The SEC may require U.S. companies disclose China exposure to shareholders - How should you think about it?

Co-authors include: Ben T. Smith, IV , Doug Mehl , Jennifer Cain , Devin Summers

In a recent hearing in front of the House Select Committee on the CCP, former SEC chairman Jay Clayton proposed a pilot program requiring large companies to disclose their China risk exposure, estimating no more than 150 companies impacted. He also recommended to include in their disclosure an outline of how their operations would be impacted in the event of a disruption in U.S.-China economic ties. The guidelines for the pilot program would require companies to disclose their exposure to China if they fit one of the following criteria:

·?????? Market capitalization over $50 billion

·?????? Revenue in China over $10 billion

·?????? Costs in China over $10 billion

As it currently stands, only 58 companies of the Fortune 500 report China in their annual statements, with global powerhouses either failing to report or rolling China up into larger buckets like ‘Asia’, ‘APAC’, or ‘Other’. Given the limited reporting on China, it is crucial for all remaining 442 Fortune 500 companies and others to understand how this mandate could affect their business and investor expectations as a whole.

Evaluating Your Position

The level of impact this mandate will have on a company will vary depending on their current level of transparency to their shareholders linked with their actual level of exposure in China. We can categorize companies into four groups:

1.?????? Discover: These companies will be heavily impacted by the mandate. They will need to implement operational and administrative changes to abide by the new guidelines. Once they have delineated their China-based operations and exposure, they will need to formulate a new reporting structure to keep investors up to date.

2.?????? Prepare: These companies will also be heavily impacted by the mandate, but they may not need to implement new initiatives. These companies currently report on a regional level, whether it be Asia, Global, or APAC, but not specifically on China. To align with the mandate, companies will need to reorganize their reporting structure to move China-related revenue or costs out from under the regional label. This shift in process will require them to take a deeper look at their operations to fully identify their China-related operations and potential exposure.

3.?????? Monitor: While these companies will not initially be impacted by the mandate, they still may be heavily impacted in the long run. These companies will need to outline their activities in China internally, monitoring their revenue or costs to ensure that they do not go above the threshold.

4.?????? Deepen: These companies already report on China and are likely to have the least impact from an SEC mandate. They will simply need to continue their current reporting practices. However, they may want to take this opportunity to deepen their awareness and pressure test their resiliency to China-related risks.

Decide Your Way Forward

Companies Within Discover and Prepare

We’ve identified 126 Fortune 500 companies that fall within the Discover or Prepare phase under the potential mandate. Right now, these companies are at an impasse: do they go ahead and proactively disclose their China-related risk to investors, simply prepare their reporting structure to disclose the risk, or wait and see if the mandate is implemented?

It is important for these companies to either proactively disclose their risks or invest in the necessary structures for future risk disclosure. While the policy is certainly not guaranteed, companies must weigh the potential benefits if they were to proactively disclose their China-related risks and exposure, including but not limited to:

-????????? Quantified Vulnerabilities: To align with the SEC mandate, Discover and Prepare companies must fully consider and quantify their pockets of exposure. Companies would be forced to carefully assess their China-related risks and identify any potential impact of disruptions caused by rising U.S.-China tensions. This will allow them to more deftly develop risk-based scenarios, minimizing any costly surprises down the road.

-????????? Increased Stakeholder Trust: Reporting China-specific risks is becoming increasingly important to investors, seeking transparency in companies to be able to make sound economic decisions. Proactively reporting risk demonstrates a company’s commitment to transparency and openness, fostering a higher level of trust among investors and attracting additional long-term investors.

Companies Within Monitor

On the other hand, companies that fall within the Monitor approach may delay implementing any changes within their organization, depending on their level of operations in China. Companies near the mandate’s threshold should begin internally assessing their exposure to China and allocating resources for any reporting shifts. Meanwhile, companies with little to no operations in China can delay any such investment, understanding that they may have to make that investment in the future to meet investor expectations.

An SEC mandate could create downstream pressure on smaller companies to report on their China risk exposure. Investors are likely to demand a similar level of transparency from these companies as they choose where to invest their money. Failure to do so could lead to diminished shareholder confidence, reduced access to capital, and other potential market disadvantages, making it compelling for all companies within Monitor to proactively prepare to disclose their China risk exposure sooner rather than later.

Taking Action Now

While this mandate may be seen as cumbersome or another step in tit-for-tat escalations, it will ultimately benefit companies, bolstering investor confidence and minimizing costly surprises in the future. For the 442 Fortune 500 companies that do not already call out China, this means first assessing where they fall within the framework above and deciding for themselves: will they proactively disclose their risk, make internal moves to prepare to disclose, or wait and see?

Sources

1-????? https://selectcommitteeontheccp.house.gov/media/press-releases/media-package-select-committee-ccp-hearing-systemic-risk-chinese-communist

2-????? https://www.sec.gov/