VICTORIA GEDDES, Executive Director.
ASX Compliance Updates with some reminders on Disclosure Rules on Earnings Guidance
Since the end of February 2020, ASX has released three key Compliance Updates (28 February, 31 March and 22 April) which include a raft of amendments or reminders, prompted in the main by the challenges associated with the impact of COVID-19 on a company’s operations, including its continuous disclosure obligations.
For investor relations professionals, any additional guidance relating to Continuous Disclosure is mandatory reading so this note focuses on ASX’s comments in relation to the application of LR 3.1 during COVID-19 and in particular those applying to Guidance Note 8 on earnings guidance.
A recent AIRA Webinar on this topic included a Q&A session with Quentin Digby, Partner Herbert Smith Freehills, and Kevin Lewis, Chief Compliance Officer, ASX. We have included some of the more common questions together with their responses.
Continuous Disclosure Obligations — COVID-19
In the current rapidly evolving and highly uncertain environment surrounding the coronavirus pandemic, ASX does not expect listed entities to announce information under LR 3.1 that ‘comprises matters of supposition or is insufficiently definite to warrant disclosure’ (carve out under LR 3.1A.1).
ASX notes that a listed entity’s continuous disclosure obligations do not extend to predicting the unpredictable. It does not expect listed entities to make forward looking statements to the market unless they have a clear and reasonable basis for doing so.
Q. How should a company manage expectations in the current environment?
A. Don’t attempt to guide consensus, companies are not required to update the market based on expected earnings relative to consensus and in this environment most sellside forecasts can be assumed to be out of date and analysts will be flying blind. Focus on updates to the market that are based on actual performance to date.
The ASX guidance update on 31 March strongly encouraged entities that have not reviewed their published guidance in light of COVID-19 to do so. Where that review reveals guidance is no longer current, entities should update it or, perhaps more sensibly in the current uncertain climate, simply withdraw it.
The 28 February update gives greater clarity in relation to the materiality threshold an entity should use to determine whether to update any earnings guidance to avoid market sensitive earnings surprises. As a general rule, entities should assume that if the expected variation in earnings relative to published guidance is less than or equal to 5%, it is not material and its guidance does not need updating. If it is greater than or equal to 10%, it is material and guidance should be updated.
Q. If an entity withdraws guidance should it replace it?
A. At the current point in time, you would be at risk of trying to predict the unpredictable. At best, point to performance to date and acknowledge the difficulty of trying to estimate trading over the next couple of months (FY2020) or the remainder of the calendar year. Withdrawal of guidance is essentially indicating that the entity no longer has confidence that it can be met, so the market shouldn’t rely on it. This doesn’t mean the entity can’t achieve it but it lacks confidence that it can.
Where the expected variation in earnings is between 5% and 10%, the entity needs to form a judgement as to whether it is material. A rough guide, that may be used is, entities in the ASX 300 or that normally have very stable or predictable earnings, should consider applying a materiality threshold closer to 5%, while entities outside the ASX 300 with relatively variable earnings may apply a materiality threshold of 10%.
Q. If guidance is in a range and an entity expects to come in 5-10% below the bottom end of the range, is that disclosable?
A. Yes you must disclose. A good rule of thumb is to take the mid-point of the range and apply the 5-10% above and below that point.
Assessing disclosure in the absence of published guidance
Importantly these recommendations around the materiality threshold only apply to entities that have published guidance. It does not apply if:
- an entity’s actual or expected earnings vary by 5-10% from consensus
- if there is no consensus, an entity’s actual or expected earnings vary by 5-10% on the previous corresponding period’s earnings.
These two points remain unchanged by the recent ASX compliance updates but, in the context of the coronavirus pandemic they are worth revisiting.
Consensus Earnings are not a proxy for Published Earnings Guidance
The use of consensus as a proxy for market expectations is a well-established practice in investor relations. It is regarded as one measure by which entities might consider whether the market has got ‘out of kilter’ with the entities’ underlying performance, prompting a Market or Trading Update to be lodged with ASX.
This position is articulated well in s7.4 of Guidance Note 8, “Correcting analyst forecasts and consensus estimates”.
If a significant difference does emerge between an entities’ internal earnings projections on the one hand and the earnings forecasts of a significant proportion of analysts and/or consensus estimates on the other, then it behoves the entity to ask why that might be so… if this leads it to the conclusion that more information needs to be disclosed, the way to address this is to make an announcement to the market, and not by selectively divulging the information to analysts.
When there is no guidance and no analyst coverage
For companies that do not provide guidance and have no analyst coverage, the default comparator is the previous corresponding period’s earnings. This is because the only (and therefore the best) available guide to likely earnings in the current period are its earnings for the prior corresponding period [note 204].
The 2019 decision in the Myer case, the first Australian securities class action to be decided at trial, clarified that when an entity comments that it expects earnings to be above, below or in line with its earnings for the corresponding prior period, then that constitutes de facto guidance.
Aside from that specific situation, if an entity becomes aware that its earnings for the current reporting period will differ (downwards or upwards) from market expectations, it needs to consider carefully whether it has a legal obligation to notify the market of that fact. This may arise if the difference is of such magnitude that a reasonable person would expect it to have a material effect on the price or value of the entity’s securities – in other words a “market sensitive earnings surprise”. A 5-10% variation in earnings relative to the previous corresponding period is not applicable here, what is relevant in assessing whether an entity is in market sensitive territory is how the following two questions mightbe answered by a relevant officer of an entity:
- “Would this information influence my decision to buy or sell securities in the entity at their current market price?”
- “Would I feel exposed to an action for insider trading if I were to buy or sell securities in the entity at their current market price, knowing this information had not been disclosed to the market?”