The SEC issued proposed rules on short-term borrowing disclosures. Separately, the SEC issued an interpretive release on the presentation of liquidity and capital resource disclosures in MD&A disclosures. The interpretive release will be effective upon publication in the Federal Register. This rule making was not required by the Dodd-Frank Act but is a response to the financial crisis.

Proposed Rules on Short-Term Borrowings

–MD&A

In the proposed release, the SEC noted existing MD&A requirements call for discussion and analysis of a registrant’s liquidity and capital resources. With respect to liquidity, registrants must identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way. Registrants are also required to identify and separately describe internal and external sources of liquidity. With respect to capital resources, a registrant is required to describe any known material trends, favorable or unfavorable, in its capital resources, indicating any expected material changes in the mix and relative cost of such resources. In its discussion of capital resources, a registrant is also required to consider changes between equity, debt and any off-balance sheet financing arrangements. However, other than in connection with this discussion of liquidity and capital resources under Item 303(a)(1) and (2) of Regulation S-K, companies that do not provide Guide 3 disclosure are not subject to any line item requirements for the reporting of specific data regarding short-term borrowing amounts or information about intra-period borrowing levels.

Currently, registrants that are bank holding companies provide statistical disclosures in accordance with the industry guidance set forth in Guide 3. Guide 3 is primarily intended to provide supplemental data to facilitate analysis and to allow for comparisons of sources of income and evaluations of exposures to risk

The SEC is proposing to amend its MD&A requirements to include a new section that would provide tabular information about a company’s short-term borrowings, as well as a discussion and analysis of those short-term borrowings. The SEC noted that the current Guide 3 disclosure of short-term borrowings does not call for a qualitative discussion of the reasons for use by a registrant of the particular types of financing techniques, or of the drivers of differences between average amounts and period-end amounts outstanding for the period. The SEC believes that including a requirement for a narrative explanation together with tabular data would provide important information so that investors can better understand the role of short-term financing and its related risks to the registrant as viewed through the eyes of management.

The proposed amendments would codify in Regulation S-K the Guide 3 provisions for disclosure of short-term borrowings applicable to bank holding companies and would apply to all companies that provide MD&A disclosure, not only to bank holding companies and other financial institutions. If the proposals are adopted, it is expected that the corresponding provisions of Guide 3 would be eliminated in their entirety to avoid redundant disclosure requirements for bank holding companies. As proposed, registrants would be required to provide disclosure in MD&A of:

  • the amount in each specified category of short-term borrowings at the end of the reporting period and the weighted average interest rate on those borrowings;
  • the average amount in each specified category of short-term borrowings for the reporting period and the weighted average interest rate on those borrowings;
  • for registrants meeting the proposed definition of “financial company,” the maximum daily amount of each specified category of short-term borrowings during the reporting period; and
  • for all other registrants, the maximum month-end amount of each specified category short-term borrowings during the reporting period.  

Specifically, as proposed, “short-term borrowings” would mean amounts payable for short-term obligations that are:

  •  federal funds purchased and securities sold under agreements to repurchase;
  • commercial paper;
  • borrowings from banks;
  • borrowings from factors or other financial institutions; and
  • any other short-term borrowings reflected on the registrant’s balance sheet.  

In order to provide context for the short-term borrowings data, the SEC is also proposing to require a narrative discussion of short-term borrowings arrangements. This narrative discussion is not currently included in Guide 3. The topics proposed to be included would be:

  • a general description of the short-term borrowings arrangements included in each category (including any key metrics or other factors that could reduce or impair the registrant’s ability to borrow under the arrangements and whether there are any collateral posting arrangements) and the business purpose of those arrangements;
  • the importance to the registrant of its short-term borrowings arrangements to its liquidity, capital resources, market-risk support, credit-risk support or other benefits;
  • the reasons for the maximum amount for the reporting period, including any non-recurring transactions or events, use of proceeds or other information that provides context for the maximum amount; and
  • the reasons for any material differences between average short-term borrowings for the reporting period and period-end short-term borrowings.  

As proposed, the requirements would be applicable to annual and quarterly reports and registration statements. For annual reports, information would be presented for the three most recent fiscal years and for the fourth quarter. In addition, registrants preparing registration statements with audited full-year financial statements would be required to include short-term borrowings disclosure for the three most recent full fiscal year periods and interim information for any subsequent interim periods, consistent in each case with general MD&A requirements and instructions applicable to the relevant registration statement form requirements. For quarterly reports, information would be presented for the relevant quarter, without a requirement for comparative data. For registrants that are not subject to Guide 3, the SEC is proposing a yearly phase-in of the requirements for comparative annual data until all three years are included in the annual presentation.

