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FSOC votes AIG, Prudential are nonbank SIFIs

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Washington — The Financial Stability Oversight Council (FSOC) voted today on whether to designate two insurers as systemically important financial institutions (SIFI) in the first-ever vote for nonbank SIFIs under the 2010 Dodd-Frank Act.

The three companies up for a vote were AIG, Prudential Insurance and GE Capital. Treasury does not comment on the companies or publically name them at this stage of the process. However, the companies themselves are free to disclose if they are named.

“As noted in the Council’s interpretive guidance, the Council does not intend to publicly announce the name of any nonbank financial company that is under evaluation before a final determination is made,” stated Treasury Spokesperson Suzanne Elio.

AIG acknowledged late today that it received notice from the U.S. Treasury that the FSOC has made a proposed determination that it is a SIFI institution pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Prudential Financial, confirmed it also received notice of a proposed determination that it should be subject to stricter prudential regulatory standards and supervision by the Board of Governors of the Federal Reserve System.

Prudential is currently evaluating whether to request a nonpublic evidentiary hearing before the Council to contest the proposed determination, as it is entitled to do under the applicable regulations, it stated. 

“If the Company is designated by the FSOC as a Covered Company, it could be subject to stricter prudential standards under the Dodd-Frank Act, which may include requirements regarding risk-based capital and leverage, liquidity, stress-testing, overall risk management, resolution plans, early remediation, and credit concentration; and may also include additional standards regarding capital, public disclosure, short-term debt limits, and other related subjects as appropriate,” Prudential advised in a statement. 

The ball is now in the companies’ courts, and the clock will begin on a final determination today.

The historic vote could set some insurers on a course where they will be not only regulated by the Federal Reserve, as some thrift holding company insurers already are, but put them in a class separate from their competitors, where different rules and expectations from all stakeholders apply, changing the market, regulatory world and perhaps the products sold from what it has experienced up until now.

The Council is made up of 10 voting members and five nonvoting members. Two of the nonvoting members are insurance-related positions. The third insurance position, the insurance expert confirmed by the Senate, votes along with the chairs of financial services agencies. 

Treasury Secretary Jacob J. Lew, the chairperson of the FSOC stated, “The Council has made significant progress over the last two years in making our financial system safer, stronger and more resilient. Today, the Council took another important step forward by exercising one of its principal authorities to protect taxpayers, reduce risk in the financial system, and promote financial stability.”

Once an insurer comes under the SIFI umbrella, it is then subject to enhanced prudential standards from the Federal Reserve, its new regulator. These rules have been proposed but not finalized and insurers have said they are not sure what the capital standards will be under a Fed regime.

The insurers also might be subject to strict Basel III minimum capital requirements unless insurers are able to get a fix for a seemingly intractable part of the Dodd-Frank statute, Section 171, which would apply strict minimum capital requirements for banks upon any nonbank SIFIs.

There are a few scenarios that could play out. All votes pass on two-thirds vote, including the vote of the FSOC chairperson, the Treasury secretary. Lew has testified recently that he plans to get moving on all facets of Dodd-Frank implementation

If a company does not request a hearing and says it is okay with the designation, the FSOC has 10 days to make a final determination. Thus, if a company responds that it is okay with the SIFI mantle as early as tomorrow, June 4, there could be a final SIFI designation made by June 14, or even before, if FSOC wants to really get down to business.

FSOC members do not have to be present in a room at Treasury to vote.

A company could receive a proposed designation and request a hearing. It must do so within 30 days of today. The FSOC must hold a hearing within 30 days of the request. The FSOC will then have 10 days to make a final determination. Thus, a request for a proposed hearing for June 4 would require a hearing by July 4. A hearing request made July 3 would give FSOC until early August to grant one.

If a company stays silent, the FSOC will make a final determination within 10 days, after the clock runs out on the hearing request time frame of 30 days.

Congress did not stay silent, however. Financial Services Committee Chairman Jeb Hensarling, R-Texas, framed the vote as a referendum on “too big to fail” and taxpayers having to fund another collapse, potentially.

“Today, all because of the Dodd-Frank Act, hardworking taxpayers are at greater risk of being forced to fund yet another Wall Street bailout as their government officially designates more large companies as being ‘too big to fail.’ Designating any company as ‘too big to fail’ is bad policy and even worse economics. It causes erosion of market discipline. It also becomes a self-fulfilling prophecy by giving these firms market advantages over their competitors, helping to make them even bigger and riskier than they otherwise would be.”

Meanwhile, the International Association of Insurance Supervisors (IAIS) is currently reviewing global insurers for designation as global systemically important insurers (GSIIs), and U.S. officials have been trying to coordinate the process so it meshes with the domestic SIFI outcomes. The IAIS is expected to send its list to the G-20′s Financial Stability Board (FSB) this month. The process for determining SIFIs is evergreen – MetLife, which was not in this round because it was recently a bank holding company, could come up for an in-depth Stage 3 review at a later time. Stage 3 reviews of financial companies utilize company information, beyond what is available from public and regulatory sources. 

AIG officials said Friday they are preparing for regulation by the Federal Reserve Board in addition to state regulation.

Contrary to the views of most other insurance companies, Robert Benmosche, AIG president and CEO, said, “in a way, we see it as a big positive.”

