As the last “systemically important” nonbank standing,
The decision marks a significant move away from a key purpose of the Dodd-Frank Act, which wanted to address the risks to financial stability posed by firms like American International Group and other nonbanks.
What happens next — if anything — is less clear.
Treasury official Craig Phillips hinted last month that the Financial Stability Oversight Council, a part of the Treasury Department, was
But for the time being, little is known about how this strategy will work going forward or how often it might be used.
Following are three big questions to consider in light of this shift:
Will FSOC actually do anything?
For critics, the concern remains that the activities-based approach will be nothing more than a slogan, at least under the current administration.
“I'm pretty skeptical we're going to see any kind of real movement that's actually significant in terms of activities-based regulation,” said Marcus Stanley, policy director of Americans for Financial Reform. “It’s a buzzword that you can use that sounds better than saying ‘we’ll do nothing.’”
Jeremy Kress, an assistant professor of business law at the University of Michigan, called the tactic a “smokescreen” Wednesday morning.
Now that we have zero nonbank SIFIs, we're going to hear regulators talking about an "activities-based approach" to systemic risk.
It's a smokescreen. A purely activities-based approach cannot succeed, as
@Dschwarcz , Pat McCoy, and I explain:https://t.co/L2VxMI3JoQ — Jeremy Kress (@Jeremy_Kress)
October 17, 2018
At the same time, Edward Mills, an analyst at Raymond James, noted that the step could be used to discourage designations of individual institutions going forward, by laying out a concrete alternative.
“Part of the reason that they are undergoing the activities-based process is to handcuff future administrations,” he said. “There’s a desire to define some contentious areas of regulation in a way that puts their stamp on creating a system that they believe would prevent regulatory overreach in the future.”
What process will the council use to identify potential risky activities and products?
In its November 2017 report, Treasury called SIFI designations “a blunt instrument” for combating systemic risk. It also cited concerns from critics that the labeling process lacked transparency and wasn’t rigorous enough.
Those are areas that regulators may want to address with any process they outline for overseeing risky activities or products — though, as Obama officials learned through the designations process, that’s not exactly an easy task. A district court threw out MetLife’s designation in early 2016, partially citing issues with the council’s analysis. A Treasury spokeswoman declined to comment on what the council is planning or precisely when more detail will become available.
The issue is that identifying risky nonbanks or risky activities is inherently a subjective exercise — officials may be seeking to contain how subjective the process is, but they’ll also want to preserve enough discretion to make necessary decisions. How will the agencies select which hot spots to identify — leveraged loans, short-term funding, problems not yet on the radar — and by what standard will they determine whether those activities need additional monitoring?
In its November report, Treasury said that the FSOC should “prioritize” identifying problematic activities and then work with individual regulators to address any issues.
“In conducting this analysis, the council should take into account available historical data, research regarding the behavior of financial market participants, and potential emerging threats that could arise in evolving marketplaces,” the report said. “This work would leverage the council’s existing processes, including frequent interagency discussions and analyses of financial market developments and potential risks to financial stability, and would provide an opportunity for a comprehensive analysis of risk.”
Yet if regulators set the bar too high on what constitutes a risky activity, it’s likely the council won’t act at all or will act too late, rendering the approach somewhat useless.
“It's going to be hard for them to create a standard that provides enough discretion, but removes the subjectivity,” said Mills.
Does FSOC have enough authority to be effective?
The council is already empowered to oversee risky activities as part of its mandate under Dodd-Frank — but the catch is it must rely on an institution’s primary regulator to actually write any new rules.
“Right now, they have the ability to name and shame member agencies — if a regulator doesn’t want to do what FSOC asks them to, they don’t have to,” said Justin Schardin, a fellow at the Bipartisan Policy Center. “It may be that we need to rethink FSOC's powers and grant them additional authority in the area of activities.”
The FSOC helped encourage the Securities and Exchange Commission to craft new rules for money market funds in 2012, and it may have helped spur the writing of SEC rules overseeing the asset management industry several years later.
But, as critics note, the tool potentially becomes much less powerful without the implicit “stick” of individual designations backing it up.
“The only reason they were even able to have that much influence [on the asset management rules] is because of the implicit threat of designation if the SEC did not act,” said Stanley. “The FSOC, by their actions and stated policies, basically seems to have taken designation off the table for the foreseeable future, so I question whether they would have the leverage to get agencies to act.”
The broader question now is whether activities-based oversight alone will be enough to ensure financial stability outside of traditional banking. Let’s hope it doesn’t take another crisis to find out.
Bankshot is American Banker’s column for real-time analysis of today's news.
