August 2021 financial reporting, governance, and risk management

| 8/18/2021
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Message from John Epperson, Managing Principal, Financial Services

Dear FIEB readers,

Just as we were beginning to resume some face-to-face meetings and return to what seemed “back to normal” activities, we are getting reports from many areas of increasing numbers of cases of the delta variant of the coronavirus. With that, a move back to further restrictions is potentially forthcoming. We will continue to keep you updated on emerging developments while supporting remote activities and taking other necessary preventive measures.

As is typically the case in the summer months, regulatory and reporting activities remained lighter for the past month. Regulators continue to execute supervisory and policy initiatives through hybrid examinations and meetings while largely continuing remote activities for agency operations. Some key developments from the federal financial institution regulatory agencies include interagency FAQs on the upcoming LIBOR transition, the annual updated OCC Bank Accounting Advisory Series, updated FDIC brokered deposit resources, and an NCUA proposed leverage ratio for complex credit unions.

The dialogue continues on environmental, social, and governance (ESG) disclosures, with a focus on climate change. The SEC continues to debate how best to balance investor calls for more ESG information with the mission of the agency. SEC discussion has also moved forward on digital assets.

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Matters of importance from the federal financial institution regulators

Agencies issue FAQs on transition away from LIBOR

The Federal Reserve Board (Fed), Federal Deposit Insurance Corp. (FDIC), and Office of the Comptroller of the Currency (OCC) on July 29, 2021, issued answers to frequently asked questions about the effects that the London Interbank Offered Rate (LIBOR) transition will have on regulatory capital instruments. The FAQs address the issue of changing a reference rate from LIBOR to an alternative rate and clarify that such a transition would not change the capital treatment of the instrument, provided the alternative rate is economically equivalent with the LIBOR-based rate. While the FDIC and OCC issued only two FAQs related to the impact on regulatory capital instruments, the Fed also included questions for global systemically important bank holding companies and intermediate holding companies.

OCC updates the Bank Accounting Advisory Series

On Aug. 16, 2021, the OCC released an update to the Bank Accounting Advisory Series (BAAS). The BAAS covers a variety of topics and promotes consistent application of accounting standards among national banks and federal savings associations. This edition of the BAAS reflects accounting standards issued by the Financial Accounting Standards Board on such topics as hedging and credit losses and includes recent answers to frequently asked questions from the industry and examiners.

The revisions include new questions on topics such as:

  • Loans held for sale
  • Employee stock options
  • Grants received by banks

Updates to topics include, but are not limited to:

  • Investments in debt and equity securities
  • Loans held for sale
  • Intangible assets

The BAAS does not represent official rules or regulations of the OCC. Rather, it represents the OCC’s Office of the Chief Accountant’s interpretations of generally accepted accounting principles and regulatory guidance based on the facts and circumstances presented. While the BAAS is published by the OCC, the information in the BAAS is relevant to all financial institutions.

FDIC updates resources on brokered deposits webpage

On July 6, 2021, the FDIC updated the resources on its Banker Resource Center Brokered Deposits webpage. The FDIC has added a list of entities for which a Primary Purpose Exception Notice has been submitted. The resource center also includes an updated question and answer section that addresses questions from banks on brokered deposit regulations.

In addition, the site includes information on the amended brokered deposit regulations and interest-rate restrictions that became effective April 1, 2021, along with a compliance guide for small entities.

FDIC proposes to simplify deposit rules for trusts and MSAs

On July 20, 2021, the FDIC issued a proposal for public comment on amendments to the regulations governing deposit insurance coverage for deposits of both revocable and irrevocable trusts and to provide consistent deposit insurance treatment for all mortgage servicing accounts (MSAs) held to satisfy principal and interest obligations to a lender.

Under existing rules, the FDIC recognizes three different insurance categories for deposits held in connection with trusts: revocable trusts, irrevocable trusts, and irrevocable trusts with an insured depository institution as trustee. The proposed rule would merge the revocable and irrevocable trusts categories into a single trust accounts category. Trust account deposits would be insured in an amount up to $250,000 multiplied by the number of trust beneficiaries, not to exceed five. This would, in effect, limit coverage for a grantor’s trust deposits at each insured depository institution to a total of $1,250,000.

With regard to MSAs, the FDIC is proposing that MSAs maintained by a mortgage servicer in an agency, custodial, or fiduciary capacity that comprise payments of principal and interest would be insured for the cumulative balance paid into the account to satisfy principal and interest obligations to the lender, whether paid directly by the borrower or by another party, up to $250,000 per mortgagor.

