04 March 2015

Reports on Payments to Government Regulations (2014) – Extractive industries

Enhancing Transparency in the Extractives Industries

The recent enactment of the Reports on Payments to Government Regulations (2014), made the UK the first of the EU member states to implement the EU Accounting Directive for Extractive Industries.

For financial years beginning on or after 1 January 2015, all large (balance sheet of £18m or net turnover of £36m or employing more than 250) or listed oil, gas, mining and logging companies are obliged to prepare annual reports on payments made to governments of £86,000 or above whether these be single payments or an aggregated series of related payments made within the financial year.

The key points to consider in relation to these new obligations include: 

  • Both monetary and non-monetary payments must be reported on a project and payment basis
  • The rules specifically prohibit the artificial disaggregation of payments in order to fall below the reporting threshold
  • The reports must be made on a consolidated basis
  • The legislation exempts directors from making a report under the UK rules where payments to governments are already reported in accordance with equivalent reporting requirements in another jurisdiction.

For the purpose of the regulations, ‘government' means any national, regional or local authority of a country (including government departments, agencies or subsidiary undertakings where the authority is the parent). The regulations will affect many of the world's largest extractive companies.

The objectives of these regulations

Part of an EU-wide effort to curb corruption and promote transparency in the energy and extractives sector, the Directive is expected to lead to a significant shift in corporate governance standards.

The stated objectives of the regulations are twofold: 

  • To provide the citizens of resource-rich countries with the information they need to hold their governments to account; and
  • To provide greater insight (for investors and all other stakeholders) into how the sector operates and the range of economic contributions that can result.

There is a clear desire on the part of the EU’s policy-makers to ensure that concession monies ultimately benefit the populations of host nations.

What constitutes ‘payments’ and how will the regulations be implemented?

The reporting obligation covers non-monetary payments: the definition of ‘payments’ is expressed to include non-monetary payments in kind (to which a value must be attributed) including taxes, royalties, dividends, licence fees, signature, discovery and production bonuses and payments for infrastructure improvements made to governments on a country and project basis. In the absence of any guidance to the contrary, it would be prudent to assume that social infrastructure payments made in fulfilment of collateral CSR arrangements (such as the building of schools, healthcare and providing training for local people) should also be reported.

It remains to be seen how this will be interpreted as businesses are often approached to engage in questionable activity through, for example, providing payments through consultants or third party agents; paying tuition for or offering jobs/internships to the children of government officials; and/or making donations to the favoured charity of a given official.

What is the likely impact of these new regulations on business?

Concerns have been raised as to the cost of implementation and the challenge businesses will face in complying with their new obligations. A UK Government impact study suggests that the additional reporting requirements could cost companies affected an initial £12m followed by £6m a year to comply.

Of equal concern is the asymmetry of disclosure and reporting obligations between the EU, the US and other jurisdictions relevant in the extractives universe. Prior to implementation, there were calls for the Department for Business, Innovation and Skills to hold fire in order to ensure the proposed measures corresponded with those that operate for US-incorporated entities. At time of writing, the US Securities and Exchange Commission (SEC) had diarised its intention to propose a revised rule, by March 2015, governing Section 1504 of the Dodd-Frank Act, which required the SEC to adopt a rule mandating oil, gas and mining companies to annually disclose the payments they made to foreign governments for things such as licenses and permits needed for development.

It remains to be seen how far the ‘publish what you pay’ Dodd Frank obligations differ from those enacted at EU level, and therefore how sizeable a compliance challenge international extractives companies will face. It may be that an exemption will be held to apply if these future US rules are judged to be equivalent reporting requirements, thereby eliminating the need for double reporting.

Several participants in the UK consultation process expressed concern that these new obligations might conflict with legislation in certain countries that would prevent disclosure of information deemed a state or trade secret, potentially placing corporates between a rock and a hard place.

These concerns fell on deaf ears and it is expected that by July 2015, every EU Member State will have enacted this Directive into domestic law. The sanctions for non-compliance in the UK at least will no doubt incentivise compliance. Failure to file a complete and accurate report may lead to an unlimited fine. In addition or alternatively, the company and each of its directors could be subject to a criminal conviction and with directors facing the prospect of imprisonment for up to two years.

It should also be noted that, being filed with Companies House in this jurisdiction, these annual reports will be public record materials, therefore not only accessible to ordinary citizens, but also to competitor undertakings. This could lead to a new frontier for competitive advantage for relevant undertakings.

Deepening compliance culture in the extractive industries

On a positive note, these new reporting requirements feed into the maturing compliance culture in this sector. Requiring the attribution of value to payments in kind will make things like gifts and hospitality protocols more robust and auditable. It should also be borne in mind that the 'naming and shaming' value of this initiative emphasised by the Extractives Industry Transparency Initiative (EITI) applies to both non-compliant companies as well as to the host nations concerned.

In the long run, although it places an additional burden on business in order to track and record relevant payments, this move should benefit the extractives and logging industries, through improvements in cost transparency and resultant efficiency.

Practical Tips

  1. The regulations apply to primary forest logging undertakings or that perform any activity involving the exploration, prospection, discovery, development, and extraction of minerals, oil, natural gas deposits or other materials that are “large undertakings” or “public interest entities”. These are defined as follows:
    • A “large undertaking” is one that meets any two of the following criteria:
      (a) A total balance sheet in excess of £18m
      (b) A net turnover in excess of £36m
      (c) An average number of employees in excess of 250
    • A “public interest” entity includes:
      (d) Entities listed on a regulated market in any EU member state (in the UK, on the main market, not the junior AIM list);
      (e) Credit institutions;
      (f) Insurance undertakings; and
      (g) Entities designated as public interest entities
  2. UK-registered companies to whom the regulation applies will be required to complete annual extractive reports on payments to governments covering financial years beginning on or after 1 January 2015.
  3. Companies required to report will be allowed up to a maximum of 11 months after the end of the financial year to file an extractive report at Companies House.
  4. A payment below £86,000 need not be reported if it relates to a single obligation and is not part of any related series of payments which in aggregate meet or exceed the £86,000 threshold.
  5. Entities that must comply with the FCA’s Disclosure and Transparency Rules may be required to file a separate transparency report under the new DTR4.3BR which was put in place for relevant issuers and listed companies.
If you would like further details of these new rules or have any questions, we would be happy to assist you.

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