The comments were linked to the announcement — after the market closed — that the Treasury Department is selling 163,934,426 shares of its AIG common stock at $30.50 per share in a public offering.

AIG issued a simultaneous announcement that it has agreed to purchase 98,360,656 IPO shares at the public offering price of $30.50. 

At the same time, Benmosche did not specifically say when Fed regulation would begin, and analysts did not ask him.

That’s because the new IPO is unlikely to trigger immediate Fed regulation.

It was believed that AIG would come under Fed oversight as a SIFI once federal ownership of the company dipped below 50 percent.

But, analysts believe that the new offering will still leave Treasury owning 54 percent of AIG stock, below the 50 percent threshold needed to trigger federal regulation of AIG as a SIFI.

Benmosche brought the issue of federal regulation to the front burner by initiating the conference call Friday morning that followed AIG’s second quarter earnings announcement by saying, “We’re often asked about regulation.”

He said he views it that way because it would help AIG handle what he downplayed as the 2008 “bump in the night” that, in fact, triggered a federal rescue of massive proportions.

“We really don’t know when we will be regulated but we do believe we will be regulated by the Federal Reserve probably,” Benmosche said at the time. “That seems the most likely candidate and we’re putting an enormous amount of effort and cost to make sure that we are Fed-ready …”

The AIG purchase of its own shares from Treasury is expected to cost $3 billion, money it has set aside to purchase the shares.

However, the final level of Treasury ownership that will remain depends on how much Treasury gets for the remainder of the offering. 

And, a further factor is that Treasury has granted the underwriters a 30-day over-allotment option with respect to approximately 24.6 million additional shares of AIG common stock.

In his comments, Benmosche said AIG has made a comprehensive study of how it will be impacted by federal regulation, and that its only concern is whether it should divest itself of its Wilton, Conn.-based thrift.

He acknowledged that AIG “is giving thought to whether we should now close the bank we have because we’re concerned about that aspect of it, and an insurance company invests very differently than a bank would …”

But aside from that issue, he said, “This is really about making sure we have really good process and good controls, especially in the risk management arena, very good controls around how we determine we can handle a bump in the night that happened in 2008, for example.”

He said AIG has “discussed internally” the effects the Volcker Rule could have, and “so there is a little concern there.”

The Volcker rule, which is still being drafted, would severely limit the ability of financial firms to invest in private equity deals for their own account.

But, he said, the key is that insurance regulators have capital maintenance agreements as to how much the capital subsidiaries they regulate must have, so, “The real question becomes the amount of money that we hold at the holding company above all of the regulated entities; and to the extent that we own these regulated entities, what requirements the Fed may have.”

For example, AIG has capital and maintenance agreements, which says it can contribute money back into the insurance companies if risk-based capital is full. “We’ve got to make sure that money is actually there and is available if, in fact, there is a crisis at an insurance company,” Benmosche said.

And so having the Fed regulate that money and making sure that when we have a liquidity plan — we have one — that’s reassuring to the insurance regulators that are looking at AIG’s ability to live up to its commitment. So in a way, we see [Fed regulation] as a big positive.”

Currently, the Treasury Department holds 61 percent of AIG. The Treasury interest stems from federal intervention starting in September 2008 through the Federal Reserve Board. The Fed agreed to provide $182.3 billion in cash aid to AIG in return for 79.9 percent of its stock.

The Fed and Treasury ultimately provided more aid through special purpose vehicles (SPVs) created by the Fed, guarantees on its commercial paper, and aid through the Troubled Asset Relief Program and other Treasury programs.

The Fed has since been paid off, either through sale of AIG assets contained in the SPVs, or through acquisition of AIG stock held by the Treasury.

AIG has been working hard to bring down the government’s investment as soon as possible, hopefully by the fall, and Friday night’s announcement was part of that.

Other insurers, both property casualty and life, are also expected to be designated as SIFIs, but they are fighting it tooth and nail, and enlisting the help of members of Congress to support their position.

They could be eligible for Fed regulation either by being designated SIFI or because they own thrift-holding companies.

A number of insurers which operate thrifts have divested their thrifts.

These include Prudential Insurance, Northwestern Mutual, Massachusetts Mutual Insurance Company and W.R. Berkley. The Principal Fiancnail is in the process of doing so. 

During the conference call, in answering an analysts’ question, Benmosche ran down the laundry list of anxieties businesses have over federal rules designed to tighten regulation of American companies this decade, for example, the so-called Sarbanes-Oxley Act.

“Look, a lot of us were frustrated with SOX 404 and so on,” Benmosche said. “It was a lot of form over substance, but the process itself made sure companies really thought through the controls they need to have to make sure that they issue numbers that are correct.”

And so we see [Fed regulation] as an enhancement to that process, and so it’s really about process, policies, and making sure we have really good controls over some of the assumptions around our liquidity and so on,” Benmosche said.

The American Insurance Association, which represents property casualty insurers, stated that “property-casualty insurers engaged in regulated insurance activities do not pose a threat to financial stability and therefore should be screened out of the SIFI designation process. As we have stressed all along, AIA believes that if members of the Council correctly apply risk-related factors, they will conclude that property-casualty insurers are not the types of companies that should be subjected to heightened prudential supervision.”

FSOC voting members are:

The nonvoting members, who serve in an advisory capacity, are: