Senate Banking on FSOC Accountability with Jacob Lew
Senate Committee on Banking, Housing, & Urban Affairs
“FSOC Accountability: Nonbank Designations”
Wednesday, March 26, 2015
Key Topics & Takeaways
- FSB & FSOC: Sen. Tom Cotton (R-Ark.) asked if the FSB’s decisions are binding on the United States. Lew said the FSOC makes the decision to designate a firm and the “FSB cannot designate a firm for us.”
- Stage Two of the Designation Process: Sen. Dean Heller (R-Nev.) asked if the changes made at FSOC will now provide a financial institution under consideration access to all information before stage two of the designation process. Lew said, “It changed the process, not the substantive criteria.”
- Designation of Risky Activities: Warren asked Lew if the FSOC would designate a specific portion or activity, rather than designating the entire firm as a SIFI. Lew said the review of asset managers is still underway and he is also not sure if it would be the FSOC that would play a role or a regulatory agency action that would follow. He added that the FSOC has not yet designated an activity.
- Structure Activities to Avoid Designation: Gary Hughes, Executive Vice President and General Counsel at the American Council of Life Insurers, argued that companies should be provided with the choice and ability to work constructively with the FSOC to structure their activities in such a way to avoid being designated as systemic.
Witness
- The Honorable Jacob J. Lew, Secretary, United States Department of the Treasury
- Douglas Holtz-Eakin, President, American Action Forum
- Gary Hughes, Executive Vice President and General Counsel, American Council of Life Insurers
- Dennis M. Kelleher, President and Chief Executive Officer, Better Markets, Inc.
- Mr. Paul Schott Stevens, President, Investment Company Institute
Opening Remarks
In his opening statement, Chairman Richard Shelby (R-Ala.) said this hearing would examine how the Financial Stability Oversight Council (FSOC) designates systemically important financial institutions (SIFIs). He added that there is “no precedent on a regulatory regime for a council like this” and the “FSOC has the authority to designate a nonbank institution” while the Federal Reserve regulates “enhanced prudential standards that do not come at a cost to our economy.”
With this responsibility, Shelby said “much rests on designation” and the FSOC has a “heightened duty to be as transparent and judicious as possible.” He added that U.S. regulators should be “free of international bodies” and that it is important to remember that the Financial Stability Board (FSB) monitors and makes recommendations, but is not a U.S. regulator. Shelby explained that three of the ten voting members on the FSOC first engaged at the FSB level, and had “already made up their minds” when they decided to designate firms at the FSOC level. Due to these concerns, Shelby said it is important to question the influence of the FSB on the FSOC.
Shelby next said that most critics do not believe that concerns about the FSOC’s transparency have sufficiently been raised and suggested that the following questions be asked of the FSOC: 1) Does the FSOC clearly disclose what factors make a firm systemically important?; 2) Is it clear what needs to occur to reduce the systemic risk of a company?; 3) Is the designation process sufficiently open, objective, and free of data influence from outside organization?
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) argued that over time, the Fed has become more accountable to the public and the “Fed’s operations are the most transparent they have ever been in its history.” He recommended that the Senate Banking Committee consider whether the Fed’s current governance “appropriately holds the regulators accountable and encourages diverse perspectives.” Brown said that perhaps the chair of the Federal Reserve Board should not be appointed by the president in order to ensure independence from leaders and accountability to the American people. He recognized that some, but not all, reforms would require legislation. He added that he also thinks the FSOC’s work has been too slow, and perhaps should have designated more than four firms in the past five years.
Panel One – Secretary Jacob Lew
In his testimony, Jacob Lew, Secretary of the United States Department of Treasury, emphasized that the crisis caused enormous hardships for the American people and “shortcomings in the regulatory framework were revealed.” Lew said the “regulatory structure was ill-equipped” with “limited tools for regulators to protect against failure and collapse of the financial system.” He said that is why the Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act “put in place critical new consumer protections and put into law that the taxpayers must never again be put at risk for the failure of a financial institution.” Under the Dodd-Frank Act, Lew explained that the FSOC was also created to bring together the entire financial regulatory body to work collaboratively, but this “work has not been easy.”
Next, Lew said the FSOC has made several improvements to its transparency, adopting a “data driven and deliberative approach,” publishing four annual reports, holding “regular public meetings,” and publishing minutes. However, he acknowledged that the FSOC is a “young organization that should be open to changes in its procedures.” He continued that the FSOC has completed the following: 1) enhanced transparency policy; 2) strengthened internal governance; 3) solicited public comment on asset managers; and 4) adopted refinements to non-bank financial company designation process. Last month, Lew said, the FSOC adopted supplemental procedures to allow companies to “know early in the process where they stand” and “will provide companies with a clearer and more robust review process.” In his view, companies have ample opportunity to discuss any issue.
He concluded that the financial system is more robust and resilient than it was before the crisis, which he believes is the truest test of reform.
Questions
Factors for SIFI Designation
Shelby asked Lew what the FSOC is doing to provide both the public and the designated companies with a better understanding of the relative weight of each factor, and what makes a designation more likely. Lew responded that “the relative weight of factors will be different depending on what the composition of a firm and the nature of the risk is. In each case, we apply the same review, which is a deliberative review.”
Sen. Jon Tester (D-Mont.) asked if the designated companies know why they were designated. Lew replied that these firms have “engaged in lots of back and forth at a staff level” and added that there is a “several-hundred-page analysis that describes where the risk is in the transmission mechanisms or the basis for the determination.”
FSOC Designation & Supervisory Role of the Fed
Shelby asked Lew how the FSOC can designate a company if the Fed is yet to promulgate rules to regulate such companies. Lew replied that the FSOC determines whether or not there is systemic risk and the Fed has the supervisory role. He continued, “So I think that the process is moving sequentially, and as the firms have to comply, that process will unfold in an orderly way. But it’s the Fed’s responsibility going forward.”
Shelby pressed Lew and asked how the FSOC can determine that it is reducing systemic risk when it has neither identified the specific activities that create systemic risk nor does it have the knowledge of what regulatory steps would be taken to mitigate such risk. Lew responded, “The task of going through the analysis to determine whether there is a systemic risk is the responsibility of FSOC. By designating the firm, the firm then is subject to supervision under the statute by the Fed.” Shelby asked if this process has occurred. Lew said the Fed is currently working through the process and no firm has been both designated and gone through the documentation process with the Fed.
SIFI Designation Threshold
Brown noted the Senate Banking Committee has talked about the $50 billion threshold for the Fed’s enhanced prudential standards for bank holding companies. He asked Lew what feedback he has received from industry and if agencies can tailor these regulations to address these concerns. Lew said, “Senator, I believe that the law was written with a great deal of flexibility and it’s been implemented with a great deal of flexibility. It is not a one-size-fits-all approach. I think that $200 million financial institutions are different than $50 billion institutions, which are different from $2 trillion institutions.” He added that he believes it is “premature to legislate in this area” because he thinks regulatory flexibility exists.
GSEs & Systemic Importance
Sen. Bob Corker (R-Tenn.) asked Lew if he considers Freddie Mac and Fannie Mae, the government-sponsored enterprises (GSEs), to be systemically important. Lew acknowledged that “the GSEs were at the heart of the last financial crisis” and said GSE reform can only happen through legislation.
Non-Political Appointee as Head of FSOC
Corker asked Lew if it would be better to have someone who was not a political appointee as head of the FSOC. Lew replied, “I think bringing somebody independent in to do it is not necessarily going to lead to a better, more cohesive result. Coordinating independent regulators is going to be a challenge for whoever chairs the commission because they each have an independent charter and they each have independent responsibility.”
