Lawmakers Fear Systemic Designation Is 'Hotel California'

WASHINGTON — A top official from the Financial Stability Oversight Council said regulators have clearly laid out a way for nonbanks to avoid or shed designation as a systemically risky institution, but members of the Senate Banking Committee suggested they have not gone far enough.

Lawmakers grilled Treasury Deputy Assistant Secretary Patrick Pinschmidt — the top staff member for FSOC — on changes to the council's nonbank SIFI designation process that were approved in February. Those changes were intended to mollify critics of the process, who argued that firms under consideration had little opportunity to contest their designation before it was effectively a foregone conclusion or to have its designation undone once it was already in place.

But Sen. Mike Crapo, R-Idaho, the chairman of the panels' securities subcommittee, said that the interagency council is still too opaque about what activities or assets it considers systemically risky. Without that kind of guidance, there is no concrete roadmap for companies to follow to avoid designation, he said.

"The February supplemental procedures appear to be a positive step toward increasing communication between FSOC staff and firms under review," Crapo said. "However … the process doesn't seem to provide clarity to the companies about which activities — together or separately — pose the greatest threat to financial stability."

Sen. Mark Warner, D-Va., the top Democrat on the panel, echoed Crapo's concerns, saying that lawmakers clearly intended for nonbanks to be able to shed their label as a systemically important financial institution if the firm's circumstances changed. To date, no firms have been de-designated, Warner said, leading to fears that a SIFI designation is like "Hotel California" — you can check out anytime you like, but you can never leave.

"I really urge that you be more collaborative with us, because there does still seem to be this transparency issue," Warner said. "We always envisioned that there would be this off-ramp. We need your help working though this, or I think you're going to end up seeing Congress … potentially take action."

Pinschmidt said that the February changes addressed many of the concerns that lawmakers were raising and pointed out that so far only four nonbanks — American International Group, Prudential, GE Capital and MetLife — have been designated at all, and the first of them only two years ago.

FSOC reviews each of its nonbank designations every year for the kinds of divestitures or other material changes the business may have made that could make it eligible for de-designation, Pinschmidt said, and if its SIFI label remains in place, it is given an explanation for why it will remain. But since the changes are so new, no firms have yet experienced that process or successfully shed designation.

"It's important to allow the supplemental process changes … to work through," Pinschmidt said. "We're just now beginning the first round of annual evaluations [since the passage of the changes]."

Pinschmidt added that there are various stages within the designation process where a firm can either present relevant information showing why they feel they or their activities are not systemically important, or show how they intend to change their business model to reduce their systemic risk after the fact.

"The council will consider any proposal from any company at any stage of the process," Pinschmidt said. "So while it's not formally in the current process for designation … that's not to preclude, down the road, a company presenting a proposal, a regulator presenting a proposal, and having them discuss that within the council."

But Warner said that the lack of formality in the process is a problem, because it depends on the goodwill and faithfulness of the administration rather than the law or established regulations. The changes made in February were in the form of guidance rather than a formal rulemaking process, and so can be disregarded by any future administration.

"I think [Treasury] Secretary [Jack] Lew has moved appropriately and aggressively to try and work through this, and I think the process has improved," Warner said. "But if it's all awash with this lack of clarity, a future secretary from either party could veer dramatically off the course that's been set."

The process of de-designation has been a cornerstone of debate around FSOC for some time. Designated firms are subject to additional prudential regulation by the Fed, though until recently it was unclear what exactly that regulatory burden would be. Wall Street hawks sought a clearer de-designation process because it could incentivize firms to downsize or adopt less risky business models, while the industry has sought greater clarity on how to avoid designation at all.

But the discussion has gone from a primarily academic exercise to one of practical importance since the beginning of the year. GE Capital announced in April that it intended to aggressively spin off most of its financial holdings in order to shed its SIFI designation — the first firm to do so. MetLife, meanwhile, has challenged its designation in court, arguing that FSOC acted arbitrarily in decision to designate the firm. And on Monday the Fed finalized its prudential rules for GE Capital, outlining a phased-in plan that would ultimately require the firm to meet the same prudential standards as a large bank holding company if it does not shed its designation by the beginning of 2018.