6044 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

1The amendments were proposed in Securities

Act Release No. 7250; Exchange Act Release No.

36643; Investment Company Act Release No. 21625;

File No. S7–35–95 (December 28, 1995) [61 FR 578].

2 17 CFR 210.4–08. Item 310 of Regulation S-B, 17

CFR 228.310, also is amended to incorporate the

changes to Rule 4–08 of Regulation S-X.

3 17 CFR Part 229.

4 17 CFR 239.11, 12, 25, 18, and 34.

5 15 U.S.C. 77a et seq.

6 17 CFR 240.14a–3.

7 17 CFR 240.14a–101.

8 17 CFR 249.210, 220f, 308a, and 310.

9 15 U.S.C. 78a et seq.

10See the instructions to Item 305 of Regulation

S-K or Item 9A of Form 20-F, infra, for complete

definitions of the terms ‘‘derivative financial

instruments,’’ ‘‘other financial instruments,’’ and

‘‘derivative commodity instruments.’’ In brief, for

purposes of this release: (1) Derivative financial

instruments include futures, forwards, swaps,

options, and other financial instruments with

similar characteristics, (2) other financial

instruments include, for example, investments,

loans, structured notes, mortgage-backed securities,

indexed debt instruments, interest-only and

principal-only obligations, deposits, and other debt

obligations, and (3) derivative commodity

instruments include, to the extent such instruments

are not derivative financial instruments, commodity

futures, commodity forwards, commodity swaps,

commodity options, and other commodity

instruments with similar characteristics that are

permitted to be settled in cash or with another

financial instrument by contract or business

custom. In addition, for purposes of this release, the

terms (1) ‘‘derivatives’’ refer to derivative financial

instruments and derivative commodity instruments,

together, and (2) ‘‘market risk sensitive

instruments’’ refer to derivative financial

instruments, other financial instruments, and

derivative commodity instruments, collectively.

11 The worldwide notional/contract amounts for

derivative financial instruments and derivative

commodity instruments increased from $7.1 trillion

in 1989 to $69.6 trillion in 1995. These notional

amounts, while one way to measure derivative

activities, do not represent a precise measure of the

risk associated with these instruments. In many

instances, the amount at risk is much smaller than

the notional amount. See Financial Derivatives:

Actions Needed to Protect the Financial System,

United States General Accounting Office Report to

Congressional Requesters (May 1994), and Survey of

Disclosures about Trading and Derivatives

Activities of Banks and Securities Firms, Basle

Committee on Banking Supervision (‘‘Basle

Committee’’) and the Technical Committee of the

International Organisation of Securities

Commissions (‘‘IOSCO’’) (November 1996).

12Market risk is the risk of loss arising from

adverse changes in market rates and prices, such as

interest rates, foreign currency exchange rates,

commodity prices, and other relevant market rate or

price changes (e.g., equity prices). See Group of

Thirty, ‘‘Derivatives: Practices and Principles’’ (July

1993), and Financial Accounting Standards Board

(‘‘FASB’’), Statement of Financial Accounting

Standards No. 105, ‘‘Disclosure of Information

about Financial Instruments with Off-Balance-Sheet

Risk and Financial Instruments with Concentrations

of Credit Risk,’’ (‘‘FAS 105’’) (March 1990), for

similar definitions of market risk.

SECURITIES AND EXCHANGE

COMMISSION

17 CFR Parts 210, 228, 229, 239, 240,

and 249

[Release Nos. 33–7386; 34–38223; IC–

22487; FR–48; International Series No. 1047;

File No. S7–35–95]

RIN 3235–AG42, 3235-AG77

Disclosure of Accounting Policies for

Derivative Financial Instruments and

Derivative Commodity Instruments and

Disclosure of Quantitative and

Qualitative Information About Market

Risk Inherent in Derivative Financial

Instruments, Other Financial

Instruments, and Derivative

Commodity Instruments

AGENCY: Securities and Exchange

Commission.

ACTION: Final rule.

SUMMARY: The Securities and Exchange

Commission (‘‘Commission’’ or ‘‘SEC’’)

is amending rules and forms for

domestic and foreign issuers to clarify

and expand existing disclosure

requirements for derivative financial

instruments, other financial

instruments, and derivative commodity

instruments, as defined (collectively

‘‘market risk sensitive instruments’’).

The amendments require enhanced

disclosure of accounting policies for

derivative financial instruments and

derivative commodity instruments

(collectively ‘‘derivatives’’) in the

footnotes to the financial statements. In

addition, the amendments expand

existing disclosure requirements to

include quantitative and qualitative

information about market risk inherent

in market risk sensitive instruments.

The required quantitative and

qualitative information should be

disclosed outside the financial

statements and related notes thereto. In

addition, the quantitative and

qualitative information will be provided

safe harbor protection under a new

Commission rule. Finally, this release

reminds registrants that any disclosures

about financial instruments, commodity

positions, firm commitments, and

anticipated transactions (‘‘reported

items’’), should include disclosures

about derivatives that directly or

indirectly affect such reported items, to

the extent such information is material

and necessary to prevent the disclosures

about the reported items from being

misleading. In the aggregate, these

amendments are designed to provide

additional information about market

risk sensitive instruments, which

investors can use to better understand

and evaluate the market risk exposures

of a registrant.

DATES: Effective Date: April 11, 1997.

Compliance Dates: § 210.4–08(n) of

Regulation S–X and the amendment to

Item 310 of Regulation S–B shall apply,

and disclosures under that rule shall be

required, for filings with the

Commission that include financial

statements for fiscal periods ending after

June 15, 1997. For bank and thrift

registrants, as defined, and non-bank

and non-thrift registrants with market

capitalizations on January 28, 1997 in

excess of $2.5 billion, Item 305 of

Regulation S–K and Item 9A of Form

20–F shall apply, and disclosures under

those items shall be required, for filings

with the Commission that include

annual financial statements for fiscal

years ending after June 15, 1997. For

non-bank and non-thrift registrants with

market capitalizations on January 28,

1997 of $2.5 billion or less, Item 305 of

Regulation S–K and Item 9A of Form

20–F shall apply, and disclosures under

those items shall be required, for filings

with the Commission that include

annual financial statements for fiscal

years ending after June 15, 1998. Under

Item 305 of Regulation S–K and Item 9A

of Form 20–F, interim information is not

required until after the first fiscal year

end in which Item 305 of Regulation S–

K and Item 9A of Form 20–F are

effective. Item 10(g) of Regulation S–B

shall apply for filings with the

Commission made on or after April 11,

1997.

FOR FURTHER INFORMATION CONTACT:

Cathy J. Cole, Thomas J. Linsmeier,

Russell B. Mallett, III, or Stephen M.

Swad, at (202) 942–4400, Office of the

Chief Accountant, Securities and

Exchange Commission, 450 Fifth Street,

N.W., Mail Stop 11–3, Washington, D.C.

20549, or Kurt R. Hohl, at (202) 942–

2960, Division of Corporation Finance,

Securities and Exchange Commission,

450 Fifth Street, N.W., Mail Stop 3–13,

Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The

Commission is amending 1 Rule 4–08 of

Regulation S–X 2 and adding a new Item

305 to Regulation S–K.3

The Commission also is making

conforming amendments to Forms S–1,

S–2, S–4, S–11, and F–4 4 under the

Securities Act of 1933,5 and Rule 14a–

3,6 Schedule 14A,7 and Forms 10, 20–

F, 10–Q, and 10–K 8 under the Securities

Exchange Act of 1934.9

I. Executive Summary

During the last several years, the use

of derivative financial instruments,

other financial instruments, and

derivative commodity instruments 10

increased substantially.11 The

Commission recognizes that these

instruments can be effective tools for

managing exposures to market risk.12

However, in using market risk sensitive

instruments some registrants

experienced significant, and sometimes

unexpected, losses. Those losses
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6045

13See FASB, Statement of Financial Accounting

Standards No. 119, ‘‘Disclosures about Derivative

Financial Instruments and Fair Value of Financial

Instruments,’’ (‘‘FAS 119’’) (October 1994).

14Those disclosure requirements are applicable

only to derivatives; the requirements do not relate

to other financial instruments. Accounting policy

disclosure requirements for other financial

instruments are prescribed by existing generally

accepted accounting principles and Commission

guidance (see, e.g., American Institute of Certified

Public Accountants (‘‘AICPA’’), Accounting

Principles Board Opinion No. 22, ‘‘Disclosure of

Accounting Policies,’’ (‘‘APB 22’’) (April 1972).

15 Items 305 and 9A do not pertain solely to

derivatives, but also to other financial instruments.

Thus, disclosures under those Items are required for

registrants that have material amounts of other

financial instruments, even when they have no

derivatives.

Items 305 and 9A also encourage registrants to

include other market risk sensitive instruments,

positions, and transactions (such as commodity

positions, derivative commodity instruments that

are not permitted by contract or business custom to

be settled in cash or with another financial

instrument, and cash flows from anticipated

transactions) within the scope of their quantitative

and qualitative disclosures about market risk.

Registrants that select the sensitivity analysis or

value at risk disclosure alternatives and voluntarily

include those other market risk sensitive

instruments, positions, and transactions within

their quantitative disclosures about market risk are

permitted to present comprehensive market risk

disclosures, which reflect the combined effect of

both the required and voluntarily selected

instruments, positions, and transactions (see section

III B.1.c.(vi) for details). Finally, if those other

market risk sensitive instruments, positions, and

transactions are not voluntarily included in the

quantitative disclosures about market risk and, as

a result, the disclosures do not fully reflect the net

market risk exposures of the registrant, Items 305(a)

and 9A(a) require that registrants discuss the

absence of those items as a limitation of the

disclosed market risk information.

16The term ‘‘financial statements’’ includes the

footnotes to the financial statements. Therefore, the

disclosures should be presented outside of the

footnotes to the financial statements. See section III

B.4.b., infra, for a more complete discussion about

where these disclosures should appear.

17For purposes of this release, the term ‘‘trading

purposes’’ has the same meaning as defined by

generally accepted accounting principles (see, e.g.,

FAS 119 ¶ 9a).

18See note 58, infra, for a definition specifying

how the term ‘‘primary market risk exposures’’ is

used in this release.

19For purposes of this release, ‘‘anticipated

transactions’’ means transactions (other than

transactions involving existing assets or liabilities

or transactions necessitated by existing firm

commitments) an enterprise expects, but is not

obligated, to carry out in the normal course of

business (see, e.g., ¶ 9 of FASB, Statement of

Financial Accounting Standards No. 80,

‘‘Accounting for Futures Contracts,’’ (‘‘FAS 80’’)

(August 1984)).

20See, e.g., Item 303 of Regulation S-B, 17 CFR

228.303, and Item 303 of Regulation S-K, 17 CFR

229.303.

resulted from changes in interest rates,

foreign currency exchange rates, and

commodity prices, among other things.

In light of those losses and the

substantial growth in the use of market

risk sensitive instruments, the adequacy

of existing disclosures about market risk

emerged as an important financial

reporting issue.

During 1994 and 1995, the SEC staff

reviewed annual reports filed with the

Commission by approximately 500

registrants to better understand this

emerging issue. In reviewing the annual

reports, the staff intended to (i) assess

the quality of current disclosures about

market risk sensitive instruments, (ii)

improve the quality of those disclosures

through the comment process, and (iii)

determine what, if any, additional

disclosures are needed to help investors

better assess the market risk inherent in

those instruments. After reviewing the

annual reports, the SEC staff noted that

the 1995 disclosures were more

informative than the 1994 disclosures,

in part because of improved FASB

disclosure guidance.13 However, the

staff observed three significant

disclosure deficiencies, which are

described in section II of this release. To

address those deficiencies:

1. The Commission is amending Rule 4–08

of Regulation S–X and Item 310 of Regulation

S–B to require enhanced descriptions of

accounting policies for derivatives in the

footnotes to the financial statements.14

2. The Commission is amending Regulation

S–K to add Item 305 and Form 20–F to add

Item 9A. Those amendments require

disclosure of quantitative and qualitative

information about market risk for derivatives

and other financial instruments 15 and require

that those disclosures be presented outside

the financial statements.16

a. Items 305(a) and 9A(a) require

registrants to disclose quantitative

information about market risk sensitive

instruments using one or more of the

following alternatives:

i. Tabular presentation of fair value

information and contract terms relevant to

determining future cash flows, categorized by

expected maturity dates;

ii. Sensitivity analysis expressing the

potential loss in future earnings, fair values,

or cash flows from selected hypothetical

changes in market rates and prices; or

iii. Value at risk disclosures expressing the

potential loss in future earnings, fair values,

or cash flows from market movements over

a selected period of time and with a selected

likelihood of occurrence.

In preparing this quantitative information,

registrants should categorize market risk

sensitive instruments into instruments

entered into for trading purposes 17 and

instruments entered into for purposes other

than trading. Within both the trading and

other than trading portfolios, separate

quantitative information should be presented

for each market risk exposure category (i.e.,

interest rate risk, foreign currency exchange

rate risk, commodity price risk, and other

relevant market risks, such as equity price

risk), to the extent material. Registrants may

use different disclosure alternatives for each

of the separate disclosures.

b. Items 305(b) and 9A(b) require

registrants to disclose qualitative information

about market risk. Those items require

disclosure of:

i. a registrant’s primary market risk

exposures 18 at the end of the current

reporting period;

ii. how the registrant manages those

exposures (such as a description of the

objectives, general strategies, and

instruments, if any, used to manage those

exposures); and

iii. changes in either the registrant’s

primary market risk exposures or how those

exposures are managed, when compared to

the most recent reporting period and what is

known or expected in future periods.

c. Items 305 and 9A state that forward

looking disclosures made pursuant to those

items are within the statutory safe harbor

under the Securities Act of 1933 and

Securities Exchange Act of 1934.

3. The Commission reminds registrants

that, when they provide disclosures about

financial instruments, commodity positions,

firm commitments, and anticipated

transactions 19 (‘‘reported items’’), disclosures

about derivatives that directly or indirectly

affect such reported items also are required,

to the extent the effects of such information

are material and necessary to prevent the

disclosures about the reported items from

being misleading.

The amendments in Rule 4–08(n) and

Item 310 relating to accounting policy

disclosures apply to registered

investment companies and small

business issuers, among other

registrants. In contrast, Item 305 and

Item 9A do not apply to registered

investment companies and small

business issuers. However, if market

risk represents a material known risk or

uncertainty, small business issuers, like

other registrants, will continue to be

required to discuss those risks and

uncertainties to the extent required by

Management’s Discussion & Analysis

(‘‘MD&A’’). 20

The amendments become effective

over the next several months to provide

registrants with time to respond to the

new disclosure requirements. Rule 4–

08(n) and the amendment to Item 310

will be effective for filings with the

Commission that include financial

statements for fiscal periods ending after

June 15, 1997. For registrants that are

likely to have experience with

measuring market risk, such as banks,

thrifts, and non-bank and non-thrift

registrants with market capitalizations

on January 28, 1997 in excess of $2.5

billion, Item 305 and Item 9A are

effective for filings with the

Commission that include annual

financial statements for fiscal years

ending after June 15, 1997. For other

registrants, Item 305 and Item 9A are

effective for filings with the

Commission that include annual

financial statements for fiscal years

ending after June 15, 1998. Under Item

305 and Item 9A, interim information is
6046 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

21The FASB currently is working on a project to

improve accounting recognition, measurement, and

related disclosures for derivatives.

22See AIMR, Financial Reporting in the 1990s

and Beyond, page 30, (1993).

23See AICPA Special Committee on Financial

Reporting, Improving Business Reporting—A

Customer Focus: Meeting the Information Needs of

Investors and Creditors, at 76 (1994).

24See General Accounting Office, Financial

Derivatives: Actions Taken or Proposed Since May

1994 (November 1996).

25See Bank for International Settlements, A

Discussion Paper on Public Disclosure of Market

and Credit Risks by Financial Intermediaries,

prepared by working group of the Euro-currency

Standing Committee of the Central Banks of the

Group of Ten Countries (September 1994).

26See Federal Reserve Bank of New York, Public

Disclosure of Risks Related to Market Activity: A

Discussion Paper (November 1994).

27See Basle Committee and the Technical

Committee of IOSCO, Framework for Supervisory

Information about the Derivatives Activities of

Banks and Securities Firms (May 1995). See also

Basle Committee and the Technical Committee of

IOSCO, Public Disclosure of the Trading and

Derivatives Activities of Banks and Securities Firms

(November 1995).

28See Group of Thirty, Derivatives: Practices and

Principles (July 1993).

29See FEI, Derivative Financial Instruments

Accounting and Disclosure Issues, (‘‘FEI Report’’)

prepared by FEI CCF/CCR Derivatives Disclosure

Task Force (August 1994).

30See note 26, supra.

31See Attachment A, page 1 of FEI Report.

32See Attachment B, pages 5 and 6 of FEI Report.

33Similar standards were recently adopted by the

International Accounting Standards Committee, the

Canadian Institute of Chartered Accountants, and

the Australian Accounting Standards Board. See

International Accounting Standards No. 32,

‘‘Financial Instruments: Disclosure and

Presentation,’’ (‘‘IAS 32’’) (March 1995), Section

3860 of the Handbook of the Canadian Institute of

Chartered Accountants, and the Australian

Accounting Standards Board’s accounting standard

entitled, ‘‘Presentation and Disclosure of Financial

Instruments,’’ (December 1996), respectively.

34See FAS 119 ¶ 12.

not required until after the first fiscal

year end in which those Items are

effective.

Taken together, Rule 4–08(n), Item

310, Item 305, and Item 9A represent

one step by the Commission to improve

disclosures about market risk to help

investors better understand and evaluate

a registrant’s market risk exposures. The

Commission recognizes the evolving

nature of market risk sensitive

instruments, market risk measurement

systems, and market risk management

strategies and, thus, intends to continue

considering how best to meet the

information needs of investors. In this

regard, the Commission expects to

monitor continuously the effectiveness

of the new rules and final disclosure

items issued today, as well as the need

for additional proposals. Specifically,

the Commission expects to reconsider

these amendments after each of the

following: (i) Issuance of a new

accounting standard for derivatives by

the FASB; 21 (ii) development in the

marketplace of new generally accepted

methods for measuring market risk; and

(iii) a period of three years from the

initial effective date of Item 305 and

Item 9A.

II. Initiatives Regarding Disclosures

About Derivatives and Market Risk

Certain private sector organizations

expressed concerns that users of

financial reports are dissatisfied with

current disclosures about market risk

sensitive instruments. For example, the

Association for Investment Management

and Research (‘‘AIMR’’), an organization

of financial analysts, noted that users of

financial information ‘‘are confounded

by the * * * complexity of financial

instruments.’’ 22 In addition, after

considerable investigation into the

needs of investors and creditors, the

American Institute of Certified Public

Accountants’ (‘‘AICPA’’) Special

Committee on Financial Reporting

stated:

Users are confused. They complain that

business reporting is not answering

important questions, such as: * * * What

[innovative financial] instruments has the

company entered into, and what are their

terms? How has the company accounted for

those instruments, and how has that

accounting affected the financial statements?

What risks has the company transferred or

taken on? 23

In addition to identifying disclosure

shortcomings, other organizations

recommended improvements to

disclosures about market risk sensitive

instruments. These organizations

include regulators, such as the General

Accounting Office, 24 Group of 10

Central Bankers, 25 the Federal Reserve

Bank of New York, 26 the Basle

Committee and the Technical

Committee of IOSCO, 27 and private

sector bodies, such as the Group of

Thirty 28 and a task force of the

Financial Executives Institute (‘‘FEI’’). 29

In general, those organizations

stressed the need to make the risks

inherent in market risk sensitive

instruments more understandable. To

that end, many recommended

additional quantitative and qualitative

disclosures about market risk. For

example, the Federal Reserve Bank of

New York recommended a new

financial statement providing

quantitative information about the

overall market risk of an entity.30 In

addition, the FEI task force

recommended that companies ‘‘disclose

some type of information which

conveys overall exposure to market

risk.’’ 31 The FEI task force specifically

suggested two distinct approaches. One

approach is to provide a high-level

summary of relevant statistics about

outstanding activity in market risk

sensitive instruments at period end. The

second approach is to communicate the

potential loss that could occur under

specified conditions using either value

at risk or another comprehensive model

for measuring market risk.32

In October 1994, the FASB,

responding in part to calls for improved

disclosure, issued FAS 119 (October

1994).33 Among other things, FAS 119

prescribes disclosures in the financial

statements about the policies used to

account for derivative financial

instruments and a discussion of the

nature, terms, and cash requirements of

derivative financial instruments. FAS

119 also encourages, but does not

require, disclosure of quantitative

information about an entity’s market

risk exposures.34

During 1994, in response, in part, to

the concerns of investors, regulators,

and private sector entities, the SEC staff

reviewed the annual reports of

approximately 500 registrants. In

addition, during 1995 the SEC staff

reviewed more recent annual reports to

assess the effect of FAS 119 on

disclosures about market risk sensitive

instruments. In comparing the 1994 and

1995 annual reports, the SEC staff

observed that FAS 119 had a positive

effect on the quality of disclosures about

derivative financial instruments.

However, the staff concluded that

investors still needed improved

disclosures about market risk sensitive

instruments. In particular, the SEC staff

identified three primary disclosure

issues:

1. Footnote disclosures of accounting

policies for derivatives often were too general

to convey adequately the diversity in

accounting that exists for derivatives. Thus,

it often was difficult to determine the impact

of derivatives on registrants’ statements of

financial position, cash flows, and results of

operations.

2. Disclosures about different types of

market risk sensitive instruments often were

reported separately. Thus, it was difficult to

assess the aggregate market risk exposures

inherent in these instruments.

3. Disclosure about reported items in the

footnotes to the financial statements, MD&A,

schedules, and selected financial data may

not have reflected adequately the effect of

derivatives on such reported items. Thus,

information about the reported items may

have been incomplete and could be

misleading.

The Commission designed Rule 4–

08(n), Item 310, Item 305, and Item 9A

to address these issues. In forming these

requirements, the Commission used the

following guiding principles:

• Disclosures should make

transparent the impact of derivatives on
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6047

35The authoritative accounting literature for

options and complex derivatives generally is

limited to a few consensuses from the FASB

Emerging Issues Task Force (‘‘EITF’’), which by

their nature address the accounting for specific

transactions. See, e.g., EITF Issues 88–8, ‘‘Mortgage

Swaps,’’ and 90–17, ‘‘Hedging Foreign Currency

Risks with Purchased Options.’’

36Under the fair value method, derivatives are

carried on the balance sheet at fair value with

changes in that value recognized in earnings or

stockholders’ equity (see, e.g., FASB, Statement of

Financial Accounting Standards No. 52, ‘‘Foreign

Currency Translation,’’ (‘‘FAS 52’’) (December

1981), and FAS 80. Under the deferral method,

gains and losses from derivatives are deferred on

the balance sheet and recognized in earnings in

conjunction with earnings of designated items (see,

e.g., FAS 52 and FAS 80). Under the accrual

method, each net payment/receipt due or owed

under the derivative is recognized in earnings

during the period to which the payment/receipt

relates; there is no recognition on the balance sheet

for changes in the derivative’s fair value (see, e.g.,

EITF Issue 84–36, ‘‘Interest Rate Swap

Transactions’’).

37For example, the risk reduction criterion in

FAS 52 is different from the risk reduction criterion

in FAS 80. FAS 52 specifies risk reduction on a

transaction basis, while FAS 80 specifies risk

reduction on an enterprise basis. In addition, FAS

80 permits the use of deferral accounting for futures

contracts used to hedge probable, but not firmly

committed, anticipated transactions, while FAS 52

prohibits deferral accounting for foreign currency

forward exchange contracts used to hedge those

same types of anticipated transactions.

38The Commission does not mean to imply by

this statement that registrants may justify the use of

any method of accounting for derivatives.

Registrants must select appropriate accounting

methods that are consistent with generally accepted

accounting principles. In particular, generally

accepted accounting principles require registrants

using derivatives for trading, dealing, or speculative

purposes to recognize those instruments on the

balance sheet at fair value and to recognize changes

in that value immediately in earnings (see, e.g., FAS

80 ¶ 3).

39APB 22 ¶ 12 states:

Disclosure of accounting policies should identify

and describe the accounting policies followed by

the reporting entity and the methods of applying

those principles that materially affect the

determination of financial position, cash flows or

results of operations. In general, the disclosure

should encompass important judgments as to the

appropriateness of principles relating to recognition

of revenue and allocation of asset costs to current

and future periods; in particular, it should

encompass those accounting principles and

methods that involve * * * a selection from

existing acceptable alternatives.

The Accounting Principles Board was the

predecessor to the FASB. Unless superseded by

FASB Statements, APB Opinions continue to be

regarded as the highest level of generally accepted

accounting principles followed by the accounting

profession. See generally AICPA, Statements on

Auditing Standards No. 69, ‘‘The Meaning of

Present Fairly in Conformity With Generally

Accepted Accounting Principles in the Independent

Auditor’s Report,’’ ¶ 5 (March 1992); AU § 411.05.

40See FAS 119 ¶ 60.

a registrant’s statements of financial

position, cash flows, and results of

operations;

• Disclosures should provide

information about a registrant’s

exposures to market risk;

• Disclosures should explain how

market risk sensitive instruments are

used in the context of the registrant’s

business;

• Disclosures about market risk

exposures should not focus on

derivatives in isolation, but rather

should reflect the risk of loss inherent

in all market risk sensitive instruments;

• Market risk disclosure requirements

should be flexible enough to

accommodate different types of

registrants, different degrees of market

risk exposure, and alternative ways of

measuring market risk;

• Disclosures about market risk

should address, where appropriate,

special risks relating to leverage, option,

or prepayment features; and

• New disclosure requirements

should build on existing requirements,

where possible, to minimize compliance

costs.

III. Discussion of Amendments

A. Disclosure of Accounting Policies for

Derivatives

1. Background

During the last several years, a

significant number of issues relating to

the accounting for derivatives have been

raised. The FASB is working on a

project that will address

comprehensively the accounting for

derivatives. However, currently there is

little authoritative literature on the

accounting for options and complex

derivatives.35

In the absence of comprehensive

accounting literature, registrants have

developed accounting practices for

options and complex derivatives by

analogy to the limited amount of

literature that does exist. Those

analogies are complicated because,

under existing accounting literature,

there are at least three distinctly

different methods of accounting for

derivatives (e.g., fair value accounting,

deferral accounting, and accrual

accounting).36 Further, the underlying

concepts and criteria used in

determining the applicability of those

accounting methods are not

consistent.37 As a result, during its 1994

and 1995 reviews of annual reports, the

SEC staff observed that registrants with

similar risk management objectives

often accounted for derivatives with

similar economic characteristics in

different ways.38 Thus, it was difficult to

ascertain and compare the financial

statement effects of derivatives among

registrants.

