The regulator’s monitoring of the marketplace in 2022 found 1,882 promotions from unauthorized firms that required amendment or withdrawal following intervention by the agency, an increase of 34% over the 1,410 promotions that received such treatment in 2021. An additional 8,582 promotions from authorized firms were similarly required to be amended or withdrawn, compared with just 573 in 2021, a massive increase of 1,398%.

The FCA notes that “[l]ast year we saw an increase in the use of bloggers and influencers on social media such as Instagram, Facebook, and YouTube, promoting financial products, particularly investment products, to younger age groups. We also saw an ongoing trend in the number of bloggers promoting credit on behalf of unauthorized third parties, with a particular growth in financial promotions targeting students.”

Finfluencers & regulations

The emergence of finfluencers (short for financial influencers) – individuals on social media who advocate a particular type of investment option – is highlighted in the Royal Mint’s 2022 Gen Z Investment Report, which found that 23% of young investors are followers of finfluencers.

… finfluencers need to be aware that social media is not an oasis where consumer protection law, advertising standards and intellectual property rights can be ignored.

Some see the dissemination of financial information via social media platforms as a healthy way of engaging people in investment activity, and they welcome the greater transparency inherent in this mode of communication. However, finfluencers need to be aware that social media is not an oasis where consumer protection law, advertising standards and intellectual property rights can be ignored.

Regulators around the world have begun to issue guidance to both finfluencers and their followers. The 2021 Statement on Investment Recommendations on Social Media by the European Securities and Markets Authority (ESMA), explores the boundaries between providing financial information and providing financial advice and recommendations online. Also, the Securities and Futures Commission of Hong Kong’s Guidelines on Online Distribution and Advisory Platforms stipulates that any licensed financial adviser will be held accountable through all channels, including social media. The New Zealand Financial Markets Authority has a Guide to Talking about Money Online, providing tips for consumers and finfluencers. Meanwhile, the Australian Securities and Investments Commission has an information sheet for finfluencers who include details of financial products and services in their content.

If finfluencers provide financial advice and recommendations per regulators’ definitions of those terms, they must adhere to regional regulations on authorization and conduct of business. However, the popularity of finfluencers, which is being fueled by shifting attitudes among investors and the more varied range of channels through which they can enter the investment market, makes it difficult for regulators and firms to ensure that customers are being treated fairly.

New attitudes toward investing

Factors such as new technology, the global pandemic and climate change concerns have caused shifts in investors’ attitudes. The Royal Mint report paints a mixed picture of young adults’ investment behavior. On the one hand, social media was found to have caused 17% of those surveyed to adopt a get-rich-quick mentality, with people expecting to double or triple what they had invested within a short space of time.

On the other hand, the report also finds that when losses occurred, 64% of 16- to 25-year-olds actively looked to diversify their risk by adding what they believed were “safer investments” to their portfolios. A total of 80% of that same group now dedicates a portion of their income to investing in their future, with two-fifths stating the pandemic made them realize the value of having secure finances. As a result, more than one-third have taken it upon themselves to learn about investing as a way of helping to grow their money.

A 2021 research report by the FCA highlighted that, for those investing in high-risk products, “the challenge, competition, and novelty are more important than conventional, more functional reasons for investing, like wanting to make their money work harder or save for their retirement.

Case study of a finfluencer

Paul Pierce, a former Boston Celtics pro basketball player and NBA Hall of Famer, promoted EthereumMax (EMAX), a cryptocurrency coin or token, on social media as did many other celebrities. In his tweets, Pierce showed screenshots of alleged profits along with links where followers could make purchases. Pierce is one of many celebrities who made such claims of financial gain using these types of investments. During his promotion of EMAX tokens on Twitter, Pierce failed to disclose that he was paid for his promotion with EMAX tokens worth more than $244,000, the US Securities and Exchange Commission (SEC) alleged.

“This year, we will continue to put the pressure on people using social media to illegally promote investments, which put people’s hard-earned money at risk.”

— Sarah Pritchard  | Executive Director for Markets, Financial Conduct Authority

Pierce has now agreed to pay more than $1.4 million to settle charges he illegally promoted digital assets, the SEC stated in February. This settlement is larger than the $1.26 million paid by Kim Kardashian to settle similar SEC charges related to promoting EMAX. The settlements with Pierce and others mark the latest move by the SEC to crack down on celebrity endorsements of crypto products.

The increase in the number of noncompliant finfluencer promotions suggests that as investors appear more willing to take risks, firms’ marketing departments may be tempted to make financial promotions more exciting.

In the UK, for example, regulations are based on the principle of being clear, fair and not misleading. Regulations also provide detailed requirements for firms about including the need for financial promotions to give a fair and prominent indication of any relevant risks, and to be presented in a way that is likely to be understood by the average member of the group to whom it is directed. Further, these promotions cannot disguise, diminish or obscure important elements, statements or warnings.

The future

This year, there won’t likely be any letup in regulators’ focus on the use of financial promotions. Sarah Pritchard, executive director for markets at the FCA, gave clear indication what the future holds. “This year, we will continue to put the pressure on people using social media to illegally promote investments, which put people’s hard-earned money at risk,” she said.

As the number of tools and resources issued by regulators for monitoring promotions increases, so too does the risk to firms of being caught for noncompliant behavior. The FCA is consulting on the introduction of tougher checks for financial promotions and measures that will remove harmful promotions more quickly.

Finally, firms in the UK need to consider the impact of the new Consumer Duty, which many are due to implement in July 2023. “Under the duty, firms will need to demonstrate that they are providing consumers with information which helps them to make effective and informed decisions about financial products and services,” the FCA stated.

