Saturday, May 24, 2014

House Hearing Calls into Stark Relief Role of Financial Stability Board in FSOC SIFI Designation Process

At a hearing on the process that the Financial Stability Oversight Council (FSOC) uses to designate systemically important financial institutions (SIFIs), and against the backdrop of growing concern over the influence of the Financial Stability Board on FSOC SIFI designations, House Financial Services Committee Chair Jeb Hensarling (R-TX) said that FSOC should cease and desist making new SIFI designations until Congress comes to an understanding of how the designation   process works. He added that empowering FSOC to impose bank-like standards on non-bank financial firms has expanded the Fed’s remit throughout the  financial system.

With regard to the designation of asset management firms as SIFIs, Chairman Hensarling found it almost inconceivable that the failure of an asset manager could cause systemic risk since they manage other people’s money. The oversight Chair is also concerned that FSOC seems to taking its direction on SIFI designations from a secretive international body, the Financial Stability Board. The Chair is concerned that FSOC is following the lead of the Financial Stability Board in designating SIFIs.  He noted that neither the Fed nor the SEC has ever reported to Congress on its participation in the FSB, nor has Congress authorized such participation. This amounts to a shadow regulatory process, he averred.

Earlier, Chairman Hensarling, in a letter also signed by his five subcommittee Chairs, asked Treasury, Fed Chair Janet Yellen and SEC Chair Mary Jo White to explain to Congress the process FSOC uses to designate SIFIs and the role played by the Financial Stability Board, which has proposed methodologies for designating non-bank global SIFIs. 

The House Chairs are troubled that sweeping power in this area has been invested in the FSB, which is an unincorporated Swiss association with no authority under U.S. law or treaty. In their view, the FSB’s semi-official status as an offshoot of the G-20 makes it an inappropriate forum for decisions of this importance. Noting that the FSB is a complete black box, the House Chairs do not believe U.S. sovereignty should be surrendered on financial regulation to what the call an ``international old boy’s club’’ that deliberates in secret. 

At a recent FSOC conference on asset management firms, Mary Miller,  Treasury Under Secretary for Domestic Finance, while noting that the FSB and the Council have a shared objective of promoting financial stability, emphasized that the domestic and international processes are entirely independent. In its work, the Council adheres to the standard and considerations for designations that are listed in the Dodd-Frank Act and in the Council’s public guidance. She assured that FSOC is the only authority that can designate an entity for Federal Reserve Board supervision and enhanced prudential standards. Her remarks take on heightened importance in light of the recent letter from Chair Hensarling to Treasury and the Fed and SEC Chairs questioning the role of the FSB in the FSOC SIFI designation process. 

In his testimony before the Financial Services Committee, former Treasury official Michael Barr defended the FSB noting that global coordination is essential to making the financial system safe for the United States, as well as for the global economy. The United States has led the way on global reforms, including robust capital rules, regulation of derivatives, and effective resolution authorities. These global efforts, including designations by the FSB, are not binding on the United States. Rather, the FSOC, and U.S. regulators, make independent regulatory judgments about domestic implementation based on U.S. law. He also pointed out that the FSB has become more transparent over time, adopting notice and comment procedures, for example, but it could do more to put in the place the kind of protections that the FSOC has established domestically.

 There seemed to be a bi-partisan consensus on the Committee that FSOC is somewhat opaque and should have a more transparent designation process. Rep. Scott Garrett (R-NJ) said that public policy should not be made in  secret. Chairman Emeritus Spencer Bachus (R-AL) said that it is very important that the FSOC designation process be open and transparent. Rep. Stephen    Lynch (D-MA) urged FSOC to maximize transparency in its processes.

Rep. Randy N eugebauer (R-TX) said that FSOC’s SIFI designation process for non-bank financial firms is fatally flawed. He described it as a highly speculative process that uses worst case scenarios.

Rep. Carolyn Maloney (D-NY) noted that non-bank firms need  to be subjected to stricter standards if they pose systemic risks. But she added that this power  must be exercised with great care, especially for asset managers that don’t operate like banks. Ultimately, it is a balancing act between a fair designation process and preserving the ability of FSOC to mitigate systemic risk.

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