To provide a better understanding of

the accounting for derivative financial

instruments, paragraph 8 of FAS 119

requires disclosure of the policies used

to account for those instruments,

pursuant to the requirements of APB

22.39 Specifically, FAS 119 emphasizes

the disclosure of ‘‘policies for

recognizing (or not recognizing) and

measuring derivative financial

instruments * * * and when

recognized, where those instruments

and related gains and losses are reported

in the statements of financial position

and income.’’ 40 Notwithstanding its

helpful guidance, FAS 119 does not

explicitly indicate the type of

information that should be included in

the accounting policies footnote to help

investors understand the effects of

derivatives on the statements of

financial position, cash flows, and

results of operations. FAS 119 also does

not address disclosure of accounting

policies for derivative commodity

instruments.

2. Rule 4–08(n) of Regulation S-X and

Item 310 of Regulation S-B

To facilitate a more informed

assessment of the effects of derivatives

on financial statements, Rule 4–08(n)

and Item 310 explicitly require that

seven items be disclosed in the

derivatives accounting policies footnote,

when material. For example, Rule 4–

08(n) and Item 310 require a description

of the methods used to account for

derivatives, the types of derivatives

accounted for under each method, and

the criteria required to be met for each

accounting method used. See Rule 4–

08(n) and Item 310 for further

requirements.

When assessing materiality under

Rule 4–08(n) and Item 310, the

Commission expects registrants to

consider (i) the financial statement

effects of all derivatives, including those

not recognized in the statement of

financial position and (ii) the relative

effects of using the accounting method

selected as compared to the other

methods available (e.g., accrual,

deferral, or fair value methods of

accounting).

In essence, Rule 4–08(n) and Item 310

clarify how the accounting policy

disclosure requirements in FAS 119

should be applied to derivative financial

instruments. They also extend those

requirements to derivative commodity

instruments. The Commission expects

to reconsider the effectiveness of and

the need for the accounting policy

disclosures, prescribed under Rule 4–

08(n) and Item 310, when a new

accounting standard for derivatives is

issued by the FASB.
6048 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

41The Commission believes that the exercise of

discretion in making such choices by registrants

should not subject registrants to liability with

respect to private rights of action.

42See, e.g., FAS 119 ¶ 8b and Rule 5–02 of

Regulation S–X, 17 CFR 210.5–02, respectively.

43 In particular, FAS 119 ¶ 12 lists five possible

quantitative methods of measuring and disclosing

market risk. They are: (i) Details about current

positions and perhaps activity during the period,

(ii) the hypothetical effects on equity, or on annual

income, of several possible changes in market price,

(iii) a gap analysis of interest rate repricing or

maturity dates, (iv) the duration of the financial

instruments, and (v) the entity’s value at risk from

derivative financial instruments and from other

positions at the end of the reporting period and the

average value at risk during the year.

44 Item 9A(a) of Form 20–F, like the other portions

of Item 9A, is substantively identical to related

sections in Item 305.

45At the current time, the Commission is not

prescribing standardized methods and procedures

specifying how to comply with each of these

disclosure alternatives. To facilitate comparison

across registrants, however, Item 305(a) requires

that registrants describe the model and assumptions

used to prepare quantitative market risk

disclosures.

B. Disclosures of Quantitative and

Qualitative Information About Market

Risk

1. Quantitative Information About

Market Risk

a. Nature of Disclosures. A primary

objective of the quantitative disclosure

requirements is to provide investors

with forward looking information about

a registrant’s potential exposures to

market risk. These quantitative

disclosures are dependent on several

choices about key model characteristics

and assumptions (e.g., hypothetical

changes in future market rates or

prices).41 By their nature, these forward

looking choices are only estimates and

will be different from what actually

occurs in the future. As a result, actual

future gains or losses will differ from

those reported in the quantitative

disclosures. For example, differences

between actual and reported gains and

losses will arise when (i) actual market

rate or price changes differ from those

estimated or (ii) the portfolio of market

risk sensitive instruments held during

the year differs from the portfolio held

at the prior year-end.

Notwithstanding this limitation, the

Commission believes that the reported

market risk information should provide

benefits to both investors and

registrants. The quantitative disclosures

should help investors better understand

specific market risk exposures of

different registrants, thereby allowing

them to better manage market risks in

their investment portfolios. Those

disclosures also should provide a

mechanism, where applicable, for

registrants to disclose that their use of

derivatives represents risk management,

rather than speculation. Those

disclosures are not precise indicators of

expected future reported losses. Instead,

depending on the modeling technique

and assumptions used, they are

indicators of remote or reasonably

possible losses. Nevertheless, those

disclosures should provide investors

with important indicators of how a

particular registrant views and manages

its market risk.

The Commission has provided

flexibility in the quantitative and

qualitative disclosure requirements to

accommodate different types of

registrants, different degrees of market

risk exposure, and alternative ways of

measuring market risk. The Commission

believes, at this time, that such

flexibility is necessary and important to

allow risk management and reporting

practices to evolve, even though such

flexibility is likely to reduce the

comparability of disclosures. To address

this comparability issue, registrants are

required to disclose the key model

characteristics and assumptions used in

preparing the quantitative market risk

disclosures. These disclosures are

designed to allow investors to evaluate

the potential impact of variations in

those model characteristics and

assumptions on the reported

information. In addition, as more

standard risk management practices and

methods of reporting market risk are

developed, the Commission anticipates

reviewing the disclosure requirements

with the view to enhancing

comparability.

b. Background. Market risk is inherent

in derivative and non-derivative

instruments, including:

• Derivative financial instruments—

futures, forwards, swaps, options, and other

financial instruments with similar

characteristics;

• Other financial instruments—nonderivative financial instruments, such as

investments, loans, structured notes,

mortgage-backed securities, indexed debt

instruments, interest-only and principal-only

obligations, deposits, and other debt

obligations;

• Derivative commodity instruments that

are permitted by contract or business custom

to be settled in cash or with another financial

instrument—commodity futures, commodity

forwards, commodity swaps, commodity

options, and other commodity instruments

with similar characteristics, to the extent

such instruments are not derivative financial

instruments.

Generally accepted accounting

principles and prior Commission rules

already require disclosure of certain

quantitative information pertaining to

some of these instruments. For example,

registrants are required to disclose

notional amounts of derivative financial

instruments and the nature and terms of

debt obligations. 42 However, this

information (i) often is abbreviated, (ii)

is presented piecemeal in different parts

of the financial statements, and (iii)

does not apply to all market risk

sensitive instruments. Thus, investors

often have been unable to assess the net

market risk exposures inherent in these

instruments.

FAS 119 encourages, but does not

require, disclosure of quantitative

information about the market risk

exposures inherent in market risk

sensitive instruments.43 However,

without an explicit requirement, the

Commission observed that registrants

often were not making these disclosures.

c. Item 305(a) of Regulation S–K and

Item 9A(a) of Form 20–F. In essence,

Items 305(a) and 9A(a) 44 are designed to

make disclosures about market risk

more comprehensive by requiring

disclosures of quantitative information

about market risk, similar to those

encouraged by FAS 119. Items 305(a)

and 9A(a) apply to market risk sensitive

instruments.

Under these Items, registrants should

furnish quantitative information about

market risk using one or more of three

prescribed alternative methods.45 The

three alternative methods, described in

detail below, are a tabular presentation,

sensitivity analysis, and value at risk.

In preparing this quantitative

information, registrants should

categorize market risk sensitive

instruments into instruments entered

into for trading purposes and

instruments entered into for purposes

other than trading. Within both the

trading and other than trading

portfolios, separate quantitative

information should be presented for

each market risk exposure category (i.e.,

interest rate risk, foreign currency

exchange rate risk, commodity price

risk, and other relevant market risks,

such as equity price risk), when

material.

A registrant may use (i) the same

alternative for all market risk

disclosures, (ii) one alternative, such as

value at risk, for all disclosures related

to instruments entered into for trading

purposes, and another alternative, such

as sensitivity analysis, for all

disclosures related to instruments

entered into for other than trading

purposes, or (iii) different or the same

alternatives for each category of market

risk within the trading and other than

trading portfolios.

(i) Tabular Presentation. The tabular

presentation alternative permits
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6049

46 In some instances, the tabular presentation

alternative is similar to the gap analysis commonly

provided by financial institutions. Thus, with

minor modifications, if any, those registrants could

report a gap analysis and comply with the tabular

information requirements.

47For purpose of Item 305 and Item 9A,

functional currency means the currency of the

primary economic environment in which the entity

operates; normally, that is the currency of the

environment in which an entity primarily generates

and expends cash. This definition is the same as the

definition of functional currency in FAS 52,

Appendix E.

48The term ‘‘sensitivity analysis,’’ as used in

Items 305(a) and 9A(a), describes a general class of

models that assesses the risk of loss in market risk

sensitive instruments based on hypothetical

changes in market rates or prices. The term

sensitivity analysis is not meant to refer to any one

model for quantifying market risk. Sensitivity

analysis models include, for example, duration

analysis or other ‘‘sensitivity’’ measures already

required to be calculated for regulatory purposes for

thrift institutions (see Office of Thrift Supervision,

Regulatory Capital: Interest Rate Risk Component,

12 CFR 567.5(c)(4) (August 1993)).

49See note 67, infra, for a definition of the term

‘‘reasonably possible.’’

50See note 66, infra, for a definition of the term

‘‘near-term.’’

51The term ‘‘value at risk,’’ as used in Items

305(a) and 9A(a), describes a general class of

models that provides a probabilistic assessment of

the risk of loss in market risk sensitive instruments.

The term value at risk is not meant to refer to any

one model for quantifying market risk. Value at risk

models can be adapted to non-trading activities as

well as trading activities and to non-financial

institutions as well as financial institutions,

depending on the model and assumptions selected

by the registrant.

registrants to provide quantitative

information about market risk sensitive

instruments in a tabular format. The

required information includes the fair

values of market risk sensitive

instruments and contract terms

sufficient to determine the future cash

flows from those instruments,

categorized by expected maturity dates.

These tabular disclosures should

present information sufficient to allow

readers of the table to determine

expected cash flows from market risk

sensitive instruments for each of the

next five years and the aggregate cash

flows expected for the remaining years

thereafter.46 These tabular disclosure

requirements were selected because

expected cash flows are common inputs

to market risk measurement methods

and, therefore, are expected to help

investors make estimates of a

registrant’s market risk exposures.

To facilitate an investor’s ability to

make such estimates, Items 305(a) and

9A(a) require that tabular information be

grouped based on common market risk

characteristics. In particular, those Items

require separate presentation of tabular

information for instruments: (i) Entered

into for trading and other than trading

purposes, (ii) subject to different

categories of market risk exposure (e.g.,

interest rate risk, foreign currency

exchange rate risk, etc.), and (iii) subject

to different market risk characteristics

within a particular exposure category

(e.g., different functional currencies, 47

different underlying commodity

exposures, different instrument types,

and different contractual rates or

prices). See Items 305(a)(1)(i) and

9A(a)(1)(i) for further requirements.

In particular, when preparing the

tabular disclosures registrants should

consider whether differences in market

risk would be reflected better by

separately presenting tabular

information for a particular instrument

or group of instruments. For example,

Items 305(a)(1)(i) and 9A(a)(1)(i) require

the grouping of options with similar

strike prices. This grouping is required

because option payouts can differ

significantly depending how far the

option is in or out of the money. Thus,

the separate presentation of tabular

information for options with dissimilar

strike prices should enhance an

investor’s ability to determine the

potential market risk inherent in those

instruments. Registrants should make

similar evaluations when determining

which instruments should be grouped

together within the tabular disclosures.

Items 305(a) and 9A(a) also require

disclosure of information regarding the

contents of the table and related

assumptions necessary to understand a

registrant’s market risk disclosures. In

this regard, registrants should describe,

for example, the different amounts

reported in the table for the various

categories of the market sensitive

instruments (e.g., principal amounts for

debt, notional amounts for swaps, and

the different types of reported market

rates or prices) and key prepayment or

reinvestment assumptions relating to

the timing of reported amounts. See

Items 305(a)(1)(i) and 9A(a)(1)(i) for

further details.

The Appendix to each of these Items

provides a sample disclosure format.

(ii) Sensitivity Analysis. The

sensitivity analysis disclosure

alternative permits registrants to express

the potential loss in future earnings, fair

values, or cash flows of market risk

sensitive instruments resulting from one

or more selected hypothetical changes

in interest rates, foreign currency

exchange rates, commodity prices, and

other relevant market rate or price

changes (e.g., equity prices) over a

selected time period. 48 Items 305(a) and

9A(a) require that registrants select

hypothetical changes in market rates

and prices that are expected to reflect

reasonably possible 49 near-term 50

changes in those rates and prices.

Absent economic justification for the

selection of a different amount,

registrants should use changes that are

not less than 10 percent of end of period

market rates or prices.

Items 305(a) and 9A(a) also require a

description of the model, assumptions,

and parameters underlying the

registrant’s sensitivity analysis that are

necessary to understand the registrant’s

market risk disclosure. In this regard,

registrants are required to specify, for

example, (i) how ‘‘loss’’ is defined by

the model (e.g., loss in earnings, fair

values, or cash flows), (ii) a general

description of the modeling technique

(e.g., the change in net present values

arising from selected shifts in market

rates or prices), (iii) the types of

instruments covered by the model, and

(iv) other relevant information about the

model’s assumptions and parameters

(e.g., the magnitude and timing of

selected hypothetical changes in market

rates or prices used). See Items

305(a)(1)(ii) and 9A(a)(1)(ii) for further

requirements.

(iii) Value at Risk. The value at risk

disclosure alternative permits

registrants to express the potential loss

in future earnings, fair values, or cash

flows of market risk sensitive

instruments over a selected period of

time, with a selected likelihood of

occurrence, from changes in interest

rates, foreign currency exchange rates,

commodity prices, and other relevant

market rates or prices. 51 Items 305(a)

and 9A(a) state that when preparing

value at risk disclosures, registrants

should select confidence intervals that

reflect reasonably possible near-term

changes in market rates and prices. In

this regard, absent economic

justification for the selection of different

confidence intervals, registrants should

use intervals that are 95 percent or

higher.

For each category for which value at

risk disclosures are presented, Items

305(a) and 9A(a) require registrants to

provide either (i) the average, high and

low amounts, or the distribution of

value at risk amounts for the reporting

period, (ii) the average, high and low

amounts, or the distribution of actual

changes in fair values, earnings, or cash

flows from market risk sensitive

instruments occurring during the

reporting period, or (iii) the percentage

or number of times the actual changes

in fair values, earnings, or cash flows

from market risk sensitive instruments

exceeded the value at risk amounts

during the reporting period.

Items 305(a) and 9A(a) also require a

description of the model, assumptions,

and parameters underlying the
6050 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

52The primary differences between the value at

risk and sensitivity analysis disclosure alternatives

are (i) value at risk analysis reports the potential

loss arising from equally likely market movements

across instruments, while sensitivity analysis

reports the potential loss arising from hypothetical

market movements with differing likelihoods of

occurrence across instruments and (ii) value at risk

explicitly adjusts the potential loss to reflect

correlations between market movements, while

sensitivity analysis is not designed explicitly to

make such adjustments.

53For transition purposes, quantitative

disclosures about market risk provided in the initial

year in which a registrant must present information

under Item 305 is not required to contain

comparable summarized information for the

preceding year. Similarly, in the first fiscal year in

which a registrant must present information under

Item 305, a discussion of the reasons for material

changes in reported amounts as compared to the

preceding year is not necessary.

54 In this regard, the Commission believes that all

changes from one disclosure alternative to another

are material; however, other changes discussed in

this section require judgment as to whether the

effects of such changes are material.

55See note 19, supra.

56 In addition, registrants should review the

requirements of Item 303 of Regulation S–K, 17 CFR

229.303, to ensure their disclosures are sufficient to

registrant’s value at risk model that are

necessary to understand the registrant’s

market risk disclosure. In this regard,

registrants should specify, for example,

(i) how ‘‘loss’’ is defined by the model

(e.g., loss in earnings, fair values, or

cash flows), (ii) the type of model used

(e.g., variance/covariance, historical

simulation, or Monte Carlo simulation

and a description as to how optionality

is addressed by the model), (iii) the

types of instruments covered by the

model, and (iv) other relevant

information about the model’s

assumptions and parameters (e.g.,

holding periods and confidence

intervals). 52 See Items 305(a)(1)(iii) and

9A(a)(1)(iii) for further requirements.

(iv) An Alternative to Reporting YearEnd Information. Items 305(a) and 9A(a)

require disclosure of quantitative

information about market risk as of the

end of the latest fiscal year.

Alternatively, registrants, such as those

with proprietary concerns about

reporting year-end information under

the sensitivity analysis and value at risk

disclosure alternatives, may report the

average, high, and low amounts for the

reporting period. In determining those

average, high, and low amounts for the

fiscal year, registrants should use

sensitivity analysis or value at risk

amounts relating to at least four equal

time periods throughout the reporting

period (e.g., four quarter-end amounts,

12-month-end amounts, or 52 week-end

amounts).

(v) Other Disclosure Requirements.

Items 305(a) and 9A(a) require

registrants to provide summarized

quantitative information about market

risk for the preceding fiscal year. In

addition, registrants should discuss the

reasons for material quantitative

changes in market risk exposures

between the current and preceding

fiscal years.53 In determining the

amount and type of summarized

information to be provided for the

preceding fiscal year, registrants should

evaluate whether sufficient information

is disclosed to enable investors to assess

material trends in quantitative market

risk information. This summary should

include information relating to each

market risk exposure category disclosed

in the preceding or latest fiscal year.

In addition, Items 305(a) and 9A(a)

permit registrants to change disclosure

alternatives or key model

characteristics, assumptions, and

parameters used in providing

quantitative information about market

risk (e.g., changing from tabular

presentation to value at risk, changing

the scope of instruments included in the

model, changing the definition of loss

from fair values to earnings). However,

if the effects of such a change are

material,54 registrants should (i) explain

the reasons for the change and (ii) either

provide summarized comparable

information, under the new disclosure

method, for the year preceding the

current reporting period or, in addition

to providing disclosure for the current

year under the new method, provide

disclosure for the current year and

preceding fiscal year under the method

used in the preceding year.

(vi) Encouraged Disclosures. The

Commission recognizes that market risk

exposures may exist in instruments,

positions, and transactions other than in

the market risk sensitive instruments

specifically covered by Items 305 and

9A. In particular, market risk, in its

broadest view, also may be inherent in

the following items:

• Derivative commodity instruments that

are not permitted by contract or business

custom to be settled in cash or with another

financial instrument—such as a commodity

forward contract that must be settled in the

commodity;

• Commodity positions—such as

investments in corn, wheat, oil, gas, lumber,

silver, gold, and other commodity inventory

positions;

• Cash flows from anticipated

transactions 55—such as cash flows from

anticipated purchases and sales of inventory,

and operating cash flows from non-financial

and non-commodity instruments (e.g., cash

flows generated by manufacturing activities);

and

• Certain financial instruments not

included among the required disclosure

items—such as insurance contracts, lease

contracts, and employers’ and plans’

obligations for pension and other postretirement benefits.

The Commission also recognizes,

however, that the amount and timing of

the cash flows inherent in such

instruments, positions, and transactions

sometimes may be difficult to estimate.

In addition, it has been represented to

the staff that many risk measurement

systems currently do not include such

instruments, positions, and transactions

in their quantitative assessments of

market risk. For these practical reasons,

the Commission is not requiring, at this

time, that these items be included in the

quantitative disclosures about market

risk. Registrants, however, are

encouraged to include such items

within their quantitative market risk

disclosures.

Registrants that choose the tabular

presentation disclosure alternative

should present voluntarily selected

instruments, positions, or transactions

in a manner consistent with the

requirements in Items 305 and 9A for

market risk sensitive instruments.

Registrants selecting the sensitivity

analysis or value at risk disclosure

alternatives are not required to provide

separate market risk disclosures for any

voluntarily selected instruments,

positions, or transactions. Instead,

registrants selecting those disclosure

alternatives are permitted to present

comprehensive market risk disclosures,

which reflect the combined market risk

exposures inherent in both the required

and any voluntarily selected

instruments, position, or transactions.

If a registrant elects to include

voluntarily a particular type of

instrument, position, or transaction in

their quantitative disclosures about

market risk, that registrant should

include all, rather than some, of those

instruments, positions, or transactions

within their disclosures. For example, if

a registrant holds in inventory a

particular type of commodity position

and elects to include that commodity

position within their market risk

disclosures, the registrant should

include the entire commodity position,

rather than only a portion thereof, in

their quantitative disclosures about

market risk.

Finally, if instruments, positions, or

transactions are not included

voluntarily in the market risk

disclosures and, as a result, the

disclosures do not fully reflect the net

market risk exposures of the registrant,

the registrant should discuss the

absence of those items as a limitation of

the quantitative information, as

discussed below.56
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6051

inform readers of material risks to which a

registrant is exposed.

57See FAS 119 ¶11a. Footnote 4 of FAS 119

illustrates the qualitative disclosures required by

¶ 11a. That footnote states:

If an entity’s objective for a derivative position is

to keep a risk from the entity’s non-derivative assets

below a specified level, the context would be a

description of those assets and their risks, and a

strategy might be purchasing put options in a

specified proportion to the assets at risk.

58For purposes of Items 305(b) and 9A(b),

primary market risk exposures mean (i) the

following categories of market risk: Interest rate

risk, foreign currency exchange rate risk,

commodity price risk, and other relevant market

rate or price risks (e.g., equity price risk) and (ii)

within each of these categories, the particular

markets that present the primary risks of loss to the

registrant. For example, if a registrant (i) has a

material exposure to foreign currency exchange rate

risk and, within this category of market risk, (ii) is

most vulnerable to changes in dollar/yen, dollar/

pound, and dollar/peso exchange rates, the

registrant should disclose those exposures.

59See section III B.1.c.(vi), supra, for a discussion

as to why these instruments are encouraged, but not

required, to be included in disclosures about market

risk.

60See 17 CFR 228.101 and 17 CFR 228.303,

respectively.

61See 17 CFR 240.12b-20 and 17 CFR 230.408,

respectively.

(vii) Limitations. Items 305(a) and

9A(a) require registrants to discuss

limitations that cause the quantitative

information about market risk not to

reflect fully the net market risk

exposures of the entity. This discussion

is to include a description of

instruments, positions, and transactions

omitted from the quantitative market

risk disclosure information, or the

features of instruments, positions, and

transactions that are included, but not

reflected fully in the quantitative

information disclosed.

Two illustrative examples are

provided. First, as just stated, certain

instruments, positions, and transactions

are excluded from the required

quantitative disclosures about market

risk, but may be included on a voluntary

basis. The failure of a registrant to

include voluntarily those instruments,

positions, or transactions in the

quantitative disclosures is a limitation

of the quantitative information

provided. This limitation should be

discussed, if material, and a

summarized description of the

instruments, positions, or transactions

not reflected fully within the

quantitative market risk disclosures

should be disclosed.

Second, the prescribed quantitative

disclosures may not inform investors of

the degree of market risk inherent in

instruments with leverage, option, or

prepayment features (e.g., options,

including written options, structured

notes, collateralized mortgage

obligations, leveraged swaps, and

options embedded in swaps). Tabular

information on fair values and contract

terms may not necessarily indicate that

instruments have such features.

Similarly, if leverage, option, or

prepayment features are triggered by

changes in market rates or prices

outside those reflected in the value at

risk and sensitivity analysis disclosures,

the potential loss from such market rate

or price changes may be significantly

larger than would be implied by a

simple linear extrapolation of the

reported numbers. Thus, to make

investors fully aware of the market risk

inherent in instruments with such

features, Item 305(a) and Item 9A(a)

require a discussion of this limitation,

including a summarized description of

the features of the instruments causing

the limitation.

2. Qualitative Information About Market

Risk

a. Background. The Commission

believes that quantitative information

about market risk is more meaningful

when accompanied by qualitative

disclosures about a registrant’s market

risk exposures and how those exposures

are managed. Such qualitative

disclosures help investors understand a

registrant’s market risk management

activities and help place those activities

in the context of the business.

FAS 119 requires qualitative

disclosures about market risk

management activities associated with

certain derivative financial instruments.

In particular, FAS 119 requires

disclosure of ‘‘the entity’s objectives for

holding or issuing the derivative

financial instruments, the context

needed to understand those objectives,

and its general strategies for achieving

those objectives.’’ 57 However, the

qualitative disclosure requirements of

FAS 119 only apply to derivative

financial instruments held or issued for

purposes other than trading.

b. Item 305(b) and Item 9A(b). Items

305(b) and 9A(b) expand the qualitative

market risk disclosure requirements of

FAS 119 to (i) Encompass derivative

commodity instruments, other financial

instruments, and derivative financial

instruments entered into for trading

purposes and (ii) require registrants to

evaluate and describe material changes

in their primary risk exposures and in

how those exposures are managed. In

particular, Items 305(b) and 9A(b)

require a description of (i) a registrant’s

primary market risk exposures 58 as of

the end of the latest fiscal year, (ii) how

those exposures are managed (such

descriptions should include, but not be

limited to, a discussion of the

objectives, general strategies, and

instruments, if any, used to manage

those exposures), and (iii) changes in

either the registrant’s primary market

risk exposures or in how those

exposures are managed, when compared

to what was in effect during the most

recently completed fiscal year and what

is known or expected to be in effect in

future reporting periods.

Items 305(b) and 9A(b) apply to

market risk sensitive instruments. In

addition, the qualitative disclosures

required by these items should be

presented separately for market risk

sensitive instruments entered into for

trading purposes and those entered into

for purposes other than trading.

