May 2021 financial reporting, governance, and risk management

| 5/19/2021
May 2021 financial reporting, governance, and risk management

Message from Mike Percy, Managing Partner, Financial Services

Dear FIEB readers,

After many years of serving as the managing partner for Crowe financial services, I am excited to turn the reins over to our next leader. It is my pleasure to introduce you to John Epperson, Crowe managing principal of financial services. John brings energy and passion to the strategic issues our financial services clients are most focused on. John is the perfect choice to lead our Crowe financial services professionals, who are passionate about shaping our clients’ better tomorrow.

First quarter financial reporting results are now largely complete. For roughly 400 public banks filing with the SEC, financial performance is continuing to improve for the majority. For the quarterly provision for credit losses over average loans, first quarter was less than the fourth quarter. CECL adopters experienced less of a decline than incurred-loss banks.

As we hopefully are on our way to having the pandemic in the rearview mirror, regulators are beginning to turn their attention to traditional risk management practices. We continue to see a great deal of interest in environmental, social, and governance (ESG) disclosures, with a focus on climate change disclosures. This month, the Basel Committee on Banking Supervision issued two reports on climate change, continuing the increased interest from policymakers from around the world. We also see elevated focus on several consumer compliance issues.

I’m excited about the possibility of seeing some of you in person soon and hope this message finds you, your friends, your family, and your colleagues well.

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Matters of importance from the federal financial institution regulators

Fed issues semiannual “Supervision and Regulation Report”

In its “Supervision and Regulation Report” released on April 30, 2021, the Board of Governors of the Federal Reserve System (Fed) highlights that financial institutions have largely demonstrated financial and operational resilience through the COVID-19 crisis. According to the Fed report, during the crisis most banks maintained capital ratios well above regulatory minimums, while liquidity positions were strengthened by strong growth in deposits.

The report also notes that the investments in technology by many banks prior to the pandemic improved their capacity to process digital transactions and provide banking services in a remote environment. However, given the increased reliance on technology during the pandemic, cybersecurity has been amplified as a supervisory concern. Banks are cautioned to remain vigilant about cyberthreats and ensure sound third-party risk management practices.

While the banking system remains healthy overall, the report says bank lending activity has been slow outside of Paycheck Protection Program loans. The report also notes some modest increases in delinquency rates in residential real estate and commercial real estate loans along with continued loan modifications as borrowers continue to face COVID-related challenges.

Federal Reserve proposes guidelines for Fed master account access

On May 5, 2021, the Fed proposed new guidelines that would be used by Reserve Banks to evaluate requests for master accounts with the Fed or access to the agency’s financial services. The Fed has been seeing more “novel institutions” that are nontraditional charters or fintechs.

The guidelines follow six principles:

  • “Each institution requesting an account or services must be eligible under the Federal Reserve Act or other federal statute to maintain an account at a Federal Reserve Bank (Reserve Bank) and receive Federal Reserve services and should have a well-founded, clear, transparent, and enforceable legal basis for its operations.”
  • “Provision of an account and services to an institution should not present or create undue credit, operational, settlement, cyber or other risks to the Reserve Bank.”
  • “Provision of an account and services to an institution should not present or create undue credit, liquidity, operational, settlement, cyber or other risks to the overall payment system.”
  • “Provision of an account and services to an institution should not create undue risk to the stability of the U.S. financial system.”
  • “Provision of an account and services to an institution should not create undue risk to the overall economy by facilitating activities such as money laundering, terrorism financing, fraud, cybercrimes, or other illicit activity.”
  • “Provision of an account and services to an institution should not adversely affect the Federal Reserve’s ability to implement monetary policy.”

If the Fed grants access, it may impose additional obligations relating to, or limitations on, the use of the account or services. Additionally, the assessments of access requests from institutions that are not federally insured may require more extensive due diligence.

Comments on the proposal are due July 12, 2021.

Agencies propose rule on tax allocation agreements for consolidated returns

The Office of the Comptroller of the Currency (OCC), the Fed, and the Federal Deposit Insurance Corp. (FDIC) on April 22, 2021, issued a proposed rule to establish requirements for tax allocation agreements between institutions and their holding companies in a consolidated tax filing group. The proposal aims to preserve depository institutions’ ownership rights in tax refunds and ensure equitable allocation of tax liabilities among entities in a holding company structure.

