The six-year-old Financial Stability Oversight Council (FSOC) for the first time rescinded a systemically important financial institution (SIFI) status this week when it essentially declared that GE Capital is no longer a threat to U.S. financial stability. This “de-designation” sets a precedent for firms seeking to shed their SIFI status in the future, but it would be a hard precedent for other SIFIs to emulate, as GE Capital’s path was to essentially break itself up.
It is also difficult to extrapolate from FSOC’s decision potential impact on the remaining SIFIs since the latter are very different companies from GE Capital, with different risk profiles, lines of business, and activities. So while the decision clarifies that de-designation can be a real outcome, it leaves open questions of what another kind of SIFI would need to do to achieve de-designation, and the overall impact that GE Capital’s designation has had on the financial system.
How did it get here?
Congress created FSOC’s designation authority in the Dodd-Frank Act to allow regulators to capture” nonbank financial firms that could threaten financial stability and subject them to regulation by the Federal Reserve Board (Fed). Between 2013 and 2015, FSOC used this authority to designate four firms as systemically important: AIG, GE Capital, Prudential, and MetLife.
MetLife sued to overturn its designation and in March 2016, a district court judge ruled in the company’s favor, leaving three SIFIs. In April 2015, GE Capital announced that it would pursue changes with an explicit goal of seeking de-designation.
The Fed, which had been developing rules to govern GE Capital as a SIFI, announced a final rule in July 2015 that took the company’s de-risking plan into account. The Fed noted GE Capital’s intention “to substantially shrink [its] systemic footprint” and its “announced timeline to accomplish this plan, progress made to date toward executing it, and GE’s stated intention to seek de-designation by FSOC.” This resulted in the Fed delaying the deadline for compliance with certain of GE Capital’s new requirements until January 1, 2018, which amounted to a kind of “suspended designation” to give the company time to make good on its plan.
FSOC’s reasoning for this week’s decision to de-designate was:
“Through a series of divestitures, a transformation of its funding model, and a corporate reorganization, the company has become a much less significant participants in financial markets and the economy. GE Capital has decreased its total assets by over 50 percent, shifted away from short-term funding, and reduced its interconnectedness with large financial institutions. Further, the company no longer owns any U.S. depository institutions and does not provide financing to consumers or small business customers in the United States.”
In further support of its decision, FSOC noted that GE Capital had reduced its reliance on short-term funding sources by 86 percent, its outstanding (short-term) commercial paper by 88 percent, and its portfolio of outstanding financing receivables by 74 percent; consolidated 54 direct lines of credit into a single one (with GE); limited its scale of activities in key funding markets; improved its liquidity; and substantially simplified its structure.
In short, GE Capital undertook a major restructuring, including divesting about $272 billion of its assets and all of its banking operations.
What does the decision mean for the de-designation process?
FSOC’s decision shows concretely that de-designation is possible for SIFIs. Dodd-Frank clearly intended for FSOC to de-designate when a SIFI no longer meets the criteria necessary for designation, something GE Capital achieved through its restructuring.
However, it is difficult to draw firm conclusions from a single instance, especially in the case of GE Capital, which does not have many close comparisons with other nonbank financial companies. The decision raises a number of questions that it will take time to answer, including:
- How much restructuring is required to achieve de-designation? GE Capital’s path to de-designation amounts to radical surgery. Would another firm need to pursue a similar strategy to rid itself of its SIFI tag, or would something less dramatic suffice? FSOC will judge each SIFI on a case-by-case basis since each have different risk profiles, so this is a difficult question to answer.
- Will FSOC treat insurance companies differently than GE Capital? Both of the remaining SIFIs, AIG and Prudential, are insurance companies, and FSOC hopes to win the government’s appeal of the ruling that removed MetLife’s SIFI status. Insurers have long been subject to state regulation but, for the most part, not to federal regulation until the passage of Dodd-Frank. Since then, about a quarter of the insurance industry has been subjected to the Fed’s jurisdiction. One of the reasons cited by FSOC for designating insurers as SIFIs is the lack of a federal insurance regulator, something that still does not exist. In addition, global regulators at the Financial Stability Board and the International Association of Insurance Supervisors have decided to designate nine globally active insurers, including AIG, Prudential, and MetLife, as global systemically important insurers, the equivalent of a global SIFI designation. These factors could make it more difficult for the insurance SIFIs to achieve de-designation.
- Was the financial system made safer as a result of GE Capital’s restructuring? To the extent that making the financial system safer is a primary goal of SIFI designation—and it should be—designation that results in de-risking should be considered a victory. It is likely that in the case of GE Capital, some de-risking was achieved, such as through a reduced reliance on short-term funding. In other cases, risky activities that GE Capital was engaged in may simply have been transferred to other market participants, some of whom may not be subject to federal regulation. Overall, though, designation seems to have achieved some success here.
We will continue to review these questions, but for the moment, FSOC’s decision represents a milestone in the new council’s role of overseeing the stability of the financial system.