NEW YORK (Thomson Reuters Regulatory Intelligence) - A recent decision by the Financial Stability Oversight Council to rescind the systemically important financial institution designation of insurer AIG(here) signals more than a change in perception of riskiness of that particular firm, but raises questions about the future of the council created under the 2010 Dodd-Frank Act.
Currently, only Prudential still remains a systemically important financial institution, or SIFI, out of the four non-bank institutions (AIG, Prudential, MetLife, and General Electric) that were initially designated as such by the intergovernmental council, also known as FSOC MetLife, having won a legal battle to remove its own SIFI designation in 2016 is currently entangled in a legal battle with the council over an appeals process.
Without a non-bank SIFI entity to oversee, the FSOC may soon become an ineffective regulatory body, devoid of one of its primary authorities, namely, to monitor and reduce systemic risk in the financial system.
“The council has worked diligently to thoroughly reevaluate whether AIG poses a risk to financial stability,” said Treasury Secretary Steven Mnuchin after FSOC decided to remove AIG’s SIFI designation. “This action demonstrates our commitment to act decisively to remove any designation if a company does not pose a threat to financial stability,” he added.
AIG’s collapse after becoming a major player in credit default swaps was a significant trigger of the 2008 financial crisis, and it received a $182 billion U.S. government bailout.
The FSOC decision means that AIG -- despite its gigantic size -- will, from now on, be primarily supervised by state insurance regulators.
And while AIG has reduced its systemic risk footprint by shrinking itself through numerous divestitures, and improving its capitalization since being designated as a SIFI, it remains a major, globally connected insurance company with total assets of half a trillion dollars.
The decision to remove AIG’s SIFI designation came amid political pressure.
The move is in line with President Donald Trump’s deregulatory policy. The president ordered a review of FSOC’s SIFI designation process in April 2017, essentially questioning the validity of its past decision-making mechanism on the matter.
It also follows a “de-sification” trend that started before Trump took office, when GE Capital successfully shed the label in June 2016. The company completely revamped its operations -- selling more than $200 billion in lending assets in the process, shifting to a more digital-oriented business model, and revising its funding.
However, while the council’s vote to rescind GE Capital’s SIFI designation was unanimous, its votes fell along more partisan lines in the case of AIG, with the exception of Federal Reserve Chair Janet Yellen, who sided with the five regulators recently appointed by the Trump Administration. As such, the council barely reached the minimum 6-3 vote, a two-thirds majority, required to remove a SIFI designation.
Critically, the FSOC representative for state insurance regulators, which provide primary regulation for the insurance industry, has only a non-voting seat on the council.
The basis of FSOC’s decision -- whether it was politically motivated or taken based on an objective evaluation of AIG’s risk profile -- may only become clear when the council decides on designating another non-bank entity as a SIFI in the future.
FSOC came into being in the wake of the financial crisis with the goal of identifying emerging risks in the financial system –and measuring their magnitude. It has the power to designate non-banks it deemed as systemically important, for stricter prudential oversight, addressing the moral hazard problem by eliminating expectations that the government will bail out a firm.
To date, the council, which comprises 10 voting members from regulatory entities together and is chaired by the U.S. Treasury Secretary, remains the only governmental entity with the power and duty to analyze and regulate systemically significant non-bank financial institutions.
In contrast to banks, where any entity with more than $50 billion assets under management automatically is deemed systemically important, non-banks are examined on a case-by-case basis.
The designation as a SIFI entails adherence to enhanced prudential standards, including stringent reporting standards, additional capital, detailed recovery and resolution plans, credit exposure limits, and liquidity stress tests.
The council has been criticized, most sharply in March, by Republican senators(here). They have said the council has shortcomings in metrics and analytical frameworks in evaluating firms for the SIFI designation, lacks transparency in the process, and has failed to provide a clear roadmap for designated SIFI firms to remove the label.
Insurance industry groups, which have been promoting an “activities-based approach” rather than “institution-based approach” to risk oversight, welcomed the decision.
“Designating a handful of insurance companies as SIFIs and subjecting them to bank-like federal regulations and capital requirement does nothing to reduce true systemic risk and instead drives up the cost of financial protection products and services,” said David A. Sampson, president and CEO of the Property Casualty Insurers Association of America (PCI) in a statement.
“The overwhelming consensus among insurance experts is that traditional insurance activities are not systemically risky,” he added.
If MetLife’s business decisions in the wake of its removal of SIFI designation serve as an indication, however, the FSOC decision may have unintended consequences of increasing systemic riskiness in the sector.
MetLife has followed an aggressive share-repurchase strategy since then, eventually intending to buy a total of $3 billion in stock.
AIG’s top brass did not wait for the official removal of the SIFI label to reveal its ambitions, when its CEO Brian Duperreault at the firm’s annual meeting in June hinted at company’s plans to expand through acquisitions.
(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 email@example.com)
This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Oct. 4. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters