In June, Prime Minister Stephen Harper announced that Canada will join other G8 countries and adopt mandatory reporting rules for mining and oil gas companies (“extractive companies”) to disclose all payments they make to host governments for resource extraction projects (“mandatory reporting”). This is one of the biggest changes to public reporting and disclosure the extractive sector has seen in years and important steps need to be taken to be ready.
The Prime Minister’s announcement followed the passage of mandatory reporting in the United States under Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 (“Section 1504”). Last August, the Securities and Exchange Commission adopted Rule 13q-1 to implement Section 1504. However, in July a District Court in the District of Columbia vacated the rule after a successful challenge by the American Petroleum Institute, which has put the timing of implementation of mandatory reporting in the United States in serious question. However, the European Union has remained active in this area and formally adopted the European Union’s Transparency Directive (“EU Directive”) on October 17th that contains similar rules to Section 1504.
Canada’s entry into mandatory reporting has been strongly influenced by the work of a Resource Revenue Transparency Working Group (the “Working Group”) that was convened last September by key mining industry groups and civil society organizations to support adopting a reporting framework in Canada similar to Section 1504. The Working Group published its draft report just two days after the Prime Minister’s announcement in June and is expected to issue its final report at the end of the month. Natural Resources Canada (“NRCan”) has picked up on many of the Working Group’s recommendations during NRCan’s own consultation process over the summer, and is expected to provide detailed recommendations for mandatory reporting after the final Working Group report is released. Once the federal government has both reports in hand it is expected to introduce legislation for mandatory reporting in early 2014.
This bulletin highlights some of the key issues for mandatory reporting that will define how this framework will be implemented and what companies should be doing now to get prepared. This includes understanding the breadth of payment types that will be covered; how ‘project-level’ reporting will work; the threshold amount requiring disclosure; how payments to aboriginal groups will be treated; and whether any exemptions will be permitted. All of these issues will be influenced by the existing frameworks in Section 1504 and the EU Directive, as well as the recommendations of the Working Group and NRCan.
Key Issues for Mandatory Reporting for Extractive Companies in Canada
1. Types of Payments
The SEC’s Rule 13q-1 provides a non-exhaustive list of payments they determined to be part of the commonly recognized revenue stream for the development of an extractive project. These include taxes, royalties, fees, production entitlements, bonuses and infrastructure payments (required by law or contract). This same list was referenced in the NRCan consultations and the Working Group’s draft report (though transportation fees and fines/penalties were also added to the latter.) It is unlikely the federal government will stray far from this list, although there is some support among extractive companies to allow for voluntary “social payments”, such as contributions to local hospitals or schools, to be included. This will likely be permitted as a voluntary category, as is the case under Rule 13q-1.
2. "Project" Definition
The payments listed above are intended to be disclosed on a project-by-project basis, but there is still an issue as to what constitutes a “project” and a preference of some companies for disclosure on a country-wide basis. This was a key debate under Section 1504 but ultimately the SEC chose to use a flexible definition of “project” based on the legal agreements that give rise to payment liabilities such as contracts, licenses, leases or concessions. The Working Group recommended adopting this approach, which seemed largely uncontroversial during the NRCan consultations. As such, expect the Canadian legislation to adopt project-level reporting, even if it means companies will have to disaggregate payments such as corporate income tax in countries where they have multiple projects.
3. Reporting Threshold
A more contentious issue concerns the reporting threshold for payments, which Section 1504 sets at a ‘non de minimus’ level, later determined by the SEC in Rule 13q-1 to be $100,000. The EU Directive set a similar threshold at €100,000, even though regulators in both jurisdictions were pressured to set the threshold at the “materiality” level that public issuers are more accustomed to. This approach was rejected given the secondary purpose of mandatory reporting to benefit local communities in creating greater accountability for resource revenue and not just investors making informed investment decisions. In Canada, the Working Group went a step further and proposed a dual reporting threshold of $100,000 for companies listed on the Toronto Stock Exchange and a lower $10,000 threshold for smaller companies listed on the TSX Venture Exchange. The purpose behind the lower threshold was to allow smaller issuers to better show the payments they are making to local governments since at a $100,000 threshold “a large part of the Canadian mining sector would effectively report no revenue paid.” Both of these thresholds proved contentious at the NRCan consultations with larger issuers seeking the materiality threshold and smaller issuers concerned that $10,000 would result in difficult and expensive compliance. While it is unlikely that Canada will adopt a materiality standard for mandatory reporting, the concerns of junior issuers did seem to resonate and so a $100,000 threshold for all issuers appears the most likely outcome.
4. Aboriginal Payments
While much of the mandatory reporting framework in Canada tracks the precedents of Section 1504 and the EU Directive, the one unique aspect in Canada’s approach is the intention to require mandatory reporting for payments to First Nations and aboriginal groups. Extractive companies often enter into joint ventures and/or impact benefit agreements with aboriginal groups in Canada or elsewhere that give rise to payment obligations not unlike payments to local host governments. During the NRCan consultations there was a lot of concern about this proposal from Canadian aboriginal groups who indicated a strong preference to keep such payments confidential. Industry representatives seemed more receptive so long as their aboriginal counterparties were on board. This resistance could pose a challenge for the mandatory reporting regime and potentially delay implementation. One solution might be a phased-in approach where disclosure to aboriginal groups is not mandated initially or even dealt with separately altogether under a purely federal framework.
5. Forum for Disclosure
One of the areas with the strongest consensus for developing a mandatory reporting framework in Canada is the choice of provincial securities regulators as the preferred forum for this disclosure to be made and enforced. During the NRCan consultations, companies expressed familiarity with provincial securities filings under SEDAR and indicated that they don’t wish to have to deal with a new federal bureaucracy for what they see as relatively minor financial reporting. This consensus raises interesting constitutional questions for the federal government, given the Supreme Court’s 2011 ruling in Reference re: Securities Act that found that much of the day-to-day regulation of securities falls under the property and civil rights concerns of the provinces. This may explain why the federal government has been quietly consulting with provincial mining ministries and may seek to support provincial legislation in this area rather than just a stand-alone federal statute. Should the federal government proceed on its own it may be better suited to survive a constitutional challenge given the international development objectives of the legislation that are a national concern and not one the provinces are actively seeking to address. Should the provinces effectively administer this framework, there could still be a role for the federal government in covering private companies not covered under securities regulation, which NRCan has indicated it is interested in addressing in any framework going forward.
Exemptions and Public Disclosure
As previously mentioned, the D.C. District Court’s ruling in July to vacate Rule 13q-1 has thrown off the timing of implementation of Section 1504 but has also raised substantive issues for Canada’s own framework. The Court vacated Rule 13q-1 by finding that the SEC’s refusal to permit exemptions for countries that prohibit such disclosure (Angola, Cameroon, China, and Qatar were cited) was “arbitrary and capricious” and, further, that the SEC had no basis to require that mandatory reporting be publicly available. The Working Group, whose draft report came out before the District Court’s ruling, firmly endorsed public disclosure and rejected any exemptions on the basis that they would “run counter to the spirit of improving transparency.” Industry views during the NRCan consultation process were more nuanced on this point with some companies fearing a loss of business or good relations if they disclosed payments against the wishes of host countries. That said, industry representatives acknowledged that confidentiality clauses in their contracts almost always permit disclosure where required by law and mining companies in particular appear prepared to reject a ‘tyrant’s veto’ approach that would carve out disclosure for certain regimes that reject mandatory reporting.
The exemption issue may be the most difficult to predict given the strong support for equivalency with Section 1504 among all stakeholders in Canada. On September 3, 2013 the SEC announced that it would not appeal the District Court’s ruling and so the agency will now have to propose a new draft rule that seeks to address the deficiencies identified by the District Court. Given the two years it took the SEC to release the final version of Rule 13q-1 there is little likelihood that a draft rule will be proposed before the Canadian legislation is introduced. Therefore, it is possible that Canada may hedge its bets and require full public disclosure of the reports with no exemptions but leave itself some flexibility to pass regulations that would permit exemptions in the future.
What Canadian Resource Companies Should Be Doing Now
Even though it is likely to be at least a year or more before mandatory reporting becomes a reality in Canada there are still a number of steps extractive companies should take now to be prepared:
1. Stay informed: There are a lot of important details for the Canadian regime to be still worked out, including the ones identified above, but also issues such as reporting payments on a cash or accrued basis; who will certify or provide assurances for the disclosure; what role auditors will play, if any; and the remedies or consequences for omissions or non-compliance. While industry has expressed its views during the NRCan consultations there will likely be further opportunities to influence this framework once the legislation is introduced. It will also be important to follow the SEC’s release of the revised Rule 13q-1, which will be made available for public comment and potentially influence Canadian regulations or equivalency provisions.
2. Watch your confidentiality clauses: Extractive projects have long timelines and so payments required under contracts being entered into now will likely have to be disclosed in the future. Therefore, companies are well advised to ensure that confidentiality clauses in any licences, agreements, concession leases or other contracts they enter into with host governments permit disclosure of what might otherwise be confidential information when required by law. This may be of particular relevance in impact benefit agreements and other contracts with aboriginal groups given some of the resistance to this disclosure seen to date.
3. Start keeping track of payments internally: Companies would be well-served to assess their own record-keeping and accounting systems to see how capable they track resource project payments. Over 100 Canadian companies are already listed on US stock exchanges and may well have started to implement compliance programs. For everyone else, Rule 13-q gave US issuers a little over a year to start tracking and reporting such payments and it is unlikely the Canadian legislation will provide much more lead time. Companies should therefore assess their capabilities sooner rather than later to ensure sufficient time to implement proper monitoring and reporting systems. Industry associations may also play a useful role in gathering best practices and coordinating the development of accounting systems that could reduce costs of compliance.
The international focus on transparency, as most recently manifest in mandatory reporting, presents one of the biggest changes to the extractive sector in some time. Legal counsel can greatly assist in ensuring companies are appropriately managing and complying with these changes. Keep watching this space for updates on mandatory reporting and how best to prepare for this new framework for project development and the resource revenues associated therewith.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.