Next Generation ASTM Standards for Environmental Liability Estimation and Disclosure

Transcription

1 Next Generation ASTM Standards for Environmental Liability Estimation and Disclosure Tim Haley, Barnes & Thornburg John Rosengard, ERCI Scott Shock, Exponent Gayle Koch, Axlor April 2017

2 Presenters 2 Timothy A. Haley Partner, Barnes & Thornburg LLP Scott Shock, M.S., P.E. Senior Managing Engineer, Exponent timothy.haley@btlaw.com ssshock@exponent.com John Rosengard, MBA President, ERCI john@erci.com Gayle Schlea Koch, M.S. Principal, Axlor Consulting LLC gkoch@axlorllc.com

3 Barnes & Thornburg 3 What s in this presentation for you and your clients? Help clients better deal with environmental liabilities: Improve liability estimates for transactions / negotiations Improve visibility of unaccrued liabilities (under privilege) Improve capital stewardship and cost recoveries Address blind spots (prevent surprises) Anticipate change Justify needed policy improvements Implement strategic transactions (M&A, bankruptcy, spin-offs, etc) Defend against unreasonable claims

4 Exponent 4 Five Types of Environmental Liabilities Liabilities Asset Retirement Obligations Environmental Obligations Commitments Contingencies Guarantees Power plant decommissioning Demolition RCRA closure Asbestos removal Lead-based paint removal Mine reclamation Oil well plugging and abandonment Spill cleanup Administrative order on consent Notice of Violation Your company promises to buy back facilities if contamination is found by buyer Your company promises to return leased land without structures or damage after the lease ends Legal claims CERCLA past cost reimbursement to USEPA Deminimis cashouts Financial assurance for mine closure, for RCRA OM&M, for CERCLA work Your company promises others will perform work

5 Exponent 5 Asset Retirement Obligation Examples Creosote pilings removal Lead-based paint removal UST removal Asbestos removal

6 Exponent 6 Asset Retirement Obligation Examples Airport decommissioning Warehouse demolition Power plant demolition

7 Exponent 7 Environmental Obligation Examples Contaminated soil removal Sediment remediation Pipeline removal Groundwater remediation

8 Exponent 8 Why was it necessary to update the standards? Recognition of environmental liabilities is challenging Default definition was contingency in 1975 Since 2001, clear bias toward obligation that can theoretically be enforced Measurement of environmental liabilities is a different challenge Hierarchy of estimates in 1996 FASB fair value in 2001, 2006 (IASB: 2011, GASB: 2015) Bias toward expected value + fair value now instead of known minimum Number of environmental regulations continues growing Increasing quantity of field data, quality of detection technologies Public data (websites with field data, costs, PRPs, enforcement actions) Counterparty defaults and remedy failures increasingly common Fewer truly unique sites with inestimable liabilities

9 Exponent 9 Context for ASTM Updates in 2016 After evaluating over 800 financial reports (10-K, 20-F), observed five issues: 1. Differences in terminology 2. Differences in presentation and disclosure 3. ERL and ARO balances at record highs 4. Spending not reducing liabilities 5. Book versus market gap

10 Overview of ASTM E2137 Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters

11 Exponent 11 Overview of ASTM E2137 Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters Published 2001 Reapproved 2006 and 2011 Substantial update in Provides framework for identifying and estimating environmental costs and liabilities ASTM International E2137

12 Exponent 12 Outline of Process in E2137 Identify purpose/objective of estimates Identify types of potential costs and liabilities Consider relevant existing information Documents and event types (obligating events, recognition benchmarks) Corporate, accounting, and regulatory policy decisions Select estimation approach(es), considering: Purpose of estimate, available information, sources of uncertainty Prepare estimates Estimate uncertainties Documentation of estimates

13 Exponent 13 Example Uses of the Standard Business decision making and portfolio optimization Due diligence and communications involving acquisitions and divestitures Regulatory requirements Cost recovery litigation Cost allocation negotiations Insurance premium calculation and claim settlement Compliance planning Construction and project controls Analysis of remedial alternatives Budgeting, strategic planning Audit defense Financing Investment analysis by shareholders

14 Exponent 14 Hierarchy of Estimation Approaches Market price with least uncertainty Estimate of the mean value of an unknown quantity that represents a probability-weighted average over the range of values Engineering estimates of most likely scenario, significant uncertainty Difficult to defend and justify over time ASTM International E2137 Likely inappropriate

