March 2023 financial reporting, governance, and risk management

| 3/21/2023
March 2023 financial reporting, governance, and risk management

Message from John Epperson, Managing Principal, Financial Services

Dear FIEB readers,

The market events over the past two weeks underscore that the ever-changing environment continues to pose unique challenges and risks. We continue to monitor the shifting landscape and share insights to help you navigate regulatory and market events and support ongoing resiliency and trust within our industry. In addition to the significant market events, regulatory actions, and policy-maker statements over the past 10 days, here are other relevant developments from regulators and standard-setters.

On a lighter note, it is March, which brings the NCAA tournaments and other festivities such as St. Patrick’s Day. For those of you participating, we wish you luck with your brackets and enjoyment of all things green.

It is our privilege to keep you informed on the topics of financial reporting, governance, and risk as the landscape continues to evolve.

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Matters of importance from the federal financial institution regulators

FDIC issues quarterly banking profile for fourth quarter 2022

The Federal Deposit Insurance Corp. (FDIC) released on Feb. 28, 2023, the quarterly banking profile (QBP) covering the fourth quarter of 2022. According to the report, FDIC-insured banks and savings institutions reported $263 billion full-year net income, a decrease of $16.1 billion or 5.8% from 2021. The decrease in net income was driven largely by higher provisions for loan losses and higher noninterest expenses, which more than offset an increase in net interest income.

The report provides these additional fourth quarter statistics:

  • Net interest income totaled $ 632.9 billion for full-year 2022, up from $527.4 billion (20%) in 2021. From the previous year, the average net interest margin (NIM) increased 82 basis points to 3.37%. The year-over-year growth in NIM was the largest increase in the history of the QBP.
  • The aggregate return on average assets (ROAA) ratio was 1.16%, down from 1.21% in the third quarter but up from 1.09% from year-end 2021.
  • Total loans and leases increased $225.5 billion (1.9%) from the previous quarter and 979.9 billion (8.7%) year over year.
  • Total deposits declined $487.4 billion (2.5%) between 2021 and 2022.
  • From the previous quarter, the noncurrent loan rate increased one basis point to 0.73%.
  • Community banks’ annual net income totaled $30.4 billion for 2022, a decrease of $ 87.1 million or 0.3% year over year.

The total number of FDIC-insured commercial banks and savings institutions declined from 4,746 in the third quarter to 4,706 in the fourth quarter. The number of banks at the end of 2021 totaled 4,839. During the fourth quarter, three new banks opened, 36 banks were absorbed by mergers, and no banks failed. The number of institutions on the FDIC’s problem bank list decreased by three from the third quarter to 39, which is the lowest level in QBP history. Total assets of problem banks declined $116.3 billion from the previous quarter to $47.5 billion.

NCUA issues fourth quarter 2022 performance data

The National Credit Union Administration (NCUA) reported on March 8, 2023, quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the fourth quarter of 2022. Highlights include:

  • The number of federally insured credit unions declined to 4,760 in the fourth quarter of 2022 from 4,942 in the fourth quarter of 2021. In the fourth quarter of 2022, 2,980 federal credit unions and 1,780 federally insured, state-chartered credit unions existed.
  • Total assets reported for federally insured credit unions rose by 5.2% to $2.17 trillion, up $108 billion from a year ago.
  • Net income totaled $18.9 billion in 2022, down $2 billion (9.5%) from the previous year.
  • The return on average assets was 89 basis points in 2022, down 107 basis points compared to a year ago.
  • The credit union system’s net worth increased by $21.4 billion, or 10.1%, over the year to $232.9 billion. The aggregate net worth ratio was 10.74% in the fourth quarter of 2022, up from 10.26% in the fourth quarter of 2021.

Agencies issue statement on liquidity risk related to crypto assets

Federal banking regulators on Feb. 23, 2023, issued a joint statement highlighting liquidity risks to banks associated with certain sources of funding from crypto-asset-related entities and some effective practices to manage those risks. According to the statement from the Federal Reserve (Fed), FDIC, and Office of the Comptroller of the Currency (OCC), banks are neither prohibited nor discouraged from providing banking services that are permitted by law or regulation. However, the agencies said, “certain sources of funding from crypto-asset-related entities may pose heightened liquidity risks to banking organizations due to the unpredictability of the scale and timing of deposit inflows and outflows.”

