June 2021 financial reporting, governance, and risk management

Message from John Epperson, Managing Principal, Financial Services

Dear FIEB readers,

While I am excited to take the reins from Mike Percy to serve as the managing principal for Crowe financial services, I also know I have big shoes to fill. Mike led our financial services team for more than 15 years, including navigating us through both the Great Recession and the pandemic. Mike is an incredible leader, and I am grateful for his service and continued leadership in shaping our financial services community.

We have experienced what feels like unprecedented change in terms of both impact and speed. The financial services industry has always been resilient, and I am confident now will be no different. I look forward to navigating the changes together, and please know my virtual door is open to your feedback and questions.

Regulators are beginning to turn their attention to risk management and consumer compliance practices with the rapid advancement of innovation and the world of digital assets. We also continue to see a great deal of interest in environmental, social, and governance disclosures, with a focus on climate change disclosures. On Monday, June 14, the comment period closed on then-acting SEC Chair Allison Herren Lee’s March 15 request for comment on climate change disclosures. To say there is passion on this topic is an understatement. The SEC received approximately 5,400 comment letters, which includes 200 unique letters and 5,200 letters from four form letter variations. The SEC staff also documented approximately 30 meetings with stakeholder groups over the past three months regarding the open request.

This week, I am attending my first in-person conference in well over 15 months and feeling a sense of moving to our next normal. I’m excited about the possibility of seeing some of you in person soon.

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Matters of importance from the federal financial institution regulators

FDIC issues quarterly banking profile

The Federal Deposit Insurance Corp. (FDIC), on May 26, 2021, issued the Quarterly Banking Profile (QBP) covering the first quarter of 2021. According to the QBP, FDIC-insured banks and savings institutions earned $76.8 billion quarterly net income, a $58.3 billion (315.3%) increase from a year ago. That increase was largely driven by an aggregate negative provision expense, reflecting improvements in economic conditions and asset quality.

The QBP provides additional first quarter highlights:

Net interest income fell 5.6% from the previous year, totaling $129.7 billion. The average net interest margin decreased 57 basis points from the previous year to a record low 2.56%.
Noninterest income rose $9.9 billion compared to the previous year.
Total loans and leases declined $38.7 billion from the previous quarter.
Noncurrent loans (those 90 days or more past due) declined $5.9 billion from fourth quarter 2020, and net charge-offs declined $5.4 billion from a year ago.
Community banks reported quarterly net income of $8.4 billion, up 78% from a year ago.

The total number of FDIC-insured commercial banks and savings institutions declined from 5,002 to 4,978 from the previous quarter. During the fourth quarter, three new banks were chartered, 25 banks were absorbed by mergers, and no bank failed. The number of institutions on the FDIC’s problem bank list declined by one to 55 in the first quarter.

NCUA issues first quarter 2021 performance data

The National Credit Union Administration (NCUA) reported, on June 4, 2021, quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the first quarter of 2021.

Highlights include:

The number of federally insured credit unions declined to 5,068 from 5,195 in the first quarter of 2020. In the first quarter of 2021, 3,167 federal credit unions and 1,901 federally insured, state-chartered credit unions existed.
Total assets reported for federally insured credit unions rose by 19% to $1.95 trillion, up $311 billion from a year ago.
Net income at an annual rate totaled $19.7 billion, up $11.3 billion (134.9%) from the previous year.
The return on average assets was 104 basis points in the first quarter of 2021, an increase of 52 basis points from the first quarter of 2020.
The credit union system’s net worth ratio decreased from 11.00% the previous year to 10.01% in the first quarter of 2021.

FDIC releases risk review for 2021

The FDIC, on May 10, 2021, released its Risk Review for 2021, which continues its coverage of credit and market risk topics from the previous issue in 2019. In the report, the FDIC notes that the banking industry remained resilient entering 2021, despite the challenges banks faced as a result of the pandemic. In addition, while federal support programs helped cushion the effects of the pandemic, close monitoring of key risks for banks remains essential.

The comprehensive report summarizes conditions in the U.S. economy, financial markets, and banking industry while also presenting key credit and market risks to banks. Specific topics include agriculture lending, commercial real estate, consumer debt, small-business lending, and other areas of credit risk. The market risk section covers interest-rate risk, net interest margin, and liquidity and deposits.

According to the report, credit risk remains heightened, and institutions with elevated levels of credit exposure to affected sectors are potentially more vulnerable to market disruptions and could present risk management challenges.

