On Wednesday, SEC Acting Chair Allison Herren Lee announced that the agency will enhance its focus on climate-related disclosures in public company filings. She has directed the agency’s Division of Corporation Finance to study how the market is currently managing climate risks, assess current compliance with existing climate-related disclosure obligations and engage with the industry to receive feedback. It will then use insights gained from this work to determine which steps are needed to promote more complete climate-related risk disclosures, which at a minimum will include updating its 2010 climate disclosure guidance. A day after her announcement, Lee gave a speech at an industry event noting that submission rates for the SEC’s voluntary diversity self-assessment have been disappointing and that the agency should revisit its disclosure requirements around diversity issues.
The focus on Environmental, Social and Governance (ESG) disclosures continued at a House Financial Services Subcommittee hearing on Investor Protection yesterday. House Democrats stressed the need for mandatory disclosure around climate risk, diversity, and worker pay, with witnesses highlighting the importance of ESG disclosures for informed investment decisions. On the other side, some Republicans argued that disclosures would increase costs that would be better spent on technology or increasing worker pay, and one witness noted that new disclosure requirements could discourage private companies from going public.
Meanwhile, Treasury Secretary Janet Yellen highlighted the potential benefits of climate stress tests in an interview this week. She noted that while they would not impact capital requirements or payouts as the Fed’s current stress testing program does, they would “be very revealing for the regulators and the firms themselves in managing their own risks.” Yesterday, a group of 145 organizations focused on ESG issues sent a letter to Secretary Yellen applauding her commitment to create a hub at the Treasury Department to focus on climate issues and appoint someone at a “very senior level” to lead it. The letter urges her to act on these promises as soon as possible and ensure that the selected leader has adequate expertise.
Acting Chair Lee’s statements this week show that she does not intend to wait for incoming Chair Gary Gensler’s confirmation to get the ball rolling on promoting better ESG disclosures. By highlighting weaknesses in existing guidance and voluntary disclosure programs, Lee is foreshadowing that more prescriptive disclosure requirements are likely on their way. With House Democrats echoing this sentiment as well as the Biden Administration’s strong focus on ESG, the pressure for Gensler to pursue mandatory disclosures is high. Considering the inevitable studies, coordination and alignment with international regulators, and notice and comment period that comes along with the rulemaking process, even this early priority will likely take some time before any new requirements become final. However, public companies should not wait for finalized or even proposed requirements to get their disclosures around climate and diversity in order. While SEC attention to climate disclosures has significantly declined over the past several years, this strong push from Acting Chair Lee will likely prompt SEC staff to renew its emphasis on the issue and scrutinize whether companies are failing to disclose material climate risks in their public filings.
With Secretary Yellen now joining Fed Governor Lael Brainard in support of climate stress tests, we are seeing more momentum toward them becoming a reality. It should come as a relief to the industry that she echoed Brainard’s view that this exercise should be used as an exploratory tool to understand climate risks rather than impact capital requirements. However, as a greater understanding of risk and sensitivity is reached in the future - and the data to reach this understanding is obtained - we could see the regulators potentially incorporating them into a capital adequacy regime. Firms can begin preparing by leveraging the work done by any overseas entities to prepare for EU and UK climate scenario analysis. With regulatory and industry attention to addressing climate risk only getting stronger, firms would be wise not to wait.
Yesterday, Fed Vice Chair for Supervision Randal Quarles gave a speech on the role of stress testing. In particular, he outlined how the US stress testing regime has evolved with the most recent innovation, the stress capital buffer (SCB), allowing the Fed to integrate the results of its annual stress tests to banks’ ongoing capital requirements. He also discussed how the maturity of the Fed’s models have allowed it to conduct additional sensitivity analyses in response to the pandemic.