Comments on the proposal are due Oct. 4, 2021.

NCUA proposes complex credit union leverage ratio

On July 22, 2021, the National Credit Union Administration (NCUA) board approved a comprehensive notice of proposed rulemaking to amend the NCUA’s capital adequacy regulation to provide a simplified measure of capital adequacy that federally insured credit unions classified as “complex” (those with total assets greater than $500 million) can opt into.

The new Complex Credit Union Leverage Ratio (CCULR) is comparable to the Community Bank Leverage Ratio that went into effect in January 2020 and would provide a streamlined capital management framework for complex credit unions that meet qualifying criteria including maintaining a minimum net worth level. A credit union in the CCULR framework would be considered well capitalized as long as it maintains the minimum net worth ratio.

Under this proposal, the minimum net worth level under the CCULR framework would initially be set at 9% on Jan. 1, 2022, and would gradually increase to 10% by Jan. 1, 2024. Using Dec. 31, 2020, financial performance data, the NCUA estimates that most complex credit unions would meet the CCULR’s initial net worth requirement of 9%.

The proposed rule also includes several amendments that would update the NCUA’s final risk-based capital rule, such as addressing asset securitizations issued by credit unions, clarifying the treatment of off balance sheet exposures, and deducting certain mortgage servicing assets from a complex credit union’s risk-based capital numerator.

Comments are due Oct. 15, 2021.

NCUA issues RFI on digital assets and related technologies

On July 22, 2021, the NCUA board issued a request for information (RFI) to gather information from interested parties on the current and potential impact that digital assets, crypto assets, decentralized finance, and other related technologies might have on federally insured credit unions.

The NCUA stated that the feedback it receives as part of this RFI will help the NCUA create a framework so that federally insured credit unions can innovate and compete in an ever-changing marketplace.

“This request is the logical next step in laying the groundwork for federally insured credit unions to leverage these innovations, but we must recognize that things continue to quickly evolve,” said Todd Harper, NCUA chair.

Comments are due Sept. 27, 2021.
Current developments in climate change and ESG matters

Disclosure debate: SEC chair outlines stakeholder calls for climate risk disclosures

At the Principles for Responsible Investment “Climate and Global Financial Markets” webinar on July 28, 2021, SEC Chair Gary Gensler addressed the need for climate-related disclosures for public companies and funds to bring transparency to the capital markets.

Gensler said that investors want to understand the climate risks of the companies they invest in or are considering investing in and these investors are looking for consistent, comparable, and decision-useful disclosures on climate risks. He shared that in response to the SEC’s March 2021 statement on climate disclosures, more than 550 unique comment letters were submitted and 75% of these responses supported mandatory climate disclosure rules.

Gensler noted that while companies already are trying to meet the demand for climate risk information, many use generic or boilerplate language that is not decision-useful for investors. Gensler said that both investors and companies would benefit from greater clarity over climate risk disclosures, which is why he has asked SEC staff to develop a mandatory climate risk disclosure rule proposal for consideration by the end of the year. He said that the proposal should consider consistency, comparability, the need for sufficient detail, and both quantitative and qualitative aspects of climate risk. Additionally, he asked SEC staff to consider whether certain metrics for specific industries such as banking should be included.

Additionally, Gensler noted an increase in funds marketing themselves as “green,” “sustainable,” “low-carbon,” and similar but said little information exists to support those claims. He has directed staff to consider whether fund managers should disclose the criteria and underlying data they use in making those claims, including looking at how funds are named.

Disclosure debate: SEC commissioner presents 10 theses for ESG stakeholder discussion

On July 20, 2021, SEC Commissioner Hester Peirce spoke before the Brookings Institution on the SEC’s role in environmental, social, and governance (ESG) disclosures and the complexities and consequences of potential rulemaking. She presented 10 theses to encourage further discussion.

As an alternative to prescriptive ESG rules, Peirce suggested that the SEC could work within its existing regulatory framework to release updated guidance to help issuers consider how the existing disclosure framework elicits ESG disclosure and to address frequently asked questions that arise in connection with the application of the existing disclosure framework. She also suggested working with investment advisers to help investors better understand each adviser’s ESG branding and investment practices.