In the US, the SEC is moving to chastise all bad actors, not just celebrities, according to Gurbir S. Grewal, director of the SEC’s Division of Enforcement. “The federal securities laws are clear that any celebrity or other individual who promotes a crypto-asset security must disclose the nature, source and amount of compensation they received in exchange for the promotion,” Grewal said.

For several years, the SEC has monitored firms’ practices in offering services based on clients’ preferences on ESG and other investing factors related to corporate responsibility along with other factors that go beyond immediate bottom-line concerns.

In the past, the agency has cited the broad provisions of Section 206 of the Advisers Act, which requires disclosure of material facts to bring ESG-related actions. But since last November, the SEC has gained broader authority under the newly implemented Marketing Rule to examine all of firms’ compliance processes for advertising and marketing material, including ESG claims. “We’re testing under the Marketing Rule previously known as the Advertising Rule where you know the basic principle is to not make any misleading advertisement (related to ESG),” said Ashish Ward, the SEC Los Angeles branch chief.

Rulemaking by examination?

Some critics have argued that examiners are pushing ahead with their reviews of ESG at a time when the agency’s own rulemaking process has been facing challenges in defining the basic terms of what constitutes ESG.

However, the SEC sees it differently. Its SEC examinations unit says it has avoided substantive concerns of investment advisers’ ESG decisions, focusing instead on disclosure and documentation. The SEC exam unit also argues that it is implementing risk-based principles based on existing securities law, and it has taken the view that financial services firms must document and disclose the factors that they are using in advising clients.

“While the concern over whether the commission is using its examination or enforcement powers to advance its ESG-related rule making agenda is a fair question to raise,” said Ken Joseph, managing director for financial services compliance and regulation at Kroll. “The commission has already demonstrated in recent enforcement cases that the federal securities laws — including the anti-fraud provisions of the Advisers Act — provide a legal framework for charging alleged false or misleading ESG-related claims or inadequate compliance policies and procedures.”

“Examiners are tasked with evaluating claims made to clients or actual or prospective investors — neither the Marketing Rule nor the proposed ESG-related rule changed that dynamic,” Joseph adds.

Firms face widening ESG compliance risk

With the expansion of rules and priorities by the SEC, what is clear is that the risk of action by the agency because of compliance issues has expanded. Investment advisers will face compliance concerns they have never faced in the past under the new Marketing Rule because the rule adds even more emphasis on raising the bar for compliance units to have processes in place to assure ESG claims are accurate. In addition, the SEC has also created a 22-member Climate and ESG Task Force in its Division of Enforcement to better monitor firms’ and issuers’ ESG practices.

Navigating the complexity in compliance risk for issuers will be tricky in the near term, but adding ESG evaluations in disclosures only adds to the murkiness. “Due diligence can be become difficult with respect to evaluating ESG factors at issuers given the varying types of disclosures that they provide,” explains SEC branch chief Ward, adding that those

Bill Singer of the Brokeandbroker blog, a securities lawyer and former counsel for the Financial Industry Regulatory Authority (FINRA), says some brokerage firms are worried about how the SEC exam unit is viewing ESG. “There are a lot of concerns at firms that the SEC exams can look all over the firm for ESG issues that could pose compliance problems,” says Singer. “I’m hearing from firms that this ESG focus in examinations — and now with a special ESG task force — they will be getting hit with more deficiency letters and enforcement actions. They see it as rulemaking by examination.”

The SEC’s proposed ESG rules in total should give firms a reason to work on their compliance practices in advance of new rules, states law firm Mayer Brown LLP in a recent client note. “Although not directly embedded in any new rule or amendment, an SEC expectation is clearly set out in the proposal: that funds and advisers would adopt new compliance policies and procedures regarding their ESG-related strategies in order to help ensure the accuracy of the various prospectus and brochure disclosures,” the client note states.

“You should look at everything you say [on ESG] and ask if you can substantiate that it’s true,” the SEC’s Ward adds. “That’s going to flow through everything, and that’s going to help fix a lot of problems.”

In what Fed Vice Chair for Supervision Michael Barr called an “unflinching” review of the U.S. central bank’s supervision of SVB, the Fed said its oversight of the Santa Clara, California-based bank was inadequate and that regulatory standards were too low. “SVB’s failure demonstrates that there are weaknesses in regulation and supervision that must be addressed,” Barr said in a letter accompanying a 114-page report, which also was supplemented by confidential materials that are typically not made public.

While it was the regional bank’s own mismanagement of basic risks that was at the root of SVB’s downfall, the Fed said, supervisors of SVB did not fully appreciate the problems, delaying their responses to gather more evidence even as weaknesses mounted, and failed to appropriately address certain deficiencies when they were identified. At the time of its failure, SVB had 31 unaddressed citations on its safety and soundness, triple the number its peers in the banking sector had, the report said.

One particularly effective change the Fed could make on supervision would be to put risk mitigation methods in place quickly in response to serious capital, liquidity, or management issues, a senior Fed official said, adding that such increased capital and liquidity requirements also would have bolstered SVB’s resilience.

Barr said that as a consequence of the failure, the central bank will reexamine how it supervises and regulates liquidity risk, beginning with the risks of uninsured deposits.

Regulators shut SVB on March 10 after customers withdrew $42 billion on the previous day and queued requests for another $100 billion the following morning. The historic run triggered massive deposit outflows at other regional banks that were seen to have similar weaknesses, including a large proportion of uninsured deposits and big holdings of long-term securities that had lost market value as the Fed raised short-term interest rates.

