Central Banks

Tuesday, April 3, 2012 - 16:59

FSOC Retains Ability to Name US SIFIs Regardless of Criteria

WASHINGTON (MNI) - Ushering in a new era of financial services regulation in the U.S., the Financial Stability Oversight Council Tuesday approved the criteria it will use to identify non-bank firms that it believes could or might someday endanger the financial system -- and then reserved the right to ignore the criteria.

The vote by the members of what has come to be known as "FSOC" was unanimous to list certain characteristics the Council will "generally" use to choose firms for a new and already abhorred status most of the target firms would mostly rather avoid.

Once designated a systemically important financial services firm after a three-stage process, the new "SIFI" gets a costly set of mandates. There will be minimum capital standards, stress tests, liquidity standards and much more.

The "interim interpretive guidance for non-bank designations" emphasizes flexibility and foresees the need to learn from experience.

The new rule is "an important tool provided in Dodd-Frank for extending the perimeter of transparency, oversight and prudential supervision," Treasury Secretary Tim Geithner told the Council, assembled under three of the largest chandeliers in Washington in Treasury's marble-lined Cash Room.

Geithner said, though, that the authority under the new rule is only "one tool, not our sole means for extending the perimeter of supervision."

For those firms covered, however, the rule represents the threat of an unfamiliar government yoke that can alter their business models, impair their stock price and subject them to sudden orders to alter behavior the Council disapproves of.

For that reason some firms and their various industry associations are expected not only to argue against any SIFI designation, and the law provides such opportunities, but to challenge any designations in court.

In the political sphere, the Dodd-Frank Act that created the FSOC is under constant challenge on Capitol Hill by some Republicans as too burdensome and intrusive an intervention in business by government.

The final rule's criteria for the SIFI designation will be matched against firm after firm in the months ahead. They will help identify the obvious candidates but in the end, all that matters is whether "the Council believes the company could pose a threat to U.S. financial stability," in the words of an FSCO guidance document.

The final rule provides for the Council to be able to designate just subsidiaries of firms if the parent itself is not primarily a financial services company. And in judging a foreign-owned company, the Council will consider only the U.S assets, liabilities and operations.

FSOC Tuesday retained the proposals of late last year for previously unregulated money market funds, broker-dealers, derivatives markets, insurance firms, hedge funds, private equity firms, investment advisers, asset managers -- but not securities exchanges -- to be considered for the expanded net of heavy regulation. Estimates vary as to the universe of non-bank SIFIs that will eventually be named by the end of the year but have been in the neighborhood of two to three dozen.

The Council will begin the assessment process by first asking the appropriate regulatory agency for data and then the firm itself if there are $50 billion in global assets and the entity meets or exceeds:

-- $30 billion in gross notional credit default swaps

-- $3.5 billion derivative liabilities

-- $20 billion of total debt

-- A 15-to-1 leverage ratio

-- A 10% ratio of debt with less than 12-months maturity to total assets

Every non-bank financial services entity -- including those middlemen known in the law as "financial market utilities" -- now falls under the authority of the Council and one of eight regulatory agencies, including the Fed, represented on the Council by Chairman Ben Bernanke. He, incidentally, left all the talking to the chairman of the Council, Geithner.

The FSOC sealed off from public scrutiny the materials it will use in assessing a firm for SIFI status, making them exempt from Freedom of Information Act queries.

The FSOC incorporated in its rule some suggestions that it should emphasize flexibility in making its judgments rather than establishing "bright line" guidelines quantifying exactly what characteristics define a SIFI.

The Council is already the most powerful manifestation of the Dodd-Frank Act, packed with government regulators like the FDIC, the SEC, the CFTC, the NCUA, the OCC and the CFPB, all acronyms already well known to banks. As it summons financial services firms to explain themselves, its footprint in the financial services sphere can only grow.

Geithner recounted how the congressional creators of Dodd-Frank were alarmed that the unregulated financial sector had slowly grown to be nearly a third of the financial services industry by the time the crisis struck. So Congress both beefed up the government's regulatory capabilities, creating the Council and several other new coordinative entities like the separate Federal Insurance Office, and widened the regulatory net to reach the non-banks. It wasn't long after passage that Republican leaders began to have buyers' regret, becoming critical of the far-reaching legislation.

Monday's notice of the Tuesday afternoon FSOC meeting took many industry watchers by surprise, since it was expected to make its SIFI rule final later in the year, perhaps by early summer.

There are 14 members of the Council but not all can vote. Non-voters include Louisiana Banking Commissioner John Ducrest, voted on to the FSOC as the representative of all state bank regulators. Ducrest is the new chairman of the Conference of State Bank Supervisors.

There are also representatives of state insurance regulators and state securities regulators.

Another little known member, but one who does have a vote, is Roy Woodall, an advisor to the Council because of his expertise in insurance. A former head of industry groups and an insurance consultant for the Congressional Research Service, he had to be confirmed by the Senate to a six-year term.

Some insurance companies and firms are so large that they already know FSOC will be knocking at their door. But many companies are on the borderline of the criteria and are girding themselves to argue against being included, for some, even if it means a fight in the courts. The Council must vote twice in order for any firm to be designated as systemically significant with two-thirds approval, including that of the chairman, necessary.

Insurance industry associations and business groups like the U.S. Chamber of Commerce and the National Association of Manufacturers argued for less Council discretion and narrower requirements that would exclude as many of their members as possible. Some other groups, however, have argued that the FSOC criteria are not inclusive enough, and will let many types of firms involved in the financial crisis off the hook.

The Council must meet at least quarterly under the law. Its work is being monitored closely by foreign regulatory groups still struggling with similar criteria for capital standards and non-banks. The G20's Financial Stability Board is in the midst of studying to what extent insurance firms should be included. Those firms considered to be SIFIs by FSOC could theoretically be subject to another layer of international regulation and harmonization of the standards is still far in the future.

Although firms that limit themselves strictly to financial services can meet the new criteria if they are large and potentially risky enough, firms that are not immediately recognizable as such could also find themselves in the Council's cross-hairs. Some have suggested the firms such as Warren Buffett's Berkshire Hathaway, and even manufacturers with big finance operations could find themselves answering the FSOC questions.

One insurance company already under the Fed's regulatory scrutiny because its banking operations, Met Life, found out how uncomfortable that scrutiny can be. It complained about the Fed's March 13 stress tests results for the 19 largest banks that found it did not yet measure up to most of its peers. Met Life said the Fed's criteria were inappropriate for an insurance operation.

** MNI Washington Bureau: 202-371-2121 **

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