Disclosure study: CAQ summarizes ESG reporting and assurance across S&P 500 companies

On Aug. 9, 2021, the Center for Audit Quality (CAQ) released summary observations of the nature and extent, including any assurance obtained, of publicly available ESG reports using the most recently available data for S&P 500 companies. The summary provides additional observations focused on S&P 100 companies.

SEC approves Nasdaq board diversity rule

On Aug. 6, 2021, the SEC approved Nasdaq’s new board diversity rule, which requires Nasdaq-listed entities to:

  • Provide standardized annual public disclosure of board-level diversity statistics
  • Maintain two directors, one female and the other of an under-represented minority or LGBTQ, or explain why it does not

The rule provides additional flexibility for smaller reporting companies, foreign issuers, and entities with five or fewer directors. It also specifies Nasdaq will provide one year of complimentary board recruiting services to eligible companies, which will facilitate identifying and evaluating diverse board candidates.

An entity must comply with the annual board-level diversity disclosure requirements by the later of Aug. 8, 2022, or the date the entity files its proxy or information statement for its annual shareholder meeting during 2022. The entity may provide the disclosure either in its SEC filings or on its website.

Entities must meet the requirement to have two diverse directors or explain why not, using a phased-in approach based on the Nasdaq tier on which the entity’s securities trade. Nasdaq has provided a summary of the rule and transition requirements.

OCC names climate change risk officer, joins NGFS

The OCC, on July 27, 2021, announced that Darrin Benhart has been appointed to serve as its climate change risk officer, a new position focused on promoting climate change risk management at banks. Benhart previously served in the OCC’s large bank supervision group, and in this new role he will report to the senior deputy comptroller for supervision risk and analysis. In the announcement, acting Comptroller Michael Hsu noted the appointment will enable the OCC “to be more proactive in accelerating the development and adoption of robust climate change risk management practices, especially at the larger banks.”

In the same release, the OCC also announced that it has joined the Network for Greening the Financial System (NGFS), a global group of central banks and supervisors that consider climate risk management.
From the Financial Accounting Standards Board (FASB)

FASB amends guidance on lessor accounting for leases with variable lease payments

The FASB, on July 19, 2021, issued Accounting Standards Update (ASU) 2021-05, “Leases (Topic 842), Lessors – Certain Leases With Variable Lease Payments,” to improve the guidance for a lessor’s accounting for certain leases with variable lease payments.

Prior to this update, under Topic 842, a lessor may have been required to recognize a selling loss at lease commencement (day-one loss) for a sales-type lease with variable payments, even if the lessor expected the arrangement would be profitable overall. During the post-implementation review of Topic 842, stakeholders commented that this accounting treatment resulted in financial reporting that did not faithfully represent the underlying economics either at lease commencement or over the lease term and did not provide decision-useful information. To address this matter, the amended ASU requires a lessor to classify and account for a lease with variable payments as an operating lease in both of these situations:

  1. The lease would have been classified as a sales-type lease or a direct financing lease in accordance with the classification criteria in paragraphs 842-10-25-2 and 25-3.
  2. The lessor otherwise would have recognized a day-one loss.

As a day-one loss or profit is not recognized under operating lease accounting, this is expected to result in more decision-useful information and more closely represent the economics of the underlying lease.

Subject to certain transition requirements, the ASU is effective for all entities for fiscal years beginning after Dec. 15, 2021, and for interim periods within those fiscal years for public business entities and interim periods within fiscal years beginning after Dec. 15, 2022, for all other entities. Early adoption is permitted. 
More from the Securities and Exchange Commission (SEC)

SEC chair remarks on stronger investor protections for crypto assets

On Aug. 3, 2021, before the Aspen Security Forum, SEC Chair Gensler discussed the current environment for crypto asset investing and trading and identified the need for greater investor protections. Gensler said that the crypto asset class is currently worth approximately $1.6 trillion without enough investor protections over crypto assets. He warned about scams and frauds across the asset class and said no structure is in place to provide comprehensive information to investors as these assets often trade and move outside of established regulatory frameworks, platforms, and regulations.

Gensler said that trading platforms where crypto assets are being bought, sold, and traded might include unregistered securities. Therefore, these are not being regulated as other registered securities are, and they are missing required disclosures and market oversight. This creates significant gaps in investor protections. Further, Gensler said he believes these trading platforms are potentially skirting securities, commodities, and banking laws. He also touched on custody of crypto assets and noted that custody protections are important to preventing theft and protecting investors.

