July 2022 financial reporting, governance, and risk management

| 7/20/2022
July 2022 financial reporting, governance, and risk management

Message from John Epperson, Managing Principal, Financial Services

Dear FIEB readers,

We are now more than halfway through calendar year 2022, but the interesting thing about financial reporting, governance, and risk management topics is that they are perpetual – we will never reach a halfway point. Our objective is to continually keep you informed of activities from standard-setters, regulators, and other stakeholders so that you can keep your eyes on those areas most important to you and your stakeholders.

This month, we have a semiannual risk perspective from the Office of the Comptroller of the Currency, a new current expected credit loss tool from the Federal Reserve, multiple items from the Consumer Financial Protection Bureau, and finalized climate principles from the Basel Committee. The Financial Accounting Standards Board issued guidance on certain equity securities, released its final report on its recent agenda consultation, and discussed tax credit investments. The Securities and Exchange Commission remains active, confirming two new commissioners, taking action on several rulemaking activities, and providing messages on new investment products. The Public Company Accounting Oversight Board issued a preview of its 2022 inspections and adopted amendments related to the lead auditor’s use of other auditors. Finally, the American Institute of Certified Public Accountants and the Chartered Institute of Management Accountants updated their digital asset practice aid for Staff Accounting Bulletin 121, and the Center for Audit Quality published the first in a new survey series.

Enjoy this month and embrace its challenges. We will bring you a new update next month.

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Matters of importance from the federal financial institution regulators

OCC issues semiannual risk report

The Office of the Comptroller of the Currency (OCC) on June 23, 2022, issued its semiannual risk perspective for spring 2022. The report highlights continuing operational and market-related effects of the pandemic and geopolitical events leading to tightening financial conditions for banks. Nonetheless, the OCC deems banks’ financial condition remains strong and well positioned to “deal with the economic headwinds arising from geopolitical events, higher interest rates, and increased inflation.” The report addresses a broad range of bank-related topics, focusing on those that pose threats to safety and soundness and compliance with laws and regulations.

This year’s spring report presents data in five main areas: operations, bank performance, special topics, trends in key risks, and supervisory actions. According to the OCC, operational risk is elevated as banks respond to an evolving and increasingly complex operating environment, and geopolitical tensions have elevated cyber risks globally. Banks’ increasing reliance on third-party relationships; development and adoption of innovative products, services, and technologies; and ongoing staffing changes add to operational risk.

Compliance risk also is heightened as banks navigate the current operational environment, regulatory changes, and policy initiatives. OCC examiners have seen increased competition for compliance subject-matter experts at both bank management and staff levels. Supervisory focus remains on fair lending risk identification and management, regulatory changes, and policy initiatives.

The report notes that overall credit risk remains moderate and problem loan levels remain manageable. The near-term outlook for credit quality remains positive, with some uncertainty and potential longer-term implications of inflation and the Russia-Ukraine war.

As it did in the fall 2021 report, the OCC again highlighted its commitment to proactive and risk-based supervision of climate-related financial risks facing banks. The OCC currently is reviewing and considering the comments received on its December 2021 “Principles for Climate-Related Financial Risk Management for Large Banks.” Those principles, if adopted, will initially apply only to banks with more than $100 billion in assets and will provide a basis for the development of future supervisory expectations on climate-related financial risk management.

Fed releases second CECL tool

On June 16, 2022, the Federal Reserve Board (Fed) released a second current expected credit loss (CECL) tool to assist a broad range of community financial institutions with calculating their allowances under the CECL accounting standard. The Expected Loss Estimator (ELE) is a spreadsheet-based tool using the weighted-average remaining maturity (WARM) method. The ELE uses each institution’s own loan-level data and assumptions to calculate the allowance estimate. The Fed has noted that the ELE is intended for institutions that have determined the WARM method is an appropriate method to use, while reminding institutions that management is responsible for ensuring that methods used in the loss estimation process are appropriate for the financial institution’s size, complexity, and risk profile.

CFPB issues RFI on consumers’ ability to obtain information from large institutions

The Consumer Financial Protection Bureau (CFPB) on June 14, 2022, issued a request for information (RFI) seeking public feedback related to relationship banking and how consumers can assert the right to obtain timely responses to requests for information about their accounts from financial institutions with more than $10 billion in assets.