Non-bank SIFIs
Sen. Elizabeth Warren (D-Mass.) pointed to AIG, Lehman Brothers, and Bear Stearns to argue that “a company does not need to be a bank to pose a serious threat to the financial system and to the economy.” She said this is why it is important that the FSOC maintain the authority to designate non-banks as systemically important and subject these firms to the Fed’s scrutiny. She asked Lew if he thinks the FSOC’s designation process “currently provides companies with the information and the opportunities they need to make changes in their business activities and potentially reverse the designation as systemically important.” Lew agreed and said several hundred pages of analysis are provided to show where the risk determination is made. He said these firms “know what it is that creates the basis for the designation.”
Sen. Bob Menendez (R-N.J.) asked how much discussion is permitted for companies to know which steps to take to avoid a designation. Lew responded that there is “enormous back-and-forth between the firms and FSOC” throughout the analytical process
Annual Review Process
Warren asked Lew if companies can “meet periodically with FSOC staff” and “appear before the full Council to discuss possible approaches to de-leveraging their risk.” Lew said appearances before the Council have occurred in the appeal stage, but there is “ongoing contact between the firms and the FSOC staff.” Warren then asked if the FSOC is willing to reverse the designation of a company if company no longer poses a risk to the financial system. Lew affirmed that the annual review process allows for a determination every year.
Sen. Tom Cotton (R-Ark.) asked Lew to explain the recourse firms have. Lew said the FSOC has only had the first annual review, but at the time of the designation, the firm may appeal to the Council itself or use the Administrative Procedures Act to appeal to a federal court. He stated that one appeal is pending.
Sen. Mark Warner (D-Va.) said certain firms have taken action to deleverage and asked Lew if firms can reverse their designation. Lew said, “It certainly is possible that they do that, yes.”
Designation of Risky Activities
Warren asked Lew if the FSOC would designate a specific portion or activity, rather than designating the entire firm as a SIFI. Lew said the review of asset managers is still underway and he is not sure that it would be the FSOC that would play a role or a regulatory agency action that would follow. He added that the FSOC has not yet designated an activity.
Cotton asked if the FSB’s decisions are binding on the United States. Lew said, “The Financial Stability Board is a deliberative body that — that sets goals that countries aspire to, but it doesn’t make policy for any of the constituent countries. Each has — each of us has our national authorities that make decisions for the companies that we are responsible for — for the economy that we’re in. So, we make at FSOC the decision to designate a firm. The FSB cannot designate a firm for us.” Cotton asked Lew to cite an example where the FSOC has deviated from the FSB’s statement in policy. Lew replied that he would have to look into it.
FSOC Request for Comment on Asset Management Activities & Systemic Risk
Cotton stated that the deadline for the public to comment was March 25, 2015 but that that the FSB has moved forward with a proposal that assumes that “SIFI designation of asset managers or funds is a virtual foregone conclusion.” He asked Lew to explain the FSB announcement and the relationship with the FSOC. Lew replied that there is not a foregone approach and that the FSOC’s approach to asset management has been “data-driven and analytically driven.”
Stage Two of the Designation Process
Sen. Dean Heller (R-Nev.) asked if the changes made at FSOC will now provide a financial institution under consideration access to all information before stage two of the designation process. Lew said, “It changed the process, not the substantive criteria.”
Economic Impact of Designations
Shelby asked Lew if the FSOC conducts any economic or cost-benefit analysis prior to making a decision. Lew said that the FSOC conducts “rigorous analysis and only designates firms if the risk determination is made.” Shelby asked why this information cannot be shared with the public. Lew said confidentiality is important in supervisory matters.
Panel Two
Witness Testimony
In his testimony, Paul Stevens, President of the Investment Company Institute (ICI), said the FSOC process must and should be understandable for the public. In his view, funds have exhibited extraordinary stability and the FSOC’s current designation process raises serious concerns because the FSOC ignores other tools and currently uses its designation authority too broadly. Stevens said designation authority was “supposed to be used in rare cases” and this “raises questions about [the FSOC’s] adherence to statutory construct.” He raised the following serious concerns: 1) the FSOC is ignoring range of tools and using designation authority broadly; 2) the FSOC has not explained the basis for decisions with any particularity; 3) instead of rigorous analysis, the FSOC’s SIFI designation is predicated on what others thought is implausible and contrived; 4) the designation process appears to be a result oriented exercise with predetermined outcome; and 5) the consequences of inappropriate designation would be quite severe.
