More Disclosure of Derivatives Activities Needed
Fitch Ratings takes a look at how US companies are faring with increasing the transparency of their derivatives activities. Fitch found that while transparency has improved, even more disclosure would be beneficial.
Improvements to derivatives disclosure, which became mandatory for all U.S. companies in 2009, are now shining more light on the use of derivatives across all issuers. To assess the improvements in disclosure, Fitch reviewed the quarterly filings of 100 companies from a range of industries representing nearly $6.4 trillion in aggregate outstanding debt.
Key findings;
- Not surprisingly, an overwhelming majority (approximately 80%) of the derivative assets and liabilities carried on the balance sheets of the companies reviewed were primarily concentrated in five financial services firms: JPMorgan Chase; Bank of America; Goldman Sachs; Citigroup; and Morgan Stanley.
- Fifty-eight percent of the companies reviewed disclosed the presence of credit risk related contingent features in their derivative positions. These contingent features generally require a company to post additional collateral or settle any outstanding derivative liability in the event of a downgrade of the company’s credit rating.
- The use of credit derivatives was limited to financial institutions, with 17 of these reporting such exposure.
- Proprietary derivatives trading by utilities and energy companies appear to be very limited, but most of the companies reviewed in both industries report the use of derivatives for hedging commodity risks.
- Generally, non-financial companies appear to use derivatives only for hedging specific risks.
- Derivative valuation is often model-based, making changes in significant valuation assumptions particularly important. Analysis would be enhanced if issuers provided additional disclosure on the sensitivity of their derivative valuations to major assumptions.
The new derivative disclosures are a welcome addition for analysts and investors. They vastly improve the public disclosure of derivative positions and they bring some much needed transparency to the financial reporting of derivatives.
Despite the improvements, Fitch believes that disclosure can go further. In particular, additional information with regard to sensitivity analysis would be very valuable to analysts. Fitch encourages issuers to provide additional information in this regard.
For details see Derivatives: A Closer Look at What New Disclosures in the U.S. Reveal.
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