Specifically, the CFPB is seeking input from the public on customer service obstacles in the banking market and what information would be helpful for consumers to obtain from their institutions pursuant to Section 1034(c) of the Consumer Financial Protection Act. The RFI includes 14 questions soliciting input on the types of information consumers request, difficulties they might experience obtaining that information from the financial institution, customer service representative compensation, obstacles consumers face that adversely affect their ability to bank, and call center practices.

Comments are due July 21, 2022.

CFPB expands review of overdraft practices

As part of a pilot supervision effort that began earlier in 2022, the CFPB has requested detailed information on overdraft and nonsufficient funds practices from more than 20 financial institutions that it has identified as having a higher share of frequent overdraft users or higher average fees. This is a continuation of the CFPB’s broader initiative to closely monitor checking account overdraft fee practices as outlined in two research reports the bureau released in December 2021. In a June 16, 2022, blog post, the CFPB says that its supervision teams are reviewing how the institutions assess their fees, their grace periods, the dollar thresholds above which fees are assessed, and the caps on the number of fees charged over a given period.

The post indicates that the CFPB intends to use this information for further examination and review and to share this information with other regulators, but the supervisory information will not be made public.

Basel Committee finalizes principles for managing climate-related financial risks

The Basel Committee on Banking Supervision (BCBS) on June 15, 2022, issued a final set of principles on the effective management and supervision of climate-related financial risks by large, globally active banks. The OCC issued substantially similar draft principles for public comment in December 2021, as did the Federal Deposit Insurance Corp. in March 2022, that, if finalized, would initially apply only to banks with more than $100 billion in assets.

The BCBS document includes 18 high-level principles, the first 12 of which provide banks with guidance on effective management of climate-related financial risks. The remaining principles provide guidance to prudential regulators on the supervision of climate-related financial risks. The bank-related principles address how banks should incorporate climate-related financial risk in their overall risk framework, including corporate governance, internal controls, and capital and liquidity adequacy. The BCBS document directs banks to manage climate-related financial risks in a manner that is proportionate to the nature, scale, and complexity of their activities and the overall level of risk that each bank is willing to accept.

The principles were not substantially changed from the version released for public comment in November 2021. Specifically, regarding scenario analysis and stress testing, the BCBS principles are formulated for large, internationally active banks and for supervisory and other relevant financial authorities in Basel Committee member jurisdictions. However, the release notes that smaller banks and authorities in all jurisdictions can benefit from a structured consideration of the potential impact of climate-related financial risks.

From the Financial Accounting Standards Board (FASB)

FASB issues fair value measurement guidance for equity securities subject to contractual sale restrictions

On June 30, 2022, the FASB issued Accounting Standards Update (ASU) 2022-03, “Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions,” to clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This ASU also clarifies that an entity cannot recognize and measure a contractual sale restriction as a separate unit of account. Entities will be required to disclose the nature and remaining duration of the restriction, the circumstances that could cause a lapse in the restriction, and the fair value of the equity securities subject to contractual sale restrictions reflected in the balance sheet.

For public business entities, the amendments are effective for fiscal years beginning after Dec. 15, 2023, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after Dec. 15, 2024, including interim periods within those fiscal years. Early adoption is permitted.

FASB releases 2021 agenda consultation report

The FASB on June 29, 2022, published its “2021 FASB Agenda Consultation Report,” which summarizes the extensive stakeholder feedback obtained during the 2021 agenda consultation project and details how the feedback influenced the FASB’s technical and research agendas and standard-setting process.

The feedback received resulted in the following:

  • Redefining the scope and direction of existing technical agenda projects
  • Adding new projects to the technical agenda
  • Adding new projects to the research agenda
  • Defining the path forward for the technical agenda
  • Providing information about other potential projects

The report addresses each of these areas. Based on the input from stakeholders, the FASB added to the technical agenda projects related to accounting for and disclosures of digital assets, accounting for environmental credit programs, and accounting for and disclosure of software costs. New research projects added relate to accounting for exchange-traded commodities; accounting for financial instruments with environmental, social, and governance features; hedge accounting; accounting for government grants; consolidation of business entities; financial key performance indicators; and statement of cash flows.

FASB discusses investments in tax credit structures

On July 13, 2022, the FASB discussed Emerging Issues Task Force (EITF) Issue No. 21-A, “Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method,” and ratified the consensus-for-exposure reached by the EITF at its June 16, 2022, meeting. The board directed the staff to draft a proposed ASU reflecting the consensus-for-exposure for vote by written ballot.