New York-based Signature Bank failed two days later (the Federal Deposit Insurance Corporation release its review of that collapse the same day as the Federal Reserve’s assessment of SVB), and the Fed and other U.S. government authorities moved to head off an emerging crisis of confidence in the banking sector with an emergency funding program for otherwise healthy banks under sudden pressure and guarantees on all deposits at the two banks.

Supervision headcount fell

Before the twin bank failures in March, banking regulators had focused most of their supervisory firepower on the very biggest U.S. banks that were seen as critical to financial stability. The realization that smaller banks are capable not only of causing disruptions in the broader financial system but of doing it at such speed has forced a banking regulators to rethink their position.

“Contagion from the failure of SVB threatened the ability of a broader range of banks to provide financial services and access to credit for individuals, families, and businesses,” Barr said. “Weaknesses in supervision and regulation must be fixed.”

In its report, the Fed said that between 2018 to 2021 its supervisory practices shifted, and there were increased expectations for supervisors to accumulate more evidence before considering taking action. The staff interviewed as part of the Fed’s review reported pressure during this period to reduce burdens on firms and demonstrate due process, the report said.

Barr signaled in his accompanying letter that this situation would change. “We need to develop a culture that empowers supervisors to act in the face of uncertainty,” he said.

Between 2016 and 2022, as assets in the banking sector grew 37%, the Fed’s supervision headcount declined by 3%, according to the report. As SVB itself grew, the Fed did not step up its supervisory game quickly enough, the report showed, allowing weaknesses to fester as executives left them unaddressed, even after staff finally did downgrade the bank’s confidential rating to “not-well-managed.”

The Fed is looking at linking executive compensation to fixing problems at banks designated as having deficient management so as to focus executives’ attention on those problems, a senior Fed official said in a briefing.

One thing the report did not do was place any blame at the feet of San Francisco Fed President Mary Daly, with a senior Fed official telling reporters that regional Fed bank presidents do not engage in nor have responsibility for day-to-day supervision of banks in their regions.

While the fallout from the failures of SVB and Signature themselves may have subsided, the ripple effects continue. The forced sale on May 1 of San Francisco-based First Republic Bank after its deposit outflows following the SVB and Signature collapses exceeded $100 billion shows that smaller, regional banks may not be out of the proverbial woods yet.

This blog post was written by Chris Prentice & Hannah Lang, both of Reuters News; with additional reporting by Ann Saphir.

It remains to be seen whether the Treasury’s document will have any impact on de-risking, but experts expressed well-founded skepticism following its release last week.

De-risking has been a major issue in the United States since shortly after the 9/11 terrorist attacks and the enactment of the USA PATRIOT Act of 2001. At the time, embassies, money services businesses, and charities were the first sectors to be seen as too risky, or as posing too high a compliance cost, to banks. In recent years, however, de-risking has grown in the correspondent banking space and has left people in some regions and even nation-states unable to receive funds transfers — such as desperately needed remittances from family members — from the United States.

Treasury’s 54-page De-risking Strategy, which was mandated by Congress in the Anti-Money Laundering Act of 2020, probes the phenomenon of de-risking and outlines its causes, victims, and recommended policy options to combat it. Treasury said the administration of President Joe Biden “places a high priority on addressing de-risking, as it does not only hurt certain communities but can pose a national security risk by driving financial activity outside of regulated channels.”

De-risking has been a major issue in the United States since shortly after the 9/11 terrorist attacks and the enactment of the USA PATRIOT Act of 2001.

Wally Adeyemo, Deputy Treasury Secretary, stated that “broad access to well-regulated financial services is in the interest of the United States. [And] this strategy represents the next step in Treasury’s longstanding commitment to combatting de-risking and highlights the importance of financial institutions assessing and managing risk.”

Treasury said it engaged in “extensive consultation” with the public and private sectors — including banks, money service businesses (MSBs) of various sizes, diaspora communities that depend on these businesses for remittances, and other small businesses and humanitarian organizations to better understand the impacts of de-risking. Unsurprisingly, Treasury found that “profitability is the primary factor in financial institutions’ de-risking decisions” and that the costs of conducting adequate due diligence and doing other anti-money laundering or counter-terrorist financing (AML/CFT) work is a key element of the decision-making process.

Other factors fueling de-risking “include reputational risk, risk appetite, a lack of clarity regarding regulatory expectations, and regulatory burdens, including compliance with sanctions regimes,” the strategy paper states, also noting that banks interviewed by Treasury said: “They tend to avoid certain customers if they determine that a given jurisdiction or class of customer could expose them to heightened regulatory or law enforcement action absent effective risk management.”

The strategy document also states that the customers facing de-risking challenges “most acutely” include: MSBs that offer money-transmitting services, non-profit organizations (NPOs) operating in high-risk jurisdictions, and foreign financial institutions with low correspondent-banking transaction volumes, particularly those operating in financial environments characterized by high AML/CFT risks.

Strategy recommendations

The Treasury’s strategy document makes several counter-de-risking recommendations for the federal government, including:

• • • Promoting consistent supervisory expectations, including through training to federal examiners, that consider the effects of de-risking.
    • Analyzing account termination notices and notice periods that banks give to NPO and MSB customers and identify ways to support longer notice periods when possible.
    • Considering regulations that require financial institutions to have reasonably designed and risk-based AML/CFT programs supervised on a risk basis, possibly taking into consideration the effects on financial inclusion.
    • Considering clarifying and revising AML/CFT regulations and guidance for MSBs in the Bank Secrecy Act(BSA).
    • Bolstering international engagement to strengthen the AML/CFT regimes of foreign jurisdictions.
    • Expanding cross-border cooperation and considering creative solutions involving international counterparts, such as regional consolidation projects.
    • Supporting efforts by international financial institutions to address de-risking through related initiatives and technical assistance.
    • Continuing to assess the opportunities, risks, and challenges of innovative and emerging technologies for AML/CFT compliance solutions.
    • Building on Treasury’s work to modernize the U.S. sanctions regime and its recognition of the need to calibrate sanctions precisely, in order to mitigate unintended economic, political, and humanitarian consequences.
    • Reducing burdensome requirements for processing humanitarian assistance transactions.
    • Tracking and measuring aggregate changes in banks’ relationships with respondent banks, MSBs, and non-profit organizations.
    • Encouraging continuous public and private sector engagement with MSBs, non-profit organizations, banks, and regulators.