Finally, to help make disclosures

about market risk more comprehensive,

the Commission encourages registrants

to include within their qualitative

disclosures about market risk, certain

instruments, positions, and transactions

not required under Items 305(b) and

9A(b). Those instruments, positions,

and transactions include derivative

commodity instruments not permitted

by contract or business custom to be

settled in cash or with another financial

instrument, commodity positions, cash

flows from anticipated transactions, and

certain financial instruments not

included among the required disclosure

items. See Items 305(b) and 9A(b) for

further requirements.59

If a registrant elects not to include

those instruments, positions, and

transactions in its qualitative

disclosures about market risk, the

Commission reminds registrants to

consider whether qualitative disclosures

about the market risk inherent in those

items would be required under (i) Items

101 or 303 of Regulation S–K 60 or (ii)

Rules 12b–20 under the Securities

Exchange Act of 1934 (‘‘Exchange Act’’)

or 408 under the Securities Act of 1933

(‘‘Securities Act’’) 61 Item 101 of

Regulation S–K requires disclosures

relating to a ‘‘Description of the

Business.’’ Item 303 requires discussion

of known risks and uncertainties within

‘‘Management’s Discussion and

Analysis.’’ Rule 12b–20 under the

Exchange Act and Rule 408 under the

Securities Act state that registrants

should include in any filings or reports

any material information necessary to

make statements made, in light of the

circumstances, not misleading.

3. Safe Harbor for Forward Looking

Information

In the release proposing Item 305 and

Item 9A, the Commission noted its

intention to consider the application of

an appropriate safe harbor to the
6052 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

62Securities Act Release No. 7280; Exchange Act

Release No. 37086; File No. S7–10–96 (April 9,

1996) [61 FR 16672].

63See section III B.4.b., infra, for a discussion

about where these disclosures should appear.

64Registrants are reminded that the safe harbor

requires that forward looking statements be

identified as such.

65 17 CFR part 228, et seq.

66For the purposes of Item 305 and Item 9A, the

term ‘‘near-term’’ means a period of time going

forward up to one year from the date of the

financial statements. See generally AICPA,

Statement of Position 94–6, Disclosure of Certain

Significant Risks and Uncertainties, at paragraph 7

(December 30, 1994).

67For purposes of Item 305 and Item 9A, the term

‘‘reasonably possible’’ is defined by ¶ 3 of FASB,

Statement of Financial Accounting Standards No.

5, ‘‘Accounting for Contingencies’’ (‘‘FAS 5’’)

(March 1975), which states that ‘‘reasonably

possible’’ means the chance of a future transaction

or event occurring is more than remote but less than

likely.

forward looking aspects of the

disclosures. Such a safe harbor

subsequently was proposed for public

comment,62 and the Commission is

adopting that provision substantially as

proposed.

As adopted, the safe harbors for

forward looking statements provided in

Section 27A of the Securities Act and

Section 21E of the Exchange Act apply

to quantitative information about market

risk provided outside the financial

statements and related notes thereto, all

of which, as described further below, is

deemed to be a forward looking

statement for purposes of the safe

harbor, pursuant to Item 305(a) or Item

9A(a); qualitative information about

market risk provided outside the

financial statements and related notes

thereto, pursuant to Item 305(b) or Item

9A(b); and interim information provided

pursuant to Item 305(c) and Item 9A(c).

As proposed, the safe harbor would

have applied to information disclosed

pursuant to Items 305 and 9A regardless

of whether the information was set forth

in the notes to the financial statements

or elsewhere in a registrant’s required

filings. As discussed below,63 the

Commission has determined that

information required by Items 305 and

9A should be disclosed outside of the

financial statements and related notes

thereto. Similarly, as adopted, the safe

harbor applies only to information

located in accordance with the revised

rule.

The safe harbors are available with

respect to the specified information,

regardless of whether the issuer

providing it or the type of transaction

otherwise is excluded from the statutory

safe harbors. For example, first-time

Commission registrants and those

making initial public offerings are

covered by the safe harbors with respect

to this specific information if all other

conditions are satisfied.

As is the case with the statutory safe

harbors, however, the safe harbors

adopted pursuant to this release apply

only to a forward looking statement

made by: (i) An issuer, (ii) a person

acting on behalf of the issuer, (iii) an

outside reviewer retained by the issuer

making a statement on behalf of the

issuer, or (iv) an underwriter, with

respect to information provided by the

issuer or information derived from

information provided by the issuer.

The Commission recognizes that, due

to the difficult nature of the disclosures,

some registrants may require assistance

in preparing the information required by

Items 305 and 9A. For example,

registrants may need assistance from

third parties with respect to compiling

the required information, assessing the

reasonableness of management’s

assumptions, or testing the

mathematical computations that

translate the assumptions into the

required disclosures. Moreover, some

registrants may wish to have outside

third parties review the information

prior to its disclosure. The Commission

considers such assistance and reviews

relating to forward looking disclosure

required by Items 305 and 9A to be

‘‘made by an outside reviewer retained

by the issuer making a statement on

behalf of the issuer’’ under the safe

harbor rule.

The rule now clarifies two additional

points about the application of the new

safe harbor rules. First, the Commission

deems all information required by

paragraphs (a), (b)(1)(i), (b)(1)(iii) and (c)

of Items 305 and 9A to be ‘‘forward

looking statements’’ for purposes of the

new safe harbor rules, except for

historical facts such as the terms of

particular contracts and number of

market risk sensitive instruments held

during or at the end of the reporting

period. To the extent that information

provided pursuant to paragraph (b)(1)(ii)

of Items 305 and 9A includes forward

looking statements, those statements

would be eligible for safe harbor

protection.

Second, the ‘‘meaningful cautionary

statements’’ prong of the safe harbors

will be satisfied with respect to the

Items 305(a) and 9A(a) disclosures if a

registrant satisfies the requirements of

those Items. In this regard, the

Commission notes that Items 305(a) and

9A(a) require disclosure of both the

assumptions underlying, and the

limitations of, the disclosure provided.

For the remainder of the information

required by the new items, registrants

desiring to qualify for the ‘‘meaningful

cautionary statements’’ prong of the safe

harbor will need to consider what

information should be given to alert

investors to important factors that could

cause actual results to differ materially

from the information given in the

forward looking statements.64

Finally, although Item 305 and Item

9A information is not required of small

business issuers (as defined by

Commission rule),65 the safe harbors are

available to those small issuers that

voluntarily choose to disclose such

information. Similarly, the safe harbors

are available to non-small business

issuers who voluntarily disclose

information under Item 305(a) and Item

9A(a) prior to the June 15, 1997 and

June 15, 1998 effective dates.

4. Implementation Issues Relating to

Quantitative and Qualitative Disclosures

About Market Risk

a. Disclosure Threshold. Under Items

305 and 9A, quantitative and qualitative

disclosures about market risk are

required, when material, for each

market risk exposure category within

the trading and other than trading

portfolios. For purposes of assessing

materiality, registrants should evaluate

both (i) the materiality of the fair values

of market risk sensitive instruments

outstanding as of the end of the latest

fiscal year and (ii) the materiality of

potential near-term 66 losses in future

earnings, fair values, and cash flows

from reasonably possible 67 near-term

changes in market rates or prices.

If either (i) or (ii) in the previous

paragraph are material, the registrant

should disclose quantitative and

qualitative information about market

risk, if such market risk for the

particular market risk exposure category

is material. However, the choice of

methods, model characteristics,

assumptions, and parameters used to

comply with the quantitative market

risk disclosures remain at the election of

the registrant, provided disclosure is

made regarding a material risk of loss in

either earnings, fair values, or cash

flows.

For example, if a registrant expects a

material near-term loss in fair values

only, that registrant should not report

quantitative market risk information in

terms of earnings or cash flows, rather

than fair values. In these circumstances,

the registrant could, of course, make

additional quantitative disclosures

about the loss in earnings or cash flows,

but should disclose the risk of loss in

fair values. In contrast, if a registrant is

required to disclose market risk

information because near-term losses in

future earnings, fair values, and cash
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6053

68 Interpretation 39 states that it is a general

principle of accounting that the offsetting of assets

and liabilities in the balance sheet is improper

except where a right of set off exists. Interpretation

39 defines right of set off and specifies what

conditions must be met to have that right. FAS 119

¶ 15(d) in disclosing the fair values of instruments

also prohibits the netting of fair values, except to

the extent that the offsetting of carrying amounts in

the statement of financial position is permitted

under Interpretation 39.

69 ‘‘Small business issuer’’ is defined to mean any

entity that (1) Has revenues of less than

$25,000,000, (2) is a United States or Canadian

issuer, (3) is not an investment company, and (4)

if a majority owned subsidiary, the parent

corporation is also a small business issuer. An

entity is not a small business issuer, however, if it

has a public float (the aggregate market value of the

outstanding securities held by non-affiliates) of

$25,000,000 or more. See 17 CFR 230.405.

70Small business issuers will not be required to

provide these market risk disclosures whether or

not they file on specially designated small business

forms.

In addition, as noted elsewhere in this release,

the Commission has extended the safe harbor for

forward looking information to Item 305 disclosures

that are made voluntarily by small business issuers.

flows all are material, it may report

quantitative information in terms of

either earnings, fair values, or cash

flows.

In assessing the materiality of the fair

values of market risk sensitive

instruments, those fair values generally

should not be netted, except to the

extent allowed under FASB

Interpretation No. 39, ‘‘Offsetting of

Amounts Related to Certain Contracts’’

(‘‘Interpretation 39’’) (March 1992).68

For example, the fair value of assets

generally should not be netted with the

fair value of liabilities. Instead, the fair

values of such instruments should be

aggregated, without netting, for

purposes of assessing materiality.

In assessing the materiality of

potential near-term losses in future

earnings, fair values, or cash flows from

reasonably possible near-term changes

in market rates or prices, registrants

should consider (i) The magnitude of

past market movements, (ii) the

magnitude of reasonably possible, nearterm market movements, and (iii)

potential losses that may arise from

leverage, option, and multiplier

features.

b. Location of Quantitative and

Qualitative Disclosures. As adopted,

Items 305 and 9A require that the

quantitative and qualitative market risk

disclosures be placed outside the

financial statements and related notes

thereto. As proposed, registrants would

have been permitted to disclose such

information in the notes to the financial

statements. Because of the evolving

nature of the disclosures and the FASB’s

pending project on accounting for

derivatives, which also will address

disclosures about derivatives within the

financial statements, the Commission

has determined that the better course, at

this time, is to require that the

disclosures mandated by Items 305 and

9A be located outside of the financial

statements and related notes.

The Commission believes that the

information required by Items 305 and

9A should be included in the annual

report delivered to shareholders;

consequently Rule 14a–3 of the proxy

rules has been amended to include this

requirement. For other documents

delivered to investors, the information

should be included or incorporated by

reference from other Commission

filings.

c. Cross-Referencing of Disclosures.

The Commission believes it is most

meaningful to disclose together, in one

location, quantitative and qualitative

information relating to the same market

risk exposure category. However,

because market risk sensitive

instruments often are used to manage

known risks and uncertainties in market

rates and prices, the disclosures

provided under Items 305 and 9A may

overlap with disclosures provided

under Item 303 of Regulation S–K. To

the extent that the disclosures in a

registrant’s MD&A satisfy the

requirements of Items 305 or 9A,

registrants need not repeat this

information elsewhere in their filings. If

this information is disclosed in more

than one location, however, registrants

should ensure that the resulting

disclosures are meaningful to investors

and provide cross-references to the

locations of the related disclosures.

d. Application to Registrants. Items

305 and 9A are required to be followed

by many different types of registrants,

including, for example, commercial and

industrial companies, financial

institutions, broker-dealers, service

companies, business development

companies, and companies registering

insurance contracts, such as marketvalue adjusted annuities and real estate

funds underlying annuity contracts.

Items 305 and 9A do not apply to

registered investment companies and, as

described further in Section IV, small

business issuers.

e. Reporting Frequency. Items 305 and

9A apply to all registration statements

filed under the Securities Act and all

reports, proxy statements, and

information statements filed under the

Exchange Act that are required to

include or incorporate financial

statements. However, for reports that

include only interim financial

statements (e.g., Form 10–Qs),

registrants need only present market

risk information if there have been

material changes in reported market

risks faced by the registrant since the

end of the most recent fiscal year. In

these circumstances, registrants should

provide a discussion and analysis that

enables investors to assess the sources

and effects of those material changes in

market risks.

IV. Applicability of Amendments

A. Application to Small Business Issuers

The Commission believes that

because of (i) The evolving nature of

these disclosures and (ii) the relative

costs of complying with these

disclosures for small business issuers,69

it is appropriate, at this time, to exempt

small business issuers from disclosing

quantitative and qualitative information

about market risk.70

Accordingly, at this time, the

Commission is not adopting

amendments to Regulation S–B to

incorporate an item similar to Item 305.

Small business issuers, however, are

required (i) To comply with the

amendment regarding accounting

policies disclosures for derivatives, (ii)

to comply with Rule 12b–20 under the

Exchange Act and Rule 408 under the

Securities Act, which require registrants

to provide additional information about

the material effects of derivatives on

other information expressly required to

be filed with the Commission, and (iii)

to the extent market risk represents a

known trend, event, or uncertainty, to

discuss the impact of market risk on

past and future financial condition and

results of operations, pursuant to Item

303 of Regulation S–B.

B. Application to Foreign Private Issuers

Item 9A of Form 20–F requires

disclosure by all foreign private issuers

of quantitative and qualitative

information about market risk. In

addition, foreign private issuers that

prepare financial statements in

accordance with Item 18 of Form 20–F

are required to provide all information

required by U.S. generally accepted

accounting principles and Regulation S–

X, including descriptions in the

footnotes to the financial statements of

the policies used to account for

derivatives. Foreign private issuers that

prepare financial statements in

accordance with Item 17 of Form 20–F

are not required to provide financial

statement disclosures required by U.S.

generally accepted accounting

principles and Regulation S–X. The

amendments requiring disclosures of

accounting policies in Rule 4–08(n) of

Regulation S–X do not apply to foreign

private issuers filing under Item 17 of

Form 20–F. However, foreign private
6054 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

71SAB Topic 1:D provides several examples of

disclosures in MD&A that might be necessary to

enable readers to understand the financial

statements as a whole. One of those example

disclosures includes significant accounting policies

and measurement assumptions which may bear

upon an understanding of operating trends or

financial condition.

72See section III B.1.c.(vi), supra, for a further

description of the instruments, positions, and

transactions described in this paragraph.

73See, e.g., Rule 12b–20 under the Exchange Act

and Rule 408 under the Securities Act. 74See, e.g., FAS 52 ¶ 21a and FAS 80 ¶ 4a.

issuers filing under Item 17 of Form 20–

F should consider the guidance

presented in Staff Accounting Bulletin

Topic 1:D (‘‘SAB Topic 1:D’’) to

determine if information regarding

accounting policies for derivatives

should be provided in MD&A.71

C. Scope and Definition of Instruments

The instructions to Rule 4–08(n), Item

305, and Item 9A define financial

instruments, derivative financial

instruments, other financial

instruments, and derivative commodity

instruments as follows. ‘‘Financial

instruments’’ have the same meaning as

defined by generally accepted

accounting principles (see, e.g., FASB,

Statement of Financial Accounting

Standards No. 107, ‘‘Disclosures about

Fair Value of Financial Instruments,’’

(‘‘FAS 107’’) paragraphs 3 and 8

(December 1991)). ‘‘Derivative financial

instruments’’ are a subset of financial

instruments and include futures,

forwards, swaps, options, and other

financial instruments with similar

characteristics, as defined by generally

accepted accounting principles (see,

e.g., FAS 119 paragraphs 5–7 (October

1994)). See, the General Instructions to

Paragraphs 305(a) and 305(b) of Item

305 or the General Instructions to

Paragraphs 9A(a) and 9A(b) of Item 9A

for further details.

Other financial instruments include

all financial instruments that must be

disclosed at fair value under FAS 107,

except for derivative financial

instruments, as defined above. For

example, other financial instruments

include trade accounts receivable,

investments, loans, structured notes,

mortgage-backed securities, trade

accounts payable, indexed debt

instruments, interest-only and

principal-only obligations, deposits, and

other debt obligations. However, for

purposes of this release, trade accounts

receivable and trade accounts payable

need not be considered other financial

instruments when their carrying

amounts approximate fair value. Other

financial instruments exclude

employers’ and plans’ obligations for

pension and other post-retirement

benefits, substantively extinguished

debt, insurance contracts, lease

contracts, warranty obligations and

rights, unconditional purchase

obligations, investments accounted for

under the equity method, minority

interests in consolidated enterprises,

and equity instruments issued by the

registrant and classified in stockholders’

equity in the statement of financial

position.

Derivative commodity instruments

include, to the extent such instruments

are not derivative financial instruments,

commodity futures, commodity

forwards, commodity swaps,

commodity options, and other

commodity instruments with similar

characteristics, that are permitted by

contract or business custom to be settled

in cash or with another financial

instrument.

Thus, the instrument definitions

described above do not encompass (i)

commodity positions, (ii) derivative

commodity instruments that are not

permitted by contract or business

custom to be settled in cash or with

another financial instrument (e.g., a

commodity forward contract that must

be settled in the commodity), (iii) cash

flows from anticipated transactions,

(e.g., operating cash flows from nonfinancial and non-commodity

instruments), and/or (iv) certain

financial instruments not included

among the required disclosure items.72

V. Disclosure of the Effects of Derivative

Instruments on Disclosures about

Financial Instruments, Commodity

Positions, Firm Commitments, and

Anticipated Transactions

In conjunction with the adoption of

Items 305 and 9A, the Commission

reminds registrants that other reporting

obligations also require certain

disclosures about derivatives. The staff’s

1994 and 1995 reviews of registrant

filings suggested that some registrants

are not providing sufficient disclosure

about how derivatives directly or

indirectly affect reported items. As a

result, those disclosures may not have

reflected as well as they otherwise

might have such matters as the effective

terms or expected cash flows of the

derivatives and reported items.

It is fundamental that registrants

include in any filings or reports any

material information necessary to make

statements made, in light of the

circumstances, not misleading.73 That

is, registrants should provide disclosure

about derivatives that affect, directly or

indirectly, the terms, fair values, or cash

flows of the reported items. This

includes derivative transactions that are

designated to reported items under

generally accepted accounting

principles.74

Thus, for example, information

required to be disclosed in the footnotes

to the financial statements about the

interest rates and repricing

characteristics of debt obligations

should include, when material,

information about the effects of

derivatives. Similarly, summary

information and disclosures in MD&A

about the interest costs of debt

obligations should include, when

material, disclosure of the effects of

derivatives. Likewise, when derivatives

directly or indirectly affect the terms

and cash flows of items such as

securities held as assets, servicing

rights, oil and gas reserves, loan

receivables, deposit liabilities, and

leases, disclosure about the terms and

cash flows of those items should

include, when material, disclosure of

the effects of derivatives to the extent

such disclosure is necessary to prevent

the disclosure about the reported item

from being misleading.

VI. Response to Comments

A. Accounting Policies

1. Disclosure Threshold

In the proposing release, disclosures

of accounting policies for derivatives

would have been required if the fair

values of derivative financial

instruments and derivative commodity

instruments were material. Commenters

noted that the disclosure threshold in

the proposing release is different than

the threshold provided by generally

accepted accounting principles (i.e.,

APB 22) and Regulation S–X. These

commenters indicated that introducing

a new and different threshold could add

unnecessary confusion to the disclosure

process. In response to those

commenters, the disclosure threshold in

the final rule relies on the standards of

materiality present in APB 22 and

Regulation S–X. APB 22 requires

disclosure of accounting policies that

materially affect the determination of

financial position, cash flows, or results

of operations. Regulation S–X limits the

information to those matters about

which an average prudent investor

ought reasonably be informed.

2. Future Reconsideration

Some commenters urged the

Commission to coordinate its efforts

with the FASB, especially by

committing to review the accounting

policies disclosure requirements after

the FASB completes its derivatives and

hedging project. Those commenters
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6055

suggested that when the accounting for

derivatives is addressed

comprehensively by the FASB, rules

explicitly prescribing the content of

derivative accounting policy disclosures

may no longer be necessary. In response

to those commenters concerns, after the

FASB completes its project, the

Commission will direct its staff to

review Rule 4–08(n) and Item 310 and

to recommend whether the Commission

should amend those items.

B. Quantitative Disclosures About

Market Risk

1. Different Alternatives for Different

Categories of Instruments

A number of commenters

recommended that the same

quantitative market risk disclosure

alternative not be required (i) For

instruments entered into for trading and

other than trading purposes and (ii) for

each market risk exposure category (e.g.,

interest rates, foreign currency exchange

rates, and commodity prices) within the

trading and other than trading

portfolios. For example, some

commenters indicated that market risk

inherent in trading portfolios is

evaluated using one approach, such as

value at risk, and market risk inherent

in the other than trading portfolios is

evaluated using another approach, such

as sensitivity analysis. Similarly, some

commenters suggested that instruments

exposed to foreign currency exchange

rate risk are evaluated using one

approach, while instruments exposed to

interest rate risk are evaluated using

another approach.

Those commenters suggested that

Items 305(a) and 9A(a) permit the use of

different quantitative disclosure

alternatives for the market risks inherent

in (i) The trading and other than trading

portfolios and (ii) different market risk

exposure categories within each of these

portfolios. Due to the evolving nature of

market risk management technologies,

the Commission has decided it is too

early to require that the same disclosure

alternative be used to report market risk

across (i) The trading and other than

trading portfolios and (ii) each market

risk exposure category within those

portfolios. The Commission, therefore,

has revised the disclosure items to

permit the use of more than one

disclosure alternative across each of

those categories.

2. Use of Additional Disclosure Methods

Some commenters suggested adding

an alternative that would allow

disclosure of quantitative information

about market risk using a ‘‘management

approach’’; that is, the approach that

management uses internally to manage

market risk. They commented that the

approaches in the proposing release (i)

Do not appear to allow gap and duration

analyses, which are currently used by

some to measure market risk and (ii)

may become outdated as new

measurement approaches are developed

in the market place. Other commenters,

however, support more consistent

reporting and requested that the

Commission limit the quantitative

disclosure alternatives for the sake of

comparability.

The approach taken in the final

disclosure items strikes a balance

between the different commenters’

perspectives. The Commission believes

that the final disclosure items allow

most registrants, if they so desire, to

report market risk using one or more of

four common methods of managing

market risk. These methods are: (i) Gap

analysis, (ii) duration, (iii) sensitivity

analysis, and (iv) value at risk. Gap

analysis is a tabular disclosure approach

and with minor revision would satisfy

the tabular disclosure requirements.

Likewise, duration is a form of

sensitivity analysis and with minor

revision would satisfy the sensitivity

analysis disclosure requirements.

Registrants that do not internally

manage market risk using any of these

four common quantitative methods,

however, still are required to report

market risk disclosures using the

methods specified by the final

disclosure items. The Commission

believes that reporting using a

management approach outside of this

framework could result in disclosures

that could make it difficult for investors

to assess market risk.

Finally, to address commenters

concerns that the alternatives for

reporting market risk may become

outdated, the Commission expects the

staff to review the disclosure

requirements periodically and to

recommend amendments to those

requirements, when appropriate, to

reflect new developments in market risk

management techniques.

3. Proprietary Information

Some commenters indicated that they

were concerned that the proposed

quantitative disclosure requirements,

particularly the tabular disclosure,

would result in presentation of

proprietary information. They expressed

concern that the tabular information

required by the proposal was so detailed

and disaggregated that competitors,

suppliers, and market traders

potentially may be able to use the

information to exploit the registrants’

positions in the market. Other

commenters maintained that, in certain

limited circumstances, period-end

reporting of sensitivity analysis and

value at risk amounts also may reveal

proprietary information. Of principal

proprietary concern were the

requirements to disclose market risk

information for derivative commodity

instruments at both year-end and

quarter-end.

After careful consideration of these

comments, the Commission has

determined to require disclosure of

quantitative information about market

risk. However, the final disclosure items

include the following four provisions to

address proprietary concerns. First, the

final disclosure items contain two

alternatives for providing quantitative

information about market risk (i.e.,

sensitivity analysis and value at risk),

which do not require disclosure of

detailed information about specific

positions held by the registrant at period

end. Second, the final disclosure items

allow registrants with concerns about

reporting fiscal year-end information, to

report the average, high, and low

sensitivity analysis or value at risk

amounts for the reporting period,

instead of requiring the reporting of

potentially proprietary year-end

information. Third, for interim

reporting, the final disclosure items

require registrants to provide a

discussion and analysis of the sources

and effects of material changes in

market risk information since the end of

the preceding fiscal year, rather than

requiring that registrants always furnish

complete Item 305(a) or Item 9A(a)

information when such material

changes occur. Fourth, registrants

selecting the sensitivity analysis or

value at risk disclosure alternatives are

not required to provide separate market

risk disclosures for any voluntarily

selected instruments, positions, or

transactions. Instead, registrants

selecting the sensitivity analysis and

value at risk disclosure alternatives are

permitted to present comprehensive

market risk disclosures, which reflect

the combined market risk exposures

inherent in both the required and

voluntarily selected instruments,

positions, and transactions. Such

comprehensive disclosures do not

reveal proprietary information about the

relative amount of market risk inherent

in market risk sensitive instruments and

any voluntarily selected instruments,

positions, and transactions.

4. Static Disclosures, Dependence on

Assumptions

Some commenters criticized the

sensitivity analysis and value at risk

disclosures as being too dependent on
6056 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

75For example, assume a French division of a

registrant presenting its financial statements in U.S.

dollars ($US) invests in a deutschmark(DM)-

denominated debt security. This division

determines that: (i) The French franc (FF) is its

functional currency according to FAS 52, (ii) the

$US is its reporting currency, and (iii) the DM is

its transactional currency. In preparing the foreign

currency sensitivity analysis disclosures, this

registrant should report the aggregate potential loss

from hypothetical changes in both the DM/FF

exchange rate exposure and the FF/$US exchange

rate exposure.

assumptions. They also commented that

sensitivity analysis and value at risk

measures are static and may not yield

amounts that fairly represent the

dynamic nature of market risk.

The Commission has considered those

comments and has determined to

continue to permit use of both the

sensitivity analysis and value at risk

disclosure alternatives for the following

primary reasons. First, the sensitivity

analysis and value at risk disclosure

alternatives are the most common and

widely accepted methods of measuring

net market risk exposures currently

available in the market place. Second,

while the reported quantitative

information depends on assumptions,

registrants are required to disclose key

assumptions, which should allow

investors to assess the quality of those

assumptions and evaluate the potential

impact of variations in those

assumptions on the reported

information. Third, an evaluation of

reported quantitative information about

market risk, over time, should help

investors assess the dynamic nature of

that risk.