To address the regulatory gaps, Gensler called on Congress to act on crypto asset legislation. He noted that the SEC is ready to work with Congress, the administration, and other regulators and partners to address regulatory gaps and focus on trading and lending platforms.

SEC chair discusses security-based swaps regulatory activities

SEC Chair Gensler discussed the SEC’s regulatory activities regarding security-based swaps at the American Bar Association Derivatives and Futures Law Committee virtual midyear meeting on July 21, 2021.

Gensler first discussed the legislation adopted in response to the 2008 financial crisis, which was meant to reduce risk related to security-based swaps by requiring dealers to register with the SEC. Registered dealers needed to have certain back-office controls and adequate cushions against losses, through both their capital levels and their customer margin. Focusing on reducing risk, newer registration requirements include new counterparty protections and requirements for capital and margin, internal risk management, supervision and chief compliance officers, trade acknowledgment and confirmation, and recordkeeping and reporting procedures. Security-based swap dealers and major security-based swap participants will begin registering with the SEC by Nov. 1, 2021.

In addition, Gensler discussed the relationship between security-based swaps and financial technology, including the topic of crypto assets. Gensler said, “There are initiatives by a number of platforms to offer crypto tokens or other products that are priced off of the value of securities and operate like derivatives.” He cautioned, “It doesn’t matter whether it’s a stock token, a stable value token backed by securities, or any other virtual product that provides synthetic exposure to underlying securities. These platforms – whether in the decentralized or centralized finance space – are implicated by the securities laws and must work within our securities regime.” He said SEC rules apply to security-based swaps.

SEC commissioners comment on lack of guidance on digital asset trading

On July 14, 2021, SEC Commissioners Peirce and Elad Roisman released a public statement addressing the lack of clarity for market participants around the application of the securities laws to digital assets and their trading. Referring to the recent Coinschedule Ltd. SEC order, which found that a publicized token offering included investment contracts, which are securities and therefore subject to securities laws, the commissioners expressed their disappointment that the order did not explain which digital assets in the offering were securities or how that was determined, which would have provided additional guidance.

Peirce and Roisman noted that although the SEC has provided some guidance and people can use and analogize settled SEC enforcement actions to determine if the tokens are securities, not enough clear guidance exists for the large number of factors to consider. Clues can be gathered from enforcement actions to make determinations; however, applying those clues to the facts of a completely different token offering does not necessarily produce clear answers. Peirce and Roisman both conclude that the SEC needs to prepare better guidance with clear and timely answers, as providing guidance piecemeal through enforcement actions is not the best way to move forward in this complex and evolving marketplace.

SEC addresses the Asset Management Advisory Committee

On July 7, 2021, before the Asset Management Advisory Committee, Chair Gensler and Commissioners Peirce and Caroline Crenshaw presented remarks covering ESG, diversity and inclusion, private investments, and technology.

Gensler shared his thoughts on sustainability related to fund disclosures and fund names. He questioned how funds that market themselves using sustainability-related terms support those claims when often the information underlying those claims is not objective, a large range of criteria and sources are used, and no standardized meanings of the sustainability-related terms exist. Gensler said he has asked SEC staff to consider recommendations about whether fund managers should disclose the criteria and underlying data they use. He added that updates to fund disclosures and to naming conventions could bring needed transparency to the asset management industry. He concluded with comments on diversity and inclusion and noted that the asset management industry has a lot of work to do to increase racial and gender diversity; therefore, he has asked SEC staff to consider ways that the SEC can enhance transparency to improve diversity and inclusion practices.

Peirce commented on the pitfalls of ESG standard-setting before addressing diversity and inclusion in U.S. capital markets and her concerns about the committee’s draft recommendations. She said that adding government-mandated diversity classifications for the asset management industry might not promote unity and empower people but rather have the opposite effect. Peirce questioned how the SEC would define diversity, how to categorize people with diverse backgrounds, and what do to with those who prefer not to identify, among others. Finally, she said that these recommendations should be open to further debate.

Crenshaw said she agrees that the SEC has a role to play in promoting diversity and inclusion in the asset management industry and she is interested in potential guidance or recommendations that would discourage discrimination by fiduciaries. She mentioned ESG disclosures and the importance that they be consistent, comparable, high quality, and decision useful. She raised concerns about lack of visibility into the private markets and the need to understand the benefits, risks, and costs of investing in the private markets. She also discussed technology-enabled personalization and how technology can be used to both benefit and harm investors.

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