The proposal also would require institutions to include certain provisions in all tax allocation agreements. These provisions include information about the timing and amount of any payments for taxes due to taxing authorities, the acknowledgement of an agency relationship between institutions and their holding companies with respect to tax refunds received, and a statement that tax-related documents will be made available to an institution during regular business hours.

If adopted, the proposal would replace the interagency policy statement on tax allocation agreements issued in 1998 and supplemented in 2014. The notice was published in the Federal Register on May 10, 2021, and comments are due by July 9, 2021.

OCC conditionally approves national bank charter for crypto firm

The OCC on April 23, 2021, granted preliminary conditional approval for a national trust bank charter for New York-based Paxos National Trust. Paxos would be the third federally regulated cryptocurrency firm that proposes to provide a range of services associated with digital assets including custody services that would operate as a nondepository trust bank.

OCC updates Comptroller’s Handbook on credit card lending

On April 29, 2021, the OCC released a revised edition of the “Credit Card Lending” booklet of the Comptroller’s Handbook. It supercedes the previous booklet, which was issued in November 2015, and is used by OCC examiners during examinations. The new edition:

  • Reflects adoption of the current expected credit loss (CECL) methodology by some banks and the increased use of models in credit card originations and risk management
  • Includes changes to OCC rules and guidance since the previous edition
  • Clarifies some supervisory guidance, sound risk management practices, and legal language
  • Revises some content for general clarity

CFPB releases consumer complaint demographics

According to the latest Consumer Financial Protection Bureau (CFPB) consumer complaint bulletin issued on April 28, 2021, consumer complaints increased across all demographic categories between 2019 and 2020 but at a greater rate in predominantly minority counties. The bulletin offers a breakdown of complaints by consumers in counties nationwide.

In the bulletin, the CFPB says it will soon be expanding its consumer complaint form to give consumers the option to provide household size and income when submitting a complaint. The bureau is also exploring ways to best understand the experiences of ethnically diverse communities that submit complaints to the CFPB.

Current developments in climate change and ESG disclosures

Basel Committee reports on climate risk

The Basel Committee on Banking Supervision (BCBS) on April 14, 2021, published two papers on climate-related financial risk that are intended to serve as a “conceptual foundation” as the committee continues work to incorporate climate risk into the regulatory framework. The Fed, OCC, and FDIC are members of the BCBS.

The first report, “Climate-Related Risk Drivers and Their Transmission Channels,” notes that the effects of climate risk may vary based on geography, sector, and economic financial system development. The paper also suggests that the impact of the risk drivers on banks can be observed through several traditional risk categories such as credit, market, liquidity, operational, and reputational risk.

The second, “Climate-Related Financial Risks – Measurement Methodologies,” provides an overview of conceptual issues related to climate-related financial risk measurement and methodologies, as well as practical implementation by banks and supervisors. The report is informed by a supervisory survey conducted among members of the Basel Committee Task Force on Climate-Related Financial Risks, as well as workshops conducted with banking industry representatives in 2020.

The BCBS said “more research on the importance of different amplifiers and mitigants of climate-related financial risk would help inform where banks and supervisors could usefully focus their resources.”

SEC chair addresses ESG questions

While testifying on market volatility before the House Committee on Financial Services on May 6, 2021, Securities and Exchange Commission (SEC) Chair Gary Gensler was questioned about the increased focus on climate-related disclosures and updates to climate disclosure guidance. In response, Gensler said that the staff has been asked to prepare recommendations based on public input about what climate-related disclosures and climate risk areas are important to investors to help bring consistency and comparability to such disclosures. 

Determinations about guidance will be made through those recommendations; economic analysis; information gathered by the environmental, social, and governance (ESG) task force; and other critical input from the public, including responses to the request for public comment on climate change disclosures issued by former acting Chair Allison Herren Lee. Comments on that request are due in June 2021. Based on analysis of the information gathered, the SEC will prepare a proposal for public comment.