5. Summarized Tabular Information

Some commenters indicated that the

proposed tabular presentation of terms

and information related to market risk

sensitive instruments would produce

lengthy and complex disclosures. They

also asserted that grouping (i) foreign

currency sensitive instruments by

functional currency and (ii) other

instruments by the common

characteristics specified in the

proposing release (e.g., fixed or variable

rate assets or liabilities, long or short

forwards or futures, etc.) would be

burdensome for registrants and the

resulting information complex to

analyze. Those commenters suggested

that more summarized information be

permitted in the tables. Finally, other

commenters suggested that the proposal

was unclear as to the information that

must be disclosed, particularly with

regard to options instruments.

The Commission is concerned that

highly summarized tabular information

will not allow investors to analyze and

develop an understanding of a

registrant’s market risk exposures. Thus,

the grouping requirements in the

proposed disclosure items have not

been changed substantially in this

release. However, the Commission has

revised the instructions to the final

disclosure items to permit combined

disclosure of foreign currency sensitive

instruments exposed to different

functional currencies, provided that

those functional currencies (i) are

economically related, (ii) are managed

together for internal risk management

purposes, and (iii) have statistical

correlations of greater than 75% over

each of the past three years. In addition,

the Commission has provided

instructions to the final disclosure items

to require the disaggregated reporting of

instruments based on common

characteristics only to the extent such

disaggregation is material. Finally, the

Commission has decided to exempt

certain currency swaps and foreign

currency denominated debt instruments

from disclosure in the foreign currency

risk exposure category if the currency

swap eliminates all foreign currency

exposure in the cash flows of the foreign

currency denominated debt instrument.

However, both the currency swap and

the foreign currency denominated debt

instrument still should be disclosed in

the interest rate risk exposure category.

With regard to the need for guidance

on information to be included in the

table, the Commission has clarified in

the final disclosure items that the table

should provide information about

contract terms sufficient to estimate the

future cash flows from market risk

sensitive instruments, categorized by

expected maturity dates. In addition, for

disclosures about options in particular,

the Commission has made clear in the

instructions to the final disclosure items

that tabular information on options with

dissimilar strike prices should be

disclosed separately to help reflect the

different market risk exposures inherent

in option instruments.

6. Sensitivity Analysis—Multiple Risk

Exposures

Commenters requested additional

guidance on how to perform the

sensitivity analysis calculations for

registrants with (i) multiple foreign

currency exchange rate exposures and

(ii) instruments that are exposed to rate

or price changes in more than one

market risk exposure category (e.g.,

interest rate risk and foreign currency

rate risk).

In response to those comments, the

Commission has added two clarifying

instructions to the disclosure items.

First, registrants with multiple foreign

currency exchange rate exposures

should present foreign currency

sensitivity analyses that measure the

aggregate sensitivity to all changes in

foreign currency exchange rate

exposures, including the changes in

both transactional currency/functional

currency exchange rate exposures and

functional currency/reporting currency

exchange rate exposures. 75 Second, for

sensitivity analysis calculation

purposes, registrants with instruments

that are exposed to rate or price changes

in more than one market risk exposure

category should include the instrument

in each market risk category to which

the instrument is exposed. Similar

instructions also were added to the

value at risk disclosure requirements.

7. Value at Risk—Contextual

Disclosures

To help place reported value at risk

amounts in context, the disclosure items

in the proposing release specified that

registrants should report either (i) the

average or range in value at risk

amounts for the current reporting

period, (ii) the average or range in actual

changes in fair values, earnings, or cash

flows from market risk sensitive

instruments occurring during the

current reporting period, or (iii) the

percentage of actual changes in fair

values, earnings, or cash flows from

market risk sensitive instruments that

exceeded the reported value at risk

amounts during the current reporting

period ((i), (ii), and (iii) collectively are

referred to as the ‘‘contextual value at

risk disclosures’’).

Some commenters suggested that the

final disclosure items should encourage,

but not require, the contextual value at

risk disclosures. Those commenters

stated that the Commission would be

penalizing registrants for choosing the

value at risk disclosure alternative by

requiring contextual disclosures that are

not required for the other two disclosure

alternatives. Other commenters, while

supporting the disclosure requirements

generally, objected to one or more of the

contextual value at risk disclosures.

The Commission acknowledges the

concerns of those commenters, but has

decided not to change significantly the

contextual disclosure requirements

because it believes those disclosures

provide investors with information that

is important in evaluating the reported

value at risk amounts. The disclosure

items have been modified only to the

extent necessary to clarify the

contextual disclosure requirements.

These contextual disclosures are

common elements to value at risk

management systems. Similar

disclosures are not available for the
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6057

tabular presentation and sensitivity

analysis alternatives; thus, comparable

contextual disclosures are not required

for those alternatives.

8. Value at Risk—Aggregated Values

The proposed disclosure items would

have required disclosure of an aggregate

value at risk amount across all market

risk sensitive instruments. A similar

aggregate amount would not have been

required for the other two disclosure

alternatives.

Some commenters suggested that it

may not be practical to require an

aggregate value at risk amount because

most registrants do not use a single risk

measurement method for all market risk

exposures. Other commenters suggested

that registrants providing an aggregate

value at risk amount for all categories of

market risk should not be required to

disclose separate value at risk amounts

for each market risk exposure category.

Recognizing that registrants often do

not use the same method internally for

managing risk across the different

market risk exposure categories within

the trading and other than trading

portfolios, the final disclosure items

encourage, but do not require, reporting

of aggregate value at risk (and sensitivity

analysis) amounts for the trading and

other than trading portfolios. Registrants

also should note that they may not

report aggregate value at risk amounts

for the trading and other than trading

portfolios in lieu of the required

separate value at risk amounts for each

market risk exposure category. Separate

value at risk amounts provide

information about a registrant’s specific

market risk exposures, which the

Commission believes is useful for

investors trying to manage specific risks

in their investment portfolios.

9. Model Parameters

In order to enhance the comparability

of sensitivity analysis and value at risk

disclosures, some commenters from the

user community suggested that the

Commission specify certain model

parameters. In particular, those

commenters suggested that the

Commission establish several standard

stress tests to be used to calculate

sensitivity analysis disclosures, such as

the greater of a 15% or 100 basis point

adverse interest rate shift along the

entire yield curve. Those standard stress

tests would require measurement of the

potential loss from reasonably expected

market movements. Other commenters,

however, requested that the

Commission not specify model

parameters at this time to allow the

reporting to be responsive to the

ongoing evolution in risk management

systems.

Due to these evolving practices, a

guiding principle in the proposing

release was to provide flexibility in the

sensitivity analysis and value at risk

market risk disclosure requirements to

accommodate different types of

registrants, different degrees of market

risk exposure, and alternative ways of

measuring market risk. The Commission

continues to believe such flexibility is

necessary at this time and, therefore, is

not specifying uniform model

parameters for the calculation of

sensitivity analysis and value at risk

disclosures.

The need for such flexibility,

however, should not result in selection

of model parameters that are not

realistic and meaningful measures of

reasonably expected market rate and

price changes. Accordingly, the

Commission has included guidance in

the final disclosure items on certain

model parameters that should be used

by registrants. In particular, this

guidance requires registrants to select

both hypothetical changes in market

rates or prices for sensitivity analysis

and confidence intervals for value at

risk that reflect reasonably possible

near-term changes in market rates and

prices. In this regard, the disclosure

items indicate that, absent economic

justification for the selection of different

model parameters, registrants should

use hypothetical changes in market rates

or prices that are not less than 10

percent of end of period market rates or

prices for sensitivity analysis

disclosures and confidence intervals

that are 95 percent or higher for value

at risk disclosures. In the long-term, as

more standard risk management

practices and methods of reporting

market risk are developed, the

Commission anticipates that it will

further limit the models, assumptions,

and parameters permitted in Items

305(a) and 9A(a) to enhance

comparability of reported information.

10. Comparative Information

Many commenters requested that, if a

registrant changes its method of

providing quantitative information

about market risk from one year to the

next, it should not be required to

provide comparable summarized

information for the preceding period

because preparing such presentations

and analyses using the new method for

preceding periods would be

burdensome and costly. Moreover, they

suggested that the cost associated with

providing comparable summarized

information for the preceding year may

be a sufficient disincentive to prevent

change to a more sophisticated

disclosure alternative.

The Commission believes that

information about market risk is most

useful for investors when compared to

one or more prior periods. For such

information to be meaningful, the

information needs to be prepared on a

consistent basis from period-to-period.

The Commission also believes that

registrants should be able to change

methods of preparing market risk

information as their risk management

practices evolve. To mitigate the costs of

preparing prior period market risk

disclosures, the final disclosure items

provide two alternatives to registrants

that change disclosure alternatives, key

model characteristics, assumptions, or

parameters. First, a registrant may

provide summarized comparable

information, under the new disclosure

method, for the year preceding the

current year. Alternatively, in addition

to providing disclosure for the current

year under the new method, the

registrant may provide disclosure for the

current year and preceding fiscal year

under the method used in the preceding

year.

11. Effective Dates

Commenters suggested that time is

needed to allow registrants to prepare

and implement the new quantitative

disclosures about market risk. The

Commission agrees with those

commenters and, thus, will phase in the

amendments over the next several

months so that registrants will have

time to respond to the new disclosure

requirements. For registrants that are

likely to have experience with

measuring market risk, such as banks,

thrifts, and non-bank and non-thrift

registrants with market capitalizations

on January 28, 1997 in excess of $2.5

billion, Items 305 and 9A are effective

for filings with the Commission that

include annual financial statements for

fiscal years ending after June 15, 1997.

For other registrants, those Items are

effective for filings with the

Commission that include annual

financial statements for fiscal years

ending after June 15, 1998. In addition,

under Items 305 and 9A, interim

information is not required until after

the first fiscal year end in which those

Items are effective.

C. Qualitative Disclosures About Market

Risk

1. Proprietary Information

Some commenters expressed concerns

that a discussion of primary market risk

exposures and how those exposures are

managed would be proprietary. The
6058 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

Commission acknowledges those

concerns, but believes that qualitative

information about market risk is

important to investors. Without the

disclosures required by Item 305(b) and

Item 9A(b), investors would be unable

to understand a registrant’s exposures to

market risk and unable to place that

registrant’s market risk management

practices within the context of its

business. In addition, the qualitative

disclosures are not so specific as to

require disclosure of the type of

information (e.g., current positions) that

may harm a registrant’s competitive

positions. For these primary reasons the

Commission has decided to retain the

qualitative market risk disclosure

requirements.

2. Examples of How Market Risks Are

Managed

Proposed Items 305(b) and 9A(b)

provide examples of possible

disclosures regarding how a registrant

manages market risk. These examples

include a description of the objectives,

general strategies, and instruments used

to manage market risk. Some

commenters inquired whether the

description of one or two of these items

would be sufficient. Others asked if the

examples are intended to be an allinclusive list of items required by Items

305(b) and 9A(b).

In general, the examples were

intended to reflect minimum

disclosures that would be necessary to

comply with the qualitative market risk

disclosure requirements. The examples

were neither meant to address all

circumstances nor to be all inclusive.

The final disclosure items clearly state

that the listed items should be

addressed within the required

disclosures and that registrants also are

responsible for providing any additional

information necessary to describe

completely their primary market risks

and how those risks are managed.

D. Implementation Issues

1. Scope of Disclosures

Several commenters raised issues

about the scope of instruments included

in the proposed disclosure items. For

example, some suggested that

information about derivative commodity

instruments should not be required

because offsetting exposures relating to

commodities held or owned were not

required. Thus, the disclosures would

be presenting only part of registrants’

exposure to market risk. Furthermore,

they indicated that registrants that

hedge commodity exposures could be

disclosing more market risk than those

that do not participate in hedging

activities, even though they may have

less exposure to market risk. Similar

arguments were made regarding (i)

Hedges of anticipated transactions,

foreign currency operating cash flows,

and inventories and (ii) issuances of

debt to fund property, plant, and

equipment. In essence, those

commenters suggested that the scope of

the disclosure requirements is limited

and as a result the information required

to be disclosed is incomplete. Some

commenters suggested that, to address

this issue, the instruments covered by

the disclosures be expanded to include

all types of instruments with market

risk. Other commenters suggested

reducing the scope of instruments

covered by the disclosures, primarily by

eliminating derivative commodity

instruments.

The Commission considered

expanding the required quantitative

disclosures about market risk to include

commodity positions and anticipated

transactions. However, many internal

risk measurement systems currently do

not incorporate many commodity

positions and anticipated transactions.

Thus, the Commission is not requiring

the inclusion of these items at this time.

The Commission believes that

derivative commodity instruments often

have risks similar to other derivatives

and can be used to alter significantly a

registrant’s commodity risk profile by,

for example, locking in the price of a

significant portion of its future

purchases of commodity inventory.

Accordingly, the Commission continues

to include those instruments within the

scope of the final disclosure items.

Without including such instruments in

the required disclosures, it would be

difficult for investors to distinguish, for

example, between those registrants that

are sensitive to changes in commodity

prices from those that are not.

In an effort to make disclosures about

market risk more comprehensive, the

Commission encourages registrants to

include voluntarily commodity

positions, anticipated transactions, and

other market risk sensitive instruments

and positions within their market risk

disclosures. When these instruments,

transactions, and positions are not

included in the quantitative disclosures

and, as a result, the disclosures do not

fully reflect the net market risk

exposures of the registrant, Items 305(a)

and 9A(a) require that registrants

discuss the limitations of the disclosed

market risk information resulting from

the absence of those items.

2. The Definition of Financial

Instrument

Commenters suggested that the

definition of financial instruments be

clarified to exclude explicitly financial

instruments that the FASB excluded

from FAS 107. Financial instruments

excluded from FAS 107 disclosures

include insurance contracts, lease

contracts, and employers’ and plans’

obligations for pension and other postretirement obligations. The cash flows

in many of these instruments are

affected significantly by more than

market risk factors, thereby making the

quantification of market risk more

difficult. The Commission agrees that

these instruments should be excluded

from the scope of the final disclosure

items. Thus, the relevant instructions to

Items 305 and 9A indicate that

instruments excluded from FAS 107 are

excluded from the scope of the final

disclosure items. However, registrants

are encouraged to include voluntarily

such instruments in their market risk

disclosures, if such inclusion would

make the information more complete

and meaningful.

3. The Definition of Derivative

Commodity Instrument

In the proposed disclosure items,

‘‘derivative commodity instruments’’

were defined to include commodity

futures, commodity forwards,

commodity swaps, commodity options,

and other commodity instruments with

similar characteristics that are

reasonably possible to be settled in cash

or with another financial instrument.

Some commenters indicated that a

reasonably possible test would be too

difficult to apply in practice. That is, it

may be difficult to distinguish between

a commodity contract for which

settlement in cash is reasonably possible

and a contract for which settlement in

cash is not reasonably possible. Some

commenters suggested that derivative

commodity instruments be defined as

those that may be settled in cash in the

normal course of business. Those

commenters also suggested that the

definition of derivative commodity

instruments include specifically

derivative instruments in which cash

settlement is based on the net change in

value of the commodity contract.

In response to those comments, the

Commission has amended the definition

of derivative commodity instruments to

include commodity futures, commodity

forwards, commodity swaps,

commodity options, and other

commodity instruments with similar

characteristics that are permitted by

contract or business custom to be settled
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6059

76 Item 305(b)(1)(iii) was proposed as Item

305(b)(3).

77See section III B.3. 78 15 U.S.C. 78w(a).

in cash or with another financial

instrument. In addition, the final

disclosure items make clear that

settlement in cash includes settlement

in cash of the net change in value of the

derivative commodity instrument.

4. Small Business Issuers

Some commenters suggested that the

disclosure requirements in Items 305

and 9A should apply to all registrants

that have material positions in

instruments covered by the proposed

disclosure items, including small

business issuers filing documents with

the Commission in accordance with

Regulation S–B. Due to cost-benefit

concerns, however, the Commission has

determined that some experience

should be gained with the disclosure

items before proposing that they be

applied to small business issuers.

5. The Disclosure Threshold

Some commenters suggested that the

Commission change the threshold for

requiring disclosures of quantitative

information about market risk to

conform with the disclosure threshold

in MD&A. That suggestion was based on

a general observation that both MD&A

and proposed Items 305 and 9A require

disclosure of information about known

risks and uncertainties and, therefore,

should be subject to the same threshold

for determining whether disclosure is

required. Those commenters indicated

that introducing a new and different

disclosure threshold could add

unnecessary confusion to the disclosure

process.

MD&A addresses a wide array of risks

and uncertainties. Thus, the MD&A

disclosure threshold (i) Is broad,

applying to many different types of

exposures, not just market risk and (ii)

does not provide specific guidance

directly relevant to a threshold for

disclosure of quantitative market risk

information. In addition, MD&A focuses

on events that are judged to be

reasonably likely of occurring.

In contrast, consistent with many

internal risk management systems, Item

305 and Item 9A require reporting of

losses from events beyond those deemed

reasonably likely of occurring. For

example, those disclosure Items require

reporting of value at risk information on

possible future losses, which, at a

minimum, are not expected to be

exceeded 95% of the time. Likewise,

those disclosure Items require reporting

of sensitivity analysis information on

possible future losses from reasonably

possible, not reasonably likely, nearterm changes in market rates and prices.

Thus, Item 305 and Item 9A are

intended to obtain quantitative

information about market risk that is

incremental to the disclosures about

reasonably likely risks and uncertainties

required by MD&A.

As a result, the Commission has

decided to retain the disclosure

threshold that was proposed. That

threshold provides guidelines that focus

on market risk, apply explicitly to

quantitative disclosures, and most

importantly, require disclosure of losses

beyond those deemed reasonably likely

of occurring.

6. ‘‘Future’’ Losses

With respect to the disclosure

threshold noted above, commenters

suggested that the Commission define

how far into the future registrants must

look to conclude whether or not they

may experience material future losses.

They suggested replacing the word

‘‘future’’ with either the phrase ‘‘near

term’’ as it is defined in AICPA

Statement of Position 94–6, ‘‘Disclosure

of Risks and Uncertainties’’ (‘‘SOP 94–

6’’) (December 1994) or ‘‘one year.’’

The Commission agrees with the

commenters and has limited the time

period over which losses in earnings,

fair values, and cash flows should be

evaluated to the ‘‘near term.’’ In the

final disclosure items, the Commission

defines ‘‘near term’’ to mean a period of

time going forward up to one year from

the date of the financial statements,

which is consistent with the definition

in SOP 94–6.

7. Safe Harbor

Nearly all of the commenters favored

explicit safe harbor protection for the

new disclosure of quantitative and

qualitative information about market

risk. Commenters did not object to the

Commission’s proposal to extend the

Item 305 and Item 9A safe harbors to all

types of issuers and transactions.

Several commenters suggested

modifications to the proposed safe

harbor. Those commenters argued that

the safe harbors should protect all of the

qualitative information required by

paragraph (b) of Item 305 and Item 9A,

and not just statements with respect to

future reporting periods provided

pursuant to paragraph (b)(1)(iii), as

proposed.76 A few of these commenters

provided examples of disclosures

responsive to paragraphs (b)(1)(i) and

(b)(1)(ii) of Item 305 and Item 9A that

they thought could be viewed as being

forward looking. As noted above,77 the

rule has been clarified to provide that

all statements (other than statements of

historical fact) provided pursuant to

paragraphs (b)(1)(i), (b)(1)(iii) and (c) of

Items 305 and 9A are ‘‘forward looking

statements’’ for purposes of the new safe

harbor rules. To the extent that

information provided pursuant to

paragraph (b)(1)(ii) of Items 305 and 9A

includes forward looking statements,

those statements would be eligible for

safe harbor protection.

Second, most of the commenters

remarking on the issue thought that

small business issuers voluntarily

providing any of the Item 305 and Item

9A disclosures should have the

protection of the safe harbor. Under the

proposals, the safe harbor would have

applied to voluntary disclosures only if

all of the quantitative disclosures or all

of the qualitative disclosures were

provided. In an effort to encourage small

business issuers to provide information

that they think is appropriate to an

understanding of their market risks,

Item 10 of Regulation S-B has been

changed to extend the Item 305 safe

harbor to any Item 305 disclosure that

is voluntarily provided by a small

business issuer.

Finally, several commenters requested

guidance as to whether registrants

would have to include ‘‘meaningful

cautionary statements’’ in addition to

the Item 305 and Item 9A disclosures to

obtain the protection of the Item 305

and Item 9A safe harbors. In response to

these comments, the Commission has

clarified in the rule that, for purposes of

the Item 305(a) and 9A(a) quantitative

disclosures, a registrant will be deemed

to have satisfied the ‘‘meaningful

cautionary statements’’ prong of the safe

harbors if it satisfies the requirements of

those items. In particular, these items

require a description of the assumptions

underlying, and the limitations of, the

disclosure provided. For the remainder

of the information required by the new

items, registrants desiring to qualify for

the ‘‘meaningful cautionary statements’’

prong of the safe harbor will need to

consider what information should be

given to alert investors to important

factors that could cause actual results to

differ materially from the information

given in the forward looking statements.

VII. Certain Findings

Section 23(a) of the Exchange Act 78

requires the Commission, in adopting

final rules under the Exchange Act, to

consider the anti-competitive effect of

such rules, if any, and to balance them

against the regulatory benefits that

further the purposes of the Exchange

Act. Furthermore, Section 2 of the
6060 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

79 15 U.S.C. 77b.

80 15 U.S.C. 78c.

81Pub. L. 104–290, 106, 110 Stat. 3416 (1996).

82See notes 22–29, supra, for examples of

investors, regulators, and other private bodies

endorsing or recommending improved quantitative

disclosures about market risk.

83See FAS 119 ¶ 60.

84See FAS 119 ¶ 8. See also note 39, supra, for

a discussion of the requirements of APB 22.

Securities Act 79 and Section 3 of the

Exchange Act,80 as amended by the

recently enacted National Securities

Market Improvement Act of 1996

(‘‘Market Improvement Act’’),81 provide

that whenever the Commission is

engaged in rulemaking and is required

to consider or determine whether an

action is necessary or appropriate in the

public interest, the Commission also

shall consider, in addition to the

protection of investors, whether the

action will promote efficiency,

competition, and capital formation.

As discussed in earlier subsections of

this release, the Commission has

considered carefully the comments that

the Item 305(a) and Item 9A(a)

quantitative disclosures of market risk,

as originally proposed, might provide

information useful to a registrant’s

competitors. The Commission has

determined, however, that quantitative

disclosures will be helpful to investors’

understanding of a registrant’s market

risk exposures and that sensitivity

analysis and value at risk disclosures

normally do not allow readers to

ascertain detailed information about

positions held by registrants. However,

in response to registrants with

proprietary concerns about reporting

period-end information under the

sensitivity and value at risk disclosure

alternatives, the final disclosure items

allow reporting of the average, high, and

low sensitivity analysis or value at risk

amounts for the fiscal year, as an

alternative to year-end amounts. In

addition, the final disclosure items also

require registrants filing interim reports

to provide a discussion and analysis of

the sources and effects of material

changes in market risk information

since the end most recent preceding

fiscal year, rather than requiring, as

originally proposed, that registrants

always furnish complete Item 305(a) or

Item 9A(a) information, when such

material changes occur.

The Commission has considered the

amendments and new disclosure items

discussed in this release in light of the

comments received in response to the

proposing release and the standards

embodied in Section 2 of the Securities

Act and Sections 3 and 23(a) of the

Exchange Act. The Commission believes

that any burdens on competition

imposed by the adoption of these

amendments and disclosure items are

necessary and appropriate in

furtherance of the purposes of the

Exchange Act. Some commenters

suggested Items 305 and 9A could create

incentives for the development of new

products that do not trade on exchanges

and would not be subject to the new

disclosures because of their non-cashsettlement feature. The Commission

intends to review the effects of the

disclosures on the markets and expects

to reconsider the disclosure items after

three years. The Commission will be

able to address any such concerns at

such time. The Commission believes

that Items 305 and 9A are necessary and

appropriate in the public interest and

for the protection of investors because of

the need for improved disclosure about

market risk to help investors better

understand and evaluate a registrant’s

exposures to market risk.

As described in more detail in the

cost-benefit section of this release, the

Commission made a number of changes

from the rules as proposed to increase

flexibility for registrants in providing

the required disclosures and keeping the

cost of compliance to a minimum, thus

promoting efficiency. In addition, by

enhancing investor’s understanding of

registrants’ market risk exposures the

disclosure items should promote the

efficient allocation of capital. Thus, the

disclosure items will promote

competition, efficiency, and enhance

the U.S. capital formation process.

VIII. Cost-Benefit Analysis

A. Background

In general, Rule 4–08(n), Item 305,

and Item 9A, clarify existing standards

and rules, include additional

instruments within existing standards,

and require specific disclosure

alternatives for providing quantitative

disclosures regarding market risk

sensitive instruments. In particular,

these provisions include:

1. Enhanced descriptions of

accounting policies for derivatives;

2. Quantitative disclosures about

market risk; and

3. Additional qualitative disclosures

about market risk.

These provisions are being adopted in

response to requests from investors and

others to provide more meaningful

information about market risk sensitive

instruments.82 The expected benefits of

these rules and items are to make

information about market risk sensitive

instruments, including derivatives,

more understandable to investors and

others. This increased understanding is

expected to enhance the ability of

investors to make investment decisions

and to improve the efficiency of the

markets. The Commission believes these

benefits will outweigh the related costs,

which are discussed below.

B. Descriptions of Accounting Policies

for Derivatives

FAS 119 was designed, in part, to

help investors and others understand

how derivative financial instruments are

reported in the financial statements.83

FAS 119 requires, among other things,

disclosure of the policies used to

account for derivative financial

instruments, pursuant to the

requirements of APB 22.84 However, the

scope of FAS 119 is limited to

derivative financial instruments and,

therefore, it does not apply to other

derivative instruments with similar

characteristics, such as derivative

commodity instruments. In addition,

FAS 119 does not provide explicit

guidance indicating what must be

described in accounting policies

footnotes to make the financial

statement effects of derivatives more

understandable. The SEC staff found

that the accounting policies footnotes

for derivatives often were too general in

nature, not reflecting adequately the

choices made by registrants in their

accounting for derivatives.

New Rule 4–08(n) requires

descriptions of accounting policies for

derivative financial instruments and

derivative commodity instruments,

unless the registrant’s derivative

activities are not material. Thus, the

scope of the amendments is broader

than the scope of FAS 119. In addition,

to help make clear the impact of

derivatives on the financial statements,

Rule 4–08(n) makes explicit the items to

be disclosed in the accounting policies

footnotes.

Rule 4–08(n) is likely to result in a

more focused and descriptive

discussion of the accounting policies for

both derivative financial instruments

and derivative commodity instruments.

