The U.S. Financial Stability Oversight Council today approved a final rule to help the panel determine which non-bank financial firms require Federal Reserve scrutiny.
The council, headed by Treasury Secretary Timothy F. Geithner, approved the criteria to identify which firms may be systemically important and pose a potential risk to the financial system. The final rule comes after two attempts by the panel, commonly referred to as FSOC, to define systemic risk designation standards.
“This interpretive guidance is an important tool provided in Dodd-Frank for extending the parameter of transparency oversight and prudential supervision over parts of the financial system that can be a particularly important source of credit to the economy and potentially important source of risk in crisis,” Geithner said at today’s FSOC meeting.
Deputy Treasury Secretary Neal Wolin told Bloomberg Television today that FSOC should begin making designations “by year’s end or some time in that timeframe but we’ll have to let the process play out to see how quickly the council can do their work.”
The final rule regulators approved is largely unchanged from that proposed in October. Under the rule, regulators will evaluate non-bank financial companies with more than $50 billion in assets if they meet any one or more of the following thresholds: A 15-to-1 leverage ratio; $3.5 billion in liabilities on derivatives contracts; $20 billion of outstanding loans borrowed and bonds issued; $30 billion in gross notional credit-default swaps outstanding; or a 10 percent ratio of short-term debt to assets.
“Until an entity is actually designated it’s just speculation about what the rule will do even if the rule is final,” said Jerome Walker, a partner at SNR Denton in New York. “Once one non-bank sifi is named, then you can study that and you can apply to other institutions. Until then, it means continued uncertainty.” The acronym “sifi” refers to a a systemically important financial institution whose failure could pose a threat to financial stability.
Under a three-step process, the council will use additional data, including size, interconnectedness and liquidity risk, to identify a subset of non-bank financial companies. The council will use publicly available figures to analyze the companies, and then regulators will contact the firm in question to collect more information.
The council retained a provision allowing it to designate any financial company if it poses a threat to U.S. financial stability regardless if it meets the metrics.
Firms designated as systemic will receive heightened supervision from the central bank. The Fed could require firms to raise capital and reduce risky practices. The companies also would have to file “living wills” so they could be unwound in an orderly way.
“U.S. financial stability -- as AIG did in 2008 -- will be subject to Federal Reserve supervision and enhanced prudential standards,” U.S. Commodity Futures Trading Commission Chairman Gary Gensler said in a statement. “This rule helps protect taxpayers from picking up the bill for such a financial entity’s failure.”
Under the Dodd-Frank act, banks with more than $50 billion in assets were automatically deemed risky to the financial system in the event of their failure.
The Fed is in the process of defining how it would regulate both bank and non-bank systemic companies. Kenneth Bentsen, the executive vice president of public policy and advocacy at the Securities Industry and Financial Markets Association, said non- banks fear if designated they would face bank-like supervision.
“Some of it may not be completely applicable to firms that pass the first threshold and what Federal Reserve supervision will mean for non-bank entities is unclear,” Bentsen said.
By setting designation standards now, the U.S. is able to frame debate on systemic risk globally. While the Financial Stability Board has named globally systemic banks, it has yet to publish rules for designating non-bank firms as systemic. The FSB is a panel charged by Group of 20 nations’ leaders to coordinate global financial reform and monitor progress.
“From a practical standpoint this allows the U.S. as they go to the G-20 to say we have our process in place and that helps the U.S. influence what” a globally systemic firm is, Bentsen said.
The council said in the rule that it will continue to evaluate and adjust this framework and the thresholds, as appropriate, as more data about firms and industries, such as asset managers, hedge funds, private equity firms, and swaps entities, become available.
From the October rule, the Treasury made minor adjustments, including confidentiality protections for information collected and written notice and opportunities for firms to contest a designation.
The council first attempted to define standards for systemic risk designation in January 2011. Lawmakers and industry executives quickly complained that the initial proposal simply restated the Dodd-Frank act provision on designation. FSOC responded in October with the proposal laying out the quantitative metrics for designation.
“It may be to their advantage to name a few now and revisit later because it sends a message to the market that they are not asleep at the switch, that this is an ongoing process that is never going away,” said Brian Gardner, the senior vice president for Washington research at Keefe Bruyette & Woods Inc. “The best way to keep both the regulators themselves and the markets on their toes is for this list to be an evolution.”
To contact the reporter on this story: Cheyenne Hopkins in Washington at firstname.lastname@example.org;
To contact the reporters on this story: Meera Louis in Washington at email@example.com