FSOC Finalizes Guidance on Designating Nonbanks for Regulation
Commentary by Steven Lofchie
The Financial Stability Oversight Council ("FSOC") finalized interpretive guidance and an analytical framework for designating nonbank financial companies for regulation.
In its final interpretive guidance, FSOC stated that it aimed to (i) provide a "durable process" for use of FSOC's nonbank financial company designation authority and (ii) maintain protections for nonbanks being reviewed for potential designation. FSOC said that it removed several "unwarranted hurdles" in its 2019 Interpretive Guidance. FSOC stated that the 2019 guidance allowed for the potential designation of a nonbank only after completing a multi-step process which FSOC said obstructed its ability to respond to risks to financial stability in a timely manner. FSOC said it also removed its cost-benefit analysis requirement, stating that such an analysis is not required by Congress and is not "reasonably estimable, useful, or warranted[.]" FSOC said that Congress also does not require FSOC to assess a nonbank's likelihood of material financial distress. FSOC said that such an assessment was removed from the final guidance due to the threat it poses to financial stability by "spurring a run on a company that is designated."
The guidance will become effective 60 days after publication in the Federal Register.
FSOC also adopted an analytic framework for "identifying, assessing, and responding to certain potential risks to U.S. financial stability." In the framework, FSOC included (i) a description of what would be considered a "threat to financial stability," (ii) a description of how vulnerabilities that contribute to risks to financial stability are assessed as well as types of quantitative metrics that may be considered in an analyses, (iii) an "expanded discussion" of transmission channels and associated vulnerabilities and (iv) "additional emphasis" on FSOC's work with state and federal regulatory agencies regarding potential risks and how existing regulations may mitigate those risks.
The framework will become effective upon publication in the Federal Register.
Statements
Treasury Secretary Janet L. Yellen said that under the final framework, FSOC "[f]or the first time, will provide a clear explanation of [how the FSOC] monitors, evaluates, and responds to potential risks to financial stability." She added that final guidance provides "strong procedural protections for companies under review" for potential designations.
SEC Chair Gary Gensler said that the final guidance is "important in reinvigorating [FSOC's] designation process in a manner consistent with Congress’s vision."
CFTC Chair Rostin Behnam called on FSOC to use its authority "with care, and with a clear awareness of its impacts." He argued that regulators must proceed in any initiation of a designation "with a surgical focus on thorough analyses and review of available data" in order to protect financial stability.
CFPB Director Rohit Chopra said that there were currently zero shadow banks that have been designated by FSOC as systemically important. He said that this has created the market perception that FSOC's authority to designate is a "dead letter." Mr. Chopra said that the new guidance should allow FSOC to evaluate whether any shadow bank meets the statutory threshold for enhanced oversight. He said that he "doubt[s] the answer is zero."
SIFMA Asset Management Group ("SIFMA AMG") expressed disappointment in the final guidance and analytical framework. SIFMA AMG said that the guidance is "entirely unnecessary for many nonbank financial companies" that are "already subject to stringent oversight by the SEC." SIFMA AMG added that many of these nonbanks have also shown "consistent resilience in times of economic stress."
Commentary
FSOC's largely unfettered authority to designate institutions for regulation is one of the worst provisions of Dodd-Frank. (See, FSOC Appeals MetLife SIFI Decision with commentary.)
If there are institutions that should be subject to additional regulation, FSOC should go to Congress and specify the activities and the scale of activities that require regulation and the parameters of that regulation. The notion that the regulators can simply use their judgement as to the types of entities that should be regulated is beyond troublesome. The last time FSOC attempted to designate an issuer as a "systemically important financial institution," the court, in reviewing FSOC's determination, found (i) "fundamental violations of established administrative law" and (ii) that FSOC's analysis "hardly adhered to any standard." (See, D.C. District Court Calls FSOC's Review of MetLife's Status "Fatally Flawed".) FSOC appears to be attempting to remedy its past violations of its own standards by largely eliminating the need for standards.