31 January 2021

ASX introduces new ‘15% Rule’

Ben Rebbeck, Founding Director

Recently, the ASX announced updates to Guidance Note 8 on continuous disclosure requirements in relation to earnings guidance.

While the ASX retained the framework of its existing guidance in the update, its changes to Guidance Note 8 include a new ‘15% Rule’ regarding the impact of broker consensus earnings on guidance and earnings surprises, as follows:

“Where an entity does not have published earnings guidance on foot for the current reporting period and it is covered by sell-side analysts, ASX would recommend that the entity carefully consider notifying the market of a potential earnings surprise if and when it expects there to be a 15% or greater difference between its actual or projected earnings for the period and its best estimate of the market’s expectations for its earnings…”

The ASX has also set out exactly what it expects to see in an announcement about a market-sensitive earnings surprise. Notably, in some circumstances, this will require announcing quantitative guidance even if it had never published earnings guidance in the first place.

Following the changes, generally, earning guidance disclosure requirements, in declining order of importance to any disclosure, can be summarised as follows:

Guidance published No Guidance Published
Analyst Coverage
No Guidance Published
No Analyst Coverage
Expected earnings 5%–10% above or below guidance range (i.e.no change in rule) Expected earnings and consensus differ by 15% ASX has not provided precise percentage guidance.
15–20% change to pcp may be relevant benchmark
Update guidance range Provide guidance and state earnings expected to differ materially from consensus Provide guidance re expected difference to the previous corresponding period

In making these changes, the ASX has affirmed that these benchmarks are indicative of when an earnings surprise announcement ‘should be considered’, rather than ‘should be made’.  While subtle, this wording difference is critically important.  They stress it is only an expected material impact on share price and market trading which drives the requirement for an ASX announcement. That is, no expected material impact on share price / trading…no announcement required.

So if the market has already taken into account sector and market specific events impacting share price, the effect of those events causing the earnings surprise need not be announced.   We suspect it will take a highly confident board to make such a non-disclosure decision.

The changes introduced by the ASX are particularly notable in the current environment as:

  • The quantum and quality of broker analyst research continues in its long term decline trend, spurred on more recently by the impacts of MIFID II, COVID-19 related employee changes and ongoing margin contraction within brokers; and
  • many ASX listed entities withdrew their earnings guidance shortly after the onset of the COVID-19 pandemic and have not since reinstated issuing earnings guidance. The 15% Rule effectively overrides this position.

It could be argued that the changes impose a new regulatory burden as they expressly require listed entities to monitor and treat broker consensus as the benchmark of market expectation and, furthermore, they require such entities to correct “mistakes” and “errors” by analysts.

And while, for mid- and small-caps dealing with issues associated with declining analyst coverage is nothing new, large caps are finally having to address this reality. In that respect, it has always been the case that entities should avoid “earnings surprises” even where they do not issue earnings guidance.

The introduction of the ‘15% Rule’ will give greater clarity to what may be considered to be an earnings surprise.

Notwithstanding this, by including the notion of entities making a ‘best estimate of market expectation’; the ASX acknowledges that the universe of published analyst research may include:

  • out of date forecasts,
  • erroneous assumptions and analysis; and
  • the impact of outlier forecasts on consensus.

Consideration should therefore be given to which analysts’ research is included in the ‘best estimate’ of consensus and which is not.   It has long been FIRST Advisers’ view that any listed company that refers to ‘consensus’ should expressly state what that consensus range is or includes.   Thus, the new ASX guidance reaffirms FIRST Advisers’ long held position.

Finally, the ASX has also taken the opportunity to make some minor editorial changes to Guidance Note 8, noting the recent decision in ASIC v Big Star Energy Limited. In that case, the Court held that Big Star breached Listing Rule 3.1 by announcing the sale of a significant asset without disclosing: (a) the identity of the purchaser; (b) that the entity had done no due diligence to verify the capacity of the purchaser to complete the purchase; and (c) that the entity had in fact been informed by the purchaser that it had not yet received all funding approvals required to complete the purchase. The transaction ultimately failed to complete. The Court specifically rejected an argument by the entity that because the purchase was for a cash consideration, the identity of the purchaser was not material.

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