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Noble's contract valuation approach in line with rules: PwC

Noble Group's mark-to-market valuation approach for long-term commodity derivative contracts managed to pass muster under the close scrutiny of PricewaterhouseCoopers (PwC).


NOBLE Group's mark-to-market valuation approach for long-term commodity derivative contracts managed to pass muster under the close scrutiny of PricewaterhouseCoopers (PwC).

In a highly anticipated review report on the commodity trader's accounting practices, PwC said that the individual valuations and the overall valuation of contracts included in Noble's consolidated balance sheet as at June 30, 2015, comply with relevant accounting rules and industry practices.

Still, PwC recommended that Noble take it further by strengthening its governance and oversight framework and improve its presentation of information.

The "relevant criteria" that PwC used to access Noble's accounting practices were developed by Noble's management based on relevant requirements of fair value measurement under International Financial Reporting Standards (IFRS 13) and standard practices for deriving mark-to-market (MTM) valuations.

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"Overall, we note that Noble has adopted an approach to valuations which is consistent with the relevant criteria in all material respects," PwC said in its report.

"Indeed, in some aspects of the model construction (such as the development of discount rates and development of counterparty credit risk curves), Noble has an approach which is more sophisticated than that of many non-financial companies," PwC said, adding that different departments of the group provided key inputs into the models to ensure accuracy.

PwC was engaged by Noble to review how its values some of its commodity assets, following criticism of its practices by anonymous group Iceberg Research initially and short-seller Muddy Waters later, which sent its shares on a dive since February. In June, Standard & Poor's cut its outlook on Noble to "negative" from "stable", saying its main concern was over Noble's valuations of long-term supply contracts.

PwC's scope of work covered valuations of the long-term contracts - which have more subjectivity than short-term contracts - on Noble's balance sheet as at June 30.

The contracts reviewed represented 81 per cent of the value of derivative contracts with a duration of at least two years, and 98 per cent of the value of unobservable inputs for assets or liabilities classified as level 3 inputs under IFRS 13. Level 3 items make up 29 per cent or US$1.2 billion of the group's total net fair value.

Releasing the full report of PwC on Monday, Noble said it has been reviewed by the board, which is now taking steps to implement the recommendations.

Richard Elman, chairman of Noble, said: "I am delighted that we have received a strong validation of our processes and controls and shareholders can now be assured, as we have always known, that our balance sheet fairly reflects the value of our long- term contracts."

Paul Brough, an independent director of Noble who headed the board committee which appointed PWC, said "the reports demonstrate clearly that the accusations of bad faith on Noble's part in the preparation of its MTM valuations have no basis".

In response to the PwC findings, SGX said it is closely monitoring developments related to Noble including any unusual share trading activity, rumours or speculation. It urged investors with questions on the MTM valuation to seek clarification from Noble if needed, at its Investor Day here on Aug 17.

Stressing the thoroughness of its review, PwC said that for each contract reviewed, it also obtained the detailed valuation model, scrutinising it by examining the inputs and supplementing the information with detailed discussions with the various departments in the group.

However, while noting that Noble has applied appropriate practices and procedures for MTM valuations, PwC flagged that there is "an absence of formal policy or documentation on some of these practices and procedures" and "a high degree of reliance on key individuals" who have a deep understanding of the contracts as well as informal guidelines and practices.

PwC recommended that the management enhance the information provided to the audit committee to include a standardised depiction of the gross value of cashflows, the unadjusted net present value and the reserves taken in deriving the adjusted net present value, for major contracts.

It also urged the management to continue to enhance quarterly MTM database reports, update the MTM policy to cover all aspects of forecasting volumes and taking of reserves to allow for uncertainty, strengthen compliance or internal audit, and formalise procedures for back-testing and stress-testing the portfolio.

Noble's controversial valuation of its 13.2 per cent associate Yancoal Australia did not come under PwC's review as it is not a matter of MTM valuation. But the valuation of Yancoal has been a point of contention with Iceberg Research since February, though the group has maintained that recognising Yancoal as an associate in view of its significant influence over Yancoal is in line with international accounting practice.

For the first time, Noble provided details on Yancoal's valuation range and recognition. The associate value of Yancoal has declined from US$825 million since the stake was held by Noble in 2012 to US$306 million as of June 30 due to losses incurred by Yancoal and impairments.

Noble said its valuation model incorporates a conservative price curve compared to broker consensus. A sensitivity analysis on its valuations was also disclosed.

Despite spending about S$130 million buying back its shares between June 11 and July 24, Noble has lost over half of its market value since mid-February.

Roger Tan, chief executive of Voyage Research, noted that while the PwC report appears sufficient, "it does not stop anyone else from trying to attack Noble anymore simply because in accounting rules, there is always room for manoeuvre".

"It depends on which end of the boxing ring you want to take. Within the accounting framework, what Noble is doing is within the accounting framework," he added.

Iceberg Research, whom Noble has said was set up by a former employee, said the report was not enough to dispel investors' doubts. "PwC merely answered the question: are Noble's MTM formally in compliance with accounting rules, which is what EY has been doing for years," a representative from Iceberg said in an email to Reuters. Noble's current auditors are Ernst & Young.

Noble's net profit for the second quarter ended June 30 dropped 5 per cent to US$62.61 million, dragged by commodity pricing pressures. Revenue for the quarter saw a 22 per cent slump to US$18.36 billion.

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