Dec.HFSC Oversight Hearing of the FSOC
House Financial Services Committee
“Oversight of the Financial Stability Oversight Council”
Tuesday, December 8, 2015
Key Topics & Takeaways
- SIFI Designation: Neugebauer asked why non-banks have 11 factors in determining systemic importance while banks are only determined by their size.
- FSOC Meetings: Reps. Garrett and Pittenger noted the “secrecy” of FSOC meetings and Pittenger announced legislation he will be introducing today that requires the FSOC testify before Congress semiannually and allow members of Congress to attend FSOC meeting.
- Cybersecurity: Panelists agreed that cybersecurity is a “critical issue” for systemic risk in the financial markets and Gruenberg noted the “significant role” for entities to share cyber threat information with each other.
- CCP Recognition: Rep. Scott (D-Ga.) said there is a terrible problem with European regulators not coming to an agreement with U.S. regulators on equivalency determinations for CCPs, which he said will have a “devastating” effect on end-users, exchanges, and clearing houses. Massad said that European regulators have “pushed out the immediate deadline” and that their differences have narrowed, and reiterated that both sides are working hard to resolve their issues.
Witness
- Mary Jo White, Chair, Securities and Exchange Commission
- Timothy G. Massad, Chairman, Commodity Futures Trading Commission
- S. Roy Woodall, Jr., Independent Member with Insurance Expertise, Financial Stability Oversight Council
- Debbie Matz, Chairwoman, National Credit Union Administration
- Melvin L. Watt, Director, Federal Housing Finance Agency
- Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation
- Richard Cordray, Director, Bureau of Consumer Financial Protection
- Thomas J. Curry, Comptroller of the Currency, Office of the Comptroller of the Currency
Opening Statements
In his opening statement, Chairman Jeb Hensarling (R-Texas) stated that financial regulators “possessed every power necessary” to prevent the last financial crisis but failed to do so. Still, he argued, Washington “rewarded them” with sweeping new powers over the economy which is most evident in the creation of the Financial Stability Oversight Council (FSOC). He called the FSOC one of the most powerful federal entities to ever exist, and “unfortunately, also one of the least transparent and accountable.” Hensarling noted that the FSOC’s power is concentrated in the hands of the Democratic Party, with all but one of its members being the presidentially-appointed head of a federal agency. He said this structure “injects partisan politics in the regulatory process, erodes the agency’s independence, and harms accountability.”
Hensarling continued that no FSOC activity generates more controversy than its designation of non-bank systemically important financial institutions (SIFIs), and he commented that designations anoint firms as too-big-to-fail (TBTF). He said “today’s SIFI designations are tomorrow’s taxpayer-funded bailouts.” Hensarling further criticized that designation “ominously grants the Federal Reserve near de facto management authority over such institutions,” leaving “huge swaths” of the economy under federal government control. He said just the prospect of designation can eliminate entrepreneurial risk-taking, innovation and economic growth.
Another responsibility of the FSOC, Hensarling said, is to identify emerging threats to financial stability, yet the Council “refuses to look in the mirror.” He lamented that the most recent FSOC annual report omits any references to specific government policies or agencies, such as loose monetary policy or regulations such as the Volcker Rule that have reduced liquidity in bond markets.
Rep. Scott Garrett (R-N.J.) quipped that he wanted to “introduce” the FSOC members to Congress, the elected representatives of the public who send countless letters that regulators “routinely ignore.” He said Congress is open to the public and very transparent, and called on the FSOC to resemble Congress in that regard.
Ranking Member Maxine Waters (D-Calif.) said in her opening statement that the FSOC has fulfilled its mandate to monitor and respond to systemic risks. However, she said many Republicans seem to be going through “amnesia” regarding the financial crisis which she argued was rooted in the inability of regulators to coordinate and consider the interconnectedness of the financial sector. She commented that opponents of Dodd-Frank are too focused on dismantling Wall Street reforms by attacking the FSOC despite its success in promoting stability and growth. She credited the FSOC for designating firms for enhanced supervision to ensure that they “never again” engage in risky, unregulated activities, and added that this oversight is leading non-banking firms to consider whether simplifying their activities will lead to better returns for their investors.
Water closed by noting that the FSOC has attempted to conduct its work in a manner that is responsive to congressional and stakeholder concerns. She pointed to voluntary changes by the FSOC announced in February to its designation process as evidence of a greater focus on transparency and accountability.
Rep. Blaine Luetkemeyer (R-Mo.) stated that an inefficient regulatory structure can have major consequences for the financial system, and particularly for banks deemed SIFIs based on “arbitrary” thresholds. He said the FSOC’s powers “should alarm all Americans” and said the designation process is an example of efforts to expand government powers.
Mary Jo White, Chair, Securities and Exchange Commission
In her testimony, White stated that Dodd-Frank established the FSOC to provide comprehensive monitoring of the nation’s financial stability through a forum for regulatory coordination. As one of two capital markets regulators, she continued, the Securities and Exchange Commission (SEC) brings an important perspective to the FSOC and unique insight into potential financial stability risks posed by asset managers and investment products. She noted the SEC’s role in bringing relevant expertise to bear, and stressed the importance of the designation process for non-banks being data-driven with proper analysis. White also commented on the FSOC’s efforts to improve transparency, and said it should “continually study” ways to optimize its functioning.
Timothy G. Massad, Chairman, Commodity Futures Trading Commission
Massad, in his testimony, said his perspectives as an FSOC member are shaped by his responsibilities as the chairman of the Commodity Futures Trading Commission (CFTC). He listed his priorities for the FSOC as: 1) an effective regulatory framework for over-the-counter (OTC) swaps; 2) ensuring the strength and resiliency of clearinghouses; 3) ensuring the resiliency of markets; 4) cybersecurity; and 5) oversight of benchmarks.
S. Roy Woodall, Jr., Independent Member with Insurance Expertise, Financial Stability Oversight Council
In his testimony, Woodall said Congress should examine ways to improve the FSOC’s procedure and structure, particularly with respect to his position. He lamented the lack of explicit statutory authorities for his position and expressed his willingness to work with Congress to strengthen the role of his position so it can be more effective in contributing to the work of the FSOC.
Debbie Matz, Chairwoman, National Credit Union Administration
Matz, in her testimony, said the financial crisis made clear that financial markets could not quickly absorb the collapse of financial markets, and that the FSOC’s primary goal is to prevent another system-wide crisis. She defended the FSOC for recognizing the importance of transparency and public participation in its designation process, explaining that it has “moved deliberately” in developing the process for non-banks.
Melvin L. Watt, Director, Federal Housing Finance Agency
In his testimony, Watt emphasized the importance of the Federal Housing Finance Agency’s (FHFA) expertise in housing finance, especially considering that the most recent crisis had its roots in the unsafe and unsound housing finance decisions of “business entities and others.” He said the FHFA participates in all FSOC committees and deliberations, including designation processes for non-banks that include “extensive engagement” with the firms in question.
Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation
Gruenberg, in his testimony, said the FSOC was established to address gaps in the regulatory framework that resulted from the inability of regulators to “see the whole picture” in the lead-up to the financial crisis. He said the FSOC facilitates information sharing, identifies risks, and promotes market discipline, and he touted the five FSOC annual reports and their demonstration of progress made since the crisis. He added that there are three areas of risk the FSOC is closely following that are of interest to the Federal Deposit Insurance Corporation (FDIC): 1) interest rate risk; 2) credit risk; and 3) cybersecurity.
Richard Cordray, Director, Consumer Financial Protection Bureau (CFPB)
In his testimony, Director Cordray stressed the “diminished” retirement and savings accounts and millions of jobs lost during the financial crisis. He continued that the FSOC and CFPB were created through congressional legislation, as well as the designation of some financial institutions as systemically important, to protect the financial markets and consumers, as market discipline and consumer protections are closely related.
Thomas J. Curry, Comptroller of the Currency, Office of the Comptroller of the Currency
Curry, in his testimony, explained that the duty of his office is to ensure that banks operate in a “safe and sound manner” and that the Office of the Comptroller of the Currency’s (OCC) primary focus is on prudential regulation. He continued that the OCC regulates different types of financial risk, to include liquidity, operational risk and credit, and that they also have expertise in asset management. Curry also commented that there have been “positive strides” in increasing the transparency for those institutions designated as systemically important.
Questions and Answers
SIFI Designation
Hensarling asked what harm there is in designating insurance companies as SIFIs. Woodall explained that the higher regulatory costs and higher priced products that result from the SIFI designation would put those companies designated in an “unlevel playing field” with competitors without the designation. He continued that financial activities should be used in the designation of SIFIs and non-bank SIFIs rather than just if financial distress within the company could threaten the U.S. financial system. Woodall commented that without using activities in SIFI designations, a SIFI could sell their risky activity to a company that is not designated, leaving the “lost” risk in the system.
Hensarling asked Matz whether an economic analysis was completed about what the SIFI designation would mean for policy holders prior to designating Prudential as such. Matz said there was not an analysis as “there wasn’t a mandate to do so,” but that the FSOC determined the company could pose an emerging threat.
Hensarling noted the 11 different factors to consider when designating a company as a SIFI and asked the extent to which leverage impacts the designation decision. Matz explained that the determination was based on how difficult the company’s financial activities, including derivatives, the extent of leverage, debt position and securities lending, would be to resolve should there be a problem.
Waters asked if legislative proposals that would rely on the FSOC to designate those other than “mega banks” for enhanced prudential standards would be ill-advised. Gruenberg said that the designation framework currently in place is “reasonable,” as it gives agencies discretion to tailor prudential standards to the size and/or complexity of the institution. He continued that the Fed has started to tailor banks under the $50 billion threshold while placing higher prudential standards on larger institutions.
Rep. Nydia Velazquez (D-N.Y.) asked if firms that have been designated as systemically important are able to meet with FSOC staff to review their status. Gruenberg said that firms are able to meet to reevaluate their designation.
Rep. Randy Neugebauer (R-Texas) asked if it is appropriate to set Basel standards and apply them to companies. Matz explained that “bright lines” have not been “drawn” regarding the standard and that the Council looks to see if there is material distress at a company that would have an impact on the U.S. financial system.
Neugebauer asked whether the 11 factors used in determining whether a non-bank is systemically important are appropriate and criticized this approach since banks are only designated based on their size. Matz and Watt agreed that the factors are appropriate for non-banks.
Rep. Randy Hultgren (R-Ill.) questioned the determination of insurance companies as systemically important. Matz commented that balance sheet activities are interconnected with other systemically important indicators. Regarding state supervision of insurance companies, she continued that while state insurers are not “ineffective,” the FSOC is mandated to analyze how activities can impact U.S. financial stability, adding that their staff conducted independent analysis.
Rep. Dennis Ross (R-Fla.) asked why the FSOC designated insurance companies as systemically important when the insurance expert on the Council disagreed with that decision, and he also inquired how insurers might pose a threat to the stability of the U.S. financial system. Woodall explained that it was a “professional disagreement” that included a “hearty debate.” Matz commented that the Council looks at a company’s derivatives positions and activities that are on and off the balance sheet.
Ross asked why asset managers have been designated as systemically important. Cordray noted that they have not been designated as SIFIs yet.
Rep. David Schweikert (R-Ariz.) asked Matz where exposure was found in the designation of insurance companies as systemically important. Matz explained that the derivatives position interconnected with other financial institutions created exposure. Garrett commented to Matz that “citing interconnectedness isn’t enough criteria.”
Rep. Mick Mulvaney (R-S.C.) asked Matz how she was briefed on the different designations of insurance companies. Matz explained that her staff and the FSOC staff briefed her and other FSOC members well in advance of the decision.
Global Impacts
Neugebauer referred to an Office of Financial Research (OFR) report that concluded the least global systemically important bank (G-SIB) was several times more systemic than major U.S. banks, and asked why U.S. banks still fall under the requirement for enhanced prudential standards due to their asset size. Matz and Watt said they were not familiar with the report.
Rep. Keith Rothfus (R-Pa.) raised concern that U.S. regulators are transferring “power” to the Financial Stability Board (FSB) and asked if foreign regulators should be “taking lead” on protecting financial institutions. Woodall answered that European insurers have a different background, accounting system and products, but that they are “united with sovereignty.”
Total Loss Absorbing Capacity
Rep. Gregory Meeks (D-N.Y.) raised the concern that the Total Loss Absorbing Capacity (TLAC) proposal requires banks to take on debt just as the Fed is about to raise interest rates. Gruenberg explained that the debt requirement is important as it lets banks fail without making taxpayers bail them out.
Impacts on Small and Community Banks
Rep. Steve Stivers (R-Ohio) asked the panel how many hours each agency spends discussing regulatory conflicts and “unnecessary regulations” that may harm small and community banks. Panelists did not have exact numbers but explained that staff members have discussions on the topic.
Garrett questioned the “secrecy” of FSOC meetings and asked the panelists if they would allow their commissioners to attend future meetings. Panelists did not answer.
Liquidity
Rep. Andy Barr (R-Ky.) noted that domestic liquidity standards are more stringent than international requirements when it comes to capital surcharges, the supplemental leverage ratio and TLAC. He asked if the potential lack of liquidity due to regulation could leave the financial markets with less capacity to endure shocks. White noted the concern of reduced liquidity in the markets and commented that the regulations “may be causing it.” She continued that there is an analysis being conducted to determine whether the Volcker Rule has had a negative impact on liquidity.
Rep. Bill Posey (R-Fla.) explained that Dodd-Frank mandates such as the Volcker Rule and Basel III’s capital regulations are “draining liquidity” from the fixed income markets. Cordray said that it is a “fair point” that different regulations and structures can adversely impact on liquidity, and added that the impacts on international competitiveness and liquidity in markets should be considered.
Posey then asked whether FSOC should be mandated to mitigate the risk of illiquidity in the bond market if there is compelling evidence that the regulations are creating systemic risk. Cordray answered that “if it does demonstrate that, it is fair game.”
GSEs
Barr asked if government-sponsored enterprises (GSEs) will be exempt from liquidity rules. Watt stated that GSEs are in a conservatorship and are currently exempt.
Minority Inclusion
Rep. Keith Ellison (D-Minn.) asked what policies GSEs can have post-conservatorship to include minorities in borrowing. Watt commented that “a lot can be done” depending on how GSE reform is conducted, but that price uncertainty for lenders is part of the “challenge” to the conservatorship, adding that the GSEs will need capital available to them.
Rep. Joyce Beatty (D-Ohio) noted Section 342 of the Dodd-Frank Act and asked the panel how they include minorities in decisions. Curry explained that his agency has an advisory committee that oversees issues facing minorities and that they enforce the Committee Reinforcement Act that has an impact on low to moderate income communities. Cordray commented that his agency enforces the Equal Credit Opportunity Act, and Gruenberg said that his agency enforces minority deposit institutions.
Rep. John Carney (D-Del.) asked the FSOC members what emerging systemic risks they can identify. Gruenberg stressed that cybersecurity is a “critical issue” and that there is a “significant role” for Congress to work with law enforcement and other entities to share information with each other, noting the cybersecurity information sharing legislation that Congress is working to pass out of conference. Curry agreed, adding that it is “imperative” that banks are able to repel cyber attacks and respond immediately. White mirrored the other members’ comments, adding that she “can’t emphasize enough the cyber risk.”
Innovation
Schweikert asked if innovation in the financial markets is “safer and more robust” than a centralized banking system. Curry commented that he is interested in the impact of innovation on the delivery of banking services.
Legislative Fixes
Rep. Robert Pittenger (R-N.C.) noted the lack of “adequate” transparency with the FSOC agencies and shared that legislation he will introduce today would provide greater transparency to the public by requiring the Council to testify semiannually before Congress and allow lawmakers to attend FSOC meetings, regardless if they are open to the public. Watt argued that the requirements were “not reasonable” and White added that the FSOC should be responsible to testify to Congress without the bill.
Rep. Luke Messer (R-Ind.) explained that H.R.3857 would prevent the FSOC from designating any other non-banks until 90 days after certain requirements are met, including that the Fed would have to establish prudential standards that would apply to systemically important non-banks, and that the FSOC would have to reevaluate in 2016 each previous SIFI designation and rescind designations that are no longer necessary. Woodall commented that more clarity on the “exit ramp” for SIFIs is needed.
Adequacy of Information for Decision Makers
Rep. Ruben Hinojosa (D-Texas) applauded the Council’s “progress to date” and emphasized the need to have a “bird’s eye” understanding of systemic risks posed by the financial services sector. He referenced the oft-criticized OFR report on the financial stability risks posed by asset managers to the financial system, noted that critics claim that asset managers do not pose systemic risk, and then asked why the SEC extended regulation of money market funds if the OFR analysis was so flawed. White explained that the SEC “independently” proceeded with a rule on money market funds, not necessarily in response to the OFR analysis.
Hinojosa also asked whether the deliberative materials provided to members of FSOC adequately prepare them to make informed decisions on designation issues. Curry responded that the “extensive” materials provided, coupled with a “fairly elaborate process” by which such designation materials are developed, and the three-stage process for systemic designation do provide adequate communication and analysis of the records.
Hinojosa asked whether FSOC is examining the aggregate levels of debt in the economy as a potential driver of systemic risk. Cordray explained that the FSOC has looked at how debt and leverage could transmit risk throughout the financial system, which he argued is an important factor for the Council to examine.
Lack of Insurance Expertise
Luetkemeyer expressed concern about the data and analysis used to make decisions on non-bank designations, given the lack of insurance experts at other FSOC member agencies. Luetkemeyer pointed to information provided by the Government Accountability Office (GAO) that claimed that member agencies have limited insurance expertise to draw on. Matz refuted the allegation, and asserted that the NCUA has two staffers working on these issues, which she then admitted are “not experts in insurance.” Still, Matz explained that the designation of insurers is based only on the “financial services part of the business,” not the insurance portion. Cordray also acknowledged that he is “not an insurance expert” but explained that the staffs of FSOC and member agencies share expertise. He cautioned that focusing on insurance paints “only a partial picture” of the analysis and resources they have at their disposal. Massad noted that the GAO’s information on CFTC staff levels were outdated, since he took over the helm after the GAO report.
Process and Transparency Concerns
Clay asked whether the FSOC’s supplemental procedures announcement in February 2015 addressed GAO’s recommendations to improve processes and transparency. White explained that the Secretary of the Treasury, as Chairman of the FSOC, responded to the GAO-specific recommendations on process and transparency improvements, which she asserted “address a number of those” concerns expressed by the GAO. Gruenberg elaborated that the process changes provided opportunities for firm to engage in the process when proceeding from stage 1 to stage 2 analysis, as well as for those firms advancing from stage 2 to stage 3. Such procedural changes, he claimed, provide “greater insight for the firm” and offer “greater opportunity” for engagement between the firm and the regulators. Cordray argued that these changes demonstrate the FSOC’s responsiveness to congressional concerns about transparency issues, and he explained that transparency is “developing and evolving” within the agency, noting that is a relatively new body.
Clay asked about firms’ due process rights in the systemic designation process, to which Gruenberg responded that the procedures provide assurance that companies can submit information and engage with the FSOC’s staff on information being considered.
Clay also noted that General Electric (GE) Capital announced that it will shed assets and take other actions necessary to be de-designated as SIFI in collaboration with their regulators, and asked how the FSOC will work with GE in this respect. Curry explained that the regulator has an “ongoing dialogue” with the company with regard to their strategic changes, and that a decision on de-designation would be made once those plans are actually “executed.”
Oversight and Information Sharing
Rep. Sean Duffy (R-Wis.) asked the panel if they agreed that Congress is entitled for perform oversight of the FSOC, to which all witnesses raised to their hands. However when he asked if Congress is entitled to receive non-public information used to make designation determinations, none of the witnesses raised their hands.
Gruenberg said there is a line when it comes to dealing with confidential supervisory information and how much the FSOC can share with Congress, saying they must “strike a balance.”
Duffy noted that Congress receives non-public information from the FBI on terrorist threats that are matters of life and death, and said Congress should be able to receive information from the FSOC, who’s work does not affect the safety of Americans.
Massad said that, as general matter, transparency and accountability is important but regulators must think carefully about sharing non-public information.
Duffy then expressed concern about potential political considerations involved in SIFI determinations, citing that some have said certain firms are not designated due to their political clout.
Huizenga noted that all testifying members of FSOC believe that Congress should provide oversight of the body, but then noted that members were reluctant to provide deliberative materials to Congress on how the FSOC makes designation determinations. Massad responded that Congress is entitled to information that it desires, however he would need to check with staff to ensure they treat non-public, confidential information as such. Gruenberg explained that confidential supervisory information is generally not shared, however Congress generally gets the information it requests. Woodall noted that one confidential memorandum in the MetLife case has been made public. Watt explained that he would not make a “unilateral decision” to turn over such deliberative materials to Congress without conferring first with the other agencies, since the FSOC is a “collaborative body.” Huizenga then reiterated his interest in coming up with a “collaborative way” to get Congress access to those materials.
Stressed vs. Normal Market Conditions
Maloney asked why the FSOC analyzes whether a company is systemically important based on whether it would destabilize in stressed market conditions, rather than in normal times. Gruenberg explained that this approach was a product of the 2008 crisis experience, and added that regulators aim to provide a realistic stress scenario to understand the impact of a firm failure. White explained that the Council shared its approach in looking at a stress period in its regulatory guidance, and she added that policies that work in times of non-stress “don’t work so well in times of stress.” Curry explained that regulators have to assume that it is a period of stress to understand how risks would be transmitted across interconnected aspects of the financial system. He added that the regulators look at a range of historical experiences, but that the 2008 crisis “certainly stands out” in terms of its significance and breadth. Watt asserted that the specific wording in the statute requires the FSOC to examine the impact of “material financial distress at nonbank financial companies.”
Maloney asked whether it was appropriate for the FSOC to tell companies what actions they needed to take in order to be de-designated as a SIFI. In particular, Maloney asked whether it is the FSOC’s role to make “core business decisions” for the company or whether companies should make independent decisions for how to eliminate the risk. White agreed that maximum transparency in the process is “important” but agreed that the “FSOC should not be telling companies how to run or structure their business.”
FSB
Rep. Brad Sherman (D-Calif.) said that the Financial Stability Board (FSB) does not answer to the American people and asked how Congress can be sure that the FSB does not push the U.S. to take unnecessary actions regarding asset managers.
White noted that the Treasury, Federal Reserve, and SEC are on the Steering Committee of the FSB and stressed that “whatever comes out of the FSB” is not binding on the U.S., especially in areas of overlapping regulatory jurisdiction.
FSOC Designation Process
Sherman then asked if the FSOC focuses on liabilities and contingent liabilities in addition to assets when making designation decisions, including off-balance sheet items such as credit default swaps.
White said the FSOC looks at “all of the above.”
Sherman then asked if the FSOC has a good process to allow de-designation, to which White said there is a good process in place and that the FSOC is looking to enhance it.
Basel III Leverage Ratio
Rep. Frank Lucas (R-Okla.) expressed concern with the impact of the Basel III leverage ratio on derivatives clearing services, saying it will negatively impact the ability of his constituents to hedge risk related to farming and energy production. He asked how margin affects clearing members’ exposure to clearing houses.
