The landscape of financial regulation in the United States is undergoing a significant transformation as U.S. regulators have recently cleared the way to increase oversight of asset managers, hedge funds, and other non-bank financial entities.
This marks a revival of a tough new regulatory regime that had been sidelined during the previous administration of President Donald Trump.
A New Framework for Identifying Looming Risks
The Financial Stability Oversight Council (FSOC), led by the Treasury Department and comprised of other major regulatory agencies, has introduced a new framework for identifying potential risks in the financial system.
The primary goal of this framework is to enhance the transparency of the council’s work.
Rethinking Systemically Important Financial Institutions (SIFI)
One of the significant changes involves the process for designating a non-bank as a “systemically important financial institution” (SIFI).
This designation brings with it increased regulatory oversight and stricter capital and liquidity requirements.
The revised process for designating SIFIs has raised concerns and garnered swift criticism from the financial industry.
Shift in Regulatory Approach
Under the previous administration, regulators focused on policing risky financial activities rather than singling out individual firms.
This approach, as stated by Treasury Secretary Janet Yellen, was founded on a “flawed view of how financial risks develop and spread.” The new approach, however, emphasizes the designation of individual firms as one of the tools the FSOC can employ to ensure financial stability.
The Revamped Process
Under the revamped process, FSOC will identify potential SIFIs based on existing information and allow the designated company to respond. If FSOC chooses to proceed, the company will engage in discussions with its primary regulator and the FSOC.
The ultimate designation as a SIFI will only occur if two-thirds of FSOC’s 10 members vote in favor. Notably, these designations will undergo annual reviews to ensure their ongoing relevance and necessity.
While this change in regulatory approach has been welcomed by some, it has faced strong criticism from various quarters, including industry representatives.
Eric Pan, the head of the Investment Company Institute, which represents global asset managers, described the SIFI designation as a “blunt tool” that focuses disproportionately on individual companies rather than conducting a holistic assessment of risk.
Similarly, the Managed Funds Association, which represents hedge funds, argued that non-banks do not pose the same risks as traditional banks. They believe that the new guidance introduces a black-box designation process that creates uncertainty for market participants.
The Historical Perspective
In the past, FSOC’s designation of four non-bank entities under President Barack Obama faced intense industry opposition.
Notably, MetLife, Inc successfully challenged its SIFI designation in court, and General Electric Capital Corporation managed to shed its designation in 2016 after significantly reducing its business operations.
The designations of American International Group, Inc, and Prudential Financial, Inc were lifted during the Trump administration.
What Lies Ahead
The recent shift in the designation process is expected to make it easier to categorize a non-bank as a SIFI, but it will still be a meticulous and time-consuming procedure.
Ian Katz, managing director of policy research firm Capital Alpha Partners, suggests that the entire process could take at least a year from start to finish.
The renewed emphasis on overseeing non-bank financial entities represents a significant policy shift with potential far-reaching implications for the U.S. financial industry.
While it aims to enhance financial stability, it has raised concerns about the methodology and consequences of designating non-banks as SIFIs.
- What is the purpose of designating non-banks as SIFIs?
Designating non-banks as SIFIs is aimed at increasing oversight and imposing stricter regulations to ensure financial stability.
- Why is the new approach receiving criticism from the financial industry?
The new approach has faced criticism for its perceived focus on individual companies rather than a holistic assessment of risk, creating uncertainty for market participants.
- Are global asset managers like BlackRock affected by these changes?
Yes, major global asset managers like BlackRock could potentially be subjected to increased oversight and regulatory requirements.
- How does the new process for designating SIFIs differ from the previous approach?
The revamped process allows for more transparency and engagement with the designated company, with annual reviews to assess the continued need for the SIFI designation.
- What are the potential consequences for non-banks designated as SIFIs?
Non-banks designated as SIFIs will face heightened regulatory scrutiny, including increased capital and liquidity requirements.