No short-term fix

Of course, Treasury’s strategy will not significantly impact the de-risking challenge in the short term. In the past, Treasury has hosted public-private sector dialogues and has encouraged financial institutions to rethink their de-risking practices, but nothing notable has been achieved.

Further, the U.S. government has no authority to force financial institutions to serve particular customers or even customer types, so the most viable government solutions to de-risking lie in making financial institutions comfortable accepting customers that may pose high financial-crime risks, while lowering the compliance costs associated with banking such customers.

Some of the recommendations above, particularly the promotion of consistent supervisory expectations, could potentially have a modest impact, but not in the short term, according to veteran AML compliance officers at two U.S. financial institutions.

The South Florida-based Financial & International Business Association (FIBA), a trade group, has long called on the U.S. government to address de-risking. “To me, the importance is that Treasury has issued a comprehensive document outlining the true reasons why de-risking occurred and [why it] continues to impact key areas such as correspondent banking,” explained David Schwartz, FIBA’s president and chief executive. “The strategies, however, are not new and do not provide a solution to this complex problem.”

Treasury plans to continue its dialogue with the private sector. “In the coming weeks and months, Treasury will be reaching out to partners in the public and private sector to coordinate the best path forward to implement the recommendations in the strategy,” the agency stated.

There seems little question that AI will lead to an upheaval among U.S. investment banks and brokerage firms. In a recent report, Goldman Sachs estimated that 35% of employment in business and financial operations is exposed to so-called generative artificial intelligence, which can generate novel, human-like output rather than merely describing or interpreting existing information. Indeed, ChatGPT is a generative AI product from research laboratory OpenAI.

While the Goldman Sachs analysis did not drill down to AI’s specific impact on investment research, Joseph Briggs, one of the report’s authors, said that “equity research is a bit more highly exposed, at least on an employment-weighted basis.”

ChatGPT & Fedspeak

There are many questions over how far AI applications can go in replacing human input and analysis, but new academic research suggests that ChatGPT can perform certain Wall Street tasks just as well as experienced analysts — even those tasks that may appear more nuanced in nature.

A new study from the Federal Reserve Bank of Richmond used Generative Pre-training Transformer (GPT) models to analyze the technical language used by the Federal Reserve to communicate its monetary policy decisions. Experts on Wall Street whose job it is to predict future monetary policy decisions — also known as Fed watchers — apply a blend of technical and interpretive skills in reading through the often opaque and obscure language that Fed officials use in their communications with the public.

There are many questions over how far AI applications can go in replacing human input and analysis, but new academic research suggests that ChatGPT can perform certain Wall Street tasks just as well as experienced analysts.

GPT models “demonstrate a strong performance in classifying Fedspeak sentences, especially when fine-tuned,” the analysis said, cautioning, however, that “despite its impressive performance, GPT-3 is not infallible. It may still misclassify sentences or fail to capture nuances that a human evaluator with domain expertise might capture.”

Fed watchers are also known to make errors in judging future monetary policy decisions, which raises questions about how ChatGPT and similar technology could be applied to less-nuanced Wall Street tasks, such as company earnings projections or more fundamental industry research.

Laws regarding AI usage lag innovation

Just how should investment banks and other investment firms approach the use of ChatGPT in their research efforts and communications with clients? The short answer from legal experts is, cautiously.

“The state of AI regulation in the U.S. is still in its early stages,” said Mary Jane Wilson-Bilik, a partner at the law firm Eversheds Sutherland in Washington, D.C. “Many regulatory agencies have issued guidelines, principles, statements, and recommendations on AI… but laws specific to AI and ChatGPT are relatively few.”

That is not to say regulations will not be forthcoming. In late April, four U.S. federal agencies issued a joint statement warning of the “escalating threat” from fast-growth artificial intelligence applications, citing a range of potential abuses. The agencies called on firms to actively oversee the use of AI technology, including ChatGPT and other “rapidly evolving automated systems.”

 Four U.S. federal agencies issued a joint statement warning of the “escalating threat” from fast-growth artificial intelligence applications, citing a range of potential abuses.

The Securities and Exchange Commission has indicated it plans to issue a rule proposal on decentralized finance tools this year, but it is unclear whether the proposal will require specific disclosures on whether AI/ChatGPT was used when providing advice or reports to customers.

Given the regulatory vacuum on specific rules for Wall Street research, Wilson-Bilik cautioned firms on how they use and disclose AI and ChatGPT in their research products. “While there are no legal requirements just yet to tell clients that AI was used in the writing of a report or analysis, it would be best practice,” she said. “Some firms, out of an abundance of caution, are adding language about the possible use of AI into their online privacy policies.”

While clients do not currently have a legal “right to know” whether AI was used in generating a research report, “risks would arise if the client was misled or deceived on how AI was used,” Wilson-Bilik explained. “If firms use AI in a misleading or deceptive way — for example, by implying or stating that results are human-generated when the results are a hybrid or mostly AI-generated — that would be a problem under the anti-fraud statutes.”