With these concerns in mind, Stevens offered the following recommendations: 1) more work is required and recent changes should be codified in statute; 2) Congress should require the FSOC to require the primary regulator to address the downside risk before designation; and 3) Congress should look at the SEC in terms of enhanced supervision and oversight, not the Fed.
In his testimony, Douglas Holtz-Eakin, President of the American Action Forum, said the FSOC was created as a macroprudential regulator and that in assessing risk it would be useful for the FSOC to incorporate more information. Holtz-Eakin said it has to be possible for firms to have a “meaningful exit from designation as a SIFI.” He concluded that he is deeply concerned with the combination of the “ineffective FSOC and the use of the Fed as the primary regulator.” He described this as “dangerous,” and said the Fed does not have expertise and experience for this role.
In his testimony, Dennis Kelleher, President and Chief Executive Office of Better Markets Inc., said the possibility of bank failures in the recent financial crisis was a shock to the system but added that AIG was also rescued by the government. For these reasons, Kelleher said the FSOC was created because of issues with accountability to the American people. He argued that the FSOC is “doing enough” and “fast enough” to protect the American people. He said the FSOC must continue to focus on identifying, minimizing, and responding to threats.
In his testimony, Gary Hughes, Executives Vice President and General Counsel of the American Council of Life Insurers (ACLI) said that additional reforms are necessary to ensure that the designation process is fair. He suggested that the FSOC embrace a process with “appropriate metrics” and that companies should be given full access to the information in which the FSOC’s decision is based. He suggested the following institutional safeguards: 1) a company should have access to the entire record; 2) the FSOC should have separate staff assigned to enforcement and adjudicative functions; 3) special weight should be given to the views of the Council member with insurance expertise and to the primary financial regulatory agency for a company; 4) the explanation of a designation should provide greater insight into the basis for designation, and a designation should be based upon evidence and data; 5) A company should have more than 30 days to seek judicial review of a final decision in a federal court, and during judicial review, the company should not be subject to supervision by the Federal Reserve Board; 6) Companies should be able to petition for a review of a designation based upon a change in operations or regulations, and a company should be provided with an analysis of the factors that would permit it to be de-designated; 7) FSOC’s determinations should be independent of international regulatory actions. Hughes concluded that companies should be provided with the choice and ability to work constructively with the FSOC to structure their activities in such a way to avoid being designated as systemic.
Questions
Challenging FSOC
Shelby asked how companies challenge the FSOC’s conclusions. Hughes said the companies do not have enough information to challenge the conclusions.
Heightened Scrutiny
Brown asked Kelleher to explain the role of the FSOC in ensuring a strong standard for designation. Kelleher replied that companies receive a 400-page document detailing the regulation from the Fed. He argued that the criticism of the FSOC is unprecedented and the FSOC has been through an “elaborate process to bring critics in and change the process.”
Non-Bank SIFI
Warren asked if Kelleher believes large insurance companies pose systemic risk to the financial system. Kelleher replied that “there is no question.”
Cost-Benefit Analysis
Warren asked Kelleher if he thinks cost-benefit analysis is a “workable approach” with the FSOC designation process. Kelleher said it would be inappropriate to quantify this on a case by case basis.
Brown asked if the cost to society during the financial crisis could have been calculated. Holtz-Eakin replied that it can be calculated and that an economic analysis would show limited access to credit.
Fewer Designations
Shelby asked why the Administration would oppose a way to have fewer firms designated. Stevens replied that under the statute, he believes it is possible to have less supervision from the Fed. Kelleher said companies know what risks they have and they can de-risk, but to put the FSOC in a place of helping companies de-risk would be a dramatic change. Hughes said that if companies can further de-risk, then why the FSOC would not work with these institutions is unclear.