The risks highlighted by the agencies include the potential volatility of deposits placed by a crypto-asset-related entity that are for the benefit of that entity’s customers. The statement specifically highlights deposits that can be susceptible to large and rapid inflows and outflows, when end customers react to market events, media reports, and uncertainty related to the crypto asset sector. Deposits that constitute stablecoin-related reserves are another risk as they are “susceptible to large and rapid outflows stemming from, for example, unanticipated stablecoin redemptions or dislocations in crypto-asset markets.”

The statement also reminds banking organizations to actively monitor liquidity risk and apply effective risk management controls when using certain sources of funding from entities related to crypto assets. Examples of effective risk management practices include:

  • Understanding the direct and indirect drivers of potential deposit behavior to ascertain which deposits are susceptible to volatility
  • Assessing concentrations or interconnectedness across deposits related to crypto assets, as well as the associated liquidity risks
  • Incorporating liquidity risks or funding volatility into contingency funding planning
  • Performing robust due diligence and ongoing monitoring of crypto-asset-related entities that establish deposit accounts to assess the accuracy of representations about these types of accounts

The statement also reminds institutions that they must comply with applicable laws and regulations, including brokered deposit rules, as applicable, and call report filing requirements.

Fed governor urges caution to banks engaging with crypto ecosystem

In related crypto asset news, Fed Gov. Christopher Waller on Feb. 10, 2023, reminded banks and other financial institutions that they must engage in a safe and sound manner in any activity they do, including dealing in crypto assets. At a Global Interdependence Center conference on digital assets, Waller expressed concern about banks “engaging in activities that present a heightened risk of fraud and scams, legal uncertainties, and the prevalence of inaccurate and misleading financial disclosures.”

Waller said, “banks considering engaging in crypto-asset-related activities face a critical task to meet the ‘know your customer’ and ‘anti-money laundering’ requirements, which they in no way are allowed to ignore.” Waller added, “So far, spillovers to other parts of the financial system from the stress in the crypto industry have been minimal. The lack of spillovers to date may be attributable in part to the relatively limited number of interconnections between the crypto ecosystem and the banking system. While it is critical that we ensure that the financial stability risks associated with crypto-assets are mitigated, it is important that we keep the various parts of the crypto ecosystem distinct in our minds as the debate about if and how to regulate crypto rolls on.”

Fed governor highlights oversight of outsourced banking services

At the Fed’s “Midwest Cyber Workshop” on Feb. 15, 2023, Fed Gov. Michelle Bowman noted in a speech that as banks become increasingly reliant on third-party service providers, regulators should consider the appropriateness of shifting the regulatory burden from community banks to more efficiently focus directly on service providers. Bowman indicated that regulators have authority to do so under the Bank Service Company Act.

She said that customer demand driving banks’ efforts to deliver innovative and personalized products and services has increased community banks’ reliance on third-party relationships to provide new technologies. She added that these service providers should bear more responsibility for ensuring that the outsourced activities are performed in a safe and sound manner.

Bowman further highlighted the importance of third-party risk management and mentioned the federal banking regulators’ proposed interagency guidance for the risk management of third-party relationships that is expected to be issued in final form soon.

Bowman also discussed regulatory expectations regarding cyber risk management and noted that the occurrence of a cyber event should not be the first time a cyber risk conversation occurs between a bank and its regulator. Bowman concluded that the agencies look forward to working with industry participants to assist in clarifying expectations, applying regulatory guidance, and seeking feedback on strategies for cyber risk management. She encouraged bank management teams to contact regulators with questions about cybersecurity matters just as they would with any other regulatory matters.

FSB plans to increase scrutiny of decentralized finance

The Financial Stability Board (FSB) issued a report on Feb. 16, 2023, that lays out several steps the FSB will take to evaluate and possibly reduce the financial stability risks posed by decentralized finance (DeFi). The report covers the current DeFi ecosystem, vulnerabilities of DeFi, possible scenarios for DeFi and implications for financial stability, and additional work to analyze, monitor, and address vulnerabilities in the DeFi ecosystem.

According to the report, the FSB will proactively analyze the financial vulnerabilities of the DeFi ecosystem as part of its regular monitoring of the wider crypto asset markets. The FSB also plans to collaborate with international standard-setting bodies and regulatory authorities to explore approaches to fill data gaps to measure and monitor the interconnectedness of DeFi with traditional finance. Lastly, the FSB will explore the extent to which its proposed policy recommendations for the international regulation of crypto asset activities might need to be enhanced to acknowledge DeFi-specific risks.

