New Year Gives FSOC More Chances to Flex Muscle

WASHINGTON — The Financial Stability Oversight Council may finally be exerting some power.

Granted a broad mandate in the 2010 Dodd-Frank Act to lessen systemic risk, the interagency council — headed by Treasury Secretary Timothy Geithner — tapped some of its authority for the first time late last year when it revealed interest in trying to reform the $2.9 trillion money market mutual fund industry. If the council, which focused on the money market sector only after the Securities and Exchange Commission tabled a reform plan, can succeed in spurring regulation of the funds, it would demonstrate a real intent by the multi-regulator body to push a reform agenda when single agencies cannot on their own.

"It's absolutely the first time the FSOC is trying to act in that manner and I think we're testing out the infrastructure, the pipes," Mary Miller, Treasury undersecretary for domestic finance, said in an interview. "We're running the plays that were anticipated in the legislation, and inevitably while you're doing that you're learning things while you're doing it. If this is a successful endeavor in advancing money market reform, then I think it does speak well of the FSOC's ability to provide support for an agency to move forward."

The FSOC's decision to weigh in about money market funds, and release three recommendations for addressing their perceived structural weaknesses, was unprecedented and one the individual regulators on the council did not take lightly.

While the council has repeatedly stressed it would prefer that a singular regulator like the SEC handle the job, FSOC's intervention is consistent with Dodd-Frank's charge that the council ensure systemic events do not cripple financial markets. Regulators have held persistent concerns that the funds are vulnerable to the types of liquidity runs seen during the financial crisis.

"I think being able to bring forces to bear on an issue that's important and try to advance rulemaking is a good thing for the FSOC to do," said Miller.

The FSOC's recommendations build on earlier work done by the SEC. Under the proposed plan, funds could be required to float their net asset values, which is an idea opposed by many in the industry. Alternatively, the funds could be required to hold a capital buffer in order to absorb losses, as well as face restrictions on how much investors can redeem at one time. A third alternative would require a fund to keep a buffer of 3% to help absorb losses and potentially use other measures to increase its resiliency.

Stakeholders have until Jan. 18 to comment on the proposal, after which the FSOC will submit its final recommendation to the SEC. The latter agency then has 90 days either to consent to the recommendation, or suggest its own suitable alternative. The SEC may also explain in writing why it will not follow the guidance of the council. If the SEC proceeds with its own separate rule writing process, the council will suspend its undertaking and not issue any further findings.

But whatever the outcome on regulating the money market funds, observers say the FSOC's recent efforts demonstrate its ability to take a greater leadership role in other areas. Yet it is still unclear exactly what that future role will be. Some said it is a question mark where the council will focus after it completes its main assignment under Dodd-Frank: designating big nonbanks firms for special systemic-risk supervision. The council has already designated eight financial market utilities as systemically important and expects to complete the final stage of identifying other companies early this year.

"As they go forward now, I think they'll be less fulfilling the clear statutory mandate and thinking more about the issues and thinking more about ways they will want to proceed," said Satish Kini, who co-chairs the banking group at Debevoise & Plimpton LLP. "I think what we're coming to in 2013 is a pivot point where they're doing more than just designating nonbank firms and designating payment systems and thinking more about emerging threats and thinking about where they want to make a statement."

While the council has often been criticized for the scripted nature of its brief public meetings, behind closed doors principals have met a dozen times in the last year — well beyond the four annual meetings statutorily required under Dodd-Frank.

"What strikes me is no one ever misses a meeting," said Miller. "We have a lot of meetings. People want to be at these meetings, which is good. I think people come because they recognize that matters of importance are going to be discussed and they may be called upon to provide their views, so people generally come prepared to share."

Observers say that is a sign that officials sitting on the council believe in its usefulness.

"If you are meeting that much it suggests you are really gelling as a group," said Ernest Patrikis, a partner with White & Case LLP and former general counsel of the New York Federal Reserve. "This is a successor of the President's Working Group. Part of it was to get the principals in the room to talk and get the views on the table and that's just invaluable. When crisis time comes it just makes things easier."

To be sure, the frequency of FSOC meetings was also likely driven by events of the past year, such as the failure of MF Global Inc., JPMorgan Chase & Co.'s multibillion-dollar trading loss, the Libor scandal, and then finally Hurricane Sandy. (The council is comprised of 15 total regulators.)

In the case of Hurricane Sandy — which ripped through New York, New Jersey and Connecticut — regulators met twice during the week of the storm to discuss the impact on the financial system. Each respective FSOC agency raised its particular concerns. For state banking regulators, it was the availability of cash and the ability of their banking networks to work across state lines. The SEC was concerned about reopening stock exchanges. The Commodity Futures Trading Commission focused on overnight liquidity and effects on the derivatives markets in Chicago, and the Federal Housing Finance Agency discussed foreclosure relief to homeowners affected by the storm.

"This was a great example of how this organization can work," Miller said. "We have a natural disaster hitting the largest financial center and you're not going through your rolodex to figure out who to call. It's already built, it's already in place."

Miller said the council's work has also been a priority for Geithner.

"This secretary has been very interested in building the institution, getting the machinery working, getting people regularly together and involved," she said.

Still, some observers are skeptical that the FSOC, which following Dodd-Frank's enactment seemed agonizingly slow at getting off the ground, is doing its job as a systemic regulator and eliminating the perception that some banks are too big to fail.

"You don't hear a lot of chatter about what FSOC is doing that would give anybody more confidence that we are less systemically at risk than we were before," said Cornelius Hurley, director of the Boston University Center for Finance, Law & Policy. "Dodd-Frank says the FSOC should be eliminating this perception. If you take a macro view of the whole situation there's an even greater perception that the system is at risk of a half-dozen institutions failing one at a time. By that yard stick you would have to give them a low grade."

A key factor in what guides the FSOC's future work is who will succeed Geithner, who is widely expected to step down early in 2013.

"A large part of it will depend on the new Treasury secretary and what type of agenda or perspective that person brings," said Kini. "It probably will be also reactive to the crises that emerge. One of the questions will be to what extent the FSOC is going to be largely reactive or will it be a more proactive body. That remains to be seen. It's not clear what exactly they have in store for 2013."