U.S. Regulators edged closer on Tuesday to defining which companies, other than banks require more government scrutiny under the Dodd-Frank financial reform law.
The Financial Stability Oversight Council--a group of regulators that includes Timothy F. Geithner and Fed Chairman Ben S. Bernanke--proposed specific requirements to determine if a company is big enough and interconnected enough to impact the stability of the financial markets. These “systemically important” firms would place them under Fed supervision and subject them to additional capital liquidity requirements.
The Fed’s proposed rule defines two key criteria for regulators to use when determining if a nonbank financial firm should qualify as systemically important: Interconnected bank holding companies with $50 billion or more in assets (Bank of America, JPMorgan Chase & Co., Citigroup, to name a feware automatically qualify) and nonbank firms would also qualify if 85 percent or more of their revenue relates to activities that are financial in nature, as defined in the Bank Holding Company Act.
The proposal will be open to public debate until March 30 and leaves insurers, hedge funds, and private equity firms wondering if they will be subject to stricter regulations that can make them less competitive. Though it’s still unclear which firms will be included, and what rules they’ll have to comply with, this seems to be a club nobody wants to be in, says Bert Ely, a financial services and monetary policy consultant. “I think we’re going to see a lot of pushing and shoving over the coming months about ultimately who gets caught in the snare and who’s able to escape it,” Ely added.
Regulators must first account for a company’s transactions and interconnectedness with other “significant” financial firms. Secondly, regulators must look only at relationships between a firm and other institutions that have at least $50 billion in assets, or for reasons not yet defined, have already been considered systemically important.
The requirements include a test to determine if a firm’s gross financial revenue is 85 percent or more of its annual gross revenue in either of the two most recently completed fiscal years. FSOC also asks for an overview of a firm’s transactions and relationships with other “significant” nonbank financial companies and “significant” bank holding companies. A firm would be considered “significant” if it has $50 billion or more in total consolidated assets.
Last month, executives from Paulson & Co. and D.E. Shaw & Co. LP, two New York-based hedge funds, “expressed concerns that confusing information was circulating about both the process and likely analytical approach” to designating firms, “contributing to market uncertainty,” according to a notice on the Fed’s website.
“Everyone who is on the cusp, so to speak, is trying to do everything they can to avoid being named…But writing to the Fed is dangerous, it’s like putting your hand up, they may call on you,” said Robert Litan, vice president for research and policy at the Kauffman Foundation.
Charles Taylor, director of the Pew Financial Reform Project said it’s crucial when determining designations to consider the interconnections, or the implications for a firm’s a failure for all the other firms connected to it. Those interconnections come not just from credit exposure but also exposures due to potential fire sale risks – the effect that distressed selling by one firm can have on the assets of other firms – and from “association” risk – the risk that firms that simply look like a failing firm lose the confidence of the market. That was what drove the remaining big investment banks to convert to bank holding company charters when Lehman Brothers failed.
“Can you be an initiator or a transmitter of a contagion? It’s very important when we think of designation, that we take interconnections into account,” Taylor added.
Fed Moves to Label ‘Systemically Important’ Nonbank Firms (The Wall Street Journal)
Paulson & Co. D.E. Shaw Told Fed of ‘Confusing’ Rules Process (Bloomberg)
Fed Eyes Systemically Important Non-Bank Firms (emii.com)