In addition, the FSB will consider assessing the regulatory perimeter across jurisdictions to determine which DeFi activities and entities fall within that perimeter. This determination includes considering whether certain crypto asset types and entities should be subjected to additional prudential and investor protection requirements or whether the enforcement of existing requirements should be stepped up to help reduce the risks inherent in closer interconnections.

From the Financial Accounting Standards Board (FASB)

FASB addresses related-party lease accounting

At its meeting on Feb. 15, 2023, the FASB approved amendments to the accounting for common control leasing arrangements and plans to issue a final Accounting Standards Update (ASU) in March 2023.

The amendments will allow a private company to elect to account for a common control leasing arrangement using the written terms and conditions without having to determine if those terms and conditions are legally enforceable. If the terms of the arrangement are not in writing, then the entity would apply existing guidance to determine the legally enforceable terms and conditions of the arrangement.

Additionally, the amendments will require leasehold improvements associated with leases between entities under common control to be amortized over the useful life of the improvements until the lessee ceases to control the use of the underlying asset through a lease, at which time the remaining value of the leasehold improvement would be accounted for as a transfer between entities under common control.

The ASU will be effective for all entities for fiscal years beginning after Dec. 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. More details on the amendments can be found in the Crowe article “FASB to Amend Related-Party Lease Accounting.”

FASB proposes improvements to income tax disclosures

On March 15, 2023, the FASB issued a proposed ASU, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures,” to provide additional transparency into an entity’s jurisdictional tax exposure by requiring enhanced disclosures primarily related to the rate reconciliation and income taxes paid information. The proposed ASU would require that public business entities disclose on an annual basis 1) specific categories in the rate reconciliation and 2) additional information for reconciling items meeting a certain quantitative threshold. On an interim basis, public business entities would be required to provide a description of any reconciling items that result in significant changes in the estimated annual effective tax rate as compared to the annual effective tax rate of the prior annual reporting period. The proposed ASU also would require that entities other than public business entities disclose qualitative information about specific categories of items and individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate.

Regarding income taxes paid, the proposed ASU would require that all entities disclose 1) the year-to-date income taxes paid (net of refunds received) disaggregated by federal (national), state, and foreign taxes on an interim and annual basis and 2) the income taxes paid (net of refunds received) disaggregated by individual jurisdictions exceeding 5% of total taxes paid (net of refunds received), on an annual basis.

In addition, the proposed ASU also would require that all entities disclose 1) income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign and 2) income tax expense (or benefit) from continuing operations disaggregated by federal (national), state, and foreign.

Comments are due May 30, 2023.

From the Securities and Exchange Commission (SEC)

SEC commissioner remarks on capital formation

Commissioner Mark Uyeda recently delivered remarks in two separate forums regarding capital formation. In his March 3, 2023, remarks at the “Going Public in the 2020s” conference, Uyeda discussed the declining trend of entities accessing the public capital markets and suggested mechanisms to foster a more hospitable environment for being a public company while maintaining investor protection. On March 7, Uyeda delivered remarks before the Institute of International Bankers, where he discussed key components of efficient capital formation and provided perspectives on how international securities activity can be facilitated across regulatory jurisdictions.

SEC Investor Advisory Committee meets

The SEC’s Investor Advisory Committee held a virtual public meeting on March 2, 2023. The panel discussions held during the meeting addressed the following topics:

  • Growth of private markets relative to the public markets: Drivers and implications. This panel discussed the factors contributing to the growth of private markets, implications of this growth on decisions made by operating companies and investors, and if there should be modifications to the existing disclosure and regulatory framework.
  • Oversight of investment advisers: Can regulators keep up with growth in the industry. This panel discussed how regulators are managing oversight of the registered investment adviser industry through their examination programs as well as potential approaches to enhancing oversight and bolstering the examination programs.
  • The open-end fund liquidity risk management and swing pricing rule proposal. This panel discussed the potential use of swing pricing in the U.S. market and focused on possible impacts of the SEC’s November 2022 proposed enhancements to the open-end fund liquidity framework and potential impacts from implementation of a “hard close” on mutual fund orders.

SEC Chair Gary Gensler provided prepared remarks, and commissioners Hester Peirce and Jaime Lizárraga spoke.

SEC proposes enhanced safeguarding rule for registered investment advisers

On Feb. 15, 2023, the SEC proposed for public comment rule changes to enhance protections of customer assets managed by registered investment advisers. If adopted, the changes would amend and redesignate Rule 206(4)-2, the SEC’s custody rule, under the Investment Advisers Act of 1940.

