Evidence From France
The users of financial statements issued by French companies are able to analyse corporate performance and make better-informed decisions thanks to the higher level of disclosure required by the country’s financial markets supervisor. Could the benefits of France’s enhanced regulatory environment be leveraged to improve financial market communication more broadly?
Internationally, several standard-setters such as the US Securities and Exchange Commission (SEC), the European Securities and Markets Authority (ESMA) and the International Accounting Standards Board (IASB) are tackling the challenge of improving financial market communication.
Survey evidence provided by the IASB shows that more than 80% of respondents believe the way financial information is currently presented could be improved. The results further illustrate that instead of necessitating users to search through large amounts of data, the communication of relevant information in financial statements needs to be revised (IASB, 2013[1]). In the same vein, a recent initiative of IASB Chairman Hans Hoogervorst aims to prioritise the effectiveness of financial market communication and to improve the quality and usefulness of financial disclosures (IASB, 2016[2]). France is a good example of these ideas in practice.
The supervisor of the French financial markets, the Autorité des Marchés Financiers (AMF), has established a so-called ‘registration document’ that offers – as an optional supplement – advanced disclosures, which include additional information about a company’s business, financial position, earnings and prospects for various stakeholders. With respect to financial risk, for example, the AMF provides in position paper n°2009-16 (Autorité des Marchés Financiers, 2009[3]) detailed guidance on extended corporate disclosures that go far beyond the governing reporting standards of International Financial Reporting Standards (IFRS) 7.33 and 7.34.4
IFRS 7.33 and 7.34 require accounting entities to deliver a qualitative and quantitative description of the nature and the extent of financial risks arising from financial instruments. For the qualitative description (7.33), this includes both the magnitude and the origin of the risk exposures, as well as the “management’s objectives, policies, and processes for managing those risks”. In quantitative terms (7.34), “summary quantitative data about exposure to each risk at the reporting date” have to be disclosed. Further, this information should be “based on information provided internally to the entity’s key management personnel”.
With regard to the management of foreign exchange (FX) or currency risks, which generally is one of the most material financial market risk categories of non-financial firms, fig. 1 shows an exemplary FX risk management report of a German DAX 30 company that complies with the specifications of IFRS 7.33 and 7.34. The data granularity provided by US S&P 500 companies is very similar. The reporting comprises the fair value of all currency forward transactions (as evaluation parameter for the balance sheet), their total notional volume (long and short combined) as well as their residual maturity. Further, a sensitivity analysis indicates hypothetical effects of exchange rate fluctuations on the income statement.
Fig 1: Example risk management report of a German DAX 30 company for currency risks
Currency risk
The fair value of the currency forwards at the balance sheet date was €-8 million (previous year € -3 million) and their notional value was € 1,698 million (previous year: €1,860 millon). As in the previous year, all of the forward contracts have a remaining maturity of up to one year. The notional values represent the aggregate of all purchase and selling amounts for derivatives. The notional values shown are not netted.
If the euro had appreciated by 10% against all currencies as of December 31 2019, the fair values of the currency forwards recognised directly within the hedging reserves in equity would have increased by €41 million (previous year: €49 million). If the euro had depreciated by 10% the fair values of the currency forwards recognised directly within the hedging reserves in equity would have decreased by €67 million (previous year: €65 million). An appreciation or depreciation of the euro would not have a material impact on the consolidated financial statements when valuing currency forwards recognised in profit and loss. This is because the resulting changes in the hedged items would compensate for the effects of any changes in the market values.
Source: Beiersdorf AG, Annual Report 2019
In this example, the reader is not informed of the actual extent of the currency risks to which the company is exposed at the end of the reporting period. The company merely specifies that forward transactions with a total notional volume of €1,698m have been concluded, which, however, is a composite sum of purchase and sales contracts, i.e., opposite long and short positions. The underlying risk associated with these forward contracts is not disclosed, nor are the currencies involved.
While an assessment of the hedging measures taken is not possible based on the above example, French companies show what risk management reporting with more relevant information can look like and what added value it can provide for its addressees (see fig. 2).
As the table illustrates, the aforementioned advanced and extended disclosures in terms of FX risk management activities comprise the specification of the actual exposure before and after management as well as its composition by year and currency. This provides the reader with a sound overview of the magnitude and the origin of the risks to which a company was, and still is exposed to, at the balance sheet date. Further, it also shows which particular hedging measures have been taken per currency, i.e. to what extent the risk has been decreased or increased by derivative instruments. Overall, the French reports offer the recipients, such as financial analysts, shareholders and potential investors, a significantly higher level of information and detail. This, in turn, helps them carry out meaningful analyses and make better-informed decisions.
Another advantage is that both recipients and the companies themselves can compare and benchmark various FX risks and the strategies of different companies and competitors. In addition, a transparency is created as to whether derivative financial instruments were used for hedging or for speculative purposes. The latter purpose, an intended increase of risk in a bid to generate additional profits, has often led to corporate losses in the millions and billions.
The enhanced transparency that results from French reporting could increase the inhibition threshold for speculation and thus prevent corporate losses from derivatives transactions. In this respect, the French method of reporting could lead the way internationally. It could show other financial supervisory authorities and standard setters how appropriate regulation and improved financial market communication can be valuable tools in assisting users of financial statements to make well-informed decisions.
Andreas Hecht
Manager Corporate Finance – Risk Management and Reporting, MAHLE International GmbH
Dr Andreas Hecht works in Corporate Finance, Risk Management and Reporting at MAHLE International GmbH, one of the largest automotive suppliers worldwide, based in Stuttgart, Germany. Prior to this, he worked at PricewaterhouseCoopers (PwC) in the Corporate Treasury Solutions department. He was a research associate from 2016 to 2019 at the University of Hohenheim, where he prepared his PhD dissertation on corporate currency and interest rate risk management. In May 2020, he successfully completed the Certified Blockchain Expert programme at the Frankfurt School of Finance & Management.