The consensus-for-exposure expands the proportional amortization method of accounting to all tax credit investments that meet the criteria in paragraph 323-740-25-1 and, among other points, includes that the proportional amortization method can be elected on a tax-credit-program-by-tax-credit-program basis.

From the Securities and Exchange Commission (SEC)

SEC adopts amendments to proxy rules

On July 13, 2022, the SEC adopted amendments to its rules governing proxy voting advice originally proposed in November 2021. The purpose of the amendments is to reduce burdens on proxy voting advice businesses that might impair the timeliness and independence of their advice. The amendments rescind two rules, adopted by the SEC in 2020, applicable to proxy voting advice businesses, specifically conditions to the availability of two exemptions from the proxy rules’ information and filing requirements on which these businesses often rely. The rescinded conditions required that:

  • “Registrants that are the subject of proxy voting advice have such advice made available to them in a timely manner”
  • “Clients of proxy voting advice businesses are provided with a means of becoming aware of any written responses by registrants to proxy voting advice”

Additionally, the amendments delete the 2020 changes made to the proxy rules’ liability provision, and the adopting release rescinds guidance that the SEC issued in 2020 to investment advisers regarding their proxy voting obligations.

The amendments and rescission of the guidance will be effective Sept. 19, 2022.

SEC proposes amendments to shareholder proposal rule

The SEC on July 13, 2022, proposed amendments to Rule 14a-8, which governs the process for including shareholder proposals in a company’s proxy statement. It provides bases for exclusion, with substantive requirements. The proposed amendments would revise three of the bases for exclusion:

  • “Substantial Implementation. The proposed amendments would specify that a proposal may be excluded under this provision if the company has already implemented the ‘essential elements’ of the proposal.
  • “Duplication. The proposed amendments would specify that a proposal ‘substantially duplicates’ another proposal previously submitted for the same shareholder meeting if it addresses the same subject matter and seeks the same objective by the same means.
  • “Resubmission. The proposed amendments would provide that a proposal constitutes a resubmission if it substantially duplicates another proposal that was previously submitted for the same company’s prior shareholder meetings.”

The comment period will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.

SEC leaders highlight risks of single-stock ETFs

On July 11, 2022, SEC Commissioner Caroline Crenshaw released a statement on single-stock exchange-traded funds (ETFs) expressing her concerns over these complex, leveraged, and inverse ETFs that might create greater risks for investors and calling for consideration of rulemaking over these risky investments. She noted that the current regulatory framework, including Rule 6c-11 of the Investment Company Act of 1940, allows ETFs meeting certain criteria to come directly to market without first obtaining permission, through an exemptive order, from the SEC. She said single-stock ETFs are coming directly to market even though they were never contemplated by this rule. She warned that the daily rebalancing and effects of compounding might cause returns to deviate significantly from the performance of the one underlying stock, and that the effects are likely to be especially evident in volatile markets. Such leveraged and inverse products can perform in unexpected ways and potentially contribute to broader systemic risks.

She reiterated her position that a comprehensive and consistent approach to the review of complex exchange-traded products is long overdue and that the regulatory framework needs to be updated to better address the risks these products pose to investors and the markets.

Lori Schock, director of the SEC’s Office of Investor Education and Advocacy, also released a statement on July 11, 2022, highlighting the risks of single-stock ETFs. Schock noted that these are meant to be held for very short periods of time, often only a single day, and holding them for longer periods might result in returns significantly different from returns if an investor held the underlying stock directly. Additionally, these single-stock ETFs do not provide the diversification of traditional ETFs or other leveraged or inverse products.

SEC adopts final rule amendments to electronic filing requirements

To modernize how information is filed or submitted to the SEC and disclosed to the public, on June 23, 2022, the agency adopted amendments to require certain documents filed by investment advisers, institutional investment managers, and certain other entities, which previously were submitted on paper, to be filed or submitted electronically. The rule includes technical amendments to modernize Form 13F and enhance the information provided.

The new rule, except the amendments to Form 13F, are effective Aug. 29, 2022. The amendments to Form 13F will be effective Jan. 3, 2023.

SEC Chair Gary Gensler released a statement in support of these new amendments, noting that “they will modernize and increase the efficiency of the filing process for filers, investors, and the SEC.”