Legal experts also warn that AI tools should be checked for accuracy and for bias. Without robust guardrails, there could well be cause for regulatory action or litigation.

Stress in the commercial real estate sector could be the next big concern for U.S. regional banks and regulators, as losses emanating from higher interest rates manifest over the coming months, analysts and bankers say. A portion of this fear stems from the possibility that each regional bank could be the next to suffer a major loss.

As banks report their first-quarter earnings, investors are scrutinizing the results for signs of stress or weakness following SVB’s collapse last month. So far, the earnings picture has not revealed any hidden bombshells, but experts say the pressures on banks’ financial health are likely to become more pronounced in the months ahead.

Of greatest concern is the banking sector’s exposure to commercial real estate (CRE), particularly the office sector. “Compared to big banks, small banks hold 4.4-times more exposure to U.S. [CRE] loans than their larger peers,” stated a new analysts report from JPMorgan Private Bank. “Within that cohort of small banks, CRE loans make up 28.7% of assets, compared with only 6.5% at big banks,” the report continued. “More worrying, a significant percentage of those loans will require refinancing in the coming years, exacerbating difficulties for borrowers in a rising rate environment.”

A separate Citigroup analysis found that banks represent 54% of the overall $5.7 trillion commercial real estate market, with small lenders holding 70% of CRE loans. More than $1.4 trillion in U.S. CRE loans will mature by 2027, with approximately $270 billion coming due this year, according to real estate data provider Trepp.

High vacancy rates

The office sector faces significant challenges following the COVID-19 pandemic, which forced a potentially permanent shift to remote work for millions of employees. A seismic shift in employee mentality following a period of flexible, remote working has led to a continued acceptance of remote and hybrid opportunities. With this change, office vacancy rates remain high across many U.S. cities. The current overall vacancy rate of 12.5% is comparable to where it was in 2010, one year after the onset of the Global Financial Crisis.

Further, chief executives from some of the largest banks have pointed to risks in the commercial real estate sector. “Weakness continues to develop in commercial real estate office,” said Wells Fargo Chief Executive Charlie Scharf on a recent earnings call with analysts. The bank set aside an additional $643 million in the first quarter for credit losses, mainly driven by expectations of higher CRE loan defaults.

California market in focus

With the tech and venture capital sector having borne the brunt of SVB’s collapse, recent data shows that California’s CRE market is one of the hardest hit in the country. San Francisco and Los Angeles had an average office vacancy rate of 21.6% in the first quarter, according to data from commercial real estate firm Cushman & Wakefield. And loans for San Francisco offices now face the highest risk of default of all U.S. metro areas.

“Difficulties are emerging by geography,” noted the JPMorgan report, adding that “Chicago and San Francisco are much more challenged than Miami, Raleigh, and Columbus, for example.”

CRE weakness is likely to affect banks of all sizes, but small and regional banks have, on a percentage basis, the greatest exposure. “While total exposure to the weakest CRE subsectors varies by bank, those with more than 100% of their capital in these buckets are more likely to be smaller regional entities,” the JPMorgan report stated, noting that Webster Financial Corporation, Valley National Bancorp, and Zions Bancorporation are a few of the banks with exposures exceeding 100% of their capital.

The bank’s base case scenario “assumes that aggregate CRE prices fall approximately 10% to 15% in the current cycle,” although for the office sector, the report revealed that price declines of 30% to 40% in the most stressed markets would be unsurprising.

Through taxes, governments can finance public initiatives and subsidize private investment in green industries and other initiatives, incentivizing a shift in private capital towards activities that will further the transition to net zero emission goals. Such investments will help prevent us from breaching our planetary boundaries and mitigate physical risks such as extreme weather, droughts, floods, and wildfires.

Tax credit investments

Investment tax credits at the federal level incentivize business investment. They let businesses deduct a certain percentage of investment costs from their taxes. In the context of green energy, tax credit investments return financial capital to companies to deploy directly into investments such as renewable energy, which boosts the investor’s ESG credentials and helps align the business with a low-carbon economy. Tax credit investments, which is a method used by corporations to provide funding for a project in exchange for the right to claim the available tax credit, enable corporations to use their access to capital to pursue their own path towards a sustainable economy in accordance with their risk/return assessments.

An increasingly popular option as part of an organization’s ESG strategy, tax credit investment has been and is set to become even more popular with the ambitious climate and energy policies of the Inflation Reduction Act (IRA), most of which relate to its more than 24 available tax credits. The IRA, which imposes a 15% corporate minimum tax, will drive $380 billion of investment into renewable energy and sustainable technologies, opening up new areas for tax credit investments such as electric vehicle charging infrastructure, bio-gas, green hydrogen, battery storage, and nuclear energy.

One significant change the IRA made to the clean energy tax credits is to make them refundable and transferable. Transferable tax credits allow companies to sell their tax credits to other entities for cash Refundable credits allow cash payment for tax credits if the amount owed is below zero.

Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050.

The Financial Accounting Standards Board, however, is now developing new guidance to clarify and smooth the process, and the Internal Revenue Service will be publishing guidance on the transferability of investment tax credits by mid-2023. Under the new rules, corporations can offset up to 75% of their federal income tax liability and roll this back three years, effectively gaining a rebate of taxes already paid to reinvest in ESG-positive opportunities.

Finally, renewable energy credits (RECs) are “tradeable, market-based instruments that represent the legal property rights to the ‘renewableness’ — or all non-power attributes — of renewable electricity generation,” according to the US Environmental Protection Agency (EPA). In effect, RECs assign ownership for the renewable aspects of the energy creation to the owner, allowing consumers to offset some of their carbon footprint.

Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050. Such credits provide a market and revenue stream for renewable energy-producing organizations. These opportunities enable companies to align themselves with a sustainable, green, low-carbon economy, which in turn, will likely lower companies’ transition and liability risks and their cost of capital.

There are also upsides as investors, lenders, and consumers recognize companies’ ESG-credentials. These opportunities for ESG-aligned investment will have notable social impacts around investments in infrastructure, human capital, and research & development. Job creation is a key outcome of investment in renewable energy, contributing to a just transition away from fossil fuels.

Under the IRA, a two-tiered system for renewable energy investment tax credits provides a base credit equal to 20% of the maximum credit and a bonus credit equal to an additional 80% of the maximum credit, but only if certain prevailing wage and apprenticeship requirements are satisfied in connection with the relevant project.

In addition, there are three adder credits that can be stacked on top of underlying credits for: i) meeting specific, domestic content requirements; ii) placing projects in the IRA’s defined energy communities; or iii) undertaking certain low-income solar activities.

While bringing more manufacturing jobs to the U.S. will strengthen employment overall, specifically selecting rural communities for large solar investments, for example, will provide an economic boom to those areas and enrich them through tax equity. There are further social benefits to community solar investments, which will have the ability to sell more than 50% of electricity generated to low-income families at discounted rates.

On the horizon

ESG alignment is the future of corporate investment, and companies should take advantage of the numerous investment opportunities that are emerging in the green transition.

In order to understand how companies can improve their status as social and environmental citizens and mitigate ESG-related risks, accurate measuring and reporting is needed as the first step. And tax credit investments are a direct, straight-forward way to turn this knowledge into a business upside.

In a time of economic and stock market uncertainty, tax credit investments offer a clear opportunity to grow and strengthen a company’s business strategy, while aligning it with the green transition.

This article was written for the Thomson Reuters Institute blog site by Foss & Co. For more information, contact ir@fossandco.com.

The International Monetary Fund (IMF) has warned that the fundamental question confronting market participants and policymakers is whether recent banking turmoil, sparked by SVB’s recent failure, is a “harbinger of more systemic stress, as previously hidden losses are exposed, or simply the isolated manifestation of challenges from tighter monetary and financial conditions after more than a decade of ample liquidity.”

One of the major factors behind the collapse of SVB and Signature Bank in New York was unrealized losses on their balance sheets. The losses stemmed largely from investments such as U.S. Treasury securities, which on paper were under water due to interest rate increases. Such paper losses are widespread across the industry. The Federal Deposit Insurance Corporation (FDIC) has estimated there are more than $600 billion of such losses sitting on U.S. bank balance sheets, a figure some say is conservative.

What appears to have caught regulators and investors off-guard is the broader market and industry impact from the SVB and Signature Bank failures. Neither bank was considered systemically important. And Congress even approved a rollback of financial regulations in 2018 on banks of this size.

“Even events at smaller banks can have systemic implications by triggering widespread loss of confidence and rapidly spreading across the financial system, amplified by technology and social media,” the IMF stated in its semi-annual Global Financial Stability Report, issued on April 11. “Because regional and smaller banks in the United States account for more than one-third of total bank lending, a retrenchment from credit provision could have a material impact on economic growth and financial stability.”

Tobias Adrian, IMF monetary and capital markets director, agreed this was a concern. “Even if you think that, on average, banks have a lot of capital and liquidity, there could be these weak institutions that then spill back into the system as a whole.”

Reverse 2018 ‘tailoring’ of bank rules

Additional bank failures, along the lines of an SVB, may well dictate the overall response by U.S. regulators and Congress. Upcoming bank earnings for the first quarter will give investors a glimpse into any further signs of weakness and possible contagion.

For the moment, however, with deposit flows having become stable, and investors slightly more confident, the next steps taken by regulators in response to SVB’s failure are likely to focus on several areas. At the end of March, top regulators from the Federal Reserve and FDIC appeared before Congress, and the discussions focused on several areas:

• • • Re-examination of regulatory tailoring — In his opening statement, Federal Reserve vice chair for supervision Michael Barr indicated that the central bank’s SVB collapse review will include the impact of reformed stress-testing, capital-planning, and liquidity risk management requirements implemented in 2018. At the time, the Fed decided that banks roughly the size of SVB did not require the strict regulatory standards imposed on systemically important banks, such as JPMorgan and Citibank. Both Barr and FDIC Chair Martin Gruenberg said that they will likely increase regulatory requirements for banks with between $100 billion and $250 billion in total assets. This might also include increased capital requirements.
    • Stress testing — There was a lot of discussion around stress testing for banks similar in size to SVB. According to the Fed, SVB was not tested for a rising rate scenario — which ultimately prompted the crisis. Barr said he will make changes to stress testing to capture a wider range of risks and channels for contagion.
    • Supervision issues — Numerous observers criticized how the Fed had highlighted liquidity and interest-rate modeling weaknesses at SVB as early as November 2021. The bank’s management, however, failed to address those concerns. The Fed is reviewing what went wrong in its supervision of SVB and will issue a report on May 1.

“Banks with between $100 billion and $250 billion in total assets can expect changes around capital adequacy, total loss-absorbing capacity, liquidity requirements, resolution planning, and the impact of accounting for unrealized gains or losses in securities portfolios,” consulting firm PwC wrote in a note to clients. “The starring role that stress testing played in the hearings demonstrates that the Fed is likely to not just reassess the frequency of tests but will look to expand their scope to capture a wider range of risks.”

