March 2021 financial reporting, governance, and risk management

| 3/17/2021
March 2021 financial reporting, governance, and risk management

Message from Mike Percy, Managing Partner, Financial Services

Dear FIEB readers,

February and early March were lighter than usual with regard to regulatory activities as the agencies remain largely on hold as part of the Jan. 20 White House memo directing executive departments and agencies to freeze any pending regulations not yet published in the Federal Register. We expect activity to pick up in the coming months once the freeze expires and the regulators have reviewed the affected pending regulations and guidance.

Meanwhile, Congress passed another stimulus package, the American Rescue Plan Act of 2021, which President Joseph Biden signed into law on March 11. While the act includes more funding for the reopened Paycheck Protection Program, the program’s March 31, 2021, cutoff date was not extended. There is some bipartisan interest in an extension.

We have seen a great deal of interest in environmental, social, and governance (ESG) as well as climate change disclosures. The past few months have brought more interest from the Securities and Exchange Commission and other stakeholders from around the world. As a side note, I find awareness is evolving: More people than not admit to “Googling ESG” to learn the acronym. Many signs point to ESG and climate change disclosures making strides in 2021.

I hope this message finds you, your friends, your family, and your colleagues safe.

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Matters of importance from the federal financial institution regulators

FDIC issues quarterly banking profile for fourth quarter 2020

The Federal Deposit Insurance Corp. (FDIC) released, on Feb. 23, 2021, the quarterly banking profile covering the fourth quarter of 2020. According to the report, FDIC-insured banks and savings institutions reported $59.9 billion quarterly net income, an increase of $5 billion or 9.1% from a year ago, but full-year net income declined $84.9 billion or 36.5% from 2019. The increase from the prior quarter is attributable primarily to the significant decline in provision expense, while the decrease compared to the prior year is a result of lower net interest income and higher provision expenses in the first half of 2020 related to the decline in economic conditions.

The report provides these additional fourth quarter statistics:

  • Net interest income decreased 3.9% ($5.4 billion) from the previous year, totaling $128.7 billion. From the previous year, the average net interest margin decreased 60 basis points to 2.68%.
  • Noninterest income, compared to the previous year, grew 6.5%, driven by net gains on loan sales and on sales of other assets.
  • Total loans and leases decreased $47.7 billion (0.4%) from the previous quarter.
  • Net charge-offs decreased by $2.8 billion (19.7%) from a year ago, and the average net charge-off rate declined 13 basis points to 0.41%.
  • From the previous quarter, the noncurrent loan rate increased by 1 basis point to 1.18%. Noncurrent loan balances (those 90 days or more past due) rose $944.9 million (.7%).
  • Community banks’ net income increased 21.2% year over year.

The total number of FDIC-insured commercial banks and savings institutions declined to 5,001 from 5,033 the previous quarter. During the fourth quarter three new banks were chartered, 31 banks were absorbed by mergers, and two banks failed. The number of institutions on the FDIC’s problem bank list remain unchanged at 56.

NCUA issues fourth quarter 2020 performance data

The National Credit Union Administration (NCUA) reported, on March 4, 2021, quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the fourth quarter of 2020. Highlights include:

  • The number of federally insured credit unions declined to 5,099 from 5,133 in the previous quarter. In the fourth quarter of 2020, 3,185 federal credit unions and 1,914 federally insured, state-chartered credit unions existed.
  • Total assets reported for federally insured credit unions rose by 17.7% to $1.84 trillion, up $278 billion from a year ago.
  • Net income at an annual rate totaled $12 billion, down $2.1 billion (14.9%) from the previous year.
  • The return on average assets decreased significantly from 93 to 70 basis points compared to a year ago.
  • The credit union system’s net worth ratio decreased from 11.37% the previous year to 10.32% in the fourth quarter of 2020.

OCC issues LIBOR transition self-assessment tool

On Feb. 10, 2021, the Office of the Comptroller of the Currency (OCC) published a self-assessment tool for national banks and federal thrift institutions to use in evaluating their preparedness for the expected end of the London Interbank Offered Rate (LIBOR). The assessment tool is intended to help assess:

  • The appropriateness of a bank’s LIBOR transition plan
  • Bank management’s execution of the bank’s transition plan
  • Related oversight and reporting

The OCC release directs banks to develop and implement risk management plans to identify and control risks related to transitioning away from LIBOR to an alternative reference rate and notes that the extent of a bank’s plans should be tailored to the bank’s specific risks. The release also points institutions to review previous Federal Financial Institutions Examination Council statements related to the LIBOR transition (OCC Bulletin 2020-68 and Bulletin 2020-98) for interagency guidance on managing the associated risks. The OCC also highlights Bulletin 2020-104, which communicates the agency’s expectation for banks to cease entering into new contracts that use LIBOR as a reference rate by Dec. 31, 2021.

