The imperative to improve financial instruments risk disclosures became apparent during both the ongoing sovereign debt crisis and the 2007-09 market crisis.
CFA Institute has undertaken a study regarding the quality of financial instruments risk disclosures across financial and non-financial institutions. The risk disclosures addressed in the study are credit, liquidity, market and hedging activities risk disclosures under IFRS 7. This paper provides a user perspective on financial instrument credit, liquidity and market risk disclosures based upon the aforementioned study. As an extension to this paper, a separate report (Volume 2) provides a user perspective on the disclosures of derivatives and hedging activities.
In its approach, the study: 1) evaluates the findings of various pieces of literature and their conclusions regarding the usefulness of risk disclosures; 2) obtains, through user surveys and interviews, feedback on the importance of, satisfaction with, and application and usefulness of current financial risk disclosures; and 3) reviews risk disclosures in annual reports of financial and non-financial institutions and construct a disclosure quality index (DQI), so as to place in context the user feedback obtained. The study triangulates these sources of information in order to analyse and convey user perspectives on IFRS 7 disclosures.
Methodology
As illustrated in Figure 1-2, this study was conducted through a combination of reviewing risk disclosure literature; obtaining user feedback through interview and survey techniques; and performing detailed analysis of company risk disclosure. The methodology is elaborated upon further below:
- Financial Risk Disclosure Literature Review – The framework used to analyse the usefulness of financial instrument risk disclosures is derived from various sources of literature including standard-setter, academic, and regulatory commentary (e.g. user comment letters).
- User Feedback – Direct user survey feedback from 133 respondents. This feedback was gathered from the administration of two surveys (i.e. an abridged and a comprehensive survey questionnaire). Respondents included 83 CFA Institute members who are users of financial statements and 50 external sell-side analysts who were not CFA Institute members. A detailed description of the survey design is included within Section 5.1 of the Appendix. Through these surveys, respondent users were queried on the following:
- General usefulness of IFRS 7 disclosures;
- Relative usefulness of different components of IFRS 7 disclosures;
- Importance of, and satisfaction with, specific categories of risk disclosures (i.e. credit, liquidity, market and hedging activities); and
- The specific use and application of information from different disclosures by analysts and investors in the performance of security selection, valuation and risk analysis process.
In addition to the survey feedback, the views of three expert users were probed in further detail, through telephone interviews, so as to substantiate the application of IFRS 7 disclosures and the potential areas for improvement. Various insights were also distilled from discussions held by the Corporate Disclosure Policy Council (CDPC) of CFA Institute with standard-setters on risk disclosures. Key points from these discussions were integrated into the user feedback.
- Company Analysis – The company analysis was carried out by reviewing the risk disclosures in the annual report of 20 IFRS reporting companies, and thereafter, constructing a disclosure quality index (DQI). The company analysis provided a context to corroborate and evaluate user comments.
The company analysis was based on the usefulness dimensions of relevance and understandability of disclosures. The coverage was on both prescribed disclosures as well as voluntary disclosures that users had indicated were useful. The companies, whose disclosures were analysed, were large cap companies across a range of industries. These companies were selected based on their large risk exposures.
Key Findings
In general, the results of this study show that – though yielding some useful information for investors – the compliance with IFRS 7 disclosure requirements by financial statement preparers is inconsistent and incomplete. In many cases, these IFRS 7 risk disclosures have limited informational content that is decision-useful. One respondent's quote as noted below aptly encapsulates the overall evaluation of these disclosures:
IFRS 7 has brought a great amount of useful additional information compared to earlier financial statements disclosures. However, I am concerned about the discrepancy of what is required by the standard and what is actually reported. Secondly, there may, in certain instances, be issues around the quality of the information that is disclosed. I am not sure how carefully such information has been audited. Often significant underlying assumptions and methodologies are not disclosed.
With some corporations the wording of the disclosures is very generic, without adding a lot of informational value. It may well be that not all risk disclosures are equally applicable for all corporations, but the focus should rather be on delivering crucial information that adds value to financial statement users as opposed to mere compliance. – Credit Analyst
The above quote, which highlights a user's general view of IFRS 7 and pinpoints several shortcomings, is consistent with other observations made regarding information quality of risk disclosures, as shown below:
In theory, a shareholder should be able to see the impact on the accounting profit and loss if, say, interest rates were to change or if foreign exchange rates were to move one way or the other. In practice, the notes surrounding risk disclosure are large in volume but not very effective at communicating the risks. This was certainly true of credit risk with financial entities in 2007.
Obviously, these guidelines are very vague and so it is possible, given the complexities of financial risk that an entity will comply with the rules of IFRS 7 without disclosing too many useful details. In simple terms, it is often difficult to prove that an auditor or accountant has failed to comply with IFRS 7 even if they hide the risks because of its very loose guidelines. Throughout 2007, there is evidence that many financial institutions suffered huge losses in the credit markets and were therefore very risky, although this was not highlighted adequately in their annual reports. – Cormac Butler
Other key findings from the study were that:
- Risk disclosures are widely used by investors;
- Discrete risk categories are more useful than general risk categories; and
- There are several specific and general areas of deficiencies across all these disclosures.
We elaborate on these findings in the full report.