OCC issues semiannual risk report

The Office of the Comptroller of the Currency (OCC) on May 18, 2021, released its “Semiannual Risk Perspective” for spring 2021. The report highlights key issues facing the banking industry and the effects of the COVID-19 pandemic on the federal banking sector. In the report, the OCC notes that while banks maintained sound capital and liquidity in 2020, profitability remains stressed due to low interest rates and stagnant loan growth. The OCC specifically cites credit, strategic, operational, and compliance risk as key themes.

The OCC notes that credit risk remains elevated, especially in commercial real estate lending. Operational risk also remains elevated, with ransomware attacks and other cybersecurity threats on the rise. In addition, third-party risk management continues to be an area of heightened supervisory focus.

The report states that the OCC will also continue to assess London Interbank Offered Rate (LIBOR) transition in national banks and that it will be increasing its oversight through 2021, particularly for banks with significant LIBOR exposure or less developed transition plans. The report refers to OCC Bulletin 2021-7, “Libor Transition: Self-Assessment Tool for Banks.”

Finally, the “Semiannual Risk Perspective” raised the issue of climate change for the first time, noting, “Banks may face risk relative to climate change through physical conditions or transitions in the economy .” Acting Comptroller Michael Hsu, who joined the OCC from the Federal Reserve earlier in May, also highlighted climate change risk for banks in his first public statement after being named to the position.

FDIC issues RFI on digital assets

On May 17, 2021, the FDIC issued a request for information (RFI) to solicit feedback from banks and other interested parties regarding insured depository institutions’ current and potential activities related to digital assets.

In the RFI, the FDIC notes that new technology and innovation play a role in the use of digital assets in financial markets and intermediation along with settlement and payment systems. Digital asset use cases might fall into one or more broader categories, but they require novel and unique considerations. Given that banks are increasingly exploring the emerging digital asset ecosystem, the FDIC aims to gather information from industry participants to help it gain a better understanding of current and potential use cases as well as risk and compliance management in conducting such activities.

Comments are due July 16, 2021.

Fed will explore central bank digital currency

In a statement on May 20, 2021, Federal Reserve Board (Fed) Chair Jerome Powell announced that the Fed plans to publish a discussion paper on the implications of fast-evolving technology for digital payments. A particular focus will be on the possibility of issuing a U.S. central bank digital currency (CBDC). The discussion paper will complement Fed research already underway aimed at understanding how a CBDC could improve the domestic payments system in serving the needs of households and businesses.

Current research activities include work at the Fed’s TechLab, established in August 2020, which has been experimenting with technologies relevant to digital currencies and other payment innovations. The Federal Reserve Bank of Boston has also been collaborating with the Massachusetts Institute of Technology on a multiyear effort to develop an understanding of the capacities and limitations of the relevant technologies.

In a May 24, 2021, speech, Fed Gov. Lael Brainard provided additional updates on the Fed’s related research and experimentation activities.

Fed proposes changes to intraday liquidity management

The Fed, on May 28, 2021, issued a request for comment on proposed changes to its policy on Payment System Risk (PSR policy), which governs the provision of intraday credit, or daylight overdrafts to financial institutions with accounts at Federal Reserve banks.

The changes would expand access to collateralized capacity. It also would clarify the terms for accessing uncollateralized intraday credit as well as the circumstances under which an institution may remain eligible for uncollateralized capacity if its holding company or affiliate is assigned a low supervisory rating.

The changes would also align the Fed’s payment system risk and overnight overdraft policies with the deployment of FedNow, the real-time payments network currently being developed.

Comments are due Aug. 2, 2021.

Fed issues proposed changes to Regulation J

On June 1, 2021, the Fed issued a proposed rule, “Collection of Checks and Other Items by Federal Reserve Banks and Funds Transfers Through Fedwire,” to add a new subpart to Regulation J that would create a new and comprehensive set of rules to govern funds transfers made over the FedNow Service. The FedNow Service is the real-time payments platform that is expected to be available in the United States in 2023.

Comments are due Aug. 10, 2021.

Current developments in climate change and ESG disclosures

SEC commissioner addresses potential costs of ESG disclosures

On June 3, 2021, before the Environmental, Social, and Governance (ESG) Board Forum, U.S. Securities and Exchange Commission (SEC) Commissioner Elad L. Roisman spoke on ESG disclosures and the potential costs of requiring specific disclosures. He shared reservations regarding the SEC issuing ESG disclosure requirements because it would be difficult to standardize such requirements to provide meaningful and not misleading information. He then raised several questions that the SEC would need to address when crafting new rules over ESG disclosures and concentrated on ways to mitigate various costs and difficulties of new ESG disclosure requirements.