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Senate Committee on Banking, Housing, & Urban Affairs
“FSOC Accountability: Nonbank Designations”
Wednesday, March 26, 2015
Key Topics & Takeaways
- FSB & FSOC: Sen. Tom Cotton (R-Ark.) asked if the FSB’s decisions are binding on the United States. Lew said the FSOC makes the decision to designate a firm and the “FSB cannot designate a firm for us.”
- Stage Two of the Designation Process: Sen. Dean Heller (R-Nev.) asked if the changes made at FSOC will now provide a financial institution under consideration access to all information before stage two of the designation process. Lew said, “It changed the process, not the substantive criteria.”
- Designation of Risky Activities: Warren asked Lew if the FSOC would designate a specific portion or activity, rather than designating the entire firm as a SIFI. Lew said the review of asset managers is still underway and he is also not sure if it would be the FSOC that would play a role or a regulatory agency action that would follow. He added that the FSOC has not yet designated an activity.
- Structure Activities to Avoid Designation: Gary Hughes, Executive Vice President and General Counsel at the American Council of Life Insurers, argued that companies should be provided with the choice and ability to work constructively with the FSOC to structure their activities in such a way to avoid being designated as systemic.
Witness
- The Honorable Jacob J. Lew, Secretary, United States Department of the Treasury
- Douglas Holtz-Eakin, President, American Action Forum
- Gary Hughes, Executive Vice President and General Counsel, American Council of Life Insurers
- Dennis M. Kelleher, President and Chief Executive Officer, Better Markets, Inc.
- Mr. Paul Schott Stevens, President, Investment Company Institute
Opening Remarks
In his opening statement, Chairman Richard Shelby (R-Ala.) said this hearing would examine how the Financial Stability Oversight Council (FSOC) designates systemically important financial institutions (SIFIs). He added that there is “no precedent on a regulatory regime for a council like this” and the “FSOC has the authority to designate a nonbank institution” while the Federal Reserve regulates “enhanced prudential standards that do not come at a cost to our economy.”
With this responsibility, Shelby said “much rests on designation” and the FSOC has a “heightened duty to be as transparent and judicious as possible.” He added that U.S. regulators should be “free of international bodies” and that it is important to remember that the Financial Stability Board (FSB) monitors and makes recommendations, but is not a U.S. regulator. Shelby explained that three of the ten voting members on the FSOC first engaged at the FSB level, and had “already made up their minds” when they decided to designate firms at the FSOC level. Due to these concerns, Shelby said it is important to question the influence of the FSB on the FSOC.
Shelby next said that most critics do not believe that concerns about the FSOC’s transparency have sufficiently been raised and suggested that the following questions be asked of the FSOC: 1) Does the FSOC clearly disclose what factors make a firm systemically important?; 2) Is it clear what needs to occur to reduce the systemic risk of a company?; 3) Is the designation process sufficiently open, objective, and free of data influence from outside organization?
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) argued that over time, the Fed has become more accountable to the public and the “Fed’s operations are the most transparent they have ever been in its history.” He recommended that the Senate Banking Committee consider whether the Fed’s current governance “appropriately holds the regulators accountable and encourages diverse perspectives.” Brown said that perhaps the chair of the Federal Reserve Board should not be appointed by the president in order to ensure independence from leaders and accountability to the American people. He recognized that some, but not all, reforms would require legislation. He added that he also thinks the FSOC’s work has been too slow, and perhaps should have designated more than four firms in the past five years.
Panel One – Secretary Jacob Lew
In his testimony, Jacob Lew, Secretary of the United States Department of Treasury, emphasized that the crisis caused enormous hardships for the American people and “shortcomings in the regulatory framework were revealed.” Lew said the “regulatory structure was ill-equipped” with “limited tools for regulators to protect against failure and collapse of the financial system.” He said that is why the Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act “put in place critical new consumer protections and put into law that the taxpayers must never again be put at risk for the failure of a financial institution.” Under the Dodd-Frank Act, Lew explained that the FSOC was also created to bring together the entire financial regulatory body to work collaboratively, but this “work has not been easy.”
Next, Lew said the FSOC has made several improvements to its transparency, adopting a “data driven and deliberative approach,” publishing four annual reports, holding “regular public meetings,” and publishing minutes. However, he acknowledged that the FSOC is a “young organization that should be open to changes in its procedures.” He continued that the FSOC has completed the following: 1) enhanced transparency policy; 2) strengthened internal governance; 3) solicited public comment on asset managers; and 4) adopted refinements to non-bank financial company designation process. Last month, Lew said, the FSOC adopted supplemental procedures to allow companies to “know early in the process where they stand” and “will provide companies with a clearer and more robust review process.” In his view, companies have ample opportunity to discuss any issue.
He concluded that the financial system is more robust and resilient than it was before the crisis, which he believes is the truest test of reform.
Questions
Factors for SIFI Designation
Shelby asked Lew what the FSOC is doing to provide both the public and the designated companies with a better understanding of the relative weight of each factor, and what makes a designation more likely. Lew responded that “the relative weight of factors will be different depending on what the composition of a firm and the nature of the risk is. In each case, we apply the same review, which is a deliberative review.”
Sen. Jon Tester (D-Mont.) asked if the designated companies know why they were designated. Lew replied that these firms have “engaged in lots of back and forth at a staff level” and added that there is a “several-hundred-page analysis that describes where the risk is in the transmission mechanisms or the basis for the determination.”
FSOC Designation & Supervisory Role of the Fed
Shelby asked Lew how the FSOC can designate a company if the Fed is yet to promulgate rules to regulate such companies. Lew replied that the FSOC determines whether or not there is systemic risk and the Fed has the supervisory role. He continued, “So I think that the process is moving sequentially, and as the firms have to comply, that process will unfold in an orderly way. But it’s the Fed’s responsibility going forward.”
Shelby pressed Lew and asked how the FSOC can determine that it is reducing systemic risk when it has neither identified the specific activities that create systemic risk nor does it have the knowledge of what regulatory steps would be taken to mitigate such risk. Lew responded, “The task of going through the analysis to determine whether there is a systemic risk is the responsibility of FSOC. By designating the firm, the firm then is subject to supervision under the statute by the Fed.” Shelby asked if this process has occurred. Lew said the Fed is currently working through the process and no firm has been both designated and gone through the documentation process with the Fed.
SIFI Designation Threshold
Brown noted the Senate Banking Committee has talked about the $50 billion threshold for the Fed’s enhanced prudential standards for bank holding companies. He asked Lew what feedback he has received from industry and if agencies can tailor these regulations to address these concerns. Lew said, “Senator, I believe that the law was written with a great deal of flexibility and it’s been implemented with a great deal of flexibility. It is not a one-size-fits-all approach. I think that $200 million financial institutions are different than $50 billion institutions, which are different from $2 trillion institutions.” He added that he believes it is “premature to legislate in this area” because he thinks regulatory flexibility exists.
GSEs & Systemic Importance
Sen. Bob Corker (R-Tenn.) asked Lew if he considers Freddie Mac and Fannie Mae, the government-sponsored enterprises (GSEs), to be systemically important. Lew acknowledged that “the GSEs were at the heart of the last financial crisis” and said GSE reform can only happen through legislation.
Non-Political Appointee as Head of FSOC
Corker asked Lew if it would be better to have someone who was not a political appointee as head of the FSOC. Lew replied, “I think bringing somebody independent in to do it is not necessarily going to lead to a better, more cohesive result. Coordinating independent regulators is going to be a challenge for whoever chairs the commission because they each have an independent charter and they each have independent responsibility.”