Fed amends Reg EE scope

The Federal Reserve Board (Fed), on Feb. 18, 2021, issued a final rule to amend Regulation EE to establish new categories of entities under the “financial institution” status covered by the netting provisions of the FDIC Improvement Act of 1991 (FDICIA), first established through Regulation EE in 1994. The FDICIA was intended to provide certainty that netting contracts among financial institutions would be enforced, even in the event of insolvency.

The amendments initially were proposed in May 2019 as the Fed recognized the dramatic evolution of financial markets and the regulatory architecture since 1994. Consistent with the proposal, the revised definition of “financial institution” under Section 402 of the FDICIA adds:

  • Swap dealers and security-based swap dealers
  • Major swap participants and major security-based swap participants
  • Nonbank systemically important financial institutions
  • Certain financial market utilities
  • Foreign banks
  • Bridge institutions
  • Fed banks

The following three categories, which were not in the original proposed version, were added in the final rule’s “financial institution” definition after the Fed’s consideration of feedback received in comment letters:

  • Qualifying central counterparties
  • Foreign central banks
  • Bank for International Settlements

The final rule is effective March 29, 2021.

Paycheck Protection Program (PPP)

Congress authorizes more funds for PPP

On March 11, 2021, President Joseph Biden signed the American Rescue Plan of 2021 (Public Law 117-2) into law. In the act, Congress added $7.25 billion to the Paycheck Protection Program’s lending authority, increasing the funding to a total of $813.7 billion. However, Congress did not extend the deadline for application beyond March 31, 2021. A bipartisan group of members in both chambers is now attempting to give small businesses more time to access these funds.

Bipartisan group works to extend the program

A bill to amend the Small Business Act and the Coronavirus Aid, Relief, and Economic Security Act to extend the covered period for the Paycheck Protection Program and for other purposes was introduced in the House (H.R. 1799) and the Senate (S. 723) on March 11, 2021. The draft legislation would create a May 31, 2021, deadline for accepting applications, but the covered period for expenses would extend to June 30, 2021. We are monitoring the progress of this legislation.

Current developments in climate change and ESG disclosures

Acting SEC chair on climate-related disclosure: Issues directive on review and requests public comments

Public company audit committees and preparers should be aware in preparing their disclosure documents that on Feb. 24, 2021, acting Securities and Exchange Commission (SEC) Chair Allison Herren Lee announced she was directing Division of Corporation Finance (Corp Fin) staff to enhance its focus on climate-related disclosures in public company filings. She said Corp Fin staff should “review the extent to which public companies address the topics identified in the 2010 guidance, assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks.” Insights learned from this review process will be used by Corp Fin to update the 2010 guidance.

On March 15, 2021, Herren Lee announced a request for public comment on climate change disclosures to further inform the SEC’s policymaking. The SEC is posing 15 questions.

Comments are due June 13, 2021.

Commissioners weigh in on enhanced focus on climate and ESG

SEC commissioners Hester M. Peirce and Elad L. Roisman issued, on March 4, 2021, a public statement addressing the recently issued statements and press releases on environmental, social, and governance (ESG) matters. In it, Peirce and Roisman contemplate the meaning of the enhanced focus on climate and ESG-related matters and provide some thoughts.

Regarding the statements from acting chair Herren in her directive to Corp Fin, the commissioners say they believe that – given the focus of Corp Fin on reviewing companies’ disclosures, assessing their compliance with disclosure requirements under the federal securities laws, and engaging with issuers on climate change and ESG issues – the initiative is a continuation of the work already being conducted and not a plan to assess disclosures against any new standards or expectations. With regard to updating the SEC’s 2010 guidance, Peirce and Roisman say they do not believe that a plan exists to issue guidance establishing more specific line items or changing the SEC’s principles-based approach to a prescriptive one.

The announcement of the 2021 examination priorities highlights that the SEC will enhance its focus on climate and ESG-related risks; however, the identified areas do not specifically include a climate or ESG focus. The commissioners note that the risk-based reviews of compliance with existing statutes and regulations will touch on climate and ESG-related risks given the current environment; however, the review will have a broader focus.

The commissioners also said that the purpose of the newly created Climate and ESG Task Force is not clear, as currently the Division of Enforcement identifies, investigates, and brings actions against those who violate the SEC’s laws and rules and no new standards related to climate and ESG have been introduced.