This additional information is likely to

result in additional preparation, audit,

and printing costs. However, because

accounting policies for these

instruments are known by registrants

and should be known by their auditors,

most of the preparation and audit costs

are expected to relate to initial

compliance with the amendments.

These costs, along with expected

printing costs, are not estimated to be

significant. Other costs, such as ongoing

recordkeeping and compliance costs,

also are not expected to be significant.
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6061

85Securities Act Industry Guide 3, ‘‘Statistical

Disclosure by Bank Holding Companies.’’ Exchange

Act Industry Guide 3 is identical to the Securities

Act guide. Detailed disclosures are required under

Guide 3 of, among other things, the registrant’s: (i)

Distribution of assets, liabilities and stockholders’

equity; interest rates and interest differential; (ii)

investment portfolio; (iii) loan portfolio (including

types of loans, maturities and sensitivities of loans

to changes in interest rates, risk elements, and loans

outstanding in foreign countries); (iv) deposits; and

(v) short-term borrowings.

86See Wall Street Journal, ‘‘Morgan Unveils the

Way It Measures Market Risk’’ C1 (October 11,

1994).

87See note 48, supra.

88See Department of the Treasury, Federal

Reserve System, and Federal Deposit Insurance

Corporation Joint final rule, ‘‘Risk-Based Capital

Standards: Market Risk,’’ 61 FR 47358 (September

6, 1996).

C. Quantitative Information About

Market Risk

As discussed earlier in this release,

under Item 305(a) and Item 9A(a),

registrants are required to present

quantitative information about market

risk. An important aspect of this

requirement, from a cost perspective, is

that registrants will have the flexibility

to choose one or more of three

disclosure alternatives (tabular

presentation, sensitivity analysis, or

value at risk) to provide such

quantitative information about market

risk.

The Commission believes that, for

registrants electing to provide tabular

disclosure, much of the required

information is currently available. Thus,

additional costs relating to

recordkeeping are not expected to be

significant. While increased reporting

and compliance burdens may result, in

many cases the information presented in

the tabular disclosures is used in

managing the business activities of the

registrant and may be available at

relatively low incremental costs.

Further, registrants complying with

Securities Act Industry Guide 3,85

principally financial institutions,

already disclose a significant amount of

the required information.

Registrants that choose to use either

the sensitivity or value at risk disclosure

alternatives may incur significant

additional costs if they currently do not

use these methodologies to manage

market risk. In contrast, if registrants

currently use sensitivity or value at risk

analyses to manage market risk, the

Commission believes that any

additional costs associated with

complying with Item 305(a) or Item

9A(a) are not expected to be significant.

The Commission recognizes that, for

some registrants, the start-up costs to

prepare the quantitative disclosures

about market risk may be significant.

However, in the near term, the

Commission expects that the

development of software related to

market risk analysis will reduce these

costs materially. In addition, the

Commission understands that some of

the data and the systems needed to

develop these analyses recently have

been made available at a relatively

moderate cost.86 Moreover, some

registrants are required to prepare such

information for regulatory capital

measurement purposes. In particular,

thrift institutions are required to prepare

fair value sensitivity analyses for riskbased capital purposes.87 Also, banks

and bank holding companies with

significant exposure to market risk are

required to prepare a value at risk

analysis for risk-based capital

purposes.88 Thus, the costs associated

with the sensitivity and value at risk

analyses may vary depending on (i)

Whether the registrant currently engages

in these analyses for other management

or regulatory purposes; and (ii) the

particular model and assumptions used

in the registrant’s calculations. Any

registrant that believes the cost of such

analyses outweigh the benefits of

disclosing them, however, may elect to

provide tabular presentation of

information about market risk sensitive

instruments.

In response to the comment letters,

the Commission made several changes

in Item 305(a) and Item 9A(a) that

should reduce the cost for registrants

preparing disclosures of quantitative

information about market risk. These

changes are described in detail above,

under the caption ‘‘Response to

Comments.’’ In brief, changes that

should reduce registrants’ costs include:

• Delaying the effective date of the market

risk disclosure requirements for banks,

thrifts, and non-bank and non-thrift

registrants with market capitalizations on

January 28, 1997 in excess of $2.5 billion

until filings made with the Commission

include annual financial statements for years

ending after June 15, 1997. For non-bank and

non-thrift registrants with market

capitalizations on January 28, 1997 of $2.5

billion or less, the effective date is delayed

until filings with the Commission include

annual financial statements for fiscal years

ending after June 15, 1998.

• Permitting the use of different

quantitative disclosure alternatives for

market risks inherent in (1) the trading

portfolio, (2) the ‘‘other than trading’’

portfolio, and (3) different market risk

exposure categories within each of those

portfolios. This often will allow registrants

that use different methods to manage

different types of market risk to report

quantitative information according to the

method used for internal risk management

purposes, instead of having to conform all

disclosures to one disclosure alternative.

• For the tabular presentation alternative,

permitting entities to report together (or

group) foreign currency sensitive instruments

according to functional currencies that are

economically related, are managed together

for internal risk purposes, and have statistical

correlations of greater than 75% over each of

the past three years.

• For the tabular presentation alternative,

requiring that instruments be reported based

on specified common characteristics only if,

or to the extent that, such disaggregation

provides material information to investors.

• For the tabular presentation alternative,

allowing elimination of disclosure in the

foreign currency risk exposure category of

currency swaps and foreign currency

denominated debt instruments, if the

currency swap eliminates all foreign

currency exposure in the cash flows of the

foreign currency denominated debt

instrument.

• Encouraging, rather than requiring, that

registrants provide aggregate sensitivity

analysis and value at risk amounts for the

trading and other than trading portfolios.

• When a registrant changes quantitative

disclosure methods from one year to the next,

providing two alternatives, rather than one,

for disclosing comparative, year-to-year

information. First, a registrant may restate the

prior year’s disclosures based on the new

alternative that has been selected for the

current year. Second, instead of recreating

prior records and information in order to

prepare restated information, the registrant

may report the prior year’s disclosures as

originally presented and, in addition to

disclosing the current year’s information in

accordance with the new method, disclose

the current year’s information under the

method used in the prior year.

• Specifically excluding from the scope of

the disclosure item certain financial

instruments that are not required by

generally accepted accounting principles to

be disclosed at fair value. Such instruments

include but are not limited to pension and

other post-retirement benefits, insurance

contracts, lease contracts, warranty

obligations and rights, and minority positions

in consolidated enterprises.

• Limiting to one year how far into the

future a registrant must look to determine

whether it is reasonably possible that it will

experience a loss from its derivative and

other financial instruments.

The comment letters did not provide

empirical or statistical information

about the costs to comply with the

proposed quantitative disclosures of

market risk. After reviewing the

anecdotal information in those letters,

however, and despite the changes listed

above that further reduce compliance

costs, the Commission has reconsidered

and increased the estimated time that it

may take registrants, on average, to

prepare and report quantitative

information under Items 305(a) and

9A(a). The Commission is increasing to

80 hours the estimated average hours

per registrant to comply with Item

305(a) or Item 9A(a). In addition, the
6062 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

89See FAS 119 ¶ 11a.

90 17 CFR 228.10 et seq.

91See note 69, supra.

92 5 U.S.C. 604.

93As noted elsewhere in this release, the

amendments do not apply to investment

companies.

94 17 C.F.R. 230.157.

95 17 C.F.R. 240.0–10.

estimated cost of $40 per hour has been

increased to $100 per hour because the

Commission believes that the levels of

professional services that may be

needed to prepare the information may

be higher than originally expected. The

revised overall cost estimate is

approximately $40 million for all

registrants complying with the required

disclosures of quantitative and

qualitative information about market

risks.

D. Qualitative Information About

Market Risk

FAS 119 requires certain qualitative

disclosures about the market risk

management activities associated with

derivative financial instruments held or

issued for purposes other than trading.

In particular, FAS 119 requires

disclosure of ‘‘the entity’s objectives for

holding or issuing the derivative

financial instruments, the context

needed to understand those objectives,

and its general strategies for achieving

those objectives.’’ 89 However, as

indicated above, these requirements of

FAS 119 only apply to certain derivative

financial instruments, and the SEC staff

has observed that these disclosures

typically have been general in nature,

providing only limited insight into an

entity’s overall market risk management

activities.

In essence, Items 305(b) and 9A(b)

expand certain disclosure requirements

set forth in FAS 119 to (1) encompass

derivative financial instruments entered

into for trading purposes, other financial

instruments, and derivative commodity

instruments and (2) require registrants

to evaluate and describe material

changes in their primary risk exposures

and their market risk management

activities. The Commission believes this

will present a more complete discussion

of a registrant’s exposure to market risks

and the way it manages those risks.

Because this information is likely to be

used by registrants as part of their risk

management activities, incremental

costs relating to such disclosure are not

expected to be significant.

E. Small Business Issuers

As noted earlier, the Commission has

determined not to amend Regulation S–

B90 to incorporate an item similar to

Item 305. Regulation S–B may be used

by small business issuers 91 required to

register their securities with the

Commission. By excluding small

business issuers from all but the

accounting policies disclosures that are

required by the amendments, the

Commission has limited substantially

the cost of those proposals for small

entities.

IX. Summary of Final Regulatory

Flexibility Analysis

The Commission has prepared a Final

Regulatory Flexibility Analysis pursuant

to the requirements of the Regulatory

Flexibility Act, 92 regarding the

amendments to Rule 4–08 of Regulation

S–X, to Regulation S–K to create Item

305, and the conforming amendments to

Forms S–1, S–2, S–4, S–11, and F–4

under the Securities Act, and Rule 14a–

3, Schedule 14A and Forms 10, 20–F,

10–Q, and 10–K under the Exchange

Act. This section summarizes that

analysis. A copy of the final analysis

may be obtained by contacting Robert E.

Burns, Chief Counsel, Office of the Chief

Accountant, U.S. Securities and

Exchange Commission, Mail Stop 11–3,

450 Fifth Street, N.W., Washington, D.C.

20549.

The final regulatory flexibility

analysis notes that the amendments

clarify existing disclosure requirements,

include additional instruments within

existing disclosure requirements, and

require specific disclosure alternatives

for providing quantitative information

regarding market sensitive instruments.

These amendments are intended to

provide investors with a clearer

understanding of registrants’ use of such

instruments and the market risks

inherent in those instruments.

For purposes of the Securities Act of

1933, the term ‘‘small business,’’ as used

with reference to a registrant (other than

an investment company) 93 for the

purposes of the Regulatory Flexibility

Act, is defined by Rule 157 as an issuer

with total assets on the last day of its

most recent fiscal year of $5 million or

less and which is engaged or proposing

to engage in an offering of securities that

does not exceed $5 million. 94 For

purposes of the Securities Exchange Act

of 1934, small business (other than an

investment company) is defined in Rule

0–10 to mean issuers having total assets

of $5 million or less as of the end of the

most recent fiscal year. 95

Approximately 1100 Exchange Act

reporting companies satisfy the

definition of ‘‘small business’’ under

Rule 157. As of December 1995, there

were approximately 5200 broker-dealers

classified as small businesses under the

above regulations.

As fully discussed in the analysis and

elsewhere in this release, the

Commission has determined not to

amend Regulation S–B to incorporate an

item similar to Items 305 and 9A. By

excluding small business issuers from

these new disclosure requirements, the

Commission has reduced substantially

the impact of the amendments on small

entities. Nonetheless, the final

regulatory flexibility analysis describes

various factors, including changes to the

disclosure requirements adopted in

response to the comments on the

proposing release, that reduce

compliance costs for all registrants.

These factors also are set forth in the

Cost-Benefit Analysis section of this

release.

Rule 4–08 clarifies how the

accounting policy disclosure

requirements under APB 22 should be

applied to derivatives and, therefore,

should not place significant additional

costs on small entities. The disclosures,

however, are likely to result in a more

focused and descriptive discussion of

the accounting policies for derivatives.

Disclosure of this information may

result in an increase in costs to prepare

and print the disclosures. However,

most of the preparation costs are

expected to relate to complying initially

with the new rule, as the disclosures

documenting those policies generally

may remain consistent from year to

year. These initial costs are not expected

to be significant. In addition, because

the accounting policies must be known

by the registrant in order for the

registrant to prepare its financial

statements, and should be known by its

auditors, no new compliance

procedures or recordkeeping is required

and there should not be a significant

increase, if any, in ongoing compliance

costs.

Moreover, the Commission has

determined that, due to the existing

disclosure requirements for accounting

policies under generally accepted

accounting principles and the

insignificant economic impact of the

enhanced accounting policy disclosures

under Rule 4–08, it is neither necessary

nor appropriate for the Commission to

establish for small entities different

compliance or reporting timetables,

simplified disclosure requirements,

performance standards, or an exemption

from the disclosure requirement.

Only one request was made for the

initial regulatory flexibility analysis,

and no comments specifically addressed

that analysis. Significant cost-benefit

issues raised by commenters in response

to the proposing release are discussed

under the Response to Comments and
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6063

96 44 U.S.C. 3501 et seq.

97 44 U.S.C. 3507.

Cost-Benefit Analysis sections of this

release, above.

X. Paperwork Reduction Act

The amendments and disclosure

items were submitted for review in

accordance with the Paperwork

Reduction Act of 1995 (‘‘the Act’’) 96 and

were approved by the Office of

Management and Budget (‘‘OMB’’) in

accordance with the clearance

procedures of that Act. 97 As Regulation

S-X, Regulation S-K, and the various

forms and rules that are being amended

already possess OMB control numbers,

new control numbers were not assigned

to the collections of information under

the amendments. The collection of

information requirements under these

amendments are mandatory and

responses are not confidential. The

collections of information are in

accordance with 44 U.S.C. 3507. An

agency may not conduct or sponsor, and

a person is not required to respond to,

a collection of information unless it

displays a currently valid control

number.

Also in accordance with the

Paperwork Reduction Act, the

Commission solicited comment on the

compliance burdens associated with the

proposals, and received no public

comment in response. Comments were

received, however, that addressed the

general costs and benefits associated

with the proposed amendment to

disclosure Items 305 and 9A. These

comments, and the Commission’s

response, are discussed in the Response

to Comments and Cost-Benefit Analysis

sections, above.

As part of its submission to the OMB

under the Paperwork Reduction Act, the

Commission estimated that

approximately 5000 registrants would

disclose quantitative and qualitative

information under Item 305 or Item 9A.

In view of the factors discussed in the

Cost-Benefit Analysis section and

elsewhere in this release, the

Commission recognized that the time

required to prepare these disclosures

would vary significantly depending on,

among other factors, the nature of the

registrant’s business, its market risk

management activities, and other

applicable regulatory requirements. The

Commission originally estimated that it

would take, on average, approximately

40 hours per registrant to prepare such

disclosures.

Upon review of the comment letters,

the Commission continues to believe

that approximately 5000 registrants will

provide Item 305 and Item 9A

disclosures. The Commission also

continues to believe that many financial

services companies will not incur

additional expense because they already

provide such disclosures. In fact, for

some of these companies, their costs

may go down as less information may be

disclosed. In addition, a significant

number of registrants, because of the

size or nature of their businesses, do not

have a significant number of derivative

instruments or do not have complex

instruments. For these companies, a

simple tabular presentation of debt and

similar instruments may suffice. The

time and cost to prepare such

disclosures should not be significant.

For larger commercial corporations,

however, the time for preparation and

presentation of the required Item 305 or

Item 9A information may be more than

the Commission initially anticipated.

Although no commenter provided

statistical or empirical information

about the cost to gather, prepare, and

disclose such information, several mid

to large commercial corporations

indicated that they believe they may

experience noticeable costs associated

with such disclosures. As a result, the

Commission is increasing to 80 hours

the estimated average hour burden per

registrant to comply with Item 305 or

Item 9A.

XI. Codification Update

The ‘‘Codification of Financial Report

Policies’’ announced in Financial

Reporting Release No. 1 (April 15, 1982)

[47 FR 21028] is updated to:

1. Include a new Section 219,

‘‘Disclosure of Accounting Policies for

Derivative Financial Instruments and

Derivative Commodity Instruments.’’

2. Include a new paragraph 219.01 to

include the text in topic III.A of this

release, ‘‘Discussion of Amendments:

Disclosure of Accounting Policies for

Derivatives.’’

3. Include a new Section 507,

‘‘Disclosure of Quantitative and

Qualitative Information About Market

Risk Inherent in Derivative Financial

Instruments, Other Financial

Instruments, and Derivative Commodity

Instruments.’’

4. Include a new paragraph 507.01 to

include the text in topic II of this

release, ‘‘Initiatives Regarding

Disclosures About Derivatives.’’

5. Include a new paragraph 507.02 to

include the text in topic III.B. of this

release, ‘‘Discussion of Amendments:

Disclosures of Quantitative and

Qualitative Information About Market

Risk.’’

6. Include a new paragraph 507.03 to

include the text in topic IV of this

release, ‘‘Applicability of

Amendments.’’

7. Include a new paragraph 507.04 to

include the text in topic V of this

release, ‘‘Disclosure of the Effects of

Derivative Instruments on Reporting

Financial Instruments, Commodity

Positions, Firm Commitments, and

Anticipated Transactions.’’

The Codification is a separate

publication of the Commission. It will

not be published in the Federal

Register/Code of Federal Regulations

System.

Statutory Basis

The additions and amendments to the

Commission’s rules and forms are

adopted pursuant to Sections 7, 10, 19,

and 27A of the Securities Act of 1933

and Sections 12, 13, 14, 21E, and 23 of

the Securities Exchange Act of 1934.

List of Subjects in 17 CFR Parts 210,

228, 229, 239, 240, and 249

Accounting, Reporting and

recordkeeping requirements, Securities.

Text of Amendments

In accordance with the foregoing,

Title 17, Chapter II of the Code of

Federal Regulations is amended as

follows:

PART 210—FORM AND CONTENT OF

AND REQUIREMENTS FOR FINANCIAL

STATEMENTS, SECURITIES ACT OF

1933, SECURITIES EXCHANGE ACT

OF 1934, PUBLIC UTILITY HOLDING

COMPANY ACT OF 1935, INVESTMENT

COMPANY ACT OF 1940, AND

ENERGY POLICY AND

CONSERVATION ACT OF 1975

1. The general authority citation for

Part 210 is revised to read as follows:

Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s,

77z-2, 77aa(25), 77aa(26), 78l, 78m, 78n,

78o(d), 78u-5, 78w(a), 78ll(d), 79e(b), 79j(a),

79n, 79t(a), 80a-8, 80a-20, 80a-29, 80a-30,

80a-37a, unless otherwise noted.

2. By amending 210.4–08 by adding

paragraph (n) to read as follows:

§ 210.4–08 General notes to financial

statements.

* * * * *

(n) Accounting policies for certain

derivative instruments. Disclosures

regarding accounting policies shall

include descriptions of the accounting

policies used for derivative financial

instruments and derivative commodity

instruments and the methods of

applying those policies that materially

affect the determination of financial

position, cash flows, or results of

operation. This description shall

include, to the extent material, each of

the following items:
6064 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

(1) A discussion of each method used

to account for derivative financial

instruments and derivative commodity

instruments;

(2) The types of derivative financial

instruments and derivative commodity

instruments accounted for under each

method; (3) The criteria required to be

met for each accounting method used,

including a discussion of the criteria

required to be met for hedge or deferral

accounting and accrual or settlement

accounting (e.g., whether and how risk

reduction, correlation, designation, and

effectiveness tests are applied);

(4) The accounting method used if the

criteria specified in paragraph (n)(3) of

this section are not met;

(5) The method used to account for

terminations of derivatives designated

as hedges or derivatives used to affect

directly or indirectly the terms, fair

values, or cash flows of a designated

item;

(6) The method used to account for

derivatives when the designated item

matures, is sold, is extinguished, or is

terminated. In addition, the method

used to account for derivatives

designated to an anticipated transaction,

when the anticipated transaction is no

longer likely to occur; and

(7) Where and when derivative

financial instruments and derivative

commodity instruments, and their

related gains and losses, are reported in

the statements of financial position,

cash flows, and results of operations.

Instructions to Paragraph (n)

1. For purposes of this paragraph (n),

derivative financial instruments and

derivative commodity instruments

(collectively referred to as ‘‘derivatives’’) are

defined as follows:

(i) Derivative financial instruments have

the same meaning as defined by generally

accepted accounting principles (see, e.g.,

Financial Accounting Standards Board

(‘‘FASB’’), Statement of Financial

Accounting Standards No. 119, ‘‘Disclosure

about Derivative Financial Instruments and

Fair Value of Financial Instruments,’’ (‘‘FAS

119’’) paragraphs 5–7, (October 1994)), and

include futures, forwards, swaps, options,

and other financial instruments with similar

characteristics.

(ii) Derivative commodity instruments

include, to the extent such instruments are

not derivative financial instruments,

commodity futures, commodity forwards,

commodity swaps, commodity options, and

other commodity instruments with similar

characteristics that are permitted by contract

or business custom to be settled in cash or

with another financial instrument. For

purposes of this paragraph, settlement in

cash includes settlement in cash of the net

change in value of the derivative commodity

instrument (e.g., net cash settlement based on

changes in the price of the underlying

commodity).

2. For purposes of paragraphs (n)(2), (n)(3),

(n)(4), and (n)(7), the required disclosures

should address separately derivatives entered

into for trading purposes and derivatives

entered into for purposes other than trading.

For purposes of this paragraph, trading

purposes has the same meaning as defined by

generally accepted accounting principles

(see, e.g., FAS 119, paragraph 9a (October

1994)).

3. For purposes of paragraph (n)(6),

anticipated transactions means transactions

(other than transactions involving existing

assets or liabilities or transactions

necessitated by existing firm commitments)

an enterprise expects, but is not obligated, to

carry out in the normal course of business

(see, e.g., FASB, Statement of Financial

Accounting Standards No. 80, ‘‘Accounting

for Futures Contracts,’’ paragraph 9, (August

1984)).

4. Registrants should provide disclosures

required under paragraph (n) in filings with

the Commission that include financial

statements of fiscal periods ending after June

15, 1997.

PART 228—INTEGRATED

DISCLOSURE SYSTEM FOR SMALL

BUSINESS ISSUERS

3. The general authority citation for

Part 228 is revised to read as follows:

Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j,

77k, 77s, 77z–2, 77aa(25), 77aa(26), 77ddd,

77eee, 77ggg, 77hhh, 77jjj, 77nnn, 77sss, 78l,

78m, 78n, 78u–5, 78o, 78w, 78ll, 80a–8, 80a–

29, 80a–30, 80a–37, 80b–11, unless otherwise

noted.

4. By amending § 228.10 by adding

paragraph (g) to read as follows:

§ 228.10 (Item 10) General.

* * * * *

(g) Quantitative and qualitative

disclosures about market risk. The safe

harbor provision included in paragraph

(d) of Item 305 of Regulation S–K

(§ 229.305(d) of this chapter) shall apply

to information required by Item 305 of

Regulation S–K (§ 229.305 of this

chapter) that is voluntarily provided by

or on behalf of a small business issuer

as defined in Rule 12b–2 of the

Exchange Act.

Note to paragraph (g): Such small business

issuers are not required to provide the

information required by Item 305 of

Regulation S–K.

5. By amending § 228.310 by revising

the first sentence of Note 2 to read as

follows:

§ 228.310 (Item 310) Financial Statements.

Notes—1. * * *.

2. Regulation S–X (17 CFR 210.1

through 210.12) Form and Content of

and Requirements for Financial

Statements shall not apply to the

preparation of such financial

statements, except that the report and

qualifications of the independent

accountant shall comply with the

requirements of Article 2 of Regulation

S–X (17 CFR 210.2), Articles 3–19 and

3–20 (17 CFR 210.3–19 and 210.3–20)

shall apply to financial statements of

foreign private issuers, the description

of accounting policies shall comply

with Article 4–08(n) of Regulation S–X

(17 CFR 210.4–08(n)), and small

business issuers engaged in oil and gas

producing activities shall follow the

financial accounting and reporting

standards specified in Article 4–10 of

Regulation S–X (17 CFR 210.4–10) with

respect to such activities. * * *

* * * * *

PART 229—STANDARD

INSTRUCTIONS FOR FILING FORMS

UNDER SECURITIES ACT OF 1933,

SECURITIES EXCHANGE ACT OF 1934

AND ENERGY POLICY AND

CONSERVATION ACT OF 1975—

REGULATION S–K

6. The general authority citation for

Part 229 is revised to read in part as

follows:

Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j,

77k, 77s, 77z–2, 77aa(25), 77aa(26), 77ddd,

77eee, 77ggg, 77hhh, 77iii, 77jjj, 77nnn,

77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u–

5, 78w, 78ll(d), 79e, 79n, 79t, 80a–8, 80a–29,

80a–30, 80a–37, 80b–11, unless otherwise

noted.

* * * * *

7. By adding § 229.305 to read as

follows:

§ 229.305 (Item 305) Quantitative and

qualitative disclosures about market risk.

(a) Quantitative information about

market risk. (1) Registrants shall

provide, in their reporting currency,

quantitative information about market

risk as of the end of the latest fiscal year,

in accordance with one of the following

three disclosure alternatives. In

preparing this quantitative information,

registrants shall categorize market risk

sensitive instruments into instruments

entered into for trading purposes and

instruments entered into for purposes

other than trading purposes. Within

both the trading and other than trading

portfolios, separate quantitative

information shall be presented, to the

extent material, for each market risk

exposure category (i.e., interest rate risk,

foreign currency exchange rate risk,

commodity price risk, and other

relevant market risks, such as equity

price risk). A registrant may use one of

the three alternatives set forth in this

section for all of the required

quantitative disclosures about market

risk. A registrant also may choose, from

among the three alternatives, one

disclosure alternative for market risk
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6065

sensitive instruments entered into for

trading purposes and another disclosure

alternative for market risk sensitive

instruments entered into for other than

trading purposes. Alternatively, a

registrant may choose any disclosure

alternative, from among the three

alternatives, for each risk exposure

category within the trading and other

than trading portfolios. The three

disclosure alternatives are:

(i)(A)(1) Tabular presentation of

information related to market risk

sensitive instruments; such information

shall include fair values of the market

risk sensitive instruments and contract

terms sufficient to determine future cash

flows from those instruments,

categorized by expected maturity dates.

(2) Tabular information relating to

contract terms shall allow readers of the

table to determine expected cash flows

from the market risk sensitive

instruments for each of the next five

years. Comparable tabular information

for any remaining years shall be

displayed as an aggregate amount.

