It is less than two years since ASX published its massive Guidance Note 8 on how to comply with the continuous disclosure rules. At 78-odd pages, the guidance dwarfs the two-page Listing Rule 3.1 which it is intended to explain. However, as is inevitable with attempts to explain relatively simple notions, the guidance note threw up some new questions of its own. As a result, ASX has now proposed some further changes.
The changes mainly focus on how companies should handle earnings surprises in compliance with the Listing Rule. That the new guidance in this area is something which needs further clarification is no surprise to us. The new rules regarding earnings surprises were significant changes for many companies, and have dominated the enquiries we have had from clients on continuous disclosure since the publication of the new guidance note in 2012.
The Guidance Note currently provides guidance on when and how companies should disclose earnings surprises to the market.
Naturally, this feeds back into a company’s own treatment of earnings forecasts. In that respect, ASX is concerned about:
- attempts to manoeuvre analyst forecasts so that they align more closely with the company's own internal forecasts; and
- instead of giving the company’s own earnings forecasts to the market, giving out analysts' forecasts or consensus estimates as a form of quasi earnings guidance.
The proposed changes to Guidance 8 aim to address these issues.
They begin by emphasising that companies have no obligation to release internal budgets or earnings projections to the market. However, if they do so, they must be vigilant to ensure that they don't leak that information in their dealings with shareholders, analysts and the press. In addition, companies should not provide individual analysts with private summaries of forecasts in an effort to get them closer to the figures produced by their peers: that type of information, says ASX, should be available to everyone through the company's website.
On a company's use of single analyst forecasts or single consensus estimates, ASX says that they should, generally, not be announced on ASX. The ASX announcements platform is intended to notify the market of market sensitive information, and publishing third parties' forecasts or estimates implies that the company itself believes that that information is market sensitive (with the result that it becomes a de facto earnings guidance by the company).
Accordingly, ASX will only allow that type of material to be published on the announcements platform if there is a "detailed and acceptable explanation as to why the entity considers this information to be market sensitive". ASX does not object to the publication of third party forecasts or estimates on a company's own website, but counsels that, even then, "a single analyst’s forecast or a single consensus estimate [may] be seen by many readers as a tacit representation by the entity that its results will be somewhere close to that forecast or estimate and therefore interpreted as de facto earnings guidance".
As an alternative, ASX is willing to allow the following on its announcements platform:
- a list of the individual earnings forecasts of the analysts covering the company's stock (that this means all forecasts is made clear by ASX's insistence that even outliers should be included); or
- a range showing the low, average (or consensus) and high earnings forecasts of the analysts covering its stock,
along with a disclaimer that the company does not endorse, confirm, or express a view as to the accuracy of the forecasts or make any representation that its earnings will fall within the range of forecasts provided.
What is a disclosable earnings surprise?
LR 3.1 clearly states that companies are only required to disclose information "that a reasonable person would expect to have a material effect on the price or value" of the company's securities. However, it appears that some companies have been interpreting the Guidance Note as requiring disclosure where their actual or projected earnings differ from consensus forecasts by a relatively small amount.
The proposed revised Guidance Note aims to reinforce the fact that the disclosure obligation only applies to material changes. To that end, it introduces the term "market sensitive earnings surprises", to clarify the difference between:
- situations in which the company's actual or projected earnings differ so significantly from market expectations that a reasonable person would expect information about its actual or projected earnings to have a material effect on the price or value of its securities (the classic LR 3.1 test); and
- what it describes as "lesser situations", where the company's reported earnings differ from consensus estimates but not to the extent that a reasonable person would expect information about its reported earnings to have a material effect on the price or value of its securities.
- ASX also wants to clarify what differences would be "market sensitive". Perhaps the most important change here is a statement that market sensitivity will, among other things, depend upon whether:
- the company itself has issued earnings guidance (in which case, a relatively small variation from that guidance may be market sensitive (since the market itself regards a company's own earnings guidance as inherently more reliable and authoritative than third party forecasts)); or
- the market's earning expectations are based on third party forecasts or the company's previous earnings.
The proposed new guidance also makes it clear that the existing recommendation that variations of 5%-10% may be material only applies where variation relates to the company's own published guidance for the relevant period – not analyst forecasts or the company's prior earnings.
Other proposed changes to Guidance Note 8 include:
- a new section on analyst briefings, which suggests that companies avoid any continuous disclosure embarrassments by posting all briefing materials on ASX before the briefing;
- the current Guidance Note says that the principles governing earnings forecasts also apply to exploration and production targets – ASX proposes to extend this to financial forecasts of matters such as operational or capital expenditure;
- the inclusion of the names of the parties to the contract in continuous disclosure announcements about contracts;
- clarifying that companies can confidentially disclose internal management accounts, budgets and forecasts to bankers, insurers and rating agencies without tripping Listing Rule 3.1.
What does this mean for you?
For listed companies which don't provide their own guidance to the market, but are covered by sell-side analysts, the clarifications by ASX in relation to earnings surprises and when they must be disclosed will be very much welcomed. The judgment companies need to make in this regard is not necessarily any easier, but the acknowledgement that the level of alignment required is not as great as for a company's own guidance is helpful.
The differential standard which now clearly applies to companies giving their own guidance compared to companies that don't is likely to cause companies to carefully assess whether they will continue to give their own guidance. Of course, if they don't, their obligation to update the market on earnings expectations will then be controlled by what the analysts think.