Non-bank SIFIs
Sen. Elizabeth Warren (D-Mass.) pointed to AIG, Lehman Brothers, and Bear Stearns to argue that “a company does not need to be a bank to pose a serious threat to the financial system and to the economy.” She said this is why it is important that the FSOC maintain the authority to designate non-banks as systemically important and subject these firms to the Fed’s scrutiny. She asked Lew if he thinks the FSOC’s designation process “currently provides companies with the information and the opportunities they need to make changes in their business activities and potentially reverse the designation as systemically important.” Lew agreed and said several hundred pages of analysis are provided to show where the risk determination is made. He said these firms “know what it is that creates the basis for the designation.”
Sen. Bob Menendez (R-N.J.) asked how much discussion is permitted for companies to know which steps to take to avoid a designation. Lew responded that there is “enormous back-and-forth between the firms and FSOC” throughout the analytical process
Annual Review Process
Warren asked Lew if companies can “meet periodically with FSOC staff” and “appear before the full Council to discuss possible approaches to de-leveraging their risk.” Lew said appearances before the Council have occurred in the appeal stage, but there is “ongoing contact between the firms and the FSOC staff.” Warren then asked if the FSOC is willing to reverse the designation of a company if company no longer poses a risk to the financial system. Lew affirmed that the annual review process allows for a determination every year.
Sen. Tom Cotton (R-Ark.) asked Lew to explain the recourse firms have. Lew said the FSOC has only had the first annual review, but at the time of the designation, the firm may appeal to the Council itself or use the Administrative Procedures Act to appeal to a federal court. He stated that one appeal is pending.
Sen. Mark Warner (D-Va.) said certain firms have taken action to deleverage and asked Lew if firms can reverse their designation. Lew said, “It certainly is possible that they do that, yes.”
Designation of Risky Activities
Warren asked Lew if the FSOC would designate a specific portion or activity, rather than designating the entire firm as a SIFI. Lew said the review of asset managers is still underway and he is not sure that it would be the FSOC that would play a role or a regulatory agency action that would follow. He added that the FSOC has not yet designated an activity.
Cotton asked if the FSB’s decisions are binding on the United States. Lew said, “The Financial Stability Board is a deliberative body that — that sets goals that countries aspire to, but it doesn’t make policy for any of the constituent countries. Each has — each of us has our national authorities that make decisions for the companies that we are responsible for — for the economy that we’re in. So, we make at FSOC the decision to designate a firm. The FSB cannot designate a firm for us.” Cotton asked Lew to cite an example where the FSOC has deviated from the FSB’s statement in policy. Lew replied that he would have to look into it.
FSOC Request for Comment on Asset Management Activities & Systemic Risk
Cotton stated that the deadline for the public to comment was March 25, 2015 but that that the FSB has moved forward with a proposal that assumes that “SIFI designation of asset managers or funds is a virtual foregone conclusion.” He asked Lew to explain the FSB announcement and the relationship with the FSOC. Lew replied that there is not a foregone approach and that the FSOC’s approach to asset management has been “data-driven and analytically driven.”
Stage Two of the Designation Process
Sen. Dean Heller (R-Nev.) asked if the changes made at FSOC will now provide a financial institution under consideration access to all information before stage two of the designation process. Lew said, “It changed the process, not the substantive criteria.”
Economic Impact of Designations
Shelby asked Lew if the FSOC conducts any economic or cost-benefit analysis prior to making a decision. Lew said that the FSOC conducts “rigorous analysis and only designates firms if the risk determination is made.” Shelby asked why this information cannot be shared with the public. Lew said confidentiality is important in supervisory matters.
Panel Two
Witness Testimony
In his testimony, Paul Stevens, President of the Investment Company Institute (ICI), said the FSOC process must and should be understandable for the public. In his view, funds have exhibited extraordinary stability and the FSOC’s current designation process raises serious concerns because the FSOC ignores other tools and currently uses its designation authority too broadly. Stevens said designation authority was “supposed to be used in rare cases” and this “raises questions about [the FSOC’s] adherence to statutory construct.” He raised the following serious concerns: 1) the FSOC is ignoring range of tools and using designation authority broadly; 2) the FSOC has not explained the basis for decisions with any particularity; 3) instead of rigorous analysis, the FSOC’s SIFI designation is predicated on what others thought is implausible and contrived; 4) the designation process appears to be a result oriented exercise with predetermined outcome; and 5) the consequences of inappropriate designation would be quite severe.