Expanding deposit insurance

Then there is the thorny question of FDIC deposit insurance. In SVB’s case, more than 90% of its deposits were uninsured, held largely by venture capital firms and other businesses. That level of uninsured deposits is high in comparison to other U.S. banks, but FDIC data shows that many banks have deposits above the current $250,000 insurance threshold.

At the end of 2022, about 43% of all bank deposits were uninsured, according to the FDIC. Some of the country’s largest banks have above-average uninsured deposit levels. For example, 59% of JPMorgan’s deposits are uninsured, FDIC data shows, and at Citibank, that number reaches 85%.

Following SVB’s failure, regulators, lawmakers, and industry groups questioned whether the deposit insurance cap should be raised from the current $250,000 per depositor. A coalition of midsize banks has asked regulators to extend insurance to all deposits for the next two years.

Regulators have the authority to make changes to most of the areas described in recent Capitol Hill hearings, but raising the FDIC insurance cap would require bipartisan agreement in Congress.

With bipartisanship in short supply on many issues, however, an agreement on what to do with FDIC deposit insurance is unlikely to happen any time soon.

In this environment, robust and proactive compliance infrastructure is imperative to safeguard businesses and the broader macroeconomic landscape. U.S. Deputy Attorney General Lisa Monaco recently called on today’s business leaders to prioritize corporate compliance — not only to uphold the rule of law, but to recognize the role of compliance in strengthening financial markets and protecting national security.

At a time when internal budgets are being squeezed, the Department of Justice is doubling down on policy-driven strategies to hold both organizations and their leadership accountable “to promote and support a culture of corporate compliance,” she said. For workplaces today, where culture is key, Monaco’s remarks on safeguarding the business with a tenacious compliance and risk management posture are critically important.

Striking a healthy balance

Corporate departments and business units are often considered either as a cost center or profit center. During times of heightened economic pressure, unsurprisingly, the cost centers are often the first to be assessed for possible budget freezes or cuts to boost cost savings. In most organizations, the risk & compliance function is perceived as a cost center.

However, the role of an effective head of compliance is to communicate the importance of the compliance department and approach the role of the function as not only as a cost center, but as a way to drive business development and revenue. This requires striking a healthy balance between compliance and other leadership teams, articulating the business value of building a robust compliance program that assesses and mitigates risk.

A successful compliance program is designed around a heat map-like calculation, an exercise that evaluates the likelihood of risk against the impact of the stated risk. Adept compliance leaders will assess the industry environment, scan the horizon, and determine how certain variables might manifest as risks within their own organizations. This exercise is fundamental to quantify — and justify — the budget of a sophisticated compliance program that is equipped to safeguard the business.

Establishing a workplace compliance culture

Prioritizing compliance is not exclusively the role of the company’s compliance officer; in fact, if the compliance team is the only function of the business thinking about compliance and implementing the appropriate controls, the organization is not set up for success. From the senior leadership and board of directors, down to the roots of the organization, all employees are responsible for contributing and upholding a culture of integrity and compliance.

The top-down implementation of policies and expected behaviors, supported by good line management, can promote a more compliant and consistent approach across the business to better create a positive risk management culture. Establishing a strong culture includes fostering an entire organization’s approach to compliance, ensuring proportionate and cost-effective use of resources, and supporting efforts to build a dynamic and inclusive organization by promoting a speak-up culture.

Just as it is the role of all employees to strive towards annual business targets, so too is their role in upholding the organization’s compliance and ethics initiatives. It is equally important for organizations’ heads of sales to prioritize risk management and compliance as it is for heads of compliance themselves. The commitment to remain compliant is the responsibility of the entire organization.

The changing role of the compliance officer

The need to establish a robust compliance program, backed by a workplace culture that prioritizes de-risking and integrity, has become increasingly important for businesses today as policy and regulation continue to evolve. In February, a judge’s decision in a derivative lawsuit in Delaware to allow a shareholder lawsuit to go forward against a former McDonald’s Corp. HR leader set a meaningful industry precedent, another signal in recent regulatory activity that is continuing to shift accountability from the organization alone to include individuals as well.

This evolution of accountability over the last several years has been one of the most fundamental transitions in the role of the corporate compliance officer. Most importantly, this shift has changed how compliance leaders interpret their role and responsibility to the organization. When an individual is personally on the hook, it magnifies the context of accountability.

Coupled with this transformation is the U.S. government’s growing expectation to see data-driven approaches to compliance. Regulators increasingly require proof, backed by data and analytics, that a robust compliance program is in place and reinforced by a compliance-first culture.

Like most business functions, the increased use of technology and data has streamlined processes and accelerated efficiencies within compliance. Specifically, compliance leaders who are taking a more proactive approach to controls are looking to leverage data in order to understand how to better allocate limited resources across the business to areas that may be more at risk. As technology becomes even more sophisticated, so too does the expectation of the compliance officer’s responsibility to leverage it.

Compliance as a business driver

The most ethical and stable organizations are the ones with leadership teams that accept the ownership of risk, establish programs to mitigate risks, and leverage the compliance team as a vital resource to run the business more successfully. Especially as economic challenges persist, it is a business imperative that organizations — across all levels and functions — are committed to compliance.

At this year’s National Institute on White Collar Crime hosted by the American Bar Association, Deputy AG Monaco spoke about these recent policy changes that seek to promote cultures of corporate compliance and reinforce the personal role of individuals. “These policies empower general counsels and compliance officers to make the case to company management, to make the case in the boardroom that investment in a robust compliance program, including a forward-leaning compensation system, is money well spent,” she said.

While this is true in any climate, it is especially critical in today’s macroeconomic landscape. Indeed, it is the role of the corporate compliance officer that breathes this ethos into the organization to not only safeguard the business but to continue driving it forward.