Looking ahead, Quarles announced that the Fed would publish details of its model methodologies in March and highlighted several areas that it is researching and exploring for the future. Specifically, he indicated that the Fed will assess the effect of pandemic stimulus, technological innovations and growth in non-bank lending on bank risk as measured by stress testing. Quarles acknowledged that previous prompts for model reviews, specifically those related to a disproportionate global market shock on public welfare investments, led to the Fed making a downward adjustment on the shock to those assets. He also noted that banks’ SCB appeals have led to investigations of issues related to interest rate hedges, loss-sharing agreements and fair value option accounting. In terms of potential changes to future stress tests, he indicated that the Fed’s agenda includes initiatives that could reduce volatility in results.
Without making any major news, this speech sends a number of signals that will be welcome to banks. Quarles has been on a mission to increase transparency around stress testing throughout his tenure as Vice Chair for Supervision, and the additional model methodology details to come next month will be just the latest in a series of disclosures that will help banks better understand the Fed’s models without getting all the answers. Quarles’s comments about SCB appeals also indicate that while no banks successfully had their SCBs modified, the Fed has been somewhat open to feedback and willing to make concrete changes in response to well-supported arguments. It is also promising that the Fed is taking a closer look at the effects of fiscal stimulus and loan forbearance on risk modeling as these have had a substantial impact in reality but thus far have not been incorporated in the Fed’s models. Banks will also be pleased to hear that potential innovations would seek to reduce volatility in stress testing results which would mean less potential for dramatic changes to their capital requirements. Notably, Quarles’s speech did not mention the possibility of climate stress tests which has been recently floated by Governor Brainard and Secretary Yellen. This could be a signal that this adaptation of the stress testing regime does not rank high on Quarles’s priority list but could also be due to the fact that it will take an extensive period of study and development before it is even proposed. With just over six months left in his term as Vice Chair for Supervision, it is more likely a question for Quarles’ successor if he is not reappointed.
On Wednesday, the Depository Trust & Clearing Corporation (DTCC) released a whitepaper outlining a proposed two-year transition to reduce the settlement time for US equities from two days to one. The paper stresses that recent market volatility - both pandemic-related as well as the recent fluctuations related to social media posts about GameStop stock - has demonstrated the need to “eliminate remaining inefficient processes” in the financial system. It explains that moving to a one-day settlement period would reduce the risk that an unpredictable event could occur between the execution and settlement of a trade and would not require significant operational or technical adjustments. It also notes that while moving to a same-day or real-time settlement system is “appealing in theory and aspirational in nature,” many challenges remain including increased difficulty in securing same-day financing and determining intraday investment amounts.
Movement to a one-day settlement system will require coordination with the industry and approval from regulators. An industry group released a response to the whitepaper explaining that doing so will require “a sufficient amount of time,” citing the need to take into account compliance obligations such as the SEC’s Consolidated Audit Trail. In 2017, the industry shortened the settlement cycle from three days to two.
We anticipate that both regulators and the industry will be supportive of the shift to one-day settlement as it reduces credit risk, which would in turn significantly reduce the amount of margin broker-dealers are required to post and would free up liquidity. This should have a direct impact to their bottom line profitability as a result of reduced borrowing costs. However, the two-year timeline outlined by DTCC may be ambitious considering that there will need to be much work to be done on back office systems. With a shortened settlement timeframe likely on the horizon, firms should begin planning early so that there is adequate time for modifying and testing all processes and systems involved in the settlement lifecycle. They should also begin developing a strategy for working with customers to ensure a smooth transition to the one-day settlement timeframe given that the time for their delivery of cash or securities would be cut in half.
These notable developments hit our radar over the past week:
Powell also reiterated that he did not consider synthetic USD LIBOR a viable solution for legacy exposures. The publication of a synthetic GBP LIBOR, i.e. a calculation based rate that no longer relies on panel bank submissions, is currently under consideration by the UK’s Financial Conduct Authority (FCA).
Watch the replay of PwC’s latest LIBOR transition webcast: “The move away from LIBOR: Bringing non-LIBOR loans to market”.
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Financial Services Leader, PwC US