SEC’s Investment Management Division Issues Guidance on Funds’ Risk Disclosure Regarding Investments in Emerging Markets

The SEC Division of Investment Management’s Disclosure Review and Accounting Office (Staff) has issued guidance (Guidance) based on current findings from the Staff’s ongoing review of risk disclosures for both actively managed and index funds with significant exposure to emerging markets. The Guidance notes that in many emerging markets there is significantly less publicly available information about domestic companies (as compared to the U.S.) due to differences in applicable regulatory, accounting, auditing, and financial reporting and recordkeeping standards.

The Staff encourages funds to provide tailored disclosures of risks in the emerging markets in which they invest and cites factors that funds should consider when drafting risk disclosures. The Staff recommends that funds consider, among other things, whether and how emerging markets risks arising from differences in regulatory, accounting, auditing, and financial reporting and recordkeeping standards could impede an adviser’s ability to evaluate local companies or impact the fund’s performance. The Guidance highlights in particular that regulatory authorities in some emerging markets currently do not provide the Public Company Accounting Oversight Board (PCAOB) with the ability to inspect public accounting firms, including sufficient access to inspect audit work papers and practices, or otherwise do not cooperate with U.S. regulators. Consequently, the Staff urges funds to assess their disclosure with regard to the unique risks associated with investments in jurisdictions that place material limitations on PCAOB inspection, investigation and enforcement. In this regard, the Guidance cites as an example the significant risks related to investments in China due to the inability of the PCAOB to inspect audit work papers and practices of PCAOB-registered accounting firms in China with respect to their audit work of U.S. reporting companies. The Guidance states that potentially unique operating considerations (i.e., with respect to a company’s regulatory environment and accounting and financial reporting matters) and any material limitations on PCAOB oversight of companies’ auditors should be considered and reflected in risk disclosures of funds that have significant exposure to emerging markets.

Other factors cited in the Guidance include (i) risks related to, but not limited to, lack of liquidity, market manipulation concerns, limited reliable access to capital, political risk, and foreign investment structures; and (ii) any limitations on the rights and remedies available to the fund against portfolio companies. In addition, the Guidance cites considerations specific to index funds, such as whether the index provider will have less reliable or current information when assessing if a company should be included in an index or determining a company’s weighting within the index; and limitations concerning the adviser’s ability to assess the index provider’s due diligence process over index data.

The Guidance is available at: Please Click Here