SEC releases updated regulatory agenda

On June 22, 2022, the SEC released its spring 2022 regulatory agenda, which lists short- and long-term regulatory actions that the SEC plans to take. This recent release lists 27 proposed rules and 26 rules in the final stage. They address the SEC’s three-part mission of protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation.

SEC announces new commissioners

On June 16, 2022, the U.S. Senate confirmed Jaime Lizarraga and Mark Uyeda as SEC commissioners. Uyeda will serve until June 5, 2023, completing the term of Elad Roisman, who recently resigned. Lizarraga’s term will run through June 5, 2027, replacing Allison Herren Lee, whose term ended in June 2022.

Uyeda was sworn in on June 30, 2022. He joined the SEC in 2006 and has served as senior adviser to Chairman Jay Clayton and acting Chairman Michael Piwowar, as counsel to Commissioner Paul Atkins, and in the Division of Investment Management. Most recently, he served on detail to the Senate Committee on Banking, Housing, and Urban Affairs as a securities counsel to the committee’s minority staff.

From the Public Company Accounting Oversight Board (PCAOB)

PCAOB issues inspection plan

On June 30, 2022, the PCAOB released “Spotlight: Staff Overview for Planned 2022 Inspections,” which includes areas of inspection focus for 2022, plans related to the PCAOB’s use of target teams in the inspection process, and plans for audit committee outreach. This spotlight is a reference point for audit committees, auditors, investors, and other stakeholders.

Selected areas of planned 2022 inspections focus include:

  • Fraud and other risks
  • Initial public offerings and merger and acquisitions activity
  • Audit firms’ execution challenges
  • Considerations specific to broker-dealers
  • Independence
  • Use of service providers in the confirmation process
  • Critical audit matters
  • Audit areas with continued deficiencies
  • Firms’ quality control systems
  • Technology

PCAOB issues new requirements for lead auditor’s use of other auditors

The PCAOB on June 21, 2022, adopted amendments to its auditing standards to strengthen requirements that apply to audits involving multiple audit firms. The amendments are intended to improve the quality of audits where other accounting firms or individual accountants perform work on the audit. The amendments detail certain procedures for the lead auditor to perform when planning and supervising an audit that involves other auditors, and they apply a risk-based supervisory approach to the lead auditor’s oversight of other auditors for whose work the lead auditor assumes responsibility.

The amendments are subject to approval by the SEC and will be effective for audits of financial statements for fiscal years ending on or after Dec. 15, 2024.

From the American Institute of Certified Public Accountants and the Chartered Institute of Management Accountants (AICPA and CIMA)

AICPA updates digital assets guidance

Due to continuing questions by entities about the scope and applicability of the guidance within Staff Accounting Bulletin (SAB) 121, in June 2022 the AICPA and CIMA issued an update to the Practice Aid “Accounting for and Auditing of Digital Assets,” which includes responses to frequently asked questions about SAB 121. The responses provide guidance on what entities should consider in determining whether they have a safeguarding obligation subject to SAB 121 and how safeguarding liabilities are reflected in an entity’s financial statements.

From the Center for Audit Quality (CAQ)

CAQ releases inaugural “Audit Partner Pulse Survey”

On July 6, 2022, the CAQ released its first “Audit Partner Pulse Survey,” a compilation of U.S. public company audit partner observations on a range of topics. The CAQ intends to publish it regularly. This first survey is based on responses from 700 audit partners from the eight governing board firms at the CAQ and is from data collected during May 2022. Topics include the overall outlook on the economy, business transformation, and quality of corporate disclosures.

According to the survey results related to economic outlook, continued inflation and rising prices are expected, with 84% of audit partners responding that they are not optimistic about the economic outlook over the next 12 months. Respondents identified inflation, labor shortages, supply shortages and supply chain disruptions, and cybersecurity threats as the top economic risks facing companies. Talent is the most important corporate priority for 2022, according to 53% of respondents, and they identified increasing flexibility and compensation as the top two methods to attract and retain talent.

Partners also said that more progress is needed in cybersecurity specifically related to managing risk, enhancing disclosures, and aligning cybersecurity with company goals; however, the results indicate that significant progress was made in communications on cybersecurity between management and the board. The surveyed audit partners also identified that climate change is both a short- and long-term priority for public companies, although they noted reporting challenges. Lastly, while cryptocurrency was not named as a priority for most industries, the financial services industry was identified as an early adopter of cryptocurrency and was more likely to be considering or preparing to accept crypto as a form of payment.

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