CAQ analyzes ESG reporting

The Center for Audit Quality (CAQ), on April 29, 2021, published “S&P 100 and ESG Reporting,” summarizing its findings from an examination of publicly available ESG information for S&P 100 companies through March 12, 2021. The CAQ reports that all companies provided some ESG information, most reported it in a separate stand-alone report, and 11 obtained assurance from a public company auditing firm for some of the information. The report shows which frameworks were most widely used and which standards were commonly referenced, information about what types of information assurance were obtained from auditors, and a description of assurances obtained from other providers such as engineering and consulting firms.

CAQ identifies actions for effective governance over ESG reporting

On April 22, 2021, the CAQ and the American Institute of CPAs published “Key Actions for Establishing Effective Governance Over ESG Reporting” to provide guidance on the creation of high-quality ESG disclosures. The report describes key actions to establish effective governance over ESG reporting, including:

  • Conducting materiality or risk assessments to determine which ESG topics are important or material to the organization, its investors, and other stakeholders
  • Implementing appropriate board oversight of material ESG matters
  • Integrating and aligning material ESG topics into the enterprise risk management process
  • Integrating ESG matters into the overall company strategy

According to the CAQ, “Good governance plays a critical role in a company’s ability to produce high-quality, accurate and reliable information,” and this document provides a starting point with actions entities can take to reach that goal.

From the Financial Accounting Standards Board (FASB)

FASB proposes additional guidance on last-of-layer hedge method

On May 5, 2021, the FASB issued a proposed Accounting Standards Update (ASU), “Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method.” This exposure draft was issued to provide additional guidance on the last-of-layer hedge method that was added with the issuance of ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The last-of-layer method permits the fair value hedge of a closed portfolio of prepayable financial assets or one or more beneficial instruments secured by prepayable financial instruments. In response to questions raised by entities and practitioners, the proposed amendments would:

  • Expand the current single-layer model to allow multiple-layer hedges of a single closed portfolio, and rename the last-of-layer method to the portfolio layer method
  • Specify that spot-starting and forward-starting constant notional and amortizing-notional interest-rate swap may be used in the portfolio layer method
  • Provide additional guidance on the accounting and disclosures of the fair value hedge basis adjustments for both single-layer and multiple-layer hedges
  • Prohibit considering basis adjustments from existing hedges when determining credit losses
  • Permit a one-time transfer of debt securities that qualify for the portfolio layer method from held-to-maturity to the available-for-sale category upon adoption

The amendments would be effective pending feedback on the proposed ASU. Adoption of the multiple-layer method will be on a prospective basis, while accounting for basis adjustments under the portfolio layer method will be on a modified retrospective basis through a cumulative-effect adjustment to the opening balance of retained earnings. Proposed amendments to disclosures can be made either on a prospective or modified-retrospective basis upon adoption of the amendments.

Comments are due July 5, 2021.

FASB issues clarifications on accounting for written call options

On May 3, 2021, the FASB issued ASU 2021-04, “Earnings Per Share (Topic 260), Debt – Modifications and Extinguishments (Subtopic 470-50), Compensation – Stock Compensation (Topic 718), and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a Consensus of the Emerging Issues Task Force).” The ASU was issued to clarify and reduce diversity in practices for modification and exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after the exchange. The amendments do not apply to modifications or exchanges of financial instruments within another topic (for example, Topic 718). The ASU provides guidance on how to measure the effect of the modification or exchange and how that effect should be recognized.

The ASU is effective for all entities for fiscal years beginning after Dec. 15, 2021, including interim periods within those fiscal years. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date. Early adoption is permitted.

More from the Securities and Exchange Commission (SEC)

SEC names new DERA chief economist and director

The SEC announced, on May 3, 2021, that Jessica Wachter has been named chief economist and director of the Division of Economic and Risk Analysis (DERA). She has been a professor at the Wharton School at the University of Pennsylvania since 2003 and is a leading academic researcher on financial markets. DERA is involved in a wide range of SEC activities, including policymaking, rulemaking, enforcement, and examination, and the division assists in identifying, analyzing, and responding to economic and market issues. DERA also provides subject-matter expertise and cost-benefit economic analysis for rule proposals and final rules.