Total losses from online scams and identity theft reported to the Federal Bureau of Investigation (FBI) have increased to $10. 3 billion in 2022 from $6.9 billion the year before, according to the FBI Internet Crime Complaint Center report, and it is estimated that that numbers are much higher because less than 7% are assumed to report to any authority due to shame and embarrassment. One type of crime that is growing significantly is cryptocurrency investment scam, which climbed an alarming 183% to $2.57 billion in 2022 from $907 million in 2021.

With these monetary losses skyrocketing, one question arises: Who is protecting consumers? Many claim that this is a matter of personal responsibility, but with the alarming growth in losses, the societal impact of these scams is yet to be truly measured. Law enforcement and the FBI might investigate some cases, but the recovery possibilities are extremely limited once the money ends up in the hands of the criminals.

Of course, financial institutions hold some liability when it comes to fraudulent transactions, but the liability to reimburse customers only happens in the case of account takeover fraud, or unauthorized transactions. In this scenario, criminals will use an array of tactics such as stolen credentials or malware to login to the legitimate customer’s account or take over an existing online banking session.

In the United States, Regulation E (Reg E), which was issued by the Federal Reserve as an implementation of the Electronic Fund Transfer Act of 1978, determines the conditions under which financial institutions will reimburse their customers for unauthorized electronic transfers. While several clarifications have been issued over the years to outline specific cases for online banking and debit card activity, one thing remains clear — If a customer performed an authorized transaction even if they were manipulated to do so by a scammer, they will not be covered under Reg E and the bank will not be liable to reimburse customers. Given the amounts of money lost to scams such schemes as romance scams, investment scams, bank impersonation scams, and many others, and the implication of billions of dollars leaving the U.S. every year to illicit actors based in foreign countries, there is a need to take action.

Interestingly, there are several activities happening with numerous federal agencies pushing to do more around scams, such as the Federal Communications Commission (FCC) to take more action in detecting scam text messages, and the Federal Trade Commission (FTC) pushing social media and video platforms to address the surge in scams.

Embracing the Contingent Reimbursement Model

One interesting example of a model for scam loss reimbursement can be taken from the United Kingdom. The Contingent Reimbursement Model (CRM) was introduced in May 2019 in the U.K. in the form of an initiative designed to reimburse victims of authorized push payment fraud (APP fraud). This is a voluntary code that can be used by banks which agree to participate in the initiative.

Since its launch in 2019, the CRM has been successful in providing a more streamlined and efficient way of compensating victims of APP fraud. In fact, a total of almost 50% of reported scam losses have been reimbursed to victims of APP fraud under the CRM between the first half of 2020 and the second half of 2022, according to the latest figures released by U.K. Finance. This represents a significant increase compared to the previous reimbursement models, which often resulted in remaining financial losses to the victims. Under the CRM, the customer’s bank will reimburse the customer and take loss liability.

Unfortunately, the U.S. banking sector has been focused on an extremely narrow section of scams that has caught headlines, which is fraud on the Zelle payment platform. There has been a significant increase in Zelle fraud due to the nature of Zelle being a faster payment person-to-person network, with the money being transferred immediately to the beneficiary. Indeed, scams increased more than 250% to more than $255 million in 2022, compared to more than $90 million in 2020, according to a report released by Sen. Elizabeth Warren (D-Mass.) in October 2022.

From April to November 2022, Sen. Warren pushed the operators of Zelle — Early Warning Services, which itself is owned by a number of large U.S. banks — to provide numbers and explain their plan to reimburse customers and provide better protection. In November 2022, the seven banks that own Zelle started to work on a rule change that will require the network’s member banks to compensate customers who fall victim to certain kinds of scams. The shift would reverse the network’s current policy, which typically leaves customers with the losses on any Zelle transactions that the customers initiated themselves — even if they were tricked into sending their cash to a criminal.

Under the planned rules, if the banks determined that a customer had been deceived into sending money, the recipient bank — the one holding the scammer’s bank account — would be responsible for returning the money to the victim’s bank. That bank would then refund its defrauded customer.

This announcement is a huge change and brings a wave of optimism; however, there are many issues with the proposed reimbursement model. First, it is still unclear which cases will be reimbursed. The news of the proposal model has also received pushback by smaller banks that claimed that they cannot afford to pay for customer scam losses on Zelle, and they might need to leave the Zelle network if this rule will be reinforced, driving more competitive challenges for smaller banks. In addition, and perhaps most obvious, although Zelle scams are skyrocketing, we see other scam vectors growing significantly in which transfers to criminals are not conducted on the Zelle payment platform.

Clearly, the industry needs a more holistic approach to protect consumers who are losing money in growing amounts, especially since Zelle fraud is a comparative drop in the multi- billion-dollar ocean of similar financial scams.

So, to answer the original question: Could the U.K.’s CRM model be deployed in the U.S.? It seems like the Zelle liability initiative that was taken to address a very isolated issue might quiet broader conversations for the time being. However, with the sophistication of the banking ecosystem in the U.S. and the many stakeholders that would need to get involved, it is highly unlikely that this model will be implemented in the U.S. as a voluntary measure.

There is a broader ecosystem that needs to take more responsibility across the scam lifecycle, starting with telecom companies and social media platforms, which facilitate communication, and then onto the banks which enable these illicit transactions.

There definitely should be more collaboration and data-sharing across sectors, and that should be facilitated by the government. At a minimum, banks should take better care of their customers by erecting stronger controls to prevent scams and drive better awareness of these schemes.

For more on protecting yourself from online scams, check out the author’s recent podcast on the Scam Rangers site.