–Possible Leverage Ratio Disclosures

Under U.S. GAAP, bank holding companies are currently required to disclose certain capital and leverage ratios (calculated in accordance with the requirements of their primary banking regulator) in the financial statements that are included in filings with the Commission. The SEC’s staff has observed that some bank holding companies also include disclosure of these ratios in their MD&A presented in annual and quarterly reports.

The SEC is considering whether to extend a leverage ratio disclosure requirement to companies that are not bank holding companies. The SEC is requesting comment as to the scope of a potential disclosure requirement, and importantly, how such a requirement would take into account the differences among metrics and industries while still providing comparability.

–Changes to Form -8-K

The SEC is proposing revisions to the definition of “direct financial obligation” used in Items 2.03 and 2.04 of Form 8-K to conform to the definition of short-term borrowings used in proposed Item 303(a)(6). Specifically, the proposed amendment would revise paragraph (4) of the definition of “direct financial obligation” contained in Item 2.03(c) of Form 8-K. In doing so, however, the SEC proposes to retain the existing carve-out in the definition of direct financial obligation for obligations that arise in the ordinary course of business, in order to maintain the focus of Items 2.03 and 2.04 on real-time disclosure of individual transactions that are not routine or “ordinary course” financing transactions.

Interpretive Release

–Liquidity Disclosure

The interpretive release points out a number of ways in which registrants can improve disclosure about financing activities in the liquidity and financial resources section of the MD&A. MD&A requires companies to provide investors with disclosure that facilitates an appreciation of the known trends and uncertainties that have impacted historical results or are reasonably likely to shape future periods. Some additional important trends and uncertainties relating to liquidity might include, for example, difficulties accessing the debt markets, reliance on commercial paper or other short-term financing arrangements, maturity mismatches between borrowing sources and the assets funded by those sources, changes in terms requested by counterparties, changes in the valuation of collateral, and counterparty risk.

In addition, the SEC noted in the context of liquidity and capital resources, if the registrant’s financial statements do not adequately convey the registrant’s financing arrangements during the period, or the impact of those arrangements on liquidity, because of a known trend, demand, commitment, event or uncertainty, additional narrative disclosure should be considered and may be required to enable an understanding of the amounts depicted in the financial statements. For example, depending on the registrant’s circumstances, if borrowings during the reporting period are materially different than the period-end amounts recorded in the financial statements, disclosure about the intra-period variations is required under current rules to facilitate investor understanding of the registrant’s liquidity position.

To provide context for the exposures identified in MD&A, companies should also consider describing cash management and risk management policies that are relevant to an assessment of their financial condition. Banks, in particular, should consider discussing their policies and practices in meeting applicable banking agency guidance on funding and liquidity risk management, or any policies and practices that differ from applicable agency guidance. In addition, a company that maintains or has access to a portfolio of cash and other investments that is a material source of liquidity should consider providing information about the nature and composition of that portfolio, including a description of the assets held and any related market risk, settlement risk or other risk exposure.

–Contractual Obligations Table Disclosure

As an aid to understanding other liquidity and capital resources disclosures in MD&A, the contractual obligations tabular disclosure should be prepared with the goal of presenting a meaningful snapshot of cash requirements arising from contractual payment obligations. The SEC’s staff has observed that divergent practices have developed in connection with the contractual obligations table disclosure, with registrants drawing different conclusions about the information to be included and the manner of presentation. The requirement itself permits flexibility so that the presentation can reflect company-specific information in a way that is suitable to a registrant’s business. Accordingly, registrants are encouraged to develop a presentation method that is clear, understandable and appropriately reflects the categories of obligations that are meaningful in light of its capital structure and business. Registrants should highlight any changes in presentation that are made, so that investors are able to use the information to make comparisons from period to period.

Since the adoption of Item 303(a)(5), registrants and industry groups have raised questions about how to treat a number of items under the contractual obligations requirement, including: interest payments, repurchase agreements, tax liabilities, synthetic leases, and obligations that arise under off-balance sheet arrangements. In addition, a variety of questions has been raised in the context of purchase obligations. Because the questions that arise tend to be fact-specific and closely related to a registrant’s particular business and circumstances, the SEC has not issued general guidance as to how to treat these resources needs and to provide context for investors to assess the relative role of off-balance sheet arrangements; registrants should prepare the disclosure consistent with that objective. Uncertainties about what to include or how to allocate amounts over the periods required in the table should be resolved consistent with the purpose of the disclosure. To that end, footnotes should be used to provide information necessary for an understanding of the timing and amount of the specified contractual obligations, as indicated in the instructions contained in Item 303(a)(5)(i), or, where necessary to promote understanding of the tabular data, additional narrative discussion outside of the table should be considered.

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