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From Banking and Finance Law Daily, June 24, 2014

FSOC’s actions and openness scrutinized by House committee,(Jun. 24, 2014)

By John M. Pachkowski, J.D.

The House Financial Services Committee held a hearing to receive the annual report of the Financial Stability Oversight Council (FSOC) and heard testimony from Treasury Secretary Jacob J. Lew. FSOC released its annual report in early May 2014 (see Banking and Finance Law Daily, May 8, 2014).

At the start of his opening statement, Committee Chairman Jeb Hensarling (R-Texas) said he “would be remiss if I did not bring up the continuing scandal at the Internal Revenue Service, an agency that is part of Treasury.” Hensarling noted that the IRS scandal made the American people “increasingly cynical and fearful of their government” and added, “[t]here is a growing resentment of one set of rules for Washington and another set of rules for everyone else.”

Openness and transparency. Hensarling continued that “It’s also past time for openness and transparency at FSOC, which you chair, Mr. Secretary. While you and other Administration officials habitually cite the purported dangers to financial stability posed by the ‘shadow banking system,’ you ignore those presented by the ‘shadow regulatory system’ of which FSOC is front and center.” He stressed that the “reason transparency and accountability are so important is because FSOC can designate practically any large financial firm in our nation as a Systemically Important Financial Institution, a SIFI, and thus render effective control over it. Thus, it has the ability to render great damage to our economy and set back the dreams of tens of millions of unemployed and underemployed Americans who are counting on their capital markets to work for them.”

To address these concerns, the chairman cited two recent bills reported out of the Financial Services Committee—H.R. 4387, the FSOC Transparency and Accountability Act and H.R. 4881, which would place a one-year moratorium on further designations of non-bank SIFIs (see Banking and Finance Law Daily, June 19, 2014).

Latest target. In her opening statement, Rep. Maxine Waters (D-Calif), the committee’s Ranking Member, was “surprised to see so many of my colleagues on the other side of the aisle with us today. Given that the FSOC has joined the ranks of the Consumer Financial Protection Bureau, the Export-Import Bank, and the Terrorism Risk Insurance Act in becoming the latest target in a relentless Republican effort to tear down important engines of job creation, economic growth and consumer protection, I didn’t think my colleagues on the other side of the aisle would have any interest in hearing about the Council’s progress or in your views of the financial stability of the U.S.” She added that the two committee-approved bills “would compromise the FSOC and erode the important role it plays. These partisan bills were nothing more than an effort to derail this cornerstone of the Dodd Frank Wall Street Reform Act.”

Questioning ≠ regulating. In his written testimony, Lew noted that “there are even some who challenge the notion that the Council should ask questions about whether certain activities or companies might pose risks to the stability of the U.S. financial system” and added “asking questions does not equal regulatory action.”

The Treasury also dispelled the notion that “the Council’s processes are opaque and its outcomes are predetermined,” calling it “simply wrong.” He cited the that the Council has “voluntarily adopted a robust transparency policy and put in place a comprehensive, deliberative approach to its evaluation of risks, and it solicits public input and carefully considers all points of view.”

Continued attention. The remainder of Lew’s testimony focused on nine areas that warrant continued attention and possibly further action from the Council’s members. The nine areas are:

  1. Regulatory agencies and market participants should continue to take action to reduce vulnerabilities in wholesale funding markets, including tri-party repo and money market mutual funds, that can lead to destabilizing fire sales.
  2. Regulators should continue to work with policymakers to implement the significant structural reforms that are needed to reduce the taxpayers’ exposure to risk in the housing market.
  3. Third, cybersecurity threats, infrastructure vulnerabilities, and other operational risks remain a top priority for the Council, and regulators should continue to take steps to prevent operational failures and improve resiliency.
  4. As the financial system evolves in response to technological, competitive, and regulatory changes, regulators should remain attentive to financial innovations and the migration of certain activities outside of traditional financial intermediaries that could create financial stability risks.
  5. U.S. regulators should continue to cooperate with foreign counterparts to address concerns about benchmark reference rates such as LIBOR.
  6. Regulators and institutions should remain vigilant in monitoring and assessing risks related to interest rate volatility, particularly as investors seek higher yields in a low interest rate environment.
  7. Council member agencies should continue to work with the Office of Financial Research (OFR) to fill financial data gaps and address related issues of data quality and comprehensiveness.
  8. Regulators should continue implementation of Dodd-Frank reforms to reduce risk-taking incentives of large, complex, interconnected financial institutions.
  9. Continued monitoring of adverse financial developments abroad and their potential impact on the U.S. financial system.

Opaque and unaccountable. In advance of the hearing, the U.S. Chamber of Commerce sent a letter to Hensarling and Waters stating that “many questions remain unanswered as the Council’s operations are opaque and unaccountable.” Regarding SIFI designations, the Chamber noted, “FSOC has not provided any guidance regarding the factors considered or the process for determining whether to move companies through the designation process. There is no guidance on how the FSOC determines that a particular metric has been triggered. As a result, companies do not have clear rules of the road to understand how they can mitigate risk-taking to avoid SIFI designation.” The letter also noted that enhanced prudential standards remain incomplete and that “potential designees, investors and the marketplace have no means to gauge the consequences of designation.” Finally, the Chamber letter observed that FSOC is underutilizing the many sources of data and expertise available to it citing the recent dissents from certain voting and nonvoting members of FSOC regarding the SIFI designation for Prudential Financial, Inc., as well as the release of a severely flawed asset management report by the OFR. Finally, the Chamber noted “more transparency is needed to also better understand how the domestic systemic risk process, will correlate with the global systemic risk process that is being constructed by the Financial Stability Board and other international entities.”

Companies: Prudential Financial, Inc.; U.S. Chamber of Commerce

MainStory: TopStory DoddFrankAct FinancialStability

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