The Financial Stability Oversight Council (FSOC) will meet Monday, April 20 in closed session. The preliminary agenda includes only a discussion of FSOC’s 2015 annual report, which highlights emerging risks to the financial system and is expected to be released in late April or early May (the 2014 annual report was released May 7). Given the recent statement by General Electric (GE) that it plans to sell or divest the majority of assets held in its GE Capital subsidiary, FSOC may also discuss its de-designation process.
Here’s what we’ll be watching for:
What will be emphasized in FSOC’s 2015 annual report?
The preliminary agenda’s only item is a discussion of FSOC’s next annual report, which the council uses to assess changes to the macroeconomic environment, financial developments and emerging threats to financial stability, and to make recommendations for reform. The annual report helps FSOC understand its priorities for the upcoming year. In particular, the report’s recommendations highlight the areas FSOC believes warrant the most significant attention to protect financial stability. Last year’s report, for example, made several recommendations to address cybersecurity risks and flagged leveraged lending as a possible emerging threat. Both topics subsequently received significant attention from various financial regulators and FSOC members. The report also assesses progress on previous recommendations the council has made. Will the 2015 annual report continue the focus on these topics? How will the report assess the actions taken by FSOC members on leveraged lending, cybersecurity and the other areas of emphasis in the 2014 annual report?
The report also plays an important role in promoting regulatory coordination as it requires that FSOC’s member agencies agree on a common set of threats to the financial system. Given that FSOC typically meets monthly, the council may give final approval to the report at this meeting. We will be watching to get a sense of what FSOC believes are the major developments and emerging threats to financial stability in 2015, and any recommendations to address them.
Although it is not on the preliminary agenda, the council may also address the recent General Electric news at Monday’s meeting. It will be the first time that all of the principals will meet since GE’s April 10 announcement that it will divest itself of most of GE Capital’s assets by 2018 and also apply for “de-designation” as a systemically important financial institution (SIFI) in 2016.1 As we wrote in response, GE’s decision “is a seminal test for whether [FSOC] can implement the Dodd-Frank Act as Congress intended. FSOC, which designated GE Capital as one of the first systemically important financial institutions, or SIFIs, will for the first time be faced with deciding whether a firm that drastically changes its business model can shed its SIFI status.”
FSOC has a de-designation process in place, but has said little publicly about how it works. In November 2014, FSOC conducted a series of outreach meetings, including with the Bipartisan Policy Center (BPC), on ways to improve its designation and de-designation processes. In February, the council clarified the process to some degree with a few amendments to the de-designation process, including allowing SIFIs to meet with designation committee staff during the re-evaluation process, allowing an oral hearing before the council once every five years and saying FSOC will provide greater detail of its reasoning if it decides not to de-designate a SIFI.2 Among the important questions, we would like to see the FSOC publicly address:
How much of the de-designation process will focus on principles that apply generally to any SIFI versus those that apply case-by-case to each individual SIFI?
The designation process makes use of both. Does the de-designation process use the same criteria so that it mirrors the designation process?
Who will be in charge of administering the annual reviews?
FSOC has a staff team, the Nonbank Designations Committee, which assesses and makes recommendations on whether to designate specific institutions as SIFIs. A de-designation process handled by the same staff has the advantage of a deep understanding of systemic concerns posed by an institution with the SIFI label. On the other hand, such a team may have a vested interest in the original analysis and recommendation, which could argue for a “fresh set of eyes” for the de-designation process.
What will be the role of the Federal Reserve, which is now the primary federal regulator of SIFIs?
The regulatory landscape for a company designated as a SIFI will by definition be different than before as a result of the Federal Reserve acquiring oversight. The point of designation is to guarantee federal oversight for systemically important nonbank financial institutions. The Federal Reserve provides firsthand data and insight into SIFIs that was not otherwise available prior to designation. The de-designation process may need to assign a role for the Federal Reserve that is different from the designation process. We will be watching to see if that happens and, if so, what that role is.
Ultimately, what does a SIFI need to do to be de-designated?
Dodd-Frank clearly envisions that when a SIFI no longer meets the criteria necessary for designation it will be de-designated. What that means in practice is unclear. FSOC may designate a nonbank financial company under two criteria: if “material distress at, … or the nature, scope, size, scale, concentration, interconnectedness, or mix of activities at the nonbank financial company, could pose a threat to the financial stability of the United States.”3 A de-designation could be thought of as a re-evaluation of the original designation and FSOC asking itself whether it would still have designated the company using the same designation criterion and reasons under different circumstances. On the other hand, the de-designation process could also be open to using a different criterion and justifications than the initial designation process.
One important consideration is that the voting system works differently in reverse.
During the designation process, 7 of FSOC’s 10 voting members, including the Treasury Secretary, must agree that a nonbank meets the criteria for it to be designated as a SIFI.4 The same rule applies for de-designation, in that to be de-designated 7 out of 10 FSOC voting members, including the Treasury Secretary must vote affirmatively for de-designation. That means, however, that only 4 of FSOC’s 10 members must agree that the company is still systemically important for it to remain a SIFI. In effect, a smaller number of FSOC members can block de-designation than is required to designate.
1 McGrane, Victoria. “GE Looks to Check Out of ‘Hotel California’ of Added Federal Oversight.” The Wall Street Journal, April 10, 2015. http://blogs.wsj.com/moneybeat/2015/04/10/ge-looks-to-check-out-of-hotel-california-of-added-federal-oversight/.
2 United States. U.S. Department of the Treasury. Financial Stability Oversight Council. Financial Stability Oversight Council Supplemental Procedures Relating to Nonbank Financial Company Determinations. February 4, 2015. http://www.treasury.gov/initiatives/fsoc/designations/Documents/Supplemental%20Procedures%20Related%20to%20Nonbank%20Financial%20Company%20Determinations%20-%20February%202015.pdf.
3 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 111th Cong., Section 113 (a) (1) (A). http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf.
4 United States. U.S. Department of the Treasury. Financial Stability Oversight Council. Financial Stability Oversight Council Supplemental Procedures Relating to Nonbank Financial Company Determinations. February 4, 2015. http://www.treasury.gov/initiatives/fsoc/designations/Documents/Supplemental%20Procedures%20Related%20to%20Nonbank%20Financial%20Company%20Determinations%20-%20February%202015.pdf. This assumes no recusals among FSOC members. Recusals may alter the number of voting members. The requirements are two-thirds.