As if oil and gas companies didn’t have enough to worry about. With West Texas Intermediate crude sinking to US$42.50 at the time of writing and going who knows where, Canadian energy executives are preoccupied with cutting costs, re-jigging capital expenditures and deciding whether or not to irk investors by slashing dividends. The last thing they want to deal with is more rules to continually disclose more details about their financial affairs.
But that’s just what regulators are demanding. From third-party related transactions to more stringent guidelines on how to describe prospective resources, energy companies are being asked to spit out more numbers. And, as well, to more accurately describe and harmonize just how they get at those numbers.
With market conditions deteriorating for oil and gas, Canadian securities administrators at both provincial and national levels have focused greater attention on continuous disclosure obligations, says lawyer Ross Bentley, a partner at Blake, Cassels & Graydon LLP in Calgary who specializes in mergers & acquisitions and corporate finance in the energy sector.
The Canadian Securities Administrators (CSA) issues national rules for publicly listed companies. Recently, says Bentley, it “put issuers on notice that they will not accept boiler plate statements” when it comes to certain kinds of continuous disclosure requirements. “Rather they are looking for issuers to disclose and specifically quantify, in sufficient detail, information for investors to be able to understand clearly a company’s financial circumstances.”
The CSA wants oil and gas companies to disclose greater information on matters such as the cash flow necessary to fund current operations and to satisfy obligations such as maintaining payments on debt facilities and dividends. They are, explains Bentley, “seeking clarity on any significant risks of defaults on dividend payments, debt payments, debt covenants or other contractual obligations.” They also want companies to do more to inform investors about their current and future ability to find funding sources through debt and credit facilities in the current economic climate.
“What they are looking for is to ensure there is a clear road map for investors to interpret the impact of this strain that issuers are facing.” However, the CSA has expressed concern about the past muddiness of those road maps, which could steer investors into a ditch.
In July, the CSA released a review of continuous disclosure programs for the fiscal year ended March 31, 2015. Noting that “investors deserve high-quality disclosure as they rely on this information to make informed investment decisions,” the CSA conducted 1058 reviews of continuous disclosure by publically listed Canadian companies. In 59 per cent of those cases reviewed, the CSA ordered issuers to improve or amend their disclosure. Some issuers were referred to enforcement or had cease trade orders issued against them because of failures to disclose pertinent information.
On July 1, CSA amendments for several “national instruments” – rules that apply to publically listed companies headquartered in all provinces and territories – came into force. For Calgary-based lawyer Roy Hudson, a partner with DLA Piper who works primarily with junior oil and gas exploration and production companies, the biggest concern for his clients are amendments to National Instrument 51-101 Standards of Disclosure for Oil and Gas.
“I guess on the energy side the one thing that has been difficult particularly for juniors is disclosure of not reserves, but where companies are in a stage of development where [new assets] haven’t been classified as reserves,” says Hudson.
Many smaller oil companies, he explains, in addition to filing detailed mandatory disclosures of their property and independently audited reserves, voluntarily disclose what are known as contingent and prospective resources. Junior companies especially, as they attempt to attract investors, often list these prospective or contingent resources: their estimated quantities of oil or gas in the ground that, depending on a number of factors might or might not one day be extracted. Such resources, for instance, can’t be classified as reserves if there isn’t yet a nearby pipeline that could transport the oil or gas to market.
“You can imagine there are real good reasons for regulations to be all encompassing in a situation like that,” says Hudson. Otherwise, investors could be misled. “However,” adds Hudson, “those companies still have to get a resource evaluation done, so they have to pay someone to do the evaluation.” Not an easy thing to do for cash-starved juniors, who, due to the costs of complying with the new amendments, may have to curtail such reporting in the future. When it comes to reeling in investors, that’s like fishing without a lure.
The new rules, which include new and standardized definitions for various kinds of resources, are now effective for issuers with a December 31, 2015, year-end. The CSA says the rules are also intended to give oil and gas companies that operate in different jurisdictions increased reporting flexibility, and covers new kinds of oil and gas products not previously covered.
