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From Securities Regulation Daily, April 16, 2013

House Panel Presses Financial Regulators on Failure to Define Grave Threat to Financial Stability Under Sec. 121 of Dodd-Frank

By Jim Hamilton, J.D., LL.M.

A hearing by the Oversight Subcommittee of the House Financial Services Committee examining the authority that the Dodd-Frank Act confers on federal financial regulators to order financial institutions to divest assets or operations centered on the meaning of, and failure to as yet define, the term "grave threat to financial stability" in Section 121 of the Act. Subcommittee Chair Patrick McHenry (R-NC) said that the hearing is one of a series of hearings as Congress looks at the components of Dodd-Frank, focusing here on Section 121.

Section 121 requires the Federal Reserve Board, in certain circumstances, to impose limits on the activities of large financial companies to mitigate grave threats to the financial system of the United States. Subsection 121(a) directs the Federal Reserve to require a bank holding company with total consolidated assets of $50 billion or more or a nonbank financial company supervised by the Federal Reserve to undertake mitigating measures if the Federal Reserve determines that the company poses a grave threat to the financial stability of the United States. Before the Federal Reserve can require the covered company to undertake mitigating measures, two-thirds of the voting members of the Financial Stability Oversight Council (FSOC) must approve the Federal Reserve’s action.

Grave threat to financial stability. A main concern of the panel is the failure to define what constitutes a grave threat to the financial stability of the United States. Noting this failure, Chairman McHenry asked if the Fed will be putting together metrics for determining if a financial institution poses a grave threat. Rep. Dennis Ross (R-Fla) noted that there are no quantitative metrics for grave threat at this time. Thus, he concluded that it appears to be within the Fed’s discretion.

Rep. Al Green (D-Tex), the Subcommittee’s Ranking Member, said that Congress cannot codify what FSOC will do when presented with a grave threat, adding that it is difficult to have one metric to determine if a financial firm will be declared a grave threat to financial stability.

Scott Alvarez, Federal Reserve Board General Counsel, acknowledged that there are currently no quantitative metrics for determining what is a grave threat to financial stability. As directed by Dodd-Frank, the Fed must first consider, and is now considering, the mitigating factors, like high capital. No findings have been made on that so far. The Fed must complete the Dodd-Frank rulemaking. The Board has not asked the staff to define the term yet.

Rep. Ann Wagner (R-Mo) noted that the term grave threat seems open-ended. Mr. Alvarez does not see the term as open-ended in the sense that it has no meaning. The term grave threat must be considered within the context of the Dodd-Frank Act, he testified. It is a high standard, he added.

Rep. Sean Duffy (R-Wis) asked why grave threat is any more complicated a term to define than other terms in the Dodd-Frank Act. Mr. Alvarez replied that some things are complicated, yet easy to measure, such as capital. Grave threat is not easy to measure, he noted, and the Fed must carefully consider the grave threat standard. Rep. Duffy noted that lack of a clear standard can allow for situations that do not foster good governance, adding that until grave threat is defined, there is no certainty and stability.

More broadly, Mr. Alvarez added that the Fed is sharing information with FSOC, the SEC and CFTC, and other various members of FSOC as the Fed moves under Section 121, including consideration of the grave threat issue. FSOC will not be a rubber stamp, he emphasized, and it will make its own interpretations. FSOC also has its own independent source of information, the Office of Financial Research, he observed, and Council members such as the SEC and CFTC have windows into firms.

Foreign subsidiaries. Turning to Section 165(b) of the Dodd-Frank Act dealing with enhanced standards as applied to foreign financial firms with U.S. operations, Rep. Spencer Bachus (R-Ala), Chairman Emeritus of the full Financial Services Committee, expressed concern that there could be retaliation by foreign authorities against the operations of U.S. firms in non-U.S. jurisdictions if the U.S. operations of foreign firms are put at a competitive disadvantage in the United States. He noted that the statute directs the Fed to give due regard to the principle of national treatment and equality of competitive opportunity and also take into account the extent to which the foreign financial company is subject to home country standards comparable to those applied to U.S. financial companies. Mr. Alvarez assured the Chairman Emeritus that the Fed is in dialogue with foreign authorities, adding that this will be a balancing test.

Too big to fail. Rep. Denny Heck (D-Wash) asked the regulators to assure his constituents that taxpayer dollars will never again be used to bail out a large failing financial firm. James Wigand, FDIC Director of the Office of Complex Financial Institutions, said that Title II expressly prohibits taxpayer dollars to be used in winding down a financial firm under the orderly liquidation authority. Similarly, Mr. Alvarez noted that, under the Title II orderly liquidation authority, the shareholders and creditors take the losses, and no taxpayer dollars are used.

Mr. Alvarez does not look at Dodd-Frank as picking financial firms as too big to fail. The Dodd-Frank Act provides a mechanism for closing down a failed or failing financial institution no matter what its size. This is the orderly liquidation authority in Title II. There is also a mechanism for designating firms for enhanced regulation under Title I of the Act.

MainStory: TopStory DoddFrankAct

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