Massad said that margin reduces exposure of clearing members, adding that while he generally supports the supplemental leverage ratio (SLR) and strong capital requirements, he has narrow concerns with it and wants to ensure that the rule is measuring exposure accurately. White agreed that the impacts need to be measured.
Curry stated that the main concern of his agency is to ensure that banks are strongly capitalized and that capital ratios are a fundamental part of safety and soundness. He explained that the leverage ratio is not a risk based measure, by definition, and that it would be “inconsistent” to use measure of risks in it. Gruenberg agreed with Curry and noted that since central counterparties (CCPs) ask intermediary banks to guarantee client positions and that potential losses from derivatives could greatly exceed posted margin, capital is needed to protect against downside risk.
Small Bank Regulatory Relief
Rep. Stephen Lynch (D-Mass.), said that he and some of his colleagues have been working with FDIC Vice Chairman Thomas Hoenig on a proposal to provide regulatory relief for small banks. He said the group has not accepted all of Hoenig’s recommendations but are focused on “a number” of them, specifically that to be eligible for relief a bank must: 1) not hold trading assets; 2) not be engaged in derivatives, except for interest rate and foreign exchange swaps; and 3) have a ratio of equity to assets of no less than 10 percent [under generally accepted account principles (GAAP) rules]. If a bank is eligible, he noted, it would be exempt from: 1) Basel risk-based standards; 2) stress tests, in some cases, or be tested every 18 months rather than annually; and 3) several call reports schedules. He then asked if the panel would be receptive to these ideas.
Gruenberg said he is sympathetic to the core concept that if a small institution is has a strong leverage ratio and does not engage in high risk activities, it would make sense to reduce its risk based capital standards and he explained that he is “open to pursuing this approach.”
Cordray noted that the CFPB tiered their mortgage rules for qualified mortgages and the ability to repay and made special provisions for smaller banks. He added that this is appropriate because default rates on loans from smaller creditors have had lower rates of default.
Rep. Scott Tipton (R-Colo.) asked how much time is spent concentrating on issues of community banks. Curry said that most of the institutions under the purview of the OCC are community banks and that regulators are looking at burdens that can be reduced, such as call report and capital requirements, so that smaller banks can continue to be viable.
FSOC Creating Systemic Risk
Rep. Ed Royce (R-Calif.) said that the FSOC is ignoring certain risk management strategies and directing institutions toward other ones and asked if such regulatory actions are creating systemic risk and how that can be avoided.
Curry said the FSOC is looking at some of the consequences of changes in the marketplace as some intuitions have changed their businesses, saying that risks created by changing institutions “warrant monitoring.” White said the FSOC needs to constantly keep in mind what impact their rules have and what mitigation actions may be needed.
OFR
Royce then asked the panel if there is any reason why all reports from the Office of Financial Research (OFR) should not be open for a public notice and comment process. No witnesses offered a reason not to allow this.
DOL Fiduciary
Rep. David Scott (D-Ga.) expressed concern about the Department of Labor’s (DOL) fiduciary rule, saying he is not sure that President Obama has been “properly advised” on how “devastating” the rulemaking will be on African-American families ability to build wealth. He said that education, financial advice, and the complexity and diversity of investment options affect wealth building and that the DOL’s rule would negatively impact the ability to access education about investments. He added that SEC Chair White has ceded its authority to promulgate a rule in this area, under Section 913 of Dodd-Frank to the DOL, and said the DOL should work with the SEC and the Financial Industry Regulatory Authority (FINRA).
Rep. Ann Wagner (R-Mo.) encouraged the witnesses to speak with the President about the DOL’s “misguided” rule, saying the President did not seem concerned with her views when she spoke to him the previous night.
Scott said there is a terrible problem with European regulators not coming to an agreement with U.S. regulators on equivalency determinations for CCPs. He said this situation will have a “devastating” effect on end-users, exchanges, and clearing houses. He asked for an update on the status of negotiations.
Massad said that European regulators have “pushed out the immediate deadline” and that their differences have narrowed. He said equivalence should have been granted “some time ago” but that both sides are working hard to resolve their issues.
Federal Home Loan Banks
Rep. Denny Heck (D-Wash.) said he is “deeply disappointed” that there was not more attention paid to the issue of equitable distribution of affordable housing after the forced merger of the Seattle and Des Moines Federal Home Loan Banks. He also expressed concern with a proposed rule to limit membership of Federal Home Loan Banks (FHLBs) and said it is time for Congress to look at the basic structure of FHLBs because they have not changed in over eighty years. He said it is up to Watt and his agency to come up with ideas on how to change the system.
Watt agreed that it is an ongoing obligation for Congress to look at every aspect of the financial markets and housing industry and that there are important needs in the home loan system that can be looked at.