With these concerns in mind, Stevens offered the following recommendations: 1) more work is required and recent changes should be codified in statute; 2) Congress should require the FSOC to require the primary regulator to address the downside risk before designation; and 3) Congress should look at the SEC in terms of enhanced supervision and oversight, not the Fed.
In his testimony, Douglas Holtz-Eakin, President of the American Action Forum, said the FSOC was created as a macroprudential regulator and that in assessing risk it would be useful for the FSOC to incorporate more information. Holtz-Eakin said it has to be possible for firms to have a “meaningful exit from designation as a SIFI.” He concluded that he is deeply concerned with the combination of the “ineffective FSOC and the use of the Fed as the primary regulator.” He described this as “dangerous,” and said the Fed does not have expertise and experience for this role.
In his testimony, Dennis Kelleher, President and Chief Executive Office of Better Markets Inc., said the possibility of bank failures in the recent financial crisis was a shock to the system but added that AIG was also rescued by the government. For these reasons, Kelleher said the FSOC was created because of issues with accountability to the American people. He argued that the FSOC is “doing enough” and “fast enough” to protect the American people. He said the FSOC must continue to focus on identifying, minimizing, and responding to threats.
In his testimony, Gary Hughes, Executives Vice President and General Counsel of the American Council of Life Insurers (ACLI) said that additional reforms are necessary to ensure that the designation process is fair. He suggested that the FSOC embrace a process with “appropriate metrics” and that companies should be given full access to the information in which the FSOC’s decision is based. He suggested the following institutional safeguards: 1) a company should have access to the entire record; 2) the FSOC should have separate staff assigned to enforcement and adjudicative functions; 3) special weight should be given to the views of the Council member with insurance expertise and to the primary financial regulatory agency for a company; 4) the explanation of a designation should provide greater insight into the basis for designation, and a designation should be based upon evidence and data; 5) A company should have more than 30 days to seek judicial review of a final decision in a federal court, and during judicial review, the company should not be subject to supervision by the Federal Reserve Board; 6) Companies should be able to petition for a review of a designation based upon a change in operations or regulations, and a company should be provided with an analysis of the factors that would permit it to be de-designated; 7) FSOC’s determinations should be independent of international regulatory actions. Hughes concluded that companies should be provided with the choice and ability to work constructively with the FSOC to structure their activities in such a way to avoid being designated as systemic.
Questions
Challenging FSOC
Shelby asked how companies challenge the FSOC’s conclusions. Hughes said the companies do not have enough information to challenge the conclusions.
Heightened Scrutiny
Brown asked Kelleher to explain the role of the FSOC in ensuring a strong standard for designation. Kelleher replied that companies receive a 400-page document detailing the regulation from the Fed. He argued that the criticism of the FSOC is unprecedented and the FSOC has been through an “elaborate process to bring critics in and change the process.”
Non-Bank SIFI
Warren asked if Kelleher believes large insurance companies pose systemic risk to the financial system. Kelleher replied that “there is no question.”
Cost-Benefit Analysis
Warren asked Kelleher if he thinks cost-benefit analysis is a “workable approach” with the FSOC designation process. Kelleher said it would be inappropriate to quantify this on a case by case basis.
Brown asked if the cost to society during the financial crisis could have been calculated. Holtz-Eakin replied that it can be calculated and that an economic analysis would show limited access to credit.
Fewer Designations
Shelby asked why the Administration would oppose a way to have fewer firms designated. Stevens replied that under the statute, he believes it is possible to have less supervision from the Fed. Kelleher said companies know what risks they have and they can de-risk, but to put the FSOC in a place of helping companies de-risk would be a dramatic change. Hughes said that if companies can further de-risk, then why the FSOC would not work with these institutions is unclear.
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