Reporting standards: Investors demand enhanced disclosures
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Reporting standards: Investors demand enhanced disclosures

EDTF adoption might regain investors’ trust; Report deserves credit as private-sector solution

At the end of October, the Enhanced Disclosure Task Force (EDTF), a body with bank and investor members presented a report to Mark Carney, chairman of the Financial Stability Board and governor of the Bank of Canada. It contained more than 30 hard-hitting recommendations for how banks could improve disclosure, and banks and investors began digesting them last month.

In the aftermath of the financial crisis, investors have grown increasingly suspicious that many banks have been underestimating the deterioration in credit quality of their loan portfolios, perhaps even with the tacit connivance of national regulators keen to avoid panic in their banking systems.

They are also concerned that certain banks have used questionable internal models to give favourable outcomes when calculating their own risk-weighted assets and regulatory capital ratios, and employed end-of-reporting-period risk-collapsing transactions to obscure the true level of liquidity and other risks they might be running in the regular course of business.

The EDTF wants banks to rethink their own voluminous disclosures to better present – in clear, balanced and accessible formats – accurate, relevant and comprehensive data on the key risks they run in ways that are consistent over time and comparable across banks.

Specific recommendations include that banks should: provide granular information to explain how RWAs relate to business activities and risks; present tables showing capital requirements for each method used for calculating RWAs for credit risk and counterparty credit risk for each Basle asset class; tabulate credit risk in the banking book showing average probability of default, loss given default and exposure at default, as well as RWAs and RWA density for Basle asset classes and leading portfolios within those classes; describe how banks manage potential liquidity needs and provide a quantitative analysis of the components of liquidity reserves, ideally by providing averages as well as period-end balances; and summarize encumbered and unencumbered assets in a tabular format by balance-sheet categories, including collateral received that can be rehypothecated.

There are a series of similar recommendations across market and other risks, including operational and legal risk.

Is this yet another long report of well-meaning recommendations – note, they are not regulatory requirements – that banks can halfheartedly commend and then quietly ignore amid the welter of other more pressing regulatory impositions?

Alastair Ryan, bank equity analyst at UBS, says: "Compared with the start of the financial crisis, there is little now that’s important to us that we don’t get from banks. And while there is a reasonable debate to be had whether all banks should give us what now only some banks do, and present it in comparable formats, you need to remember that explanations over funding, liquidity risk and RWA treatment often come through in management discussions rather than audited numbers."

He also suggests the heat is already coming out of what were the most contentious areas just 12 to 18 months ago.

"We have little time for this discussion on inconsistent risk-weighted asset calculations for similar portfolios," says Ryan. "We have looked and cannot find any pattern for this. If you take portfolios of similar loans at different banks, over time the difference in risk weights is not going to be that big. If banks’ actual loss experience differs from what their models suggested over a number of years, then regulators will force them to change their models."

However, investors remain suspicious and want clarity on how recently fast-moving changes in banks’ reported RWAs reflect simply balance-sheet reduction, changes to the actual retained risk, or model changes.

Russell Picot, chief accounting officer at HSBC
Russell Picot, chief accounting officer at HSBC

Russell Picot, chief accounting officer at HSBC, co-chaired the task force. He says: "Possibly the most important suggestion in the report is for an RWA flow statement that would show, among other things, how model changes affect RWAs, the key inputs into models for calculating RWAs, including the length of data sets used, and whether models are approved by regulators or self-certified. No bank that I know of currently supplies such a statement." The need for this springs from a general worry about opacity of bank statements.

Picot says: "What investors were telling us is that it’s hard to understand bank business models and how they relate to the risks banks take and how those business models and risks actually show up in the balance sheet and the profit and loss.

"That has been because reporting is quite compliance based and that has led to reports hundreds of pages long, with important disclosures scattered throughout but not presented in a way that conveys a clear and readily understandable picture of what banks do."

Regulators must be impressed that the private-sector task force took just five months to produce its recommendations and that they are quite forceful. They will want to see banks comply. Banks have a lot to gain by giving investors the disclosures they want. When banks were supported by implicit sovereign guarantees, investors could swallow this opacity more easily than they can now in the era of too-big-to-fail and bail-inable debt.

Lauritz Ringdal, managing director, fixed income at BlackRock, tells Euromoney: "Banks accept that if they do a better job on disclosures they could see the benefit in better access to the capital markets. That will be increasingly important if we get more new types of capital instruments, for example contingent write-down bonds that are triggered by breaches of certain ratios that banks may calculate using different models. As investors, we need better information on those models. And remember a lot of the disclosures we’re asking for are already out there. We want them presented more visibly, regularly and consistently in ways that allow greater comparability across banks in different jurisdictions." Ringdal worked on the task-force recommendations on improved disclosures over the most basic and essential banks risk: credit exposure. He says: "We would like to see very clear quantitative information on specific credit risks, including major concentrations that we can track the development of over time."

Banks will worry about being forced to disclose sensitive information above and beyond what regulators already require, especially when doing so might put them at a competitive disadvantage.

"The report is not mandatory. But hopefully the 10 large banks that took part will set an example for others to follow, starting in reports for 2012 and peer pressure will then carry other banks along," says Ringdal.

Picot says: "We are absolutely committed to this. We probably comply with half of the recommendations already. We are working hard to get as much of it as we can into our 2012 reports and the rest will follow in 2013."

It will be hard for banks to duck what leading investors are demanding. However, banks and regulators in more troubled jurisdictions will not be forging ahead too quickly. It is something of a prisoner’s dilemma. How further damaged can market access be for troubled banks?

Simon Martin, portfolio manager at BlackRock, tells Euromoney: "It’s very important for investors to understand what the true level of a bank’s non-performing loans might be. Investors are very well aware that forbearance is occurring. It’s talked about in some depth. There are jurisdictions, the US, for example, with good disclosures for example on other real estate owned and restructured. If other banks move towards more comprehensive disclosure, there may be a transition period during which banks’ market access could weaken before it improves. But if banks don’t improve disclosures on forbearance then on that question, as on liquidity risk, investors will simply assume the worst anyway."

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