(3) Within each risk exposure

category, the market risk sensitive

instruments shall be grouped based on

common characteristics. Within the

foreign currency exchange rate risk

category, the market risk sensitive

instruments shall be grouped by

functional currency and within the

commodity price risk category, the

market risk sensitive instruments shall

be grouped by type of commodity.

(4) See the Appendix to this Item for

a suggested format for presentation of

this information; and

(B) Registrants shall provide a

description of the contents of the table

and any related assumptions necessary

to understand the disclosures required

under paragraph (a)(1)(i)(A) of this Item

305; or

(ii)(A) Sensitivity analysis disclosures

that express the potential loss in future

earnings, fair values, or cash flows of

market risk sensitive instruments

resulting from one or more selected

hypothetical changes in interest rates,

foreign currency exchange rates,

commodity prices, and other relevant

market rates or prices over a selected

period of time. The magnitude of

selected hypothetical changes in rates or

prices may differ among and within

market risk exposure categories; and

(B) Registrants shall provide a

description of the model, assumptions,

and parameters, which are necessary to

understand the disclosures required

under paragraph (a)(1)(ii)(A) of this Item

305; or

(iii)(A) Value at risk disclosures that

express the potential loss in future

earnings, fair values, or cash flows of

market risk sensitive instruments over a

selected period of time, with a selected

likelihood of occurrence, from changes

in interest rates, foreign currency

exchange rates, commodity prices, and

other relevant market rates or prices;

(B)(1) For each category for which

value at risk disclosures are required

under paragraph (a)(1)(iii)(A) of this

Item 305, provide either:

(i) The average, high and low

amounts, or the distribution of the value

at risk amounts for the reporting period;

or

(ii) The average, high and low

amounts, or the distribution of actual

changes in fair values, earnings, or cash

flows from the market risk sensitive

instruments occurring during the

reporting period; or

(iii) The percentage or number of

times the actual changes in fair values,

earnings, or cash flows from the market

risk sensitive instruments exceeded the

value at risk amounts during the

reporting period;

(2) Information required under

paragraph (a)(1)(iii)(B)(1) of this Item

305 is not required for the first fiscal

year end in which a registrant must

present Item 305 information; and

(C) Registrants shall provide a

description of the model, assumptions,

and parameters, which are necessary to

understand the disclosures required

under paragraphs (a)(1)(iii)(A) and (B) of

this Item 305.

(2) Registrants shall discuss material

limitations that cause the information

required under paragraph (a)(1) of this

Item 305 not to reflect fully the net

market risk exposures of the entity. This

discussion shall include summarized

descriptions of instruments, positions,

and transactions omitted from the

quantitative market risk disclosure

information or the features of

instruments, positions, and transactions

that are included, but not reflected fully

in the quantitative market risk

disclosure information.

(3) Registrants shall present

summarized market risk information for

the preceding fiscal year. In addition,

registrants shall discuss the reasons for

material quantitative changes in market

risk exposures between the current and

preceding fiscal years. Information

required by this paragraph (a)(3),

however, is not required if disclosure is

not required under paragraph (a)(1) of

this Item 305 for the current fiscal year.

Information required by this paragraph

(a)(3) is not required for the first fiscal

year end in which a registrant must

present Item 305 information.

(4) If registrants change disclosure

alternatives or key model

characteristics, assumptions, and

parameters used in providing

quantitative information about market

risk (e.g., changing from tabular

presentation to value at risk, changing

the scope of instruments included in the

model, or changing the definition of loss

from fair values to earnings), and if the

effects of any such change is material,

the registrant shall:

(i) Explain the reasons for the change;

and

(ii) Either provide summarized

comparable information, under the new

disclosure method, for the year

preceding the current year or, in

addition to providing disclosure for the

current year under the new method,

provide disclosures for the current year

and preceding fiscal year under the

method used in the preceding year.

Instructions to Paragraph 305(a)

1. Under paragraph 305(a)(1):

A. For each market risk exposure category

within the trading and other than trading

portfolios, registrants may report the average,

high, and low sensitivity analysis or value at

risk amounts for the reporting period, as an

alternative to reporting year-end amounts.

B. In determining the average, high, and

low amounts for the fiscal year under

instruction 1.A. of the Instructions to

Paragraph 305(a), registrants should use

sensitivity analysis or value at risk amounts

relating to at least four equal time periods

throughout the reporting period (e.g., four

quarter-end amounts, 12 month-end

amounts, or 52 week-end amounts).

C. Functional currency means functional

currency as defined by generally accepted

accounting principles (see, e.g., FASB,

Statement of Financial Accounting

Standards No. 52, ‘‘Foreign Currency

Translation’’, (‘‘FAS 52’’) paragraph 20

(December 1981)).

D. Registrants using the sensitivity analysis

and value at risk disclosure alternatives are

encouraged, but not required, to provide

quantitative amounts that reflect the

aggregate market risk inherent in the trading

and other than trading portfolios.

2. Under paragraph 305(a)(1)(i):

A. Examples of contract terms sufficient to

determine future cash flows from market risk

sensitive instruments include, but are not

limited to:

i. Debt instruments—principal amounts

and weighted average effective interest rates;

ii. Forwards and futures—contract amounts

and weighted average settlement prices;

iii. Options—contract amounts and

weighted average strike prices;

iv. Swaps—notional amounts, weighted

average pay rates or prices, and weighted

average receive rates or prices; and

v. Complex instruments—likely to be a

combination of the contract terms presented

in 2.A.i. through iv. of this Instruction;

B. When grouping based on common

characteristics, instruments should be

categorized, at a minimum, by the following

characteristics, when material:

i. Fixed rate or variable rate assets or

liabilities;
6066 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

ii. Long or short forwards and futures;

iii. Written or purchased put or call

options with similar strike prices;

iv. Receive fixed and pay variable swaps,

receive variable and pay fixed swaps, and

receive variable and pay variable swaps;

v. The currency in which the instruments’

cash flows are denominated;

vi. Financial instruments for which foreign

currency transaction gains and losses are

reported in the same manner as translation

adjustments under generally accepted

accounting principles (see, e.g., FAS 52

paragraph 20 (December 1981)); and

vii. Derivatives used to manage risks

inherent in anticipated transactions;

C. Registrants may aggregate information

regarding functional currencies that are

economically related, managed together for

internal risk management purposes, and have

statistical correlations of greater than 75%

over each of the past three years;

D. Market risk sensitive instruments that

are exposed to rate or price changes in more

than one market risk exposure category

should be presented within the tabular

information for each of the risk exposure

categories to which those instruments are

exposed;

E. If a currency swap (see, e.g., FAS 52

Appendix E for a definition of currency

swap) eliminates all foreign currency

exposures in the cash flows of a foreign

currency denominated debt instrument,

neither the currency swap nor the foreign

currency denominated debt instrument are

required to be disclosed in the foreign

currency risk exposure category. However,

both the currency swap and the foreign

currency denominated debt instrument

should be disclosed in the interest rate risk

exposure category; and

F. The contents of the table and related

assumptions that should be described

include, but are not limited to:

i. The different amounts reported in the

table for various categories of the market risk

sensitive instruments (e.g., principal amounts

for debt, notional amounts for swaps, and

contract amounts for options and futures);

ii. The different types of reported market

rates or prices (e.g., contractual rates or

prices, spot rates or prices, forward rates or

prices); and

iii. Key prepayment or reinvestment

assumptions relating to the timing of

reported amounts.

3. Under paragraph 305(a)(1)(ii):

A. Registrants should select hypothetical

changes in market rates or prices that are

expected to reflect reasonably possible nearterm changes in those rates and prices. In this

regard, absent economic justification for the

selection of a different amount, registrants

should use changes that are not less than 10

percent of end of period market rates or

prices;

B. For purposes of instruction 3.A. of the

Instructions to Paragraph 305(a), the term

reasonably possible has the same meaning as

defined by generally accepted accounting

principles (see, e.g., FASB, Statement of

Financial Accounting Standards No. 5,

‘‘Accounting for Contingencies,’’ (‘‘FAS 5’’)

paragraph 3 (March 1975));

C. For purposes of instruction 3.A. of the

Instructions to Paragraph 305(a), the term

near term means a period of time going

forward up to one year from the date of the

financial statements (see generally AICPA,

Statement of Position 94–6, ‘‘Disclosure of

Certain Significant Risks and Uncertainties,’’

(‘‘SOP 94–6’’) at paragraph 7 (December 30,

1994));

D. Market risk sensitive instruments that

are exposed to rate or price changes in more

than one market risk exposure category

should be included in the sensitivity analysis

disclosures for each market risk category to

which those instruments are exposed;

E. Registrants with multiple foreign

currency exchange rate exposures should

prepare foreign currency sensitivity analysis

disclosures that measure the aggregate

sensitivity to changes in all foreign currency

exchange rate exposures, including the

effects of changes in both transactional

currency/functional currency exchange rate

exposures and functional currency/reporting

currency exchange rate exposures. For

example, assume a French division of a

registrant presenting its financial statements

in U.S. dollars ($US) invests in a

deutschmark(DM)-denominated debt

security. In these circumstances, the $US is

the reporting currency and the DM is the

transactional currency. In addition, assume

this division determines that the French

franc (FF) is its functional currency

according to FAS 52. In preparing the foreign

currency sensitivity analysis disclosures, this

registrant should report the aggregate

potential loss from hypothetical changes in

both the DM/FF exchange rate exposure and

the FF/$US exchange rate exposure; and

F. Model, assumptions, and parameters

that should be described include, but are not

limited to, how loss is defined by the model

(e.g., loss in earnings, fair values, or cash

flows), a general description of the modeling

technique (e.g., duration modeling, modeling

that measures the change in net present

values arising from selected hypothetical

changes in market rates or prices, and a

description as to how optionality is

addressed by the model), the types of

instruments covered by the model (e.g.,

derivative financial instruments, other

financial instruments, derivative commodity

instruments, and whether other instruments

are included voluntarily, such as certain

commodity instruments and positions, cash

flows from anticipated transactions, and

certain financial instruments excluded under

instruction 3.C.ii. of the General Instructions

to Paragraphs 305(a) and 305(b)), and other

relevant information about the model’s

assumptions and parameters, (e.g., the

magnitude and timing of selected

hypothetical changes in market rates or

prices used, the method by which discount

rates are determined, and key prepayment or

reinvestment assumptions).

4. Under paragraph 305(a)(1)(iii):

A. The confidence intervals selected

should reflect reasonably possible near-term

changes in market rates and prices. In this

regard, absent economic justification for the

selection of different confidence intervals,

registrants should use intervals that are 95

percent or higher;

B. For purposes of instruction 4.A. of the

Instructions to Paragraph 305(a), the term

reasonably possible has the same meaning as

defined by generally accepted accounting

principles (see, e.g., FAS 5, paragraph 3

(March 1975));

C. For purposes of instruction 4.A. of the

Instructions to Paragraphs 305(a), the term

near term means a period of time going

forward up to one year from the date of the

financial statements (see generally SOP 94–

6, at paragraph 7 (December 30, 1994));

D. Registrants with multiple foreign

currency exchange rate exposures should

prepare foreign currency value at risk

analysis disclosures that measure the

aggregate sensitivity to changes in all foreign

currency exchange rate exposures, including

the aggregate effects of changes in both

transactional currency/functional currency

exchange rate exposures and functional

currency/reporting currency exchange rate

exposures. For example, assume a French

division of a registrant presenting its

financial statements in U.S. dollars ($US)

invests in a deutschmark(DM)-denominated

debt security. In these circumstances, the

$US is the reporting currency and the DM is

the transactional currency. In addition,

assume this division determines that the

French franc (FF) is its functional currency

according to FAS 52. In preparing the foreign

currency value at risk disclosures, this

registrant should report the aggregate

potential loss from hypothetical changes in

both the DM/FF exchange rate exposure and

the FF/$US exchange rate exposure; and

E. Model, assumptions, and parameters

that should be described include, but are not

limited to, how loss is defined by the model

(e.g., loss in earnings, fair values, or cash

flows), the type of model used (e.g., variance/

covariance, historical simulation, or Monte

Carlo simulation and a description as to how

optionality is addressed by the model), the

types of instruments covered by the model

(e.g., derivative financial instruments, other

financial instruments, derivative commodity

instruments, and whether other instruments

are included voluntarily, such as certain

commodity instruments and positions, cash

flows from anticipated transactions, and

certain financial instruments excluded under

instruction 3.C.ii. of the General Instructions

to Paragraphs 305(a) and 305(b)), and other

relevant information about the model’s

assumptions and parameters, (e.g., holding

periods, confidence intervals, and, when

appropriate, the methods used for aggregating

value at risk amounts across market risk

exposure categories, such as by assuming

perfect positive correlation, independence, or

actual observed correlation).

5. Under paragraph 305(a)(2), limitations

that should be considered include, but are

not limited to:

A. The exclusion of certain market risk

sensitive instruments, positions, and

transactions from the disclosures required

under paragraph 305(a)(1) (e.g., derivative

commodity instruments not permitted by

contract or business custom to be settled in

cash or with another financial instrument,

commodity positions, cash flows from

anticipated transactions, and certain

financial instruments excluded under

instruction 3.C.ii. of the General Instructions

to Paragraphs 305(a) and 305(b)). Failure to
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6067

include such instruments, positions, and

transactions in preparing the disclosures

under paragraph 305(a)(1) may be a

limitation because the resulting disclosures

may not fully reflect the net market risk of

a registrant; and

B. The ability of disclosures required under

paragraph 305(a)(1) to reflect fully the market

risk that may be inherent in instruments with

leverage, option, or prepayment features (e.g.,

options, including written options,

structured notes, collateralized mortgage

obligations, leveraged swaps, and options

embedded in swaps).

(b) Qualitative information about

market risk. (1) To the extent material,

describe:

(i) The registrant’s primary market

risk exposures;

(ii) How those exposures are

managed. Such descriptions shall

include, but not be limited to, a

discussion of the objectives, general

strategies, and instruments, if any, used

to manage those exposures; and

(iii) Changes in either the registrant’s

primary market risk exposures or how

those exposures are managed, when

compared to what was in effect during

the most recently completed fiscal year

and what is known or expected to be in

effect in future reporting periods.

(2) Qualitative information about

market risk shall be presented

separately for market risk sensitive

instruments entered into for trading

purposes and those entered into for

purposes other than trading.

Instructions to Paragraph 305(b)

1. For purposes of disclosure under

paragraph 305(b), primary market risk

exposures means:

A. The following categories of market risk:

interest rate risk, foreign currency exchange

rate risk, commodity price risk, and other

relevant market rate or price risks (e.g.,

equity price risk); and

B. Within each of these categories, the

particular markets that present the primary

risk of loss to the registrant. For example, if

a registrant has a material exposure to foreign

currency exchange rate risk and, within this

category of market risk, is most vulnerable to

changes in dollar/yen, dollar/pound, and

dollar/peso exchange rates, the registrant

should disclose those exposures. Similarly, if

a registrant has a material exposure to

interest rate risk and, within this category of

market risk, is most vulnerable to changes in

short-term U.S. prime interest rates, it should

disclose the existence of that exposure.

2. For purposes of disclosure under

paragraph 305(b), registrants should describe

primary market risk exposures that exist as

of the end of the latest fiscal year, and how

those exposures are managed.

General Instructions to Paragraphs 305(a)

and 305(b)

1. The disclosures called for by paragraphs

305(a) and 305(b) are intended to clarify the

registrant’s exposures to market risk

associated with activities in derivative

financial instruments, other financial

instruments, and derivative commodity

instruments.

2. In preparing the disclosures under

paragraphs 305(a) and 305(b), registrants are

required to include derivative financial

instruments, other financial instruments, and

derivative commodity instruments.

3. For purposes of paragraphs 305(a) and

305(b), derivative financial instruments,

other financial instruments, and derivative

commodity instruments (collectively referred

to as ‘‘market risk sensitive instruments’’) are

defined as follows:

A. Derivative financial instruments has the

same meaning as defined by generally

accepted accounting principles (see, e.g.,

FASB, Statement of Financial Accounting

Standards No. 119, ‘‘Disclosure about

Derivative Financial Instruments and Fair

Value of Financial Instruments,’’ (‘‘FAS

119’’) paragraphs 5–7 (October 1994)), and

includes futures, forwards, swaps, options,

and other financial instruments with similar

characteristics;

B. Other financial instruments means all

financial instruments as defined by generally

accepted accounting principles for which fair

value disclosures are required (see, e.g.,

FASB, Statement of Financial Accounting

Standards No. 107, ‘‘Disclosures about Fair

Value of Financial Instruments,’’ (‘‘FAS

107’’) paragraphs 3 and 8 (December 1991)),

except for derivative financial instruments,

as defined above;

C.i. Other financial instruments include,

but are not limited to, trade accounts

receivable, investments, loans, structured

notes, mortgage-backed securities, trade

accounts payable, indexed debt instruments,

interest-only and principal-only obligations,

deposits, and other debt obligations;

ii. Other financial instruments exclude

employers’ and plans’ obligations for pension

and other post-retirement benefits,

substantively extinguished debt, insurance

contracts, lease contracts, warranty

obligations and rights, unconditional

purchase obligations, investments accounted

for under the equity method, minority

interests in consolidated enterprises, and

equity instruments issued by the registrant

and classified in stockholders’ equity in the

statement of financial position (see, e.g., FAS

107, paragraph 8 (December 1991)). For

purposes of this item, trade accounts

receivable and trade accounts payable need

not be considered other financial instruments

when their carrying amounts approximate

fair value; and

D. Derivative commodity instruments

include, to the extent such instruments are

not derivative financial instruments,

commodity futures, commodity forwards,

commodity swaps, commodity options, and

other commodity instruments with similar

characteristics that are permitted by contract

or business custom to be settled in cash or

with another financial instrument. For

purposes of this paragraph, settlement in

cash includes settlement in cash of the net

change in value of the derivative commodity

instrument (e.g., net cash settlement based on

changes in the price of the underlying

commodity).

4.A. In addition to providing required

disclosures for the market risk sensitive

instruments defined in instruction 2. of the

General Instructions to Paragraphs 305(a) and

305(b), registrants are encouraged to include

other market risk sensitive instruments,

positions, and transactions within the

disclosures required under paragraphs 305(a)

and 305(b). Such instruments, positions, and

transactions might include commodity

positions, derivative commodity instruments

that are not permitted by contract or business

custom to be settled in cash or with another

financial instrument, cash flows from

anticipated transactions, and certain

financial instruments excluded under

instruction 3.C.ii. of the General Instructions

to Paragraphs 305(a) and 305(b).

B. Registrants that voluntarily include

other market risk sensitive instruments,

positions and transactions within their

quantitative disclosures about market risk

under the sensitivity analysis or value at risk

disclosure alternatives are not required to

provide separate market risk disclosures for

any voluntarily selected instruments,

positions, or transactions. Instead, registrants

selecting the sensitivity analysis and value at

risk disclosure alternatives are permitted to

present comprehensive market risk

disclosures, which reflect the combined

market risk exposures inherent in both the

required and any voluntarily selected

instruments, position, or transactions.

Registrants that choose the tabular

presentation disclosure alternative should

present voluntarily selected instruments,

positions, or transactions in a manner

consistent with the requirements in Item

305(a) for market risk sensitive instruments.

C. If a registrant elects to include

voluntarily a particular type of instrument,

position, or transaction in their quantitative

disclosures about market risk, that registrant

should include all, rather than some, of those

instruments, positions, or transactions within

those disclosures. For example, if a registrant

holds in inventory a particular type of

commodity position and elects to include

that commodity position within their market

risk disclosures, the registrant should include

the entire commodity position, rather than

only a portion thereof, in their quantitative

disclosures about market risk.

5.A. Under paragraphs 305(a) and 305(b),

a materiality assessment should be made for

each market risk exposure category within

the trading and other than trading portfolios.

B. For purposes of making the materiality

assessment under instruction 5.A. of the

General Instructions to Paragraphs 305(a) and

305(b), registrants should evaluate both:

i. The materiality of the fair values of

derivative financial instruments, other

financial instruments, and derivative

commodity instruments outstanding as of the

end of the latest fiscal year; and

ii. The materiality of potential, near-term

losses in future earnings, fair values, and/or

cash flows from reasonably possible nearterm changes in market rates or prices.

iii. If either paragraphs B.i. or B.ii. in this

instruction of the General Instructions to

Paragraphs 305(a) and 305(b) are material,

the registrant should disclose quantitative

and qualitative information about market
6068 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

risk, if such market risk for the particular

market risk exposure category is material.

C. For purposes of instruction 5.B.i. of the

General Instructions to Paragraphs 305(a) and

305(b), registrants generally should not net

fair values, except to the extent allowed

under generally accepted accounting

principles (see, e.g., FASB Interpretation No.

39, ‘‘Offsetting of Amounts Related to Certain

Contracts’’ (March 1992)). For example,

under this instruction, the fair value of assets

generally should not be netted with the fair

value of liabilities.

D. For purposes of instruction 5.B.ii. of the

General Instructions to Paragraphs 305(a) and

305(b), registrants should consider, among

other things, the magnitude of:

i. Past market movements;

ii. Reasonably possible, near-term market

movements; and

iii. Potential losses that may arise from

leverage, option, and multiplier features.

E. For purposes of instructions 5.B.ii and

5.D.ii of the General Instructions to

Paragraphs 305(a) and 305(b), the term near

term means a period of time going forward

up to one year from the date of the financial

statements (see generally SOP 94–6, at

paragraph 7 (December 30, 1994)).

F. For the purpose of instructions 5.B.ii.

and 5.D.ii. of the General Instructions to

Paragraphs 305(a) and 305(b), the term

reasonably possible has the same meaning as

defined by generally accepted accounting

principles (see, e.g., FAS 5, paragraph 3

(March 1975)).

6. For purposes of paragraphs 305(a) and

305(b), registrants should present the

information outside of, and not incorporate

the information into, the financial statements

(including the footnotes to the financial

statements). In addition, registrants are

encouraged to provide the required

information in one location. However,

alternative presentation, such as inclusion of

all or part of the information in

Management’s Discussion and Analysis, may

be used at the discretion of the registrant. If

information is disclosed in more than one

location, registrants should provide crossreferences to the locations of the related

disclosures.

7. For purposes of the instructions to

paragraphs 305(a) and 305(b), trading

purposes has the same meaning as defined by

generally accepted accounting principles

(see, e.g., FAS 119, paragraph 9a (October

1994)). In addition, anticipated transactions

means transactions (other than transactions

involving existing assets or liabilities or

transactions necessitated by existing firm

commitments) an enterprise expects, but is

not obligated, to carry out in the normal

course of business (see, e.g., FASB, Statement

of Financial Accounting Standards No. 80,

‘‘Accounting for Futures Contracts,’’

paragraph 9, (August 1984)).

(c) Interim periods. If interim period

financial statements are included or are

required to be included by Article 3 of

Regulation S–X (17 CFR 210),

discussion and analysis shall be

provided so as to enable the reader to

assess the sources and effects of material

changes in information that would be

provided under Item 305 of Regulation

S–K from the end of the preceding fiscal

year to the date of the most recent

interim balance sheet.

Instructions to Paragraph 305(c)

1. Information required under paragraph

(c) of this Item 305 is not required until after

the first fiscal year end in which this Item

305 is applicable.

(d) Safe Harbor. (1) The safe harbor

provided in Section 27A of the

Securities Act of 1933 (15 U.S.C. 77z–

2) and Section 21E of the Securities

Exchange Act of 1934 (15 U.S.C. 78u–

5) (‘‘statutory safe harbors’’) shall apply,

with respect to all types of issuers and

transactions, to information provided

pursuant to paragraphs (a), (b), and (c)

of this Item 305, provided that the

disclosure is made by: an issuer; a

person acting on behalf of the issuer; an

outside reviewer retained by the issuer

making a statement on behalf of the

issuer; or an underwriter, with respect

to information provided by the issuer or

information derived from information

provided by the issuer.

(2) For purposes of paragraph (d) of

this Item 305 only:

(i) All information required by

paragraphs (a), (b)(1)(i), (b)(1)(iii), and

(c) of this Item 305 is considered

forward looking statements for purposes

of the statutory safe harbors, except for

historical facts such as the terms of

particular contracts and the number of

market risk sensitive instruments held

during or at the end of the reporting

period; and

(ii) With respect to paragraph (a) of

this Item 305, the meaningful

cautionary statements prong of the

statutory safe harbors will be satisfied if

a registrant satisfies all requirements of

that same paragraph (a) of this Item 305.

(e) Small business issuers. Small

business issuers, as defined in § 230.405

of this chapter and § 230.12b–2 of this

chapter, need not provide the

information required by this Item 305,

whether or not they file on forms

specially designated as small business

issuer forms.

General Instructions to Paragraphs 305(a),

305(b), 305(c), 305(d), and 305(e)

1. Bank registrants, thrift registrants, and

non-bank and non-thrift registrants with

market capitalizations on January 28, 1997 in

excess of $2.5 billion should provide Item

305 disclosures in filings with the

Commission that include annual financial

statements for fiscal years ending after June

15, 1997. Non-bank and non-thrift registrants

with market capitalizations on January 28,

1997 of $2.5 billion or less should provide

Item 305 disclosures in filings with the

Commission that include financial

statements for fiscal years ending after June

15, 1998.

2.A. For purposes of instruction 1. of the

General Instructions to Paragraphs 305(a),

305(b), 305(c), 305(d), and 305(e), bank

registrants and thrift registrants include any

registrant which has control over a

depository institution.

B. For purposes of instruction 2.A. of the

General Instructions to Paragraphs 305(a),

305(b), 305(c), 305(d), and 305(e), a registrant

has control over a depository institution if:

i. The registrant directly or indirectly or

acting through one or more other persons

owns, controls, or has power to vote 25% or

more of any class of voting securities of the

depository institution;

ii. The registrant controls in any manner

the election of a majority of the directors or

trustees of the depository institution; or

iii. The Federal Reserve Board or Office of

Thrift Supervision determines, after notice

and opportunity for hearing, that the

registrant directly or indirectly exercises a

controlling influence over the management or

policies of the depository institution.

C. For purposes of instruction 2.B. of the

General Instructions to Paragraphs 305(a),

305(b), 305(c), 305(d), and 305(e), a

depository institution means any of the

following:

i. An insured depository institution as

defined in section 3(c)(2) of the Federal

Deposit Insurance Act (12 U.S.C.A. Sec. 1813

(c));

ii. An institution organized under the laws

of the United States, any State of the United

States, the District of Columbia, any territory

of the United States, Puerto Rico, Guam,

American Somoa, or the Virgin Islands,

which both accepts demand deposits or

deposits that the depositor may withdraw by

check or similar means for payment to third

parties or others and is engaged in the

business of making commercial loans.