The amendments, says the CSA, provide clearer guidance for disclosure of contingent and prospective reserves. The amendments include requirements to increase detail concerning the risked net present value of future net revenue, and requirements to clarify the concept of marketability in reporting oil and gas volumes. As well, the CSA, concerned about inconsistencies in reporting well abandonment and reclamations costs, have added requirements that those costs be more accurately detailed in future net revenue disclosures and identified as significant factors or uncertainties in disclosures going forward.
But Hudson wonders if the new changes under NI51-101, which had been in the works for several years, are still relevant in a rapidly changing and depressed market that is hard for regulators to keep pace with. At one point, junior resource issuers, already struggling with the costs of complying with disclosure obligations for companies listed on the TSX and TSX-V, were gunning for rule changes that would mean smaller companies would only have to report financials every six months instead of quarterly. That would save them money, but it didn’t happen.
Yet, say lawyers interviewed, few oil companies, large or small, or their legal counsel, have voiced much concern about amendments to NI 51-101 or other regulatory changes surrounding continuous disclosure. In part, that’s because they’re preoccupied helming their companies through the commodities storm.
As well, adds Hudson, who has practised in the oil and gas sector for 30 years, “So much of the regulatory environment used to be people on the ground, dealing with issuers, dealing with enforcement. Now there’s a whole section of securities regulators, in particular, focused on policy development. Those are regulators that energy executives and their legal counsel rarely get to see. And you wonder,” muses Hudson, “if...they aren’t talking to industry, how they are coming up with the rules?”
Securities regulators do have a consultation process that seeks industry input. But, as it’s morphed in recent years, securities administrators have sent out an increasing torrent of requests for comments from industry on a plethora of proposed rules, amendments and other matters. “But there are only so many hours in the day,” says Hudson, “so even a lot of law firms are not in the position to pull together cogent and useful comment on all this flood of request for comments.”
In the case of NI 51-101, says Hudson, only one law firm commented on those proposed amendments (and just 12 of the 319 oil-and-gas related companies listed on Toronto’s two exchanges responded). “I was sort of shocked at that...” says Hudson.
Other recent rule changes affecting disclosure, specifically amendments to NI 51-102 Continuous Disclosure Obligations, intended for all publically listed companies, have gotten little reaction from the energy sector so far. Intended to help streamline reporting for issuers on the Venture exchange, the CSA says the changes will improve the quality of information reported while reducing the burden of preparation.
Applying to fiscal years beginning on or after July 1, 2015, venture issuers now have the option of providing quarterly highlights instead of full interim Management Discussion & Analysis (MD&A) of the previous year’s activities and results. Those highlights, says the CSA, must include short discussions “of all material information regarding a company’s operations, liquidity, capital resources, as well as analysis of the company’s financial condition, trends, uncertainties and other factors.”
The CSA – spurred by reviews showing companies were often overly vague in their materials – has also issued directives that publically traded companies must improve reporting of significant transactions between related parties.
One area securities regulators are particularly focused on are good-will impairments — that somewhat nebulous balance-sheet item that encompasses the ongoing value of an acquired asset’s brand name and its relationship with customers.
In times like these, explains Bentley, securities commissions have noted that current economic and market conditions are likely to adversely affect the carrying amounts of assets companies acquired before oil prices tanked. “We are seeing a greater focus and expectation around the clarity of information about how write downs [of goodwill] were arrived at and how carried balances an issuer continues to show on its balance sheet are justified.”
If there’s one thing the energy industry really dislikes, says Calgary lawyer William Osler, co-head of Bennett Jones LLP’s capital markets and mergers and acquisition practice, it’s regulatory uncertainty. As long as new regulations provide clarity (Osler says he has heard no complaints about them so far), the energy sector will adapt, he says. “The industry is a very resilient, flexible industry filled with very smart people. What the industry can deal with...and make it look effortless is certainty. They like to know what their playing field is, and what their rules are.”