SEC commissioner addresses LIBOR and ESG

On April 28, 2021, SEC Commissioner Hester M. Peirce provided remarks before the International Swaps and Derivatives Association Derivatives Trading Forum on Regulatory Change. Peirce spoke about upcoming changes related to the discontinued use of the London Interbank Offered Rate (LIBOR), the enhanced focus on ESG reporting, and the implementation of the SEC’s security-based swap framework for dealers.

Peirce shared her thoughts on the importance of embracing changes and warns of consequences of not addressing changes. As LIBOR is set to be discontinued, Peirce, referencing others’ statements, warns that LIBOR discontinuation “could have a significant impact on the municipal securities market and may present a material risk for many issuers of municipal securities and other obligated persons.” She said that trillions of dollars of contracts still reference LIBOR, that many of these contracts lack fallback language, and that changing to alternative reference rates creates a diverse mix of significant challenges. She noted that the SEC is continuing to closely follow developments in this area and is working with other regulators and entities to help ensure steps are being taken to address this challenge. She mentioned the SEC risk alert covering LIBOR transition readiness and the work that the SEC, in conjunction with other regulators, has been doing to address the transition from LIBOR. Peirce also discussed proposed legislation that would insert a fallback into contracts that do not include one, and the concern that such legislation would override private contracts.

Following her remarks on LIBOR, Peirce warned the audience that it must learn from the LIBOR situation before rushing into the ESG space. She said that LIBOR lacked precision and that we are diving right into adopting ESG measures that portray an impression of precision but may not be as precise with such varying approaches. She noted that it is very difficult to measure how green a particular investment, issuer, or transaction is, and numerous factors need to be considered when making capital decisions. She further stressed caution and the need to proceed with care as ESG strategies are implemented, as there is a responsibility to shareholders and customers not to embrace approaches that will harm the capital markets, the financial system, or the planet.

SEC reopens comments for universal proxy rule

The SEC, on April 16, 2021, reopened the comment period for the proposed universal proxy rule that was originally published in the Federal Register on Nov. 10, 2016. The proposal would require the use of universal proxy cards in all nonexempt solicitations in connection with contested elections of directors. The proposed rules create new procedures for the solicitation of proxies and address other improvements to the proxy voting process. The comment period has been reopened to allow for additional feedback to be provided as there have been significant developments in proxy contests, corporate governance over funds, and shareholder activism since 2016.

Comments are due June 7, 2021.

From the Center for Audit Quality (CAQ)

CAQ issues alert on SPACs

The CAQ issued Alert 2021-01, “Auditor and Audit Committee Considerations Relating to Special Purposes Acquisition Company (SPAC) Initial Public Offerings and Mergers,” on May 3, 2021. It describes the five phases of a SPAC life cycle and provides a listing of considerations for auditors and audit committees regarding challenges of a private company entering the public markets through a merger with a SPAC. While these considerations are intended for auditors and audit committees, members of management also might find them helpful.

Referring to the SEC statement on “Financial Reporting and Auditing Considerations of Companies Merging With SPACs,” the alert repeats, “it is critical that the board of directors, audit committees (as applicable), management, and auditors of operating companies involved in a merger with a SPAC fully understand and fulfill their professional responsibilities so that companies meet their obligations under the federal securities laws and investors are provided with high quality financial reporting at the time of the merger and on an ongoing basis.” To help address this responsibility, the alert lists numerous considerations related to SPAC merger transactions for auditors and audit committees. For audit committees, the alert describes considerations related to public company readiness; SPAC sponsor experience; corporate governance; accounting, reporting, and disclosure issues; and external auditor selection and oversight.

CAQ reports on effectiveness of management review controls

On April 21, 2021, the CAQ released “Issues Related to the Assessment of the Effectiveness of Management Review Controls: Roundtable Summary.” This report summarizes the information gathered during a roundtable discussion led by the CAQ and the Financial Education & Research Foundation with preparers and auditors who did not participate in the research study on internal control over financial reporting management review controls, “Perspectives on Management Review Controls: Challenges and Solutions.” The objective of the roundtable was to identify and share practices that can mitigate challenges of addressing management review controls. The report addresses planning and communication, design and precision, and operation and performance of management review controls. It identifies important best practices to address management review control challenges and provides a detailed listing of suggested actions to address challenges with management’s assessment and the auditor’s evaluation of the effectiveness of management review controls.

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