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From Banking and Finance Law Daily, November 21, 2014

Republican-requested GAO report could mean more nonbank SIFIs

By Richard A. Roth, J.D.

A Government Accountability Office report on the Financial Stability Oversight Council, prepared at the request of Senate Banking Committee Ranking Member Michael Crapo (R-Idaho), makes recommendations that could result in more nonbank companies being designated systemically important financial institutions that should be supervised by the Federal Reserve Board. While the report, Financial Stability Oversight Council—Further Actions Could Improve the Nonbank Designation Process, calls for changes that would enhance transparency and accountability at the FSOC, it also recommends that the FSOC consider more companies for designation.

The Dodd-Frank Act created the FSOC as a way of helping the financial system regulatory agencies spot emerging threats to financial stability. Among the council’s specific tasks are recommending heightened prudential standards for the largest and most interconnected financial companies—also known as systemically important financial institutions or SIFIs—and designating which nonbank companies qualify as SIFIs and thus should be supervised by the Fed.

The FSOC has drawn criticism on several fronts. According to some critics, the council is not sufficiently transparent. For example, Rep. Scott Garrett (R-NJ) has attempted unsuccessfully to attend the FSOC’s meetings. As a result, he has introduced a bill he says would make the council more open by, among other things, allowing members of Congress who sit on committees that oversee the FSOC to attend all of its meetings (see Banking and Finance Law Daily, April 4, 2014).

Other critics have attacked the basic idea that some financial companies, such as insurance companies and money market funds, ever should be considered to be SIFIs. These companies do not pose the type of systemic threat the FSOC was intended to address, the critics say.

GAO report. At Crapo’s request, the GAO looked into how and on what basis the FSOC analyzed the three nonbank companies that so far have been designated as SIFIs—American International Group Inc., General Electric Capital Corporation, Inc., and Prudential Financial, Inc. The GAO found both procedural and substantive deficiencies in what the council is doing, both when it designated those companies and as it considers others that remain under consideration.

Recordkeeping. The GAO’s first recommendation addresses changes the FSOC could make to enhance the transparency of its activities and its accountability. First, the GAO says, the council does not adequately track important dates and deadlines.

Moreover, the council is not keeping track of staff activities. According to the GAO, the FSOC relies on the other financial regulatory agencies to contribute staff members, on a voluntary basis, to carry out council activities. However, there are no adequate records of how many individuals have been seconded from each of those agencies or how much time they have spent on FSOC activities. As a result, “FSOC’s ability to effectively monitor the progress and evaluate the quality and efficiency of determination evaluations is limited,” the report said.

Information disclosure. The FSOC’s written determinations do not always provide the reasons for its decisions, the GAO also says. While a final decision on whether a nonbank firm is a SIFI will rely, in part, on confidential and proprietary information, the council also will consider a great deal of information that is publicly available. In fact, much of the information on which the council relies in the first two steps of its three-step evaluation process is publicly available.

However, the FSOC’s written determinations often have omitted much of this public information, the GAO points out. This has “resulted in questions about the process and may hinder accountability and public and market confidence in the process.”

Crapo’s response. Responding to the report, Crapo highlighted these findings. According to the senator, “GAO concluded that FSOC’s process lacks transparency and accountability, insufficiently tracks data and does not have a consistent methodology for determinations.” He described the nonbank SIFI designation process as “immeasurable and unclear” and called for the FSOC to cease further considerations until the problems have been addressed.

Further recommendations. The GAO did not, however, stop at considering issues of transparency. It also looked at how the FSOC decides which nonbank companies should be considered for designation. The report points out flaws that could be leading the FSOC to fail to designate some eligible nonbank companies as SIFIs.

First, the report again notes that the FSOC’s three-step process relies on publicly available information in step one. As a result, firms that do not report information publicly may never be considered. The GAO says it found at least two privately-owned companies that could fit the Dodd-Frank Act definition of nonbank financial company but were never included by the FSOC at even the first step of the process.

In other cases, a lack of information meant that council consideration was limited only to subsidiaries of parent companies that could themselves have been nonbank financial companies. These corporate parents might have been appropriate for consideration as nonbank financial companies, but they were not evaluated, the GAO says.

Second, the report criticizes the FSOC for applying only one of the Dodd-Frank Act’s two standards for what constitutes a nonbank SIFI. Under the act, a nonbank can be a SIFI if either material financial distress at the company or the company’s activities could pose a threat to U.S. financial stability. According to the GAO, the FSOC has applied the first standard, but never the second; that is, the council has focused only on the danger from financial distress at a company and never has considered whether the “nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company” could pose a systemic threat.

Because it is not applying both standards, “FSOC may not be able to ensure that it identifies and ultimately designates all nonbank financial companies that may pose a threat to U.S. financial stability,” the GAO report says. If the FSOC adopts and implements the GAO’s recommendations, it may need to consider more nonbank companies for the SIFI designation.

Companies: American International Group Inc.; General Electric Capital Corporation, Inc.; Prudential Financial, Inc.

MainStory: TopStory DoddFrankAct FinancialStability

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