After its last meeting at the end of July, the
Financial Stability Oversight Council (FSOC) announced that it has
“directed staff to undertake a more focused analysis of industry-wide
products and activities” in the asset management industry. This has been
interpreted as a step back from the FSOC's earlier position that the
financial distress of large asset managers — or at least the funds they
manage — could have systemic effects on the U.S. financial system and
thus warrant designation as systemically important financial
institutions, or SIFIs. The Wall Street Journal reported that the FSOC
had “agreed to revamp their review of asset management firms to focus on
potentially risky products and activities rather than individual
firms.” If so, it’s good news for the U.S. capital markets.
If the FSOC’s new position is maintained, it has significant
implications for the efforts of the Financial Stability Board (FSB), a
largely European group of central bankers and bank regulators, to gain
control of what it calls “shadow banks.” Both the Federal Reserve and
Treasury are members of the FSB and have been strong supporters of the
FSB’s efforts to subject shadow banks to bank-like supervision and
regulation.
In 2009, in the wake of the financial crisis, the FSB was deputized
by the G-20 leaders to reform the international financial system, and
the agency has thus far used this baton to designate 39 banks and nine
insurance firms as global SIFIs. The standards for global SIFIs are
roughly the same as the standards for SIFI designation in the Dodd-Frank
Act. The FSB has no enforcement power, but relies on its G-20 member
organizations to carry out its mandates within their respective
jurisdictions. In the United States, the FSOC has that role and has
followed it diligently up to now. For example, after the FSB designated
three U.S. insurance firms as global SIFIs — AIG, Prudential, and
MetLife — the FSOC designated AIG and Prudential as SIFIs and has been
investigating MetLife for this purpose.
“Shadow banks” have been a particular target of the FSB. In September
2013, the FSB defined a shadow bank as any financial intermediary that
was not subject to bank-like regulation — about as broad a definition as
could be imagined — and announced that it was “reviewing how to extend
the SIFI framework to global systemically important nonbank noninsurance
financial institutions.” This category of firms, said the FSB,
“includes securities broker dealers, finance companies, asset managers,
and investment funds, including hedge funds.” Given the breadth of the
FSB’s definition of shadow banks, it also includes insurers.
The FSOC’s announcement may reflect a
recognition that the FSOC isn’t ready to answer hard questions from
Congress about asset managers and insurers.
Then, in January 2014, the FSB said that asset managers with more
than $100 billion in funds under management should be considered for
SIFI designation, and several European scholars and officials backed up
this position by opining that large asset managers could create systemic
risk. Shortly thereafter, the FSOC let it be known that BlackRock and
Fidelity Investors, two of the largest asset managers in the United
States, had been moved to the second stage of the three-stage process
the FSOC uses to determine whether a nonbank financial firm should be
designated as a SIFI. It seemed as though the FSB’s designation program
was firmly in place.
But then Congress started to point out some major and troubling
problems with what the FSOC is doing. On July 30, nine Republican
members of the Senate Banking Committee, led by Senators Toomey, Crapo,
and Shelby, sent a letter to Treasury Secretary Jack Lew, in his
capacity as chair of the FSOC, strongly urging a suspension of SIFI
designation until the Federal Reserve — which has the power to regulate
and supervise the SIFIs that are designated by the FSOC — makes clear
how insurers, asset managers, and others will be regulated. The senators
argued, with some force, that it can’t be a responsible act to
designate a firm as a SIFI without knowing how the Fed intends to
regulate it; the Fed has given no indication how it will regulate
Prudential and AIG, which have already been designated as SIFIs.
In addition, in appearances before Congress, Secretary Lew has been
unable to explain how Prudential Financial received a fair or objective
hearing on designation — or how MetLife could be getting one as it is
investigated now — when the Treasury and the Fed have already approved
their designation as global SIFIs by the FSB. In House hearings,
witnesses have ridiculed the lack of data in the FSOC’s Prudential
decision, suggesting that the agency really has no idea how to define
systemic risk for an insurer.
Finally, the FSOC’s designation process has encountered sharp
criticism in the House Financial Services Committee. Several weeks ago,
the chairman, Jeb Hensarling, called on the FSOC to “cease and desist”
its designations of nonbank SIFIs until Congress has had an opportunity
to consider their economic effects. This was backed up by a one-year
moratorium on SIFI designations adopted by the committee earlier in
July, and the recent adoption of the same moratorium in an amendment to a
House appropriations bill.
The FSOC’s announcement may reflect a recognition that the FSOC isn’t
ready to answer hard questions from Congress about asset managers and
insurers. If so, there is little it can do to assist the FSB in
corralling and regulating shadow banks. The Dodd-Frank Act requires
extensive reporting to the SEC and the FDIC by asset managers, but does
not confer on the FSOC any authority to regulate fund managers or the
funds themselves. The FSOC’s only role is to designate a nonbank firm
as a SIFI, which automatically turns it over to the Fed for bank-like
regulation and supervision.
‘Shadow banks’ have been a particular target of the FSB.
In the absence of a SIFI designation, the SEC is the primary
regulator of asset managers, and while the FSOC under Dodd-Frank can
make recommendations about activities that should be terminated or
regulated more stringently, the SEC is not required to follow them. The
SEC recently demonstrated its independence of the FSOC by adopting rules
for money market mutual funds that were less stringent than the FSOC
had recommended. The FSOC will have even less traction with insurers,
which are regulated at the state level.
Accordingly, the FSOC’s decision to focus on products and activities —
if it remains the agency’s policy — could be the end of the FSB’s
effort to place securities firms, asset managers, insurers, or others
that it considers shadow banks under FSB’s SIFI framework. Such
institutions can’t be regulated or supervised like banks unless the FSOC
is willing to designate them as SIFIs and — in light of the hostile
congressional reaction it has received thus far — the FSOC may have
decided that what the FSB wants to do won’t work now that Congress is
asking difficult questions and threatening to legislate moratoriums.
The FSOC’s decision to pull back from the designation of asset
managers as SIFIs may be temporary or it may end what was shaping up as a
serious threat to the U.S. capital markets. Those in Congress who let
the FSOC know of their objections deserve the thanks of everyone who
understands the value of the free U.S. capital markets, but the threat
isn’t over until the FSB gives up.
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