Roisman first identified the importance of minimizing costs and burdens related to understanding what investors want. He warned of the foreseeable costs not only of obtaining and presenting new information but also of increased liability related to such new disclosures. Roisman stated that if the costs are foreseeable, they can be addressed beforehand as the new rules are developed.

Roisman then offered ways to tailor ESG disclosure requirements, including:

Scaling the disclosures for public issuers based on size
Providing flexibility in sources and methodologies
Considering safe harbors for companies that are making an earnest effort to provide this new information
Considering having the disclosure information furnished to instead of filed with the SEC
Extending the implementation period and having a phased-in approach

In closing, Roisman said, “any new ESG disclosure rules will inevitably come with costs. Especially since such disclosure would involve information that is based on uncertain underlying assumptions, or is difficult to calculate, the Commission should be particularly careful to ensure that (1) investors understand the limitations of the information disclosed and (2) companies can actually provide such information without incurring undue costs and burdens.”

SEC commissioner shares thoughts on materiality misconceptions related to ESG disclosures

On May 24, 2021, SEC Commissioner Allison Herren Lee presented keynote remarks at the 2021 ESG Disclosure Priorities Event hosted by the American Institute of CPAs, the Chartered Institute of Management Accountants, the Sustainability Accounting Standards Board, and the Center for Audit Quality. Her remarks concentrated on the misconceptions about materiality specifically related to ESG and required disclosures.

She explained that materiality is a fundamental proposition in the securities laws and in the capital markets and disclosure is focused on providing information that is important to reasonable investors. Lee identified four misconceptions about materiality specifically related to ESG:

“Myth #1: ESG matters (indeed all matters) material to investors are already required to be disclosed under the securities laws.” Lee said that without a specific requirement to disclose, the existence of material or important information by itself does not mandate its disclosure. She also noted that current securities laws do not include much regarding specific ESG disclosure requirements.
“Myth #2: Where there is a duty to disclose climate and ESG matters, we can rest assured that such disclosures are being made.” To this point, Lee shared that determinations about what is material are judgment calls that might differ for all parties involved and disclosures might not include all information considered material to reasonable investors.
“Myth #3: SEC disclosure requirements must be strictly limited to material information.” According to Lee, this is not what the law requires and not how the SEC approaches rules about disclosures.
“Myth #4: Climate and ESG are matters of social or ‘political’ concern, and not material to investment or voting decisions.” Lee pointed out that the SEC is seeing increased interest from market participants in ESG factors as significant drivers of decision-making, risk assessment, and capital allocation.

Lee closed with a warning not to believe these misconceptions. She shared her hope that the misconceptions can be overcome as the deliberations continue on how best to craft a rule proposal on climate and ESG risks and opportunities.

President orders national strategy on climate-related financial risk

On May 20, 2021, President Joe Biden issued an executive order addressing climate-related financial risk. According to the order, “The failure of financial institutions to appropriately and adequately account for and measure [climate-related] physical and transition risks threatens the competitiveness of U.S. companies and markets, the life savings and pensions of U.S. workers and families, and the ability of U.S. financial institutions to serve communities.” As such, the federal government should lead by example, and it is the president’s policy to “advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk.”

To further this purpose, Biden ordered the development of a governmentwide climate-related financial risk strategy addressing the measurement, assessment, mitigation, and disclosure of climate-related financial risk and the related financing needs. The order calls for financial regulators to assess climate-related financial risk and for the secretary of labor to address the resilience of life savings and pensions to the threats of climate-related financial risk. Additionally, the order aims to modernize federal lending, underwriting, and procurement to improve financial management and reporting by incorporating climate-related financial risk. Finally, the order addresses the long-term budget outlook and the exposure to increased costs and lost revenue resulting from unaddressed climate risks.

From the Financial Accounting Standards Board (FASB)

FASB hosts roundtable on credit losses

As part of the FASB’s post-implementation review process, the FASB hosted, on May 20, 2021, a virtual roundtable on implementation of the current expected credit losses (CECL) standard and related technical issues. The 21-page handout includes the agenda, topics for discussion, FASB participants, and external participants. Feedback from various stakeholders primarily addressed implementation, purchased financial assets with credit deterioration (PCD) accounting, and consideration of troubled debt restructurings (TDRs).

Participant insight into CECL implementation included how CECL performed for large public institutions considering the dynamic environment as a result of COVID-19, the lack of comparability in CECL disclosures across entities, and whether there is sufficient flexibility in required disclosures for different size institutions. The participants also addressed observations on applying the PCD accounting model to all acquired assets. Additionally, participants discussed the relevance of TDRs as a measure of troubled loans, including consideration of discontinuing the TDR accounting given the forward-looking measurement of the allowance under CECL.

