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In 1997, the US Securities and Exchange
Commission (SEC) issued new disclosure
rules in an amendment to Regulation S-X
entitled ‘‘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’’ (SEC, 1997). As
indicated by its title, this release requires the
disclosure of both qualitative and
quantitative information about market risk
by all companies registered with the SEC for
annual periods ending after 15 June 1998.
Larger companies, with market
capitalizations in excess of $2.5 billion,
banks, and thrifts were required to apply the
regulation’s provisions for annual periods
after 15 June 1997. This early adoption was
required because these companies were
likely to have experience with measuring
market risk, and therefore could provide an
experience base for subsequent compliance
with the regulations. Market risk is defined
as the risk of loss arising from adverse
changes in market rates and prices from such
items as interest rates, currency exchange
rates, commodity prices, or equity prices.
The new SEC disclosure rules were issued
in response to large derivative losses
incurred by companies in the early 1990s, and
the fear that losses of these magnitudes could
lead to systemic failure of financial
institutions. Among the most notable were
Showa Shell Sekiya’s $1.58 billion loss on
currency derivatives, Procter & Gamble’s
$157 million loss on leveraged currency
swaps, and ARCO’s employee savings loss of
$22 million on money market derivatives.
Highlighting the potential worldwide risk,
Loomis (1994) indicated that the total
notional value of all derivative contracts
outstanding in 1994 was $16 trillion[1]. By
contrast, the 1994 gross national product of
the USA was $6.4 trillion.Given the high-profile losses, as well as dollar amounts running into the trillions, regulators and legislators began to express concern over the use of derivative instruments, leading to calls for tighter regulation. In fact, congressional hearings resulted in proposed legislation that could have adversely affected the derivatives market by regulating their use. The SEC responded to these proposals by indicating that derivatives are a potentially costeffective risk management tool; they argued the most effective solution was to improve disclosure of the risk involved in using derivatives, rather than congressional regulation of the derivatives market. Subsequently, the SEC staff undertook a review of the 10,000 filings for 500 registrants to determine their disclosure of market risk.
Alan Blankley
Previously published in: Managerial Auditing Journal, Volume 17, Number 8, 2002
Emerald Group Publishing Limited; January 2002
78 pages; ISBN 9781845447052
Read online, or download in secure PDF format
78 pages; ISBN 9781845447052
Read online, or download in secure PDF format