D. For purposes of instruction 1. of the

General Instructions to Paragraphs 305(a),

305(b), 305(c), 305(d) and 305(e), market

capitalization is the aggregate market value

of common equity as set forth in General

Instruction I.B.1. of Form S–3; provided

however, that common equity held by

affiliates is included in the calculation of

market capitalization; and provided further

that instead of using the 60 day period prior

to filing referenced in General Instruction

I.B.1. of Form S–3, the measurement date is

January 28, 1997.

Appendix to Item 305—Tabular Disclosures

The tables set forth below are illustrative

of the format that might be used when a

registrant elects to present the information

required by paragraph (a)(1)(i)(A) of Item 305

regarding terms and information about

derivative financial instruments, other

financial instruments, and derivative

commodity instruments. These examples are

for illustrative purposes only. Registrants are

not required to display the information in the

specific format illustrated below. Alternative

methods of display are permissible as long as

the disclosure requirements of the section are

satisfied. Furthermore, these examples were

designed primarily to illustrate possible

formats for presentation of the information

required by the disclosure item and do not

purport to illustrate the broad range of

derivative financial instruments, other
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6069

1The information is presented in U.S. dollars

because that is the registrant’s reporting currency.

financial instruments, and derivative

commodity instruments utilized by

registrants.

Interest Rate Sensitivity

The table below provides information

about the Company’s derivative

financial instruments and other

financial instruments that are sensitive

to changes in interest rates, including

interest rate swaps and debt obligations.

For debt obligations, the table presents

principal cash flows and related

weighted average interest rates by

expected maturity dates. For interest

rate swaps, the table presents notional

amounts and weighted average interest

rates by expected (contractual) maturity

dates. Notional amounts are used to

calculate the contractual payments to be

exchanged under the contract. Weighted

average variable rates are based on

implied forward rates in the yield curve

at the reporting date. The information is

presented in U.S. dollar equivalents,

which is the Company’s reporting

currency. The instrument’s actual cash

flows are denominated in both U.S.

dollars ($US) and German deutschmarks

(DM), as indicated in parentheses.

December 31, 19X1

Expected maturity date

19X2 19X3 19X4 19X5 19X6 Thereafter Total Fair

value

Liabilities (US$ Equivalent in millions)

Long-term Debt:

Fixed Rate ($US) ....................................... $XXX $XXX $XXX $XXX $XXX $XXX $XXX $XXX

Average interest rate .......................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Fixed Rate (DM) ......................................... XXX XXX XXX XXX XXX XXX XXX XXX

Average interest rate .......................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Variable Rate ($US) ................................... XXX XXX XXX XXX XXX XXX XXX XXX

Average interest rate .......................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Interest Rate Derivatives (In millions)

Interest Rate Swaps:

Variable to Fixed ($US) .............................. $XXX $XXX $XXX $XXX $XXX $XXX $XXX $XXX

Average pay rate ................................ X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Average receive rate ........................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Fixed to Variable ($US) .............................. XXX XXX XXX XXX XXX XXX XXX XXX

Average pay rate ................................ X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Average receive rate ........................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Exchange Rate Sensitivity

The table below provides information

about the Company’s derivative financial

instruments, other financial instruments, and

firmly committed sales transactions by

functional currency and presents such

information in U.S. dollar equivalents.1 The

table summarizes information on instruments

and transactions that are sensitive to foreign

currency exchange rates, including foreign

currency forward exchange agreements,

deutschmark (DM)-denominated debt

obligations, and firmly committed DM sales

transactions. For debt obligations, the table

presents principal cash flows and related

weighted average interest rates by expected

maturity dates. For firmly committed DMsales transactions, sales amounts are

presented by the expected transaction date,

which are not expected to exceed two years.

For foreign currency forward exchange

agreements, the table presents the notional

amounts and weighted average exchange

rates by expected (contractual) maturity

dates. These notional amounts generally are

used to calculate the contractual payments to

be exchanged under the contract.

December 31, 19X1

Expected maturity date

19X2 19X3 19X4 19X5 19X6 Thereafter Total Fair

value

On-Balance Sheet Financial Instruments (US$ Equivalent in millions)

$US Functional Currency 2:

Liabilities

Long-Term Debt:

Fixed Rate (DM) .................................. $XXX $XXX $XXX $XXX $XXX $XXX $XXX $XXX

Average interest rate .......................... X.X X.X X.X X.X X.X X.X X.X ................

Expected maturity or transaction date

Anticipated Transactions and Related

Derivatives 3

(US$ Equivalent in millions)

$US Functional Currency:
6070 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

December 31, 19X1

Expected maturity date

19X2 19X3 19X4 19X5 19X6 Thereafter Total Fair

value

Firmly committed Sales Contracts (DM) .... $XXX $XXX ................ ................ ................ ................ $XXX $XXX

Forward Exchange Agreements

(Receive $US/Pay DM):.

Contract Amount .......................... XXX XXX ................ ................ ................ ................ XXX XXX

Average Contractual Exchange

Rate .......................................... X.X X.X ................ ................ ................ ................ X.X ................

2Similar tabular information would be provided for other functional currencies.

3Pursuant to General Instruction 4. to Items 305(a) and 305(b) of Regulation S–K, registrants may include cash flows from anticipated transactions and operating cash flows resulting from non-financial and non-commodity instruments.

Commodity Price Sensitivity

The table below provides information

about the Company’s corn inventory

and futures contracts that are sensitive

to changes in commodity prices,

specifically corn prices. For inventory,

the table presents the carrying amount

and fair value at December 31, 19x1. For

the futures contracts the table presents

the notional amounts in bushels, the

weighted average contract prices, and

the total dollar contract amount by

expected maturity dates, the latest of

which occurs one year from the

reporting date. Contract amounts are

used to calculate the contractual

payments and quantity of corn to be

exchanged under the futures contracts.

December 31, 19X1

Carrying

amount

Fair

value

(In millions)

On Balance Sheet Commodity Position and Related Derivatives

Corn Inventory 4 ........................................................................................................................................................ $XXX $XXX

Expected

maturity Fair

1992 value

Related Derivatives

Futures Contracts (Short):

Contract Volumes (100,000 bushels) ....................................................................................................................... XXX ....................

Weighted Average Price (Per 100,000 bushels) ...................................................................................................... $X.XX ....................

Contract Amount ($US in millions) ........................................................................................................................... $XXX $XXX

4Pursuant to General Instruction 4. to Items 305(a) and 305(b) of Regulation S–K, registrants may include information on commodity positions,

such as corn inventory.

PART 239—FORMS PRESCRIBED

UNDER THE SECURITIES ACT OF 1933

8. The general authority citation for

Part 239 is revised to read, in part, as

follows:

Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s,

77z–2, 77sss, 78c, 78l, 78m, 78n, 78o(d),

78u–5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 79l,

79m, 79n, 79q, 79t, 80a–8, 80a–29, 80a–30

and 80a–37, unless otherwise noted.

* * * * *

9. By amending Form S–1 (referenced

in § 239.11) by redesignating Items 11(j)

through 11(m) as Items 11(k) through

11(n) and adding Item 11(j) to read as

follows:

Note—The text of Form S–1 does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form S–1—Registration Statement

Under the Securities Act of 1933

* * * * *

Item 11. Information with Respect to the

Registrant

* * * * *

(j) Information required by Item 305 of

Regulation S–K (§ 229.305 of this

chapter), quantitative and qualitative

disclosures about market risk.

* * * * *

10. By amending Form S–2

(referenced in § 239.12) by adding

paragraph (9) to Item 11(b), removing

‘‘and’’ at the end of Item 12(a)(3)(vii),

removing the period at the end of Item

12(a)(3)(viii) and in its place adding ‘‘;

and’’, and adding paragraph (ix) to Item

12(a)(3) to read as follows:

Note—The text of Form S–2 does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form S–2—Registration Statement

Under the Securities Act of 1933

* * * * *

Item 11. Information with Respect to the

Registrant

(a) * * *

(b) * * *

(9) Furnish quantitative and

qualitative disclosures about market risk

required by Item 305 of Regulation S–

K (§ 229.305 of this chapter).

* * * * *

Item 12. Incorporation of Certain

Information by Reference

(a) * * *

(3) * * *
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6071

(ix) quantitative and qualitative

disclosures about market risk as

required by Item 305 of Regulation S–

K (§ 229.305 of this chapter).

* * * * *

11. By amending Form S–11

(referenced in § 239.18) to redesignate

Items 30 through 36 as Items 31 through

37 and to add Item 30 to Part I to read

as follows:

Note—The text of Form S–11 does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form S–11—Registration Statement

Under the Securities Act of 1933

* * * * *

Item 30. Quantitative and Qualitative

Disclosures About Market Risk

Furnish the information required by

Item 305 of Regulation S–K (§ 229.305 of

this chapter).

* * * * *

12. By amending Form S–4

(referenced in § 239.25) by removing

‘‘and’’ at the end of Item 12(b)(3)(v) and

the period at the end of Item 12(b)(3)(vi)

and in its place adding ‘‘; and’’, adding

paragraph (vii) to Item 12(b)(3),

removing ‘‘and’’ at the end of Item

13(a)(3)(v) and the period at the end of

Item 13(a)(3)(vi) and in its place adding

‘‘; and’’, adding paragraph (vii) to Item

13(a)(3), removing ‘‘and’’ at the end of

Item 14(h) and the period at the end of

Item 14(i) and in its place adding ‘‘;

and’’, adding paragraph (j) to Item 14,

and adding paragraph (10) to Item 17(b)

to read as follows:

Note—The text of Form S–4 does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form S–4—Registration Statement

Under the Securities Act of 1933

* * * * *

Item 12. Information with Respect to S–

2 or S–3 Registrants

* * * * *

(b) * * *

(3) * * *

(vii) Item 305 of Regulation S–K

(§ 229.305 of this chapter), quantitative

and qualitative disclosures about market

risk.

* * * * *

Item 13. Incorporation of Certain

Information by Reference

* * * * *

(a) * * *

(3) * * *

(vii) Item 305 of Regulation S–K

(§ 229.305 of this chapter) quantitative

and qualitative disclosures about market

risk.

* * * * *

Item 14. Information with Respect to

Registrants Other Than S–3 or S–2

Registrants

* * * * *

(j) Item 305 of Regulation S–K

(§ 229.305 of this chapter), quantitative

and qualitative disclosures about market

risk.

* * * * *

Item 17. Information with Respect to

Companies Other Than S–3 or S–2

Companies

* * * * *

(b) * * *

(10) Item 305 of Regulation S–K

(§ 229.305 of this chapter), quantitative

and qualitative disclosures about market

risk.

* * * * *

13. By amending Form F–4

(referenced in § 239.34) to redesignate

Item 12(b)(3)(vi) as Item 12(b)(3)(vi)(A),

add paragraph (B) to Item 12(b)(3)(vi),

redesignate Item 14(g) as Item 14(g)(1),

add Item 14(g)(2), redesignate Item

17(b)(4) as Item 17(b)(4)(i), and add Item

17(b)(4)(ii) to read as follows:

Note—The text of Form F–4 does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form F–4—Registration Statement

Under the Securities Act of 1933

* * * * *

Item 12. Information With Respect to F–

2 or F–3 Registrants

* * * * *

(b) * * *

(3) * * *

(vi)(A) * * *

(B) Item 9A of Form 20–F,

quantitative and qualitative disclosures

of market risk.

* * * * *

Item 14. Information With Respect to

Foreign Registrants Other Than F–2 or

F–3 Registrants

* * * * *

(g)(1) * * *

(2) Item 9A of Form 20–F, quantitative

and qualitative disclosures of market

risk.

* * * * *

Item 17. Information With Respect to

Foreign Companies Other Than F–2 or

F–3 Companies

* * * * *

(b) * * *

(4)(i) * * *

(b)(4)(ii) Item 9A of Form 20–F,

quantitative and qualitative disclosures

of market risk.

* * * * *

PART 240—GENERAL RULES AND

REGULATIONS, SECURITIES

EXCHANGE ACT OF 1934

14. The general authority citation for

Part 240 is revised to read in part as

follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j,

77s, 77z–2, 77eee, 77ggg, 77nnn, 77sss, 77ttt,

78c, 78d, 78f, 78i, 78j, 78k, 78k–1, 78l, 78m,

78n, 78o, 78p, 78q, 78s, 78u–5, 78w, 78x,

78ll(d), 79q, 79t, 80a–20, 80a–23, 80a–29,

80a–37, 80b–3, 80b–4 and 80b–11, unless

otherwise noted.

* * * * *

15. By amending § 240.14a-3 by

adding paragraph (b)(5)(iii) to read as

follows:

§ 240.14a–3 Information to be furnished to

security holders.

* * * * *

(b) * * *

(5) * * *

(iii) The report shall contain the

quantitative and qualitative disclosures

about market risk required by Item 305

of Regulation S–K (§ 229.305 of this

chapter).

* * * * *

16. By amending § 240.14a–101 to

remove the word ‘‘and’’ at the end of

Item 13(a)(4), redesignate Item 13(a)(5)

as Item 13(a)(6), add Item 13(a)(5), add

Instruction 6 to Item 13, remove ‘‘and’’

at the end of Item 14(b)(2)(i)(B)(3)(vi)

and the period at the end of Item

14(b)(2)(i)(B)(3)(vii) and in its place add

‘‘; and’’, add paragraph (viii) to Item

14(b)(2)(i)(B)(3), remove ‘‘and’’ at the

end of Item 14(b)(2)(ii)(A)(3)(v) and the

period at the end of Item

14(b)(2)(ii)(A)(3)(vi) and in its place add

‘‘; and’’, add paragraph (vii) to Item

14(b)(2)(ii)(A)(3), remove ‘‘and’’ at the

end of Item 14(b)(3)(i)(H) and the period

at the end of Item 14(b)(3)(i)(I) and in its

place add ‘‘; and’’, add paragraph (J) to

Item 14(b)(3)(i), and add Instruction 8 to

Item 14 to read as follows:

§ 240.14a–101 Schedule 14A. Information

required in proxy statement.

* * * * *

Item 13. Financial and other

information

(a) Information required. * * *

(5) Item 305 of Regulation S–K,

quantitative and qualitative disclosures

about market risk; and

* * * * *

Instructions to Item 13

* * * * *

6. A registered investment company

need not comply with items (a)(2),

(a)(3), and (a)(5) of this Item 13.

* * * * *
6072 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

Item 14. Mergers, consolidations,

acquisitions and similar matters

* * * * *

(b) Information about the registrant

and the other person.

* * * * *

(2) Information with respect to S–2 or

S–3 registrants.

(i) Information required to be

furnished. * * *

(B) * * *

(3) * * *

(viii) Item 305 of Regulation S–K

(§ 229.305 of this chapter), quantitative

and qualitative disclosures about market

risk.

(ii) Incorporation of certain

information by reference. ***

(A) * * *

(3) * * *

(vii) Item 305 of Regulation S–K

(§ 229.305 of this chapter), quantitative

and qualitative disclosures about market

risk.

* * * * *

(3) Information with respect to

registrants other than S–2 or S–3

registrants.

(i) * * *

(J) Item 305 of Regulation S–K

(§ 229.305 of this chapter), quantitative

and qualitative disclosures about market

risk.

* * * * *

Instructions to Item 14

* * * * *

8. A registered management

investment company need not comply

with items (A), (D), (F), (G), (H), and (J)

of paragraph (b)(3)(i) of this Item 14.

* * * * *

PART 249—FORMS, SECURITIES

EXCHANGE ACT OF 1934

17. The authority for Part 249

continues to read, in part, as follows:

Authority: 15 U.S.C. 78a, et seq., unless

otherwise noted;

18. By amending Form 10 (referenced

in § 249.210) by revising Item 2 to read

as follows:

Note—The text of Form 10 does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form 10—General Form for

Registration of Securities

* * * * *

Item 2. Financial Information

Furnish the information required by

Items 301, 303, and 305 of Regulation

S–K (§§ 229.301, 229.303, and 229.305

of this chapter).

* * * * *

19. By amending Form 20-F

(referenced in § 249.220f) by adding

Item 9A to be inserted after Item 9 and

before Item 10 in Part I to read as

follows:

Note—The text of Form 20-F does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form 20–F—Registration Statement

Pursuant to Section 12(b) or (g) of the

Securities Exchange Act of 1934; or

Annual Report Pursuant to Section 13

or 15(d) of the Securities Exchange Act

of 1934; or Transaction Report

Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

* * * * *

Part I

* * * * *

Item 9A. Quantitative and Qualitative

Disclosures About Market Risk

(a) Quantitative information about

market risk. (1) Registrants shall

provide, in their reporting currency,

quantitative information about market

risk as of the end of the latest fiscal year,

in accordance with one of the following

three disclosure alternatives. In

preparing this quantitative information,

registrants shall categorize market risk

sensitive instruments into instruments

entered into for trading purposes and

instruments entered into for purposes

other than trading purposes. Within

both the trading and other than trading

portfolios, separate quantitative

information shall be presented, to the

extent material, for each market risk

exposure category (i.e., interest rate risk,

foreign currency exchange rate risk,

commodity price risk, and other

relevant market risks, such as equity

price risk). A registrant may use one of

the three alternatives set forth below for

all of the required quantitative

disclosures about market risk. A

registrant also may choose, from among

the three alternatives, one disclosure

alternative for market risk sensitive

instruments entered into for trading

purposes and another disclosure

alternative for market risk sensitive

instruments entered into for other than

trading purposes. Alternatively, a

registrant may choose any disclosure

alternative, from among the three

alternatives, for each risk exposure

category within the trading and other

than trading portfolios. The three

disclosure alternatives are:

(i)(A)(1) Tabular presentation of

information related to market risk

sensitive instruments; such information

shall include fair values of the market

risk sensitive instruments and contract

terms sufficient to determine future cash

flows from those instruments,

categorized by expected maturity dates.

(2) Tabular information relating to

contract terms shall allow readers of the

table to determine expected cash flows

from the market risk sensitive

instruments for each of the next five

years. Comparable tabular information

for any remaining years shall be

displayed as an aggregate amount.

(3) Within each risk exposure

category, the market risk sensitive

instruments shall be grouped based on

common characteristics. Within the

foreign currency exchange rate risk

category, the market risk sensitive

instruments shall be grouped by

functional currency and within the

commodity price risk category, the

market risk sensitive instruments shall

be grouped by type of commodity.

(4) See the Appendix to this Item for

a suggested format for presentation of

this information; and

(B) Registrants shall provide a

description of the contents of the table

and any related assumptions necessary

to understand the disclosures required

under paragraph (a)(1)(i)(A) of this Item

9A; or

(ii)(A) Sensitivity analysis disclosures

that express the potential loss in future

earnings, fair values, or cash flows of

market risk sensitive instruments

resulting from one or more selected

hypothetical changes in interest rates,

foreign currency exchange rates,

commodity prices, and other relevant

market rates or prices over a selected

period of time. The magnitude of

selected hypothetical changes in rates or

prices may differ among and within

market risk exposure categories; and

(B) Registrants shall provide a

description of the model, assumptions,

and parameters, which are necessary to

understand the disclosures required

under paragraph (a)(1)(ii)(A) of this Item

9A; or

(iii)(A) Value at risk disclosures that

express the potential loss in future

earnings, fair values, or cash flows of

market risk sensitive instruments over a

selected period of time, with a selected

likelihood of occurrence, from changes

in interest rates, foreign currency

exchange rates, commodity prices, and

other relevant market rates or prices;

(B)(1) For each category for which

value at risk disclosures are required

under paragraph (a)(1)(iii)(A) of this

Item 9A, provide either:

(i) The average, high and low

amounts, or the distribution of the value

at risk amounts for the reporting period;

or

(ii) The average, high and low

amounts, or the distribution of actual

changes in fair values, earnings, or cash
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6073

flows from the market risk sensitive

instruments occurring during the

reporting period; or

(iii) The percentage or number of

times the actual changes in fair values,

earnings, or cash flows from the market

risk sensitive instruments exceeded the

value at risk amounts during the

reporting period;

(2) Information required under

paragraph (a)(1)(iii)(B)(1) of this Item 9A

is not required for the first fiscal year

end in which a registrant must present

Item 9A information; and

(C) Registrants shall provide a

description of the model, assumptions,

and parameters, which are necessary to

understand the disclosures required

under paragraphs (a)(1)(iii) (A) and (B)

of this Item 9A.

(2) Registrants shall discuss material

limitations that cause the information

required under paragraph (a)(1) of this

Item 9A not to reflect fully the net

market risk exposures of the entity. This

discussion shall include summarized

descriptions of instruments, positions,

and transactions omitted from the

quantitative market risk disclosure

information or the features of

instruments, positions, and transactions

that are included, but not reflected fully

in the quantitative market risk

disclosure information.

(3) Registrants shall present

summarized market risk information for

the preceding fiscal year. In addition,

registrants shall discuss the reasons for

material quantitative changes in market

risk exposures between the current and

preceding fiscal years. Information

required by this paragraph (a)(3),

however, is not required if disclosure is

not required under paragraph (a)(1) of

this Item 9A for the current fiscal year.

Information required by this paragraph

(a)(3) is not required for the first fiscal

year end in which a registrant must

present Item 9A information.

(4) If registrants change disclosure

alternatives or key model

characteristics, assumptions, and

parameters used in providing

quantitative information about market

risk (e.g., changing from tabular

presentation to value at risk, changing

the scope of instruments included in the

model, or changing the definition of loss

from fair values to earnings), and if the

effects of any such change is material,

the registrant shall:

(i) Explain the reasons for the change;

and

(ii) Either provide summarized

comparable information, under the new

disclosure method, for the year

preceding the current year or, in

addition to providing disclosure for the

current year under the new method,

provide disclosures for the current year

and preceding fiscal year under the

method used in the preceding year.

Instructions to Item 9A(a)

1. Under Item 9A(a)(1):

A. For each market risk exposure

category within the trading and other

than trading portfolios, registrants may

report the average, high, and low

sensitivity analysis or value at risk

amounts for the reporting period, as an

alternative to reporting year-end

amounts.

B. In determining the average, high,

and low amounts for the fiscal year

under instruction 1.A. of the

Instructions to Item 9A(a), registrants

should use sensitivity analysis or value

at risk amounts relating to at least four

equal time periods throughout the

reporting period (e.g., four quarter-end

amounts, 12 month-end amounts, or 52

week-end amounts).

C. Functional currency means

functional currency as defined by

generally accepted accounting

principles (see, e.g., FASB, Statement of

Financial Accounting Standards No. 52,

‘‘Foreign Currency Translation’’, (‘‘FAS

52’’) paragraph 20 (December 1981)).

D. Registrants using the sensitivity

analysis and value at risk disclosure

alternatives are encouraged, but not

required, to provide quantitative

amounts that reflect the aggregate

market risk inherent in the trading and

other than trading portfolios.

2. Under Item 9A(a)(1)(i):

A. Examples of contract terms

sufficient to determine future cash flows

from market risk sensitive instruments

include, but are not limited to:

i. Debt instruments—principal

amounts and weighted average effective

interest rates;

ii. Forwards and futures—contract

amounts and weighted average

settlement prices;

iii. Options—contract amounts and

weighted average strike prices;

iv. Swaps—notional amounts,

weighted average pay rates or prices,

and weighted average receive rates or

prices; and

v. Complex instruments—likely to be

a combination of the contract terms

presented in 2.A.i. through iv. of this

Instruction;

B. When grouping based on common

characteristics, instruments should be

categorized, at a minimum, by the

following characteristics, when

material:

i. Fixed rate or variable rate assets or

liabilities;

ii. Long or short forwards and futures;

iii. Written or purchased put or call

options with similar strike prices;

iv. Receive fixed and pay variable

swaps, receive variable and pay fixed

swaps, and receive variable and pay

variable swaps;

v. The currency in which the

instruments’ cash flows are

denominated;

vi. Financial instruments for which

foreign currency transaction gains and

losses are reported in the same manner

as translation adjustments under

generally accepted accounting

principles (see, e.g., FAS 52 paragraph

20 (December 1981)); and

vii. Derivatives used to manage risks

inherent in anticipated transactions;

C. Registrants may aggregate

information regarding functional

currencies that are economically related,

managed together for internal risk

management purposes, and have

statistical correlations of greater than

75% over each of the past three years;

D. Market risk sensitive instruments

that are exposed to rate or price changes

in more than one market risk exposure

category should be presented within the

tabular information for each of the risk

exposure categories to which those

instruments are exposed;

E. If a currency swap (see, e.g., FAS

52 Appendix E for a definition of

currency swap) eliminates all foreign

currency exposures in the cash flows of

a foreign currency denominated debt

instrument, neither the currency swap

nor the foreign currency denominated

debt instrument are required to be

disclosed in the foreign currency risk

exposure category. However, both the

currency swap and the foreign currency

denominated debt instrument should be

disclosed in the interest rate risk

exposure category; and

F. The contents of the table and

related assumptions that should be

described include, but are not limited

to:

i. The different amounts reported in

the table for various categories of the

market risk sensitive instruments (e.g.,

principal amounts for debt, notional

amounts for swaps, and contract

amounts for options and futures);

ii. The different types of reported

market rates or prices (e.g., contractual

rates or prices, spot rates or prices,

forward rates or prices); and

iii. Key prepayment or reinvestment

assumptions relating to the timing of

reported amounts.