SEC announces climate and ESG enforcement task force

The SEC announced, on March 4, 2021, the creation of a Climate and ESG Task Force in the Division of Enforcement. The task force, led by Kelly L. Gibson, the acting deputy director of enforcement, will develop initiatives to identify misconduct related to ESG issues. Initially, the task force will focus on identifying material gaps or misstatements in issuers’ disclosure of climate and ESG risks under existing rules and will coordinate the division’s resources to identify potential violations. In addition, the task force will assess and pursue tips, referrals, and whistleblower complaints, and it will provide expertise to teams working on ESG-related matters.

Crowe offers a primer on ESG disclosures

As investors and other stakeholders increasingly focus on ESG factors as part of their investment decisions, some entities are seeking a greater understanding of ESG disclosures. Crowe published an article, “Got ESG? Current developments in ESG disclosure,” with information about ESG disclosure developments.

Acting Corp Fin director speaks on ESG disclosures

Acting Corp Fin Director John Coates shared observations on ESG disclosures at the 33rd annual Tulane Corporate Law Institute on March 11, 2021. He remarked on issues including:

  • Considerations for an effective ESG disclosure system
  • Costs of not having ESG disclosure requirements
  • Mandatory versus voluntary disclosure
  • Benefits of having a global ESG reporting framework

Coates said he believes policymakers, including the SEC, should consider these issues when debating ESG disclosures, and he remarked the SEC’s approach to ESG disclosures should be both “adaptive and innovative.”

CAQ issues ESG disclosure information

On Feb. 17, 2021, the Center for Audit Quality (CAQ) and the Association of International Certified Professional Accountants issued a joint publication, “ESG Reporting and Attestation: A Roadmap for Audit Practitioners.” Although written from the perspective of audit practitioners, it contains a number of data points that could help preparers understand ESG disclosures, including where and how to report ESG information.

From the Financial Accounting Standards Board (FASB)

FASB continues post-implementation reviews and research

As with regulatory agencies recently, February and early March activity at the FASB have been lighter than usual. However, the FASB is continuing its post-implementation review of credit losses, leases, and revenue recognition to evaluate whether these standards are achieving their objectives and if areas of improvement exist that the FASB should address in future projects, codification improvements, or other clarifications.

Additionally, the FASB continues its active research agenda and agenda prioritization. At its most recent board meeting on March 3, 2021, the board decided not to add potential projects related to 1) pushdown of parent’s basis in a common control transaction and 2) clarification of guidance for certain asset acquisitions and nonemployee share-based payment transactions.

The FASB requested academic research papers on the effectiveness of the recent standards on credit losses, leases, and revenue recognition, including if the standards met their objectives, provided benefits to financial statement users, had any unexpected implementation issues or costs, or created unforeseen consequences. Selected papers will be presented at a conference in November and considered for publication by the Accounting Review.

FASB releases video for investors on convertible instruments

On Feb. 9, 2021, the FASB posted on its website an investor education video, “New Accounting Standard for Convertible Instruments,” that provides guidance on Accounting Standards Update (ASU) 2020-06, “Debt – Debt With Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The video explains how the guidance simplifies the accounting for convertible instruments and improves relevance and comparability of information available to investors. In addition, it walks through examples of how ASU 2020-06 may affect a company’s financial statements, earnings-per-share calculations, and other related areas.

More from the Securities and Exchange Commission (SEC)

SEC chair nominee appears before the Senate banking committee

On March 2, 2021, Gary Gensler, President Biden’s nominee for the SEC chair, appeared before the Senate banking committee. On March 10, 2021, the committee voted 14-10 to approve Gensler both for the remainder of the Jay Clayton term ending on June 5, 2021, and for a full term ending on June 5, 2026. The nomination now moves to the full Senate.

SEC announces 2021 examination priorities

On March 3, 2021, the SEC’s Division of Examinations announced its 2021 examination priorities. Examinations will include a greater focus on climate and ESG-related risks and will also focus on, among other topics, these areas:

  • Compliance with Regulation Best Interest, Form CRS, and whether registered investment advisers have fulfilled their fiduciary duties of care and loyalty
  • Information security and operational resiliency, including review of entities’ business continuity and disaster recovery plans to confirm that they are accounting for the increasing physical and other relevant climate change and related risks
  • Financial technology and innovation, including digital assets
  • Compliance with anti-money laundering requirements
  • LIBOR transition
  • Investment advisers and investment companies, including compliance programs, registered funds, and registered investment advisers to private funds
  • Broker-dealers and municipal advisers, including compliance with the Customer Protection Rule and the Net Capital Rule; the adequacy of internal processes, procedures, controls, and compliance with requirements; and whether municipal advisers have met their fiduciary duty obligations to municipal entity clients
  • Market infrastructure including clearing agencies, national securities exchanges, regulation systems compliance and integrity, and transfer agents

The listing of 2021 priorities is not meant to be comprehensive and will not be the only areas of the SEC’s examinations, risk alerts, and outreach.

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