FSOC Designation Impacts
Rep. Stevan Pearce (R-N.M.) said that SIFI designation will have an effect on the insurance market itself and that there will be “downstream” effects from the actions taken by the FSOC. Woodall agreed that if regulations are increased, business expenses will increase which impacts how these companies operate in the market. Massad said he “wouldn’t characterize it that way” and that the FSOC considers how it can protect people.
Pearce also asked if the FSOC itself could be contributing to systemic risk and how the FSOC assesses such downside risks. White said that the FSOC has to carry out its mission to assess risk to the financial system and that they directly consider all the impacts of their actions using a wide range of factors.
Wagner asked which U.S. agency agreed to an international SIFI designation of Prudential before there was a hearing. Woodall said it was Treasury.
When Wagner asked how U.S. businesses can be confident that these decisions are made by U.S. agencies and not international policymakers, Woodall said the domestic and international decisions are “technically separate” but are not in practice. He noted that the FSB was not created by a treaty approved by Congress but, rather, an ad hoc self-appointed group.
Asset Managers
Rep. Bruce Poliquin (R-Maine) asked Matz if there is anything the SEC should be doing to regulate asset managers and if she did not have other ideas for what they should do, why did she vote for their designation as SIFIs.
Matz said that she has great confidence in Chair White and explained that she noted to have the FSOC staff look at the activities of asset managers to see if they may be systemically important, not to designate them.
Poliquin said the FSOC should “move on” from looking at asset managers and said that designation could reduce the long term rate of return for investors.
FSOC Metrics
Rep. French Hill (R-Ark.) said there is a lack of transparency in the SIFI designation process and expressed concern that processes for routine decisions for non-bank determinations are not written down. Gruenberg said that the FSOC established a process for SIFI designations including a set of metrics and thresholds that an institution must pass to be designated that “any company can calculate.”
SIFI Threshold
Rep. Mia Love (R-Utah) noted that Curry previously stated that bank asset size is a “starting point” but not the sole determinant for tailoring supervision and asked what changes when a bank with simple operations goes from being $49 billion to $50 billion in assets. Curry noted that heighted capital and liquidity standards are triggered at that threshold.
Love asked if this automatic trigger makes sense, to which Curry replied that the asset threshold has value as a “first screen” and that the OCC focuses on risks presented by banks and then uses tailored supervision based on an analysis of this risk.
FSOC Judgment
Hill asked whether Dodd-Frank requires the Commission of the SEC to vote on an issue before the Chair votes at the FSOC if there are opposing views. White said that she consults with her fellow Commissioners and listens to differing points of view but that there is no formal requirement for a vote.
Hill then asked if another Commissioner could join the Chair to an FSOC meeting if he/she has another point of view. White said that according to protocol FSOC members can bring a “plus one,” which is usually a staff member, and that the current structure does not allow for an additional vote.
Rep. Tom Emmer (R-Minn.) asked Massad if he had concerns that the FSOC, which includes banking and housing regulators, has the ability to intervene in the CFTC’s markets and substitute their judgment for the CFTC’s. Massad said the FSOC does not substitute his judgment, as FSOC does not vote on things such as CFTC enforcement matters or rules, but rather brings together regulators to share information, which is beneficial to the overall financial system.
Emmer then asked if other CFTC commissioners have recourse for differences in opinion on topics considered at the FSOC. Massad said he tries to have good dialogue on FSOC issues with his fellow commissioners.
Emmer said Congress has the power of the purse but that the FSOC and OFR are funded by assessments on bank holding companies with $50 billion or more in assets which are placed into the Financial Research Fund, saying this money is given without oversight. He said he has a bill that would subject the FSOC and OFR to Congressional oversight.
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House Financial Services Committee
“Oversight of the Financial Stability Oversight Council”
Tuesday, December 8, 2015
Key Topics & Takeaways
- SIFI Designation: Neugebauer asked why non-banks have 11 factors in determining systemic importance while banks are only determined by their size.
- FSOC Meetings: Reps. Garrett and Pittenger noted the “secrecy” of FSOC meetings and Pittenger announced legislation he will be introducing today that requires the FSOC testify before Congress semiannually and allow members of Congress to attend FSOC meeting.
- Cybersecurity: Panelists agreed that cybersecurity is a “critical issue” for systemic risk in the financial markets and Gruenberg noted the “significant role” for entities to share cyber threat information with each other.
- CCP Recognition: Rep. Scott (D-Ga.) said there is a terrible problem with European regulators not coming to an agreement with U.S. regulators on equivalency determinations for CCPs, which he said will have a “devastating” effect on end-users, exchanges, and clearing houses. Massad said that European regulators have “pushed out the immediate deadline” and that their differences have narrowed, and reiterated that both sides are working hard to resolve their issues.