3. Under Item 9A(a)(1)(ii):

A. Registrants should select

hypothetical changes in market rates or

prices that are expected to reflect

reasonably possible near-term changes

in those rates and prices. In this regard,

absent economic justification for the

selection of a different amount,
6074 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

registrants should use changes that are

not less than 10 percent of end of period

market rates or prices;

B. For purposes of instruction 3.A. of

the Instructions to Item 9A(a), the term

reasonably possible has the same

meaning as defined by generally

accepted accounting principles (see,

e.g., FASB, Statement of Financial

Accounting Standards No. 5,

‘‘Accounting for Contingencies,’’ (‘‘FAS

5’’) paragraph 3 (March 1975));

C. For purposes of instruction 3.A. of

the Instructions to Item 9A(a), the term

near term means a period of time going

forward up to one year from the date of

the financial statements (see generally

AICPA, Statement of Position 94–6,

‘‘Disclosure of Certain Significant Risks

and Uncertainties,’’ (‘‘SOP 94–6’’) at

paragraph 7 (December 30, 1994));

D. Market risk sensitive instruments

that are exposed to rate or price changes

in more than one market risk exposure

category should be included in the

sensitivity analysis disclosures for each

market risk category to which those

instruments are exposed;

E. Registrants with multiple foreign

currency exchange rate exposures

should prepare foreign currency

sensitivity analysis disclosures that

measure the aggregate sensitivity to

changes in all foreign currency

exchange rate exposures, including the

effects of changes in both transactional

currency/functional currency exchange

rate exposures and functional currency/

reporting currency exchange rate

exposures. For example, assume a

French division of a registrant

presenting its financial statements in

U.S. dollars ($US) invests in a

deutschmark(DM)-denominated debt

security. In these circumstances, the

$US is the reporting currency and the

DM is the transactional currency. In

addition, assume this division

determines that the French franc (FF) is

its functional currency according to FAS

52. In preparing the foreign currency

sensitivity analysis disclosures, this

registrant should report the aggregate

potential loss from hypothetical changes

in both the DM/FF exchange rate

exposure and the FF/$US exchange rate

exposure; and

F. Model, assumptions, and

parameters that should be described

include, but are not limited to, how loss

is defined by the model (e.g., loss in

earnings, fair values, or cash flows), a

general description of the modeling

technique (e.g., duration modeling,

modeling that measures the change in

net present values arising from selected

hypothetical changes in market rates or

prices, and a description as to how

optionality is addressed by the model),

the types of instruments covered by the

model (e.g., derivative financial

instruments, other financial

instruments, derivative commodity

instruments, and whether other

instruments are included voluntarily,

such as certain commodity instruments

and positions, cash flows from

anticipated transactions, and certain

financial instruments excluded under

instruction 3.C.ii. of the General

Instructions to Items 9A(a) and 9A(b)),

and other relevant information about the

model’s assumptions and parameters

(e.g., the magnitude and timing of

selected hypothetical changes in market

rates or prices used, the method by

which discount rates are determined,

and key prepayment or reinvestment

assumptions).

4. Under Item 9A(a)(1)(iii):

A. The confidence intervals selected

should reflect reasonably possible nearterm changes in market rates and prices.

In this regard, absent economic

justification for the selection of different

confidence intervals, registrants should

use intervals that are 95 percent or

higher;

B. For purposes of instruction 4.A. of

the Instructions to Item 9A(a), the term

reasonably possible has the same

meaning as defined by generally

accepted accounting principles (see,

e.g., FAS 5, paragraph 3 (March 1975));

C. For purposes of instruction 4.A. of

the Instructions to Item 9A(a), the term

near term means a period of time going

forward up to one year from the date of

the financial statements (see generally

SOP 94–6, at paragraph 7 (December 30,

1994));

D. Registrants with multiple foreign

currency exchange rate exposures

should prepare foreign currency value at

risk analysis disclosures that measure

the aggregate sensitivity to changes in

all foreign currency exchange rate

exposures, including the aggregate

effects of changes in both transactional

currency/functional currency exchange

rate exposures and functional currency/

reporting currency exchange rate

exposures. For example, assume a

French division of a registrant

presenting its financial statements in

U.S. dollars ($US) invests in a

deutschmark(DM)-denominated debt

security. In these circumstances, the

$US is the reporting currency and the

DM is the transactional currency. In

addition, assume this division

determines that the French franc (FF) is

its functional currency according to FAS

52. In preparing the foreign currency

value at risk disclosures, this registrant

should report the aggregate potential

loss from hypothetical changes in both

the DM/FF exchange rate exposure and

the FF/$US exchange rate exposure; and

E. Model, assumptions, and

parameters that should be described

include, but are not limited to, how loss

is defined by the model (e.g., loss in

earnings, fair values, or cash flows), the

type of model used (e.g., variance/

covariance, historical simulation, or

Monte Carlo simulation and a

description as to how optionality is

addressed by the model), the types of

instruments covered by the model (e.g.,

derivative financial instruments, other

financial instruments, derivative

commodity instruments, and whether

other instruments are included

voluntarily, such as certain commodity

instruments and positions, cash flows

from anticipated transactions, and

certain financial instruments excluded

under instruction 3.C.ii. of the General

Instructions to Items 9A(a) and 9A(b)),

and other relevant information about the

model’s assumptions and parameters,

(e.g., holding periods, confidence

intervals, and, when appropriate, the

methods used for aggregating value at

risk amounts across market risk

exposure categories, such as by

assuming perfect positive correlation,

independence, or actual observed

correlation).

5. Under Item 9A(a)(2), limitations

that should be considered include, but

are not limited to:

A. The exclusion of certain market

risk sensitive instruments, positions,

and transactions from the disclosures

required under Item 9A(a)(1) (e.g.,

derivative commodity instruments not

permitted by contract or business

custom to be settled in cash or with

another financial instrument,

commodity positions, cash flows from

anticipated transactions, and certain

financial instruments excluded under

instruction 3.C.ii. of the General

Instructions to Items 9A(a) and 9A(b)).

Failure to include such instruments,

positions, and transactions in preparing

the disclosures under Item 9A(a)(1) may

be a limitation because the resulting

disclosures may not fully reflect the net

market risk of a registrant; and

B. The ability of disclosures required

under Item 9A(a)(1) to reflect fully the

market risk that may be inherent in

instruments with leverage, option, or

prepayment features (e.g., options,

including written options, structured

notes, collateralized mortgage

obligations, leveraged swaps, and

options embedded in swaps).

(b) Qualitative information about

market risk. (1) To the extent material,

describe:

(i) The registrant’s primary market

risk exposures;
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6075

(ii) How those exposures are

managed. Such descriptions shall

include, but not be limited to, a

discussion of the objectives, general

strategies, and instruments, if any, used

to manage those exposures; and

(iii) Changes in either the registrant’s

primary market risk exposures or how

those exposures are managed, when

compared to what was in effect during

the most recently completed fiscal year

and what is known or expected to be in

effect in future reporting periods.

(2) Qualitative information about

market risk shall be presented

separately for market risk sensitive

instruments entered into for trading

purposes and those entered into for

purposes other than trading.

Instructions to Item 9A(b)

1. For purposes of disclosure under

Item 9A(b), primary market risk

exposures means:

A. The following categories of market

risk: Interest rate risk, foreign currency

exchange rate risk, commodity price

risk, and other relevant market rate or

price risks (e.g., equity price risk); and

B. Within each of these categories, the

particular markets that present the

primary risk of loss to the registrant. For

example, if a registrant has a material

exposure to foreign currency exchange

rate risk and, within this category of

market risk, is most vulnerable to

changes in dollar/yen, dollar/pound,

and dollar/peso exchange rates, the

registrant should disclose those

exposures. Similarly, if a registrant has

a material exposure to interest rate risk

and, within this category of market risk,

is most vulnerable to changes in shortterm U.S. prime interest rates, it should

disclose the existence of that exposure.

2. For purposes of disclosure under

Item 9A(b), registrants should describe

primary market risk exposures that exist

as of the end of the latest fiscal year, and

how those exposures are managed.

General Instructions to Items 9A(a) and

9A(b)

1. The disclosures called for by Items

9A(a) and 9A(b) are intended to clarify

the registrant’s exposures to market risk

associated with activities in derivative

financial instruments, other financial

instruments, and derivative commodity

instruments.

2. In preparing the disclosures under

Items 9A(a) and 9A(b), registrants are

required to include derivative financial

instruments, other financial

instruments, and derivative commodity

instruments.

3. For purposes of Items 9A(a) and

9A(b), derivative financial instruments,

other financial instruments, and

derivative commodity instruments

(collectively referred to as ‘‘market risk

sensitive instruments’’) are defined as

follows:

A. Derivative financial instruments

has the same meaning as defined by

generally accepted accounting

principles (see, e.g., FASB, Statement of

Financial Accounting Standards No.

119, ‘‘Disclosure about Derivative

Financial Instruments and Fair Value of

Financial Instruments,’’ (‘‘FAS 119’’)

paragraphs 5–7 (October 1994)), and

includes futures, forwards, swaps,

options, and other financial instruments

with similar characteristics;

B. Other financial instruments means

all financial instruments as defined by

generally accepted accounting

principles for which fair value

disclosures are required (see, e.g., FASB,

Statement of Financial Accounting

Standards No. 107, ‘‘Disclosures about

Fair Value of Financial Instruments,’’

(‘‘FAS 107’’) paragraphs 3 and 8

(December 1991)), except for derivative

financial instruments, as defined above;

C.i. Other financial instruments

include, but are not limited to, trade

accounts receivable, investments, loans,

structured notes, mortgage-backed

securities, trade accounts payable,

indexed debt instruments, interest-only

and principal-only obligations, deposits,

and other debt obligations;

ii. Other financial instruments

exclude employers’ and plans’

obligations for pension and other postretirement benefits, substantively

extinguished debt, insurance contracts,

lease contracts, warranty obligations

and rights, unconditional purchase

obligations, investments accounted for

under the equity method, minority

interests in consolidated enterprises,

and equity instruments issued by the

registrant and classified in stockholders’

equity in the statement of financial

position (see, e.g., FAS 107, paragraph

8 (December 1991)). For purposes of this

item, trade accounts receivable and

trade accounts payable need not be

considered other financial instruments

when their carrying amounts

approximate fair value; and

D. Derivative commodity instruments

include, to the extent such instruments

are not derivative financial instruments,

commodity futures, commodity

forwards, commodity swaps,

commodity options, and other

commodity instruments with similar

characteristics that are permitted by

contract or business custom to be settled

in cash or with another financial

instrument. For purposes of this

paragraph, settlement in cash includes

settlement in cash of the net change in

value of the derivative commodity

instrument (e.g., net cash settlement

based on changes in the price of the

underlying commodity).

4.A. In addition to providing required

disclosures for the market risk sensitive

instruments defined in instruction 2. of

the General Instructions to Items 9A(a)

and 9A(b), registrants are encouraged to

include other market risk sensitive

instruments, positions, and transactions

within the disclosures required under

Items 9A(a) and 9A(b). Such

instruments, positions, and transactions

might include commodity positions,

derivative commodity instruments that

are not permitted by contract or

business custom to be settled in cash or

with another financial instrument, cash

flows from anticipated transactions, and

certain financial instruments excluded

under instruction 3.C.ii. of the General

Instructions to Items 9A(a) and 9A(b).

B. Registrants that voluntarily include

other market risk sensitive instruments,

positions and transactions within their

quantitative disclosures about market

risk under the sensitivity analysis or

value at risk disclosure alternatives are

not required to provide separate market

risk disclosures for any voluntarily

selected instruments, positions, or

transactions. Instead, registrants

selecting the sensitivity analysis and

value at risk disclosure alternatives are

permitted to present comprehensive

market risk disclosures, which reflect

the combined market risk exposures

inherent in both the required and any

voluntarily selected instruments,

position, or transactions. Registrants

that choose the tabular presentation

disclosure alternative should present

voluntarily selected instruments,

positions, or transactions in a manner

consistent with the requirements in Item

9A(a) for market risk sensitive

instruments.

C. If a registrant elects to include

voluntarily a particular type of

instrument, position, or transaction in

their quantitative disclosures about

market risk, that registrant should

include all, rather than some, of those

instruments, positions, or transactions

within those disclosures. For example,

if a registrant holds in inventory a

particular type of commodity position

and elects to include that commodity

position within their market risk

disclosures, the registrant should

include the entire commodity position,

rather than only a portion thereof, in

their quantitative disclosures about

market risk.

5.A. Under Items 9A(a) and 9A(b), a

materiality assessment should be made

for each market risk exposure category

within the trading and other than

trading portfolios.
6076 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

B. For purposes of making the

materiality assessment under

instruction 5.A. of the General

Instructions to Items 9A(a) and 9A(b),

registrants should evaluate both:

i. The materiality of the fair values of

derivative financial instruments, other

financial instruments, and derivative

commodity instruments outstanding as

of the end of the latest fiscal year; and

ii. The materiality of potential, nearterm losses in future earnings, fair

values, and cash flows from reasonably

possible near-term changes in market

rates or prices.

iii. If either paragraphs B.i. or B.ii. in

this instruction of the General

Instructions to Items 9A(a) and 9A(b)

are material, the registrant should

disclose quantitative and qualitative

information about market risk, if such

market risk for the particular market risk

exposure category is material.

C. For purposes of instruction 5.B.i. of

the General Instructions to Items 9A(a)

and 9A(b), registrants generally should

not net fair values, except to the extent

allowed under generally accepted

accounting principles (see, e.g., FASB

Interpretation No. 39, ‘‘Offsetting of

Amounts Related to Certain Contracts’’

(March 1992)). For example, under this

instruction, the fair value of assets

generally should not be netted with the

fair value of liabilities.

D. For purposes of instruction 5.B.ii.

of the General Instructions to Items

9A(a) and 9A(b), registrants should

consider, among other things, the

magnitude of:

i. Past market movements;

ii. Reasonably possible, near-term

market movements; and

iii. Potential losses that may arise

from leverage, option, and multiplier

features.

E. For purposes of instructions 5.B.ii.

and 5.D.ii. of the General Instructions to

Items 9A(a) and 9A(b), the term near

term means a period of time going

forward up to one year from the date of

the financial statements (see generally

SOP 94–6, at paragraph 7 (December 30,

1994)).

F. For the purpose of instructions

5.B.ii. and 5.D.ii. of the General

Instructions to Items 9A(a) and 9A(b),

the term reasonably possible has the

same meaning as defined by generally

accepted accounting principles (see,

e.g., FAS 5, paragraph 3 (March 1975)).

6. For purposes of Items 9A(a) and

9A(b), registrants should present the

information outside of, and not

incorporate the information into, the

financial statements (including the

footnotes to the financial statements). In

addition, registrants are encouraged to

provide the required information in one

location. However, alternative

presentation, such as inclusion of all or

part of the information in Management’s

Discussion and Analysis, may be used at

the discretion of the registrant. If

information is disclosed in more than

one location, registrants should provide

cross-references to the locations of the

related disclosures.

7. For purposes of the instructions to

Items 9A(a) and 9A(b), trading purposes

has the same meaning as defined by

generally accepted accounting

principles (see, e.g., FAS 119, paragraph

9a (October 1994)). In addition,

anticipated transactions means

transactions (other than transactions

involving existing assets or liabilities or

transactions necessitated by existing

firm commitments) an enterprise

expects, but is not obligated, to carry out

in the normal course of business (see,

e.g., FASB, Statement of Financial

Accounting Standards No. 80,

‘‘Accounting for Futures Contracts,’’

paragraph 9, (August 1984)).

(c) Interim periods. If interim period

financial statements are included or are

required to be included by Article 3 of

Regulation S–X (17 CFR 210),

discussion and analysis shall be

provided so as to enable the reader to

assess the sources and effects of material

changes in information that would be

provided under Item 9A of Form 20–F

from the end of the preceding fiscal year

to the date of the most recent interim

balance sheet.

Instructions to Item 9A(c)

1. Information required by paragraph

(c) of this Item 9A is not required until

after the first fiscal year end in which

this Item 9A is applicable.

(d) Safe Harbor. (1) The safe harbor

provided in Section 27A of the

Securities Act of 1933 (15 U.S.C. 77z-2)

and Section 21E of the Securities

Exchange Act of 1934 (15 U.S.C. 78u-5)

(‘‘statutory safe harbors’’) shall apply,

with respect to all types of issuers and

transactions, to information provided

pursuant to paragraphs (a), (b), and (c)

of this Item 9A, provided that the

disclosure is made by an issuer; a

person acting on behalf of the issuer; an

outside reviewer retained by the issuer

making a statement on behalf of the

issuer; or an underwriter, with respect

to information provided by the issuer or

information derived from information

provided by the issuer.

(2) For purposes of this paragraph (d)

of this Item 9A only:

(i) All information required by

paragraphs (a), (b)(1)(i), (b)(1)(iii), and

(c) of this Item 9A is considered forward

looking statements for purposes of the

statutory safe harbors, except for

historical facts such as the terms of

particular contracts and the number of

market risk sensitive instruments held

during or at the end of the reporting

period; and

(ii) With respect to paragraph (a) of

this Item 9A, the meaningful cautionary

statements prong of the statutory safe

harbors will be satisfied if a registrant

satisfies all requirements of that same

paragraph (a) of this Item 9A.

(e) Small business issuers. Small

business issuers, as defined in § 230.405

of this chapter and § 240.12b-2 of this

chapter, need not provide the

information required by this Item 9A,

whether or not they file on forms

specially designated as small business

issuer forms.

General Instructions to Items 9A(a),

9A(b), 9A(c), 9A(d), and 9A(e)

1. Bank registrants, thrift registrants,

and non-bank and non-thrift registrants

with market capitalizations on January

28, 1997 in excess of $2.5 billion should

provide Item 9A disclosures in filings

with the Commission that include

annual financial statements for fiscal

years ending after June 15, 1997. Nonbank and non-thrift registrants with

market capitalizations on January 28,

1997 of $2.5 billion or less should

provide Item 9A disclosures in filings

with the Commission that include

annual financial statements for fiscal

years ending after June 15, 1998.

2.A. For purposes of instruction 1. of

the General Instructions to Items 9A(a),

9A(b), 9A(c), 9A(d), and 9A(e), bank

registrants and thrift registrants include

any registrant which has control over a

depository institution.

B. For purposes of instruction 2.A. of

the General Instructions to Items 9A(a),

9A(b), 9A(c), 9A(d), and 9A(e), a

registrant has control over a depository

institution if:

i. The registrant directly or indirectly

or acting through one or more other

persons owns, controls, or has power to

vote 25% or more of any class of voting

securities of the depository institution;

ii. The registrant controls in any

manner the election of a majority of the

directors or trustees of the depository

institution; or

ii. The Federal Reserve Board or

Office of Thrift Supervision determines,

after notice and opportunity for hearing,

that the registrant directly or indirectly

exercises a controlling influence over

the management or policies of the

depository institution;

C. For purposes of instruction 2.B. of

the General Instructions to Items 9A(a),

9A(b), 9A(c), 9A(d), and 9A(e), a

depository institution means any of the

following:
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6077

1The information is presented in U.S. dollars

because that is the registrant’s reporting currency.

i. An insured depository institution as

defined in section 3(c)(2) of the Federal

Deposit Insurance Act (12 U.S.C.A. Sec.

1813 (c));

ii. An institution organized under the

laws of the United States, any State of

the United States, the District of

Columbia, any territory of the United

States, Puerto Rico, Guam, American

Somoa, or the Virgin Islands, which

both accepts demand deposits or

deposits that the depositor may

withdraw by check or similar means for

payment to third parties or others and

is engaged in the business of making

commercial loans.

D. For purposes of instruction 1. of

the General Instructions to Items 9A(a),

9A(b), 9A(c), 9A(d), and 9A(e), market

capitalization is the aggregate market

value of common equity as set forth in

General Instruction I.B.1. of Form S–3;

provided however, that common equity

held by affiliates is included in the

calculation of market capitalization; and

provided further that instead of using

the 60 day period prior to filing

referenced in General Instruction I.B.1.

of Form S–3, the measurement date is

January 28, 1997.

Appendix to Item 9A—Tabular Disclosures

The tables set forth below are illustrative

of the format that might be used when a

registrant elects to present the information

required by paragraph (a)(1)(i)(A) of Item 9A

regarding terms and information about

derivative financial instruments, other

financial instruments, and derivative

commodity instruments. These examples are

for illustrative purposes only. Registrants are

not required to display the information in the

specific format illustrated below. Alternative

methods of display are permissible as long as

the disclosure requirements of the section are

satisfied. Furthermore, these examples were

designed primarily to illustrate possible

formats for presentation of the information

required by the disclosure item and do not

purport to illustrate the broad range of

derivative financial instruments, other

financial instruments, and derivative

commodity instruments utilized by

registrants.

Interest Rate Sensitivity

The table below provides information

about the Company’s derivative financial

instruments and other financial instruments

that are sensitive to changes in interest rates,

including interest rate swaps and debt

obligations. For debt obligations, the table

presents principal cash flows and related

weighted average interest rates by expected

maturity dates. For interest rate swaps, the

table presents notional amounts and

weighted average interest rates by expected

(contractual) maturity dates. Notional

amounts are used to calculate the contractual

payments to be exchanged under the

contract. Weighted average variable rates are

based on implied forward rates in the yield

curve at the reporting date. The information

is presented in U.S. dollar equivalents, which

is the Company’s reporting currency. The

instrument’s actual cash flows are

denominated in both U.S. dollars ($US) and

German deutschmarks (DM), as indicated in

parentheses.

December 31, 19X1

Expected maturity date

19X2 19X3 19X4 19X5 19X6 Thereafter Total Fair

value

Liabilities (US$ Equivalent in millions)

Long-term Debt:

Fixed Rate ($US) ....................................... $XXX $XXX $XXX $XXX $XXX $XXX $XXX $XXX

Average interest rate .......................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Fixed Rate (DM) ......................................... XXX XXX XXX XXX XXX XXX XXX XXX

Average interest rate .......................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Variable Rate ($US) ................................... XXX XXX XXX XXX XXX XXX XXX XXX

Average interest rate .......................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Interest Rate Derivatives (In millions)

Interest Rate Swaps:

Variable to Fixed ($US) .............................. $XXX $XXX $XXX $XXX $XXX $XXX $XXX $XXX

Average pay rate ................................ X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Average receive rate ........................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Fixed to Variable ($US) .............................. XXX XXX XXX XXX XXX XXX XXX XXX

Average pay rate ................................ X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Average receive rate ........................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Exchange Rate Sensitivity

The table below provides information

about the Company’s derivative financial

instruments, other financial instruments, and

firmly committed sales transactions by

functional currency and presents such

information in U.S. dollar equivalents. 1 The

table summarizes information on instruments

and transactions that are sensitive to foreign

currency exchange rates, including foreign

currency forward exchange agreements,

deutschmark (DM)-denominated debt

obligations, and firmly committed DM sales

transactions. For debt obligations, the table

presents principal cash flows and related

weighted average interest rates by expected

maturity dates. For firmly committed DMsales transactions, sales amounts are

presented by the expected transaction date,

which are not expected to exceed two years.

For foreign currency forward exchange

agreements, the table presents the notional

amounts and weighted average exchange

rates by expected (contractual) maturity

dates. These notional amounts generally are

used to calculate the contractual payments to

be exchanged under the contract.
6078 Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations

December 31, 19X1

Expected maturity date

19X2 19X3 19X4 19X5 19X6 Thereafter Total Fair

value

On-Balance Sheet Financial Instruments (US$ Equivalent in millions)

$US Functional Currency 2:

Liabilities.

Long-Term Debt:.

Fixed Rate (DM) .................................. $XXX $XXX $XXX $XXX $XXX $XXX $XXX $XXX

Average interest rate .......................... X.X% X.X% X.X% X.X% X.X% X.X% X.X%

Expected maturity or transaction date

Anticipated Transactions and Related

Derivatives 3

(US$ Equivalent in millions)

$US Functional Currency:

Firmly committed Sales Contracts (DM) .... $XXX $XXX ................ ................ ................ ................ $XXX $XXX

Forward Exchange Agreements (Receive $US/Pay DM):

Contract Amount ........................................ XXX XXX ................ ................ ................ ................ XXX XXX

Average Contractual Exchange Rate ........ X.X% X.X% ................ ................ ................ ................ X.X% ................

2Similar tabular information would be provided for other functional currencies.

3Pursuant to General Instruction 4. to Items 9A(a) and 9A(b) of Form 20–F, registrants may include cash flows from anticipated transactions

and operating cash flows resulting from non-financial and non-commodity instruments.

Commodity Price Sensitivity

The table below provides information

about the Company’s corn inventory and

futures contracts that are sensitive to changes

in commodity prices, specifically corn prices.

For inventory, the table presents the carrying

amount and fair value at December 31, 19x1.

For the futures contracts the table presents

the notional amounts in bushels, the

weighted average contract prices, and the

total dollar contract amount by expected

maturity dates, the latest of which occurs one

year from the reporting date. Contract

amounts are used to calculate the contractual

payments and quantity of corn to be

exchanged under the futures contracts.

December 31, 19X1

Carrying

amount

Fair

value

(In millions)

On Balance Sheet Commodity Position and Related Derivatives

Corn Inventory 4 ........................................................................................................................................................ $XXX $XXX

Expected

maturity Fair

1992 value

Related Derivatives

Futures Contracts (Short):

Contract Volumes (100,000 bushels) ....................................................................................................................... XXX ....................

Weighted Average Price (Per 100,000 bushels) ...................................................................................................... $X.XX ....................

Contract Amount ($US in millions) ........................................................................................................................... $XXX $XXX

4Pursuant to General Instruction 4. to Items 305(a) and 305(b) of Regulation S-K, registrants may include information on commodity positions,

such as corn inventory.

20. By amending Form 10–Q (referenced in

§ 249.308a) by removing references to ‘‘Items

1 and 2 of Part I of this form’’ and adding

in their place references to ‘‘Items 1, 2, and

3 of Part I of this form’’ in paragraphs 1 and

2 of General Instruction F, adding paragraph

2.c. to General Instruction H and Item 3 to

Part I to read as follows:

Note—The text of Form 10–Q does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form 10–Q—Quarterly Report Pursuant

to Section 13 or 15(d) of the Securities

Exchange Act of 1934; or Transition

Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

* * * * *

General Instructions

* * * * *

H. Omission of Information by Certain

Wholly-Owned Subsidiaries

* * * * *

2. * * * c. Such registrants may omit

the information called for by Item 3 of

Part I, Quantitative and Qualitative

Disclosures About Market Risk.

* * * * *

Part I—Financial Information

* * * * *
Federal Register / Vol. 62, No. 27 / Monday, February 10, 1997 / Rules and Regulations 6079

Item 3. Quantitative and Qualitative

Disclosures About Market Risk

Furnish the information required by

Item 305 of Regulation S-K (§ 229.305 of

this chapter).

* * * * *

21. By amending Form 10–K

(referenced in § 249.310) by adding Item

7A to be inserted after Item 7 and before

Item 8 in Part II to read as follows:

Note—The text of Form 10–K does not, and

this amendment will not, appear in the Code

of Federal Regulations.

Form 10–K—Annual Report Pursuant

to Section 13 or 15(d) of the Securities

Exchange Act of 1934; or Transition

Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

* * * * *

Part II

* * * * *

Item 7A. Quantitative and Qualitative

Disclosures About Market Risk

Furnish the information required by

Item 305 of Regulation S-K (§ 229.305 of

this chapter).

* * * * *

Dated: January 31, 1997.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 97–2991 Filed 2–7–97; 8:45 am]

BILLING CODE 8010–01–P