-specific information, and the ability to adjust and report emergent risk factors
- The ability of auditors to provide assurance of risk disclosures weighed against the backdrop of likely litigation if such risk information is subsequently considered inaccurate.
How to Improve Risk Disclosures for Investors?
There was significant alignment among financial statement user representatives regarding the general principles required to improve the disclosures around key risk categories. These included articulating ideas to improve the presentation of risk information. For its part, CFA Institute presented the key findings from our recently issued report on financial instruments disclosures made under IFRS. In particular, we have highlighted the need for the following:
- Executive summaries for key risk categories. These should be succinct and portray an entity-wide picture of key risk exposures and effectiveness of risk management.
- Differentiating the risk factors considered under the market-risk category (for example: disclosing interest rate risk as a distinctive category).
- Qualitative disclosures should primarily explain quantitative numbers and not be littered with boilerplate or generic clutter.
- Standardisation and greater assurance on quantitative disclosures
- Improved presentation including centralisation and greater use of the tabular format
- Integrated presentation of related information (for example: the exposure at default information under Pillar 3 requirements and the maximum exposure information under IFRS 7)
Furthermore, different user representatives supported the disclosure of meaningful sensitivity analysis across all key risk factors.
Overall, there was general consensus on the usefulness of bringing together key participants involved in the production, auditing, and utilisation of financial reporting information. Such a gathering of key actors can help facilitate the sharing of knowledge and best practices, opening a line of communication that could ultimately lead to improved disclosures for capital market participants.