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U.S. House Republican report slams federal council FSOC for 'inconsistent' SIFI designation process

NEW YORK (Thomson Reuters Regulatory Intelligence) - A report by the Republican staff of the powerful U.S. House of Representatives Committee on Financial Services found that the federal Financial Stability Oversight Council acts inconsistently and arbitrarily in exercising its power to designate certain non-bank companies as “too big to fail.”

U.S. Treasury Secretary Timothy Geithner (L) and Federal Reserve Chairman Ben Bernanke leave a ceremony to debut the new design for the US$100 note at the Department of the Treasury in Washington, April 21, 2010.

Based on documents requested by the committee in 2015, and testimony of Treasury Department officials, both obtained as the result of a Congressional subpoena, the report calls the federal interagency council’s analysis is inconsistent. It also accuses the council of failing to follow its own rules.

“Today’s FSOC designations are tomorrow’s taxpayer-funded bailouts. The FSOC typifies Washington’s shadow regulatory system of powerful government bureaucrats, secretive meetings, arbitrary rules and unchecked power to punish enemies and reward friends,” committee Chairman Jeb Hensarling said last year following a court decision rejecting the council’s designation of Metlife as a systemically important financial institution, or SIFI.

The staff report details the non-public analysis associated with FSOC’s processes to designate certain firms as SIFI’s, subject to greater regulatory oversight. It comes in the midst of the FSOC’s appeal of the federal district court decision on MetLife.

AN OPAQUE DESIGNATION PROCESS

In response to previous concerns that its designation process is arbitrary, FSOC has said its analysis is based on unspecified “industry-specific and company-specific factors.” The congressional report said FSOC took into account certain factors when designating one company while failing to consider identical factors in the designation of another company.

One instance where FSOC did not treat two companies the same was its evaluation of a company’s vulnerability to material financial distress.

For the four nonbank financial companies that the FSOC designated as systemically important financial institutions (SIFIs), the FSOC did not evaluate the vulnerability to material financial distress of those companies, the report found. The FSOC has said in court both that it is not required to evaluate the probability or likelihood of material financial distress at a nonbank financial company, and that the FSOC’s own guidance does not state it will do so.

The committee-obtained FSOC documents reveal that the FSOC evaluated the vulnerability of some companies to material financial distress – and then declined to designate those companies. The FSOC made multiple statements about the vulnerability to financial distress of some companies in their confidential evaluations such as “temporary market disruptions would be unlikely to threaten the imminent solvency” of a company, or for another company that its available liquidity resources “make it less likely for liquidity concerns and maturity mismatches to translate into a viable source of systemic risk.”

The FSOC’s documents did not explain this disparate treatment, nor was it explained to the court.

The report also said FSOC did not follow its own rules for the nonbank designation process. The FSOC says that it will “assess the impact of the nonbank financial company’s material financial distress in the context of a period of overall stress in the financial services industry and in a weak macroeconomic environment.”

But the documents in the staff report detail a number of companies where the conclusions reached by the FSOC were made based on a scenario of the company failing “in isolation,” as opposed to a scenario involving developments that cause distress at the firm and other firms simultaneously. These companies were not designated by the FSOC.

THE FUTURE OF FSOC IN DOUBT

Hensarling’s proposed Financial CHOICE Act intended to replace the Dodd-Frank regulatory overhaul – casts doubt onto FSOC’s future.

The proposal includes provisions to eliminate FSOC’s authority to designate certain firms as “too big to fail” and rescinds previous FSOC designations. In addition, the CHOICE Act would require the FSOC to operate with a more transparency and inclusiveness.

--U.S. House of Representatives Committee report: here

--Jeb Hensarling statement on Metlife as a designated SIFI: here

--Hensarling's proposed Financial CHOICE Act: here

(Bora Yagiz, FRM is a New York-based Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence, specializing in risk. He is a certified Financial Risk Manager. Mr. Yagiz has held positions as a bank examiner for the Federal Reserve Bank of New York, as senior consultant with Ernst & Young and vice president at Morgan Stanley. Follow Bora on Twitter @Bora_Yagiz. Email Bora at bora.yagiz@thomsonreuters.com)

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