The FASB is planning to further analyze the feedback and determine if a project or projects should be added to the technical agenda.

Stakeholders should continue to provide feedback on CECL.

More from the Securities and Exchange Commission (SEC)

SEC designates new acting PCAOB chair, seeks board candidates

On June 4, 2021, the SEC announced that it appointed Duane M. DesParte to serve as acting chair of the Public Company Accounting Oversight Board (PCAOB), replacing William D. Duhnke, effective immediately. DesParte has been a member of the PCAOB since early 2018. The SEC, which selects all members and the chair of the PCAOB, also announced that it will solicit applications for all five board positions.

SEC issues statements on proxy voting rules

SEC Chair Gary Gensler, on June 1, 2021, issued a directive to SEC staff to consider whether to recommend further regulatory action specifically related to the September 2019 interpretation and guidance addressing the application of the proxy rules to proxy voting advice businesses and the July 2020 amendments to Rules 14a-1(l), 14a-2(b), and 14a-9 concerning proxy voting advice. He also asked staff to consider whether to recommend that the SEC revisit its 2020 codification of the definition of solicitation as encompassing proxy voting advice, the 2019 interpretation and guidance regarding that definition, and the conditions on exemptions from the information and filing requirements in the 2020 rule amendments.

Responding to Gensler’s directive, the Division of Corporation Finance (Corp Fin) staff announced that it will not recommend enforcement action to the SEC based on the 2019 interpretation and guidance or the 2020 rule amendments during the period in which the SEC is considering further regulatory action in this area. Also, if regulatory action leaves the 2020 exemption conditions in place with the current compliance date of Dec. 1, 2021, the staff will not recommend any enforcement action based on those conditions for a reasonable period of time.

In response to the directive from Gensler and the Corp Fin announcement, SEC Commissioners Elad L. Roisman and Hester M. Peirce noted that they are open to seeing what, if any, rule changes the staff recommends. However, they said they find it difficult to imagine what has changed since the amendments were issued in July 2020, especially considering that the compliance date has not yet occurred. They stated that the amendments that were adopted already reflected a long analysis process that considered a broad range of input. They also shared that they hope that any actions would not “deprive users of proxy voting advice of information they need to properly consider such advice or lead them to make decisions based on misinformation.”

SEC chair testifies on resources and trends

SEC Chair Gary Gensler appeared before the Subcommittee on Financial Services and General Government of the U.S. House Appropriations Committee on May 26, 2021, to testify on trends in capital markets affecting SEC resources, the impact of the pandemic on the SEC’s work, and other SEC initiatives. Gensler shared his opinion on the vast scope of the SEC, the significant growth in the capital markets, and the lack of growth in the size of the SEC and its resources. Gensler emphasized that the SEC needs to ensure it has the resources to protect investors accessing the capital markets, and he identified the following five key capital market trends that will affect SEC resource needs:

Significant increases in initial public offerings and special-purpose acquisition companies
Substantial growth in the number of private funds
Growth in the use of crypto assets, which are highly volatile and speculative
New business models resulting from developments in financial technology (fintech)
Increasing reliance on data analytics

Gensler provided details to give a better picture of how each of these key capital market trends is currently affecting and will affect SEC resources and how each is affecting the capital markets. Additionally, Gensler identified these four initiatives affecting the SEC:

Rules on security-based swaps that will be effective in 2021
Implementation of Regulation Best Interest
Consideration of economic analysis and input from the public on disclosures
Addressing the transition from LIBOR

In closing, Gensler repeated that the SEC is working with fewer resources than it had five years ago and noted that he looks “forward to working with Congress on additional resources so the SEC can stay apace of these important trends.”

From the Public Company Accounting Oversight Board (PCAOB)

PCAOB releases 2020 annual report

The PCAOB published its “2020 Annual Report” in May 2021. The report summarizes the PCAOB’s operations and financial results for fiscal year 2020 and highlights accomplishments and developments for the year for each of the PCAOB’s five strategic goals:

“Drive improvement in the quality of audit services through a combination of prevention, detection, deterrence, and remediation.”
“Anticipate and respond to the changing environment, including emerging technologies and related risks and opportunities.”
“Enhance transparency and accessibility through proactive stakeholder engagement.”
“Pursue operational excellence through efficient and effective use of [PCAOB] resources, information, and technology.”
“Develop, empower, and reward [PCAOB] people to achieve our shared goals.”

Additionally, the report includes audited financial statements, a financial review, and management’s report on internal control over financial reporting.

Sydney Garmong

Partner, National Office

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Dennis Hild

Principal, National Office

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Mark Shannon

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