15 Exponent Update to ASTM E2137 Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters Many additions and revisions, new appendices and examples ASTM International E2137

16 Exponent 16 Scope of Revised ASTM E2137 ASTM International E2137

17 Exponent Update to ASTM E2137 Standard Guide for Estimating Monetary Costs and Liabilities for Environmental Matters Improved guidance on: Estimation methods Uncertainty analysis Estimate documentation Examples lists of: Environmental costs and liabilities Liabilities drivers and modifying factors Appendices with examples of estimate methods, site and portfolio liability tracking, updating and resolution; supporting references

18 Exponent 18 Added Table: Environmental Costs and Liabilities List of Examples Note Financial Assurance and Counterparty Risk ASTM International E2137

19 Exponent 19 Expanded Lists of Liability Drivers Examples of Liability Triggers: New EPA air emission control requirements Leaking landfill Site PRP notice Worker exposure Site decommissioning Compliance audit findings Notice of violation Filing of a lawsuit Recognition benchmarks and obligating events (Appendix) Examples of Factors Modifying Liabilities: Changes to GAAP Changes to audit requirements Changes to policies to comply with audits New or modified environmental laws and regulations NGO involvement and scrutiny Degree of communication with and cooperation of the public Changes in investor expectations

20 Exponent More Detailed Guidance on Estimation Methods, Uncertainty Analysis, and Documentation 20 Documentation including identification of: Estimator Purpose of estimate Potential biases in the estimates ASTM International E2137

21 Exponent 21 Updated and New Appendices with Examples Updated: Related documents ASTM, FASB, GASB, PCAOB, FASAB, IASB, other GAAP references Note regarding limitations of CORPS/EPA (2000) FS Cost Estimate guide Example of expected value approach Addition of event tree statistics, counterparty risk, remedy failure examples Potential allocation considerations New: Display of portfolio aggregation (with example tables) Inflation and discount rate assumptions Threshold for performing additional analysis (e.g., when to update) Recognition benchmarks and obligating events (from ASC and GASB) Guidance from PCAOB Audit Standard

22 Exponent 22 Restructured Expected Value Example ASTM International E2137

23 Example Expanded Event Tree Branch for Counterparty Risk Exponent 23 Exponent ASTM International E2137

24 Example Expanded Event Tree Branch for Remedy Failure Risk Exponent 24 ASTM International E2137

25 Overview of ASTM E2173 Standard Guide for Disclosure of Environmental Liabilities

26 ERCI Update to ASTM E2173 Standard Guide for Disclosure of Environmental Liabilities Many additions and revisions, new appendices and examples ASTM International E2173

27 Federal Environmental Legislation and GAAP Timeline ERCI 27

28 FASB Conceptual Framework (2010) A. Objective of Financial Reporting Information B. Fundamental Qualitative Characteristics Relevant Predictive value Confirmatory value Source: FASB Statement of Financial Accounting Concepts No. 8, September 2010 C. Enhancing Qualitative Characteristics Comparability Verifiability D. Elements of Financial Statements Recognition Measurement ERCI 28 Useful to Decisions Faithful Representation Complete Neutral Timeliness Presentation Free from error Understandability Disclosure Cost Constraint Materiality Constraint

29 ERCI 29 Five Types of Environmental Liabilities Liabilities Asset Retirement Obligations FASB: ASC GASB: GASB 83 IASB: IAS 37 Environmental Obligations FASB: ASC GASB: GASB 49 IASB: IAS 37 Commitments FASB: ASC 440 GASB: Note discl IASB: IAS 16 Contingencies FASB: ASC 450 GASB: GASB 10 IASB: IAS 37 Guarantees FASB: ASC 460 GASB: GASB 70 IASB: IAS 39 Power plant decommissioning Demolition RCRA closure Asbestos removal Lead-based paint removal Mine reclamation Oil well plugging and abandonment Spill cleanup Administrative order on consent Notice of Violation Both allowed Fair Value Measurement Your company promises to buy back facilities if contamination is found by buyer Legal claims CERCLA past cost reimbursement to USEPA Deminimis cashouts Probable and Reasonably Estimable Financial assurance for mine closure, for RCRA OM&M, for CERCLA work Your company promises others will perform work