The proposed amendments would:

  • Expand the current custody rule to include a wider array of client assets and advisory activities in the rule’s protections
  • Enhance the custodial protections that client assets receive under the rule
  • Update certain recordkeeping and reporting requirements for advisers

Although the proposal retains the current requirement for an adviser with custody of client assets to undergo a surprise examination from an independent public accountant to verify those assets, the proposal would modify the audit provision to expand the availability of its use to satisfy the requirement, enhance investor protection, and facilitate compliance.

Comments are due May 8, 2023.

SEC releases small-entity compliance guide on insider trading

The SEC on Feb. 24, 2023, released a small-entity compliance guide on insider trading arrangements and related disclosures to address the Dec. 14, 2022, adopted amendments to Rule 10b5-1 under the Securities Exchange Act of 1934. The amendments update conditions of the affirmative defense to insider trading liability in Rule 10b5-1, place certain restrictions on Rule 10b5-1 plans, and require new disclosures. More details are in the Crowe article “New SEC Insider Trading Rule: What Registrants Should Know.”

SEC extends EDGAR filing deadline for Form 144

On Feb. 21, 2023, the SEC adopted an amendment to Regulation S-T to extend the filing deadline for Form 144 from 5:30 p.m. to 10 p.m., Eastern Standard Time or Eastern Daylight Saving Time, whichever is currently in effect, on SEC business days. Additionally, the SEC adopted technical amendments designed to enhance the consistency of recently revised provisions related to the filing format of Form 144.

The amendments are effective on March 20, 2023.

SEC finalizes rule changes to securities settlement cycle

Rule changes designed to benefit investors and reduce the credit, market, and liquidity risks in securities transactions faced by market participants were adopted by the SEC on Feb. 15, 2023. They shorten the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one (T+1) and shorten the separate standard settlement cycle for firm commitment offerings prices after 4:30 p.m. from four business days after the trade date to two business days.

The rules also improve the processing of institutional trades by requiring broker-dealers to either enter into written agreements or establish, maintain, and enforce written policies and procedures reasonably designed to ensure the completion of allocations, confirmations, and affirmations as soon as technologically practicable and no later than the end of trade date.

Lastly, the rules add a new requirement to facilitate straight-through processing, which applies to clearing agencies that are central matching service providers. The rules require these providers to establish, implement, maintain, and enforce new policies and procedures reasonably designed to facilitate straight-through processing and require submission of an annual report to the SEC.

The final rules will be effective May 5, 2023. The compliance date for the final rules is May 28, 2024.

SEC names new deputy director of disclosure operations

On Feb. 14, 2023, the SEC announced that Cicely LaMothe was named deputy director of disclosure operations of the Division of Corporation Finance (Corp Fin), effective Feb. 12, 2023. LaMothe has served as acting deputy director for disclosure operations since August 2022.

LaMothe joined the SEC in 2002 and has held a number of senior leadership roles in Corp Fin including director of the disclosure review program, associate director of the Office of Assessment and Continuous Improvement, and associate director of disclosure operations.

From the Center for Audit Quality (CAQ)

CAQ releases publication on the role of auditors in climate information

On March 9, 2023, the CAQ issuedThe Role of the Auditor in Climate-Related Information.” The publication helps stakeholders understand what types of climate-related information companies disclose today and how auditors might be involved.

CAQ posts panel discussion of fall audit partner survey results

On Feb. 15, 2023, the CAQ posted video of a virtual panel discussion of its fall 2022 “Audit Partner Pulse Survey,” a compilation of comments, observations, and responses of U.S. public company audit partners on a range of topics. The publication was released on Nov. 16, 2022, and summarizes responses from 648 audit partners from the eight governing board firms at the CAQ.

The survey asked audit partners about what they are observing in the industries they audit in terms of economic health indicators, challenges, and risks facing businesses within their sectors, and how those businesses are adjusting their strategies in the current environment. Topics in the survey include the overall outlook on the economy, shifting strategies to mitigate economic risks, talent retention, and emerging risks. From the results of this survey, the CAQ observed noteworthy shifts in audit partners’ perspectives suggesting that U.S. businesses are responding to inflation and a possible recession by scaling back on certain growth strategies while increasing focus on cost savings, liquidity, and productivity improvement. The survey revealed that to retain employees businesses are increasing workplace flexibility, increasing compensation, and upskilling their employees.

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