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Financial Planning > Behavioral Finance

FSOC Proposes Changes to Nonbank SIFI Designation

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An examination of risky activities of nonbanks like insurers and asset managers will be federal agencies’ first line of defense when the agencies are assessing threats to the financial system, under new guidance proposed Wednesday.

The Financial Stability Oversight Council voted unanimously to propose interpretive guidance for nonbank financial company designations that would also put in place a cost-benefit analysis requirement before any firm or entity is designated as systemically important.

The system updates how the United States deals with financial threats to the market as a whole under the Dodd-Frank Act, which was enacted in response to the financial meltdown of 2008-2009.

This would update the 2012 interpretive guidance formerly used to review asset managers and insurance companies, and even designate a few of the former.

A nonbank financial company would get a systemically important financial institution (SIFI) label only if the “expected benefits justify the expected costs of the designation,” the Treasury Department said in a statement.

A designation would be made only if, after recommendations to and work with primary financial regulators, there was no system put in place to address financial system risks in time.

Federal Reserve Chairman and FSOC member Jerome Powell said during the public meeting at the Treasury building following the vote that an entity-based approach where a firm itself is designated as systemically risky should only be “used sparingly.”

Former insurance designees AIG, MetLife and Prudential Financial have all shed their designations upon FSOC and in the case of MetLife, a court decision.

The FSOC provided a roadmap in its new proposal that would require it to work with the primary regulators of the companies, whether they are state regulators, the Commodity Futures Trading Commission or the Securities and Exchange Commission, to address any risk issues before moving on to the next steps.

Also, just because a firm’s failure would cause a financial meltdown, doesn’t mean it will be designated under the new system, if implemented. The previous guidance, which was used for Prudential and MetLife did not look at the likelihood that they would fail as part of the calculation. Now, the FSOC plans to not just consider the impact of a failure, but also the likelihood it will actually occur.

The new FSOC proposal “would make significant improvements to how the council identifies, assesses, and responds to potential risks to U.S. financial stability,” said Treasury Secretary Steven Mnuchin, chair of the FSOC, in a statement released with the proposal.

The current three-stage designation system would also be shortened to two stages, while transparency and stakeholder engagement would increase, FSOC says.

The quantitative metrics used in the 2012 Stage One applied to a big swath of nonbank companies in the first part of the designation process “generated confusion among firms and members of the public and is not compatible with the proposal to prioritize an activities-based approach,” the proposal stated.

Tom Workman, the presidentially appointed independent insurance voting member on the FSOC, heartily endorsed the proposal.

Workman told ThinkAdvisor after the vote at Treasury that he hasn’t seen anything this well worked out or structured, whether here or in Europe, with respect to reviewing financial risk. Workman said that if a risk is identified, it needn’t take months or years to address by primary regulators if FSOC needed to act, suggesting a more efficient and nimble oversight mechanism.

Once published in the Federal Register, the proposal will stay open for a 60-day public comment period.


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