30 ERCI 30 Why is Spending Not Reducing ERLs? $6.0 $5.0 $4.0 Jan 1 balance Year end increase New Jan 1 balance Source: 10-K Reports, $ billions (Large Oil Companies) $3.0 $2.0 Spending $1.0 $0.0

31 ERCI 31 Why is Spending Not Reducing AROs? $25.0 $20.0 $15.0 Source: 10-K Reports, $ billions (Large Oil Companies) $10.0 $5.0 Legacy definitions AROs redefined $0.0

32 ERCI 32 Is Book Value vs. Market Value an Issue? $3.0 Source: 10-K Reports, $ billions. $2.0 $1.0 Market Value/Fair Value Zone Environmental: $0.4 B (Probable and reasonably estimable) Refinance proxy: $2.6 B Dividend proxy: $1.9 B Pension proxy: $1.5 B $0.0

33 ERCI 33 Environmental Obligations (ASC , GASB 49 and IAS 37) Flowchart of Disclosures for Material Environmental Liabilities Commitments (ASC 440 and IAS 16); Guarantees (ASC 460, GASB 70 and IAS 39) Contingencies (ASC 450) and GASB 10 Environmental Obligations (ASC 410); Guarantees (ASC 460, GASB 70 and IAS 39) AROs (ASC ) IAS 37 and GASB ARO) ASTM International E2173

34 ERCI 34 Updated and New Appendices in E2173 Updated: Related documents: ASTM, FASB, GASB, PCAOB, FASAB, IASB, etc Use of obligating events and recognition benchmarks to justify booking Materiality references from relevant sources: Court cases, SEC, PCAOB, etc. New: Watch list Site-specific watch list and remediation portfolio watch list examples Display of portfolio aggregation Asset retirement obligations and remediation obligations portfolio tracking tables Portfolio assumptions tracking table Portfolio metrics, recoveries, and reporting tables Inflation and discount rate assumptions

35 ERCI 35 Site Specific Pre-recognition Watch List Example Source of Risks How Risks become Costs Inputs to Generate Expected Value Liability Type Site-Specific Definition of Environmental Liability Current Obligating Event(s) or Recognition Benchmark(s) Future Obligating Event or Recognition Benchmark(s) Probability of Future Obligating Event or Recognition Benchmark(s) Range of dates (current expectations) Range of Costs (low to High) Asset Retirement Obligation UST removals (4), demolition of 800,000 SF warehouse Purchased 1962 Building in service in 1983 Decision to remove building from service 100% years $4 $50 M RCRA Closure Obligation Closure of process water cooling system, 8 acres Purchased 1962 RCRA Permit 1993 Decision to terminate RCRA permit by owner or regulator Decision to modify or sell operation 10% Decision to close 100% 1 40 years $20 $80 M Remediation Obligation Remediation Obligation Abandonment of groundwater well network Soil excavation, 2 acres x depth of 6-10 feet Purchased Spill Response 2014 Groundwater remediation system installation Purchased Fire Regulatory approval of the well abandonment step Regulator issues notice of violation Regulatory approval 100% Decision to close facility and convert use 95% $1 M 25% $2 $3 M ASTM International E2173

36 ERCI 36 Portfolio Tracking Examples ARO Site Population Tracking Project Counts with a Year Progression Over Time A. ARO Sites at start of fiscal year B. ARO Sites added or reopened C. ARO Sites closed or transferred (1) (2) (3) D. ARO Sites at end of fiscal year Portfolio Financial Tracking Table ($ millions) Cost Components Specified in GAAP (ASC 410) Progression Over Time A. Remediation Obligation Value start of fiscal year $125 $160 $150 B. Liabilities incurred $10 $10 $10 C. Liabilities settled (includes spending) ($15) ($30) ($30) D. Accretion expense $0 $0 $0 E. Revisions in estimated cash flows (includes derecognition) $20 ($15) $30 F. Remediation Obligation Value end of fiscal year $140 $125 $160 G. Portion of Liability Value offset by deferred tax assets $49 $44 $56 H. Corporate tax rate assumption applied 35% 35% 35% ASTM International E2173

37 ERCI 37 Portfolio Assumption Tracking Financial Assumptions [A, B, C] Performance Metrics [D through I] Portfolio Financial Tracking Table A. Inflation assumption (average) applied to portfolio 0% 0% 0% B. Discount assumption (average) applied to portfolio 4% 4% 4% C. Default time horizon used for portfolio liability forecasting 20 years 20 years 20 years D. Percent of liability balance calculated using expected value 90% 85% 80% E. Percentile we used for determining our own ability to pay (max = 100) 94% 90% 95% F. Weighted average percentile of our counterparties abilities to pay (max = 100) 21% 17% 33% G. Percent of liability balance concentrated in five largest environmental counterparties (or PRPs) 2% 25% 18% H. Percentage of liability balance with updated estimates 40% 0% 10% I. Date of cost index used Jun-15 Jan-12 Jan-12 ASTM International E2173 D: Gradual increase is desirable. E versus F, G: our credit standing vs. business partners is used regularly in core businesses. H and I: Timely data improves GAAP s reliability and faithful representation.

38 ERCI 38 Portfolio Metrics Tracking Performance Metrics [A through H] Progression Over Time Portfolio Metrics Tracking Table ($ millions unless noted) A. Percent of liability balance in 3 rd party financial assurance instrument 10% 0% 0% B. Percent of liability balance which is self-insured 90% 100% 100% C. Approximate percentile of liability value ( likely ) 55 th 55 th 55 th D. Approximate percentile of reasonably possible value 75 th 75 th 75 th E. Approximate percentile of remote value 95 th 95 th 95 th F. Remediation Obligation balance end of year (value of percentile expressed in item C in this table.) $310 $270 $330 G. reasonably possible increment (difference of dollar values of the percentiles expressed in items C and D in this table.) $20 $30 $40 H. Remote increment (difference of dollar values of the percentiles expressed in items D and E in this table.) $105 $115 $125 ASTM International E2173 A: Gradual increase is expected from regulators. C: Should not be below 50% and may show increase over time. G and H: should increase only rarely; long-term trend should be downward.

39 ERCI 39 Fair Value Measurement Tracking Level 1: Quoted prices for identical liabilities Level 2: Similar prices for similar liabilities Level 3: Unobservable inputs Fair Value Measurement Tracking ($ millions) A. Portion at Level 1 $21 $13 $8 % of total 15% 10% 5% B. Portion at Level 2 $28 $19 $16 % of total 20% 15% 10% C. Portion at Level 3 $91 $94 $136 % of total 65% 75% 85% D. Sum $140 $125 $160 % of total 100% 100% 100% ASTM International E2173 Fair value measurement was implemented by FASB (2001 and 2006), IASB (2011) and GASB (2015). The basis of a liability calculation can be market, cost or income, and must be at level 1, 2 or 3.

40 ERCI 40 Summary of E2137 and E2173 Updates Addressing the Book vs Market differences Acknowledging extensive changes to GAAP Five types of environmental liabilities instead of one Preference for Fair Value Measurement Auditors authority has expanded significantly with changes in GAAP Capturing good commercial practice Environmental costs and liabilities estimation Disclosure of environmental liabilities

41 ERCI 41 Applying ASTM Standards to Answer Key Questions Do liability reductions match spending on liabilities? Is spending at the right level to discharge booked liabilities and manage the gap to market? Are commitments, obligations, and guarantees from acquisitions and divestitures booked yet? Are cost recoveries capturing the expected full life-cycle costs? Are our asset retirement obligation forecasts appropriate given the current size of our asset base? Are our organization s tools, policies and processes capable of preventing surprises or strategy failures?

42 How can you use ASTM E2137 and E2173 to benefit your clients? Improve liability estimates for transactions / negotiations Improve visibility of unaccrued liabilities (under privilege) Improve capital stewardship and cost recoveries Address blind spots (prevent surprises) Help clients anticipate change Justify needed policy improvements Counsel on strategic transactions (M&A, bankruptcy, spin-offs, etc) Defend against unreasonable claims ERCI 42

