Upcoming FASB Proposal to Expand Derivative Scope Exception Rule
In April 2024, the FASB voted in favor of releasing a new proposal that would expand the existing derivative scope exception to include “contracts with underlyings based on the operations or activities” that are specific to one of the parties to the contract. In general, this has the potential for more arrangements to meet the scope exception and thereby avoid following the derivative accounting rules. The discussion comes almost 20 years since the original derivative guidance was issued. The FASB has heard from its constituents that the definition of a derivative is being applied too broadly and is often going beyond the intention of the original guidance. A formal proposal is expected to be released this summer.
SEC Disclosure Priorities
SEC officials from the Division of Corporation Finance (“CorpFin”) announced key areas in which they will focus their review efforts in 2024. Among the most significant areas is the new segment reporting disclosures, which became effective for companies with fiscal years beginning after December 15, 2023. The new standard, ASU No. 2023-07 – Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, requires public entities to disclose significant expenses of a reportable segment if those expenses are regularly provided to the chief operating decision maker. Among other amendments, the standard is intended to help investors better understand an entity’s segment performance and assess potential future cash flows within that segment.
SEC officials also announced that inflation remains a key topic for disclosure review. Although CorpFin has indicated that inflation appears to be turning the corner in 2024, it warns that any material impacts to a company’s operations as a result of ongoing inflation levels, including the impact on costs of operations, should be appropriately disclosed. CorpFin also asks that companies avoid high-level trend summaries on inflation in their disclosures and instead asks companies to discuss the more “particularized risks and impacts” to their operations of elevated inflation levels.
We are now over a year removed from the disruptions in the banking industry caused by the failures of Signature Bank, Silicon Valley Bank, and First Republic Bank, among others, which were primarily caused by steep inflation and rapidly rising interest rates in early 2023. SEC officials have stated they will continue to monitor and closely assess disclosures related to the 2023 banking crisis and any ongoing impacts to a company’s operations related to interest rate risk and liquidity risk.
New on the SEC’s review priority list is the ongoing impact of declining property values and elevated interest rates on the asset quality of holdings in commercial real estate (“CRE”). Hybrid work has become the norm for many companies in the post-COVID world, which means companies generally need less office space for their operations. This has resulted in declining demand for commercial property and has resulted in declines in CRE property values. More broadly, lending companies have seen an overall uptick in loan delinquencies on CRE lending. CorpFin asks that companies disclose in detail, and at a granular level, concentrations of CRE in loan portfolios as well as potential credit risks and loss exposure. Specifically, SEC officials noted companies should discuss movements or changes in CRE loan balances in context of other quantitative information including past-due statistics and in relation to other non-performing loans.
Other areas of priority, according to CorpFin, include disclosures related to a company’s use of generative AI technology, appropriate use of non-GAAP disclosures, and appropriate level of detail in pay for performance disclosures in a company’s proxy statements.
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