BoardMatters Quarterly, April 2013
Conflict minerals and OTC derivatives
Complying with new Dodd-Frank requirements
In recent years, there has been an increasing international focus on conflict minerals emanating from mining operations in the Democratic Republic of the Congo (DRC) and adjoining countries. Armed groups engaged in mining operations in this region are believed to subject workers and indigenous people to human rights abuses and are using proceeds from the sale of conflict minerals to finance regional conflicts.
In response to these concerns, Section 1502 of Dodd-Frank requires certain public companies to provide disclosures about the use of specified conflict minerals emanating from the DRC and nine adjoining countries.
The SEC rule mandated by Dodd-Frank applies to all SEC issuers (including foreign issuers) that manufacture or contract to manufacture products where “conflict minerals are necessary to the functionality or production” of the product.
Conflict minerals are defined to include columbite-tantalite (coltan), cassiterite, gold, wolframite or their derivatives (which are currently limited to tantalum, tin and tungsten). The industries most likely to be affected include electronics and communications, aerospace, automotive, jewelry and industrial products.
Companies should determine whether their products contain conflict minerals, as well as evaluate their supply chains and, where applicable, develop and implement controls necessary to comply with the SEC rule, while monitoring a legal challenge to it. The U.S. Chamber of Commerce and the National Association of Manufacturers have asked the U.S. Court of Appeals for the District of Columbia Circuit to modify or overturn the rule, which is effective for calendar year 2013 (with initial reports required by June 2, 2014 because May 31 falls on a weekend).
The SEC estimates that approximately 6,000 issuers will be directly affected by the rule and that many private companies in the supply chains of these issuers will be affected indirectly. The SEC has stated that it expects that the costs will be substantial to both issuers and non-issuer suppliers and estimates the initial cost of compliance to be between US$3 billion and US$4 billion, with annual costs thereafter of between US$207 million and US$609 million.
The final rule states that the conflict minerals report must be audited by an independent private sector auditor. The objective of this audit is not to confirm the “conflict free” status of a company’s products; instead, the objective is to confirm that a company’s due diligence conforms to the nationally or internationally recognized framework the company uses and is described properly in the conflict minerals report.
Dodd-Frank OTC derivatives regulation
Thousands of companies hedge business risks by entering into over-the-counter (OTC) derivatives with banks or other dealers. Examples include interest rate, foreign exchange, energy and other commodity derivatives. Historically, such OTC derivatives have not been subject to government regulation, but Title VII of Dodd-Frank changes that.
Under Title VII, all OTC derivatives — even hedges executed by non-financial end users — are subject to regulatory oversight and new requirements. Boards and the appropriate committees (which might include audit committees or finance committees) should focus on the effect of Title VII at the companies they oversee. Compliance with some of the new regulations mandates direct board involvement.
The two primary goals of Title VII are to reduce risk to the US financial system and American taxpayers and to increase transparency in the OTC derivatives market. The aim is to reduce systemic risk by mandating central clearing of previously unregulated derivative instruments and requiring more collateral to back derivative trades. In addition, OTC derivatives will be subject to new trading, margin and reporting requirements.
Questions for the audit committee to consider
- Does the company have a road map for complying with all of the requirements of Dodd-Frank and for managing a compliance effort on multiple tracks? Has the road map been shared with the audit committee?
- Has the company identified the individuals or functions that will address compliance with the conflict minerals reporting requirements?
- For OTC derivatives, can the company elect the commercial end-user exception or any of the other exceptions to clearing? If so, does the audit committee (or another committee) have enough information to review and approve this decision?