Disclosures about distributions – still fighting the boilerplate…

The OSC has issued OSC Staff Notice 51-724 Report on Staff’s Review of REIT Distributions Disclosure.

Here’s the summary from the news release:

  • Real estate investment trusts (REITs) provide investors with cash flow in the form of distributions. However, REITs are subject to a number of factors that may negatively affect their cash available for distributions. In these cases, some portion of distributions may come from a REIT’s own capital, or financing sources other than cash flows from operations. As such, it is critical to provide investors with sufficient disclosure regarding sources of cash used for distributions.
  • “Investors are entitled to know the sources of distributions, especially when distributions exceed cash flow from operations” said Huston Loke, Director of Corporate Finance. “These disclosures should highlight the risks and their impact on the issuer as well as the sustainability of distributions. We encourage issuers and their advisers to refer to the guidance in this Notice as they prepare their annual and interim filings.”
  • In conducting the review, OSC staff assessed the disclosures of the 30 Ontario-based reporting issuers against staff expectations outlined in NP 41-201, particularly where distributions exceeded the cash generated by operations. Half the issuers received comments from OSC staff seeking clarification about their distributions and/or their disclosure. Of those, 67% were asked to enhance their disclosure prospectively, which they did.

It seems from the notice that most of these prospective disclosure enhancements were for the purpose of avoiding “boilerplate” language, in particular in those cited situations where distributions exceeded cash flow from operations. For example, the notice provides the following as an example of boilerplate: “For the year ended December 31, 20XX the REIT’s distributions paid of $25 million exceeds cash flow from operations over the same period, by $5 million. In assessing its distribution policy, the REIT considers certain items that may not be included in cash flow from operations, where the timing of cash flows may differ from the timing of payment of distributions.”

In contrast, more entity-specific disclosure would emphasize that the excess represents a return of rather than on capital; specify how the excess amount was financed; and provide more discussion of the reason for this situation and the company’s ability to sustain it – for instance: “The REIT has elected to provide distributions partly representing a return of capital in order to maintain the stability of current distribution levels. Management believes that the current per share level of distributions is sustainable, given that cash flow from operations is expected to improve as the REIT continues to integrate its recently acquired European operations.” Of course, inevitably, this expanded language might often merely constitute a more artful form of boilerplate (considering, for example, how often acquisitions – of European operations or otherwise – fail to realize management’s expectations).

This material, and the comments in the notice on the presentation of measures such as adjusted funds from operations (that they’re often presented with undue prominence compared to GAAP measures, inadequately reconciled to the financial statements, or otherwise insufficiently disclosed) all constitutes long-familiar territory. Somewhat more interesting from an IFRS-related perspective is the commentary on borrowing costs. The notice observes that (unlike old Canadian GAAP) IFRS allows an issuer to choose how it classifies these amounts in the statement of cash flows, with the following consequence: “for 10% of REITs reviewed, distributions did not exceed cash flow from operations only because the REIT has made an accounting policy choice to classify interest paid as a financing activity on the statement of cash flows. If these REITs had instead elected to classify interest as an operating cash flow item, then their distributions would have exceeded cash flow from operations.” This leads the staff to express the view that in these circumstances, an issuer should still address the situation in its disclosure as if it had made such an “excess distribution.”.

It’s an interesting passage in that the report seems hardly able to conceal its disdain for the malleability of IFRS in this regard, even approvingly citing US GAAP (which doesn’t allow such a policy choice) as if this proved that something is amiss. This seems out of step with the emphasis elsewhere on the primacy of IFRS measures, which of course are typically riddled (but less prominently) with the impact of other policy choices. It might also be pointed out that the amount of borrowing costs presented as a financing outflow is only one of the non-operating cash flow items that might be relevant to assessing whether an entity has (by some measure) distributed an “excessive” amount. The (as it then was) CICA has in the past explored this area, discussing for example the possibility and practicality of incorporating the cost of maintaining productive capacity into standard expressions of such measures, but I don’t think regulators have ever shown much enthusiasm for that line of investigation. And one also wonders whether an investor who needs spoon-feeding on such a matter isn’t probably beyond help anyway. Still, for all these obvious limitations, this might constitute a small example of modest Canadian regulatory defiance before the generally all-conquering force of the IASB’s standards…

The opinions expressed are solely those of the author

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