43 WK57207 Workgroup for Draft Standard on Recognition/Derecognition of Environmental Liabilities

44 FASB Conceptual Framework (2010) Our WK57207 Source: FASB Statement of Financial Accounting Concepts No. 8, September 2010 A. Objective of Financial Reporting Information B. Fundamental Qualitative Characteristics Relevant Predictive value C. Enhancing Qualitative Characteristics Comparability D. Elements of Financial Statements Recognition Confirmatory value Verifiability Measurement Useful to Decisions Faithful Representation Complete Neutral Timeliness ASTM E2137 Presentation Free from error Understandability Disclosure Cost Constraint ASTM E2173 Documents limited to Workgroup; see ASTM website for restrictions Materiality Constraint 44

45 What Workgroup WK57207 Will Do Develop this standard Complete a subcommittee ballot Review and re-ballot (likely) Submit for full committee ballot Review and reballot at committee level (likely) Publicize the new standard Conduct workshops, training and webinars to encourage adoption For Q1/Q2-2017, we work these questions: - When and how does an environmental risk become a liability? - How does materiality affect recognition and derecognition? - When is it appropriate to derecognize a liability? - Different types of environmental liabilities have different accounting criteria for recognition; can we streamline? Documents limited to Workgroup; see ASTM website for restrictions

46 Do we have an enforceable obligation CD, AOC, NOV NPDES, RCRA permit Reportable-quantity spill or release PRP agreement Asset bought and/or placed in service Do we have a commitment Purchase & sales agreement Cost sharing agreement Merger / spinoff agreement PRP agreement Do we have a guarantee Joint/several liability Financial assurance Do we have a contingency Claim Lawsuit Past cost recovery action Documents limited to Workgroup; see ASTM website for restrictions ARO ERL Flowchart Overview Calculate fair value and check for other types Calculate probable and reasonably estimable, check for other types Calculate fair value and check for other types Calculate fair value and check for other types Calculate probable and reasonably estimable, check for other types Check for duplicates Estimate ASTM E2137 Disclose ASTM E2173

47 Derecognition Watch List: Site Specific Example Source of Risks How Were Liabilities (and Risks) Resolved Inputs to Generate Expected Value Liability Type Asset Retirement Obligation RCRA Closure Obligation Remediation Obligation Offsite Sediment Offsite Sediment Air Pollution Control Site-Specific Definition of Environmental Liability UST removals (4), demolition of 800,000 SF warehouse Closure of process water cooling system, 8 acres Soil excavation, 2 acres x depth of 6-10 feet Up to 500 feet of stormwater discharge lines, eight sewer outfalls and 2,000 feet of adjacent river Counterparty Default by any of three PRPs Installation of selective catalytic reduction (SCR) system Documents limited to Workgroup; see ASTM website for restrictions Action Impact Probability of Future Obligating Event or Recognition Benchmark(s) Tanks removed in 2018 No contamination remains on Demolition in 2019 site; site bought in 2020 with buyers indemnifications for Post-demo assessment 2020 successor contamination. Demolition in 2018 Post-closure completed in 2029 RCRA FI in 2018 NFA from USEPA in 2030 RCRA CA in RCRA permit expired 2020 Excavation completed in 2016 for $7.5 M Sewers decommissioned and studies in 2017 Sediments studied PRP Agreement, signed January 2010 Remedy executed and site in OM&M 2020 Consent order essentially satisfied in 2017 Scrubbers installed in 2016 Source removed above water table; none at or below water table Range of dates (current expectations) Range of Costs (low to High) 0-2% years $1 - $2M 0 1% years $1 - $2M 0-10% years $1 $2 M NFA from USEPA in % years $1 - $2M Financial stress or bankruptcy leaving PRP group Consent order terminated by mutual agreement in % $1 - $10 M 0% years $1 - $2M

48 48 Observations and Issues In Application of ASTM E2137 and E2173 Estimation and Disclosure Standards

49 Axlor Consulting 49 Observations/Issues Old school boilerplate Head in the sand Cooking the books Waiting for certainty Splitting until you reach non-material Opaque versus transparent disclosure Blind repurposing Ignoring counterparty risk Best wish versus reality Bells & whistles/no substance Making up numbers Garbage in/garbage out Use of irrelevant guidance Obsolete information Materiality before estimation Bias/advocacy Selection of estimator(s)

50 Thank you! Questions? 50 Timothy A. Haley Partner, Barnes & Thornburg LLP Scott Shock, M.S., P.E. Senior Managing Engineer, Exponent John Rosengard, MBA President, ERCI Gayle Schlea Koch, M.S. Principal, Axlor Consulting LLC