Witness
- Mary Jo White, Chair, Securities and Exchange Commission
- Timothy G. Massad, Chairman, Commodity Futures Trading Commission
- S. Roy Woodall, Jr., Independent Member with Insurance Expertise, Financial Stability Oversight Council
- Debbie Matz, Chairwoman, National Credit Union Administration
- Melvin L. Watt, Director, Federal Housing Finance Agency
- Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation
- Richard Cordray, Director, Bureau of Consumer Financial Protection
- Thomas J. Curry, Comptroller of the Currency, Office of the Comptroller of the Currency
Opening Statements
In his opening statement, Chairman Jeb Hensarling (R-Texas) stated that financial regulators “possessed every power necessary” to prevent the last financial crisis but failed to do so. Still, he argued, Washington “rewarded them” with sweeping new powers over the economy which is most evident in the creation of the Financial Stability Oversight Council (FSOC). He called the FSOC one of the most powerful federal entities to ever exist, and “unfortunately, also one of the least transparent and accountable.” Hensarling noted that the FSOC’s power is concentrated in the hands of the Democratic Party, with all but one of its members being the presidentially-appointed head of a federal agency. He said this structure “injects partisan politics in the regulatory process, erodes the agency’s independence, and harms accountability.”
Hensarling continued that no FSOC activity generates more controversy than its designation of non-bank systemically important financial institutions (SIFIs), and he commented that designations anoint firms as too-big-to-fail (TBTF). He said “today’s SIFI designations are tomorrow’s taxpayer-funded bailouts.” Hensarling further criticized that designation “ominously grants the Federal Reserve near de facto management authority over such institutions,” leaving “huge swaths” of the economy under federal government control. He said just the prospect of designation can eliminate entrepreneurial risk-taking, innovation and economic growth.
Another responsibility of the FSOC, Hensarling said, is to identify emerging threats to financial stability, yet the Council “refuses to look in the mirror.” He lamented that the most recent FSOC annual report omits any references to specific government policies or agencies, such as loose monetary policy or regulations such as the Volcker Rule that have reduced liquidity in bond markets.
Rep. Scott Garrett (R-N.J.) quipped that he wanted to “introduce” the FSOC members to Congress, the elected representatives of the public who send countless letters that regulators “routinely ignore.” He said Congress is open to the public and very transparent, and called on the FSOC to resemble Congress in that regard.
Ranking Member Maxine Waters (D-Calif.) said in her opening statement that the FSOC has fulfilled its mandate to monitor and respond to systemic risks. However, she said many Republicans seem to be going through “amnesia” regarding the financial crisis which she argued was rooted in the inability of regulators to coordinate and consider the interconnectedness of the financial sector. She commented that opponents of Dodd-Frank are too focused on dismantling Wall Street reforms by attacking the FSOC despite its success in promoting stability and growth. She credited the FSOC for designating firms for enhanced supervision to ensure that they “never again” engage in risky, unregulated activities, and added that this oversight is leading non-banking firms to consider whether simplifying their activities will lead to better returns for their investors.
Water closed by noting that the FSOC has attempted to conduct its work in a manner that is responsive to congressional and stakeholder concerns. She pointed to voluntary changes by the FSOC announced in February to its designation process as evidence of a greater focus on transparency and accountability.
Rep. Blaine Luetkemeyer (R-Mo.) stated that an inefficient regulatory structure can have major consequences for the financial system, and particularly for banks deemed SIFIs based on “arbitrary” thresholds. He said the FSOC’s powers “should alarm all Americans” and said the designation process is an example of efforts to expand government powers.
Mary Jo White, Chair, Securities and Exchange Commission
In her testimony, White stated that Dodd-Frank established the FSOC to provide comprehensive monitoring of the nation’s financial stability through a forum for regulatory coordination. As one of two capital markets regulators, she continued, the Securities and Exchange Commission (SEC) brings an important perspective to the FSOC and unique insight into potential financial stability risks posed by asset managers and investment products. She noted the SEC’s role in bringing relevant expertise to bear, and stressed the importance of the designation process for non-banks being data-driven with proper analysis. White also commented on the FSOC’s efforts to improve transparency, and said it should “continually study” ways to optimize its functioning.
Timothy G. Massad, Chairman, Commodity Futures Trading Commission
Massad, in his testimony, said his perspectives as an FSOC member are shaped by his responsibilities as the chairman of the Commodity Futures Trading Commission (CFTC). He listed his priorities for the FSOC as: 1) an effective regulatory framework for over-the-counter (OTC) swaps; 2) ensuring the strength and resiliency of clearinghouses; 3) ensuring the resiliency of markets; 4) cybersecurity; and 5) oversight of benchmarks.
S. Roy Woodall, Jr., Independent Member with Insurance Expertise, Financial Stability Oversight Council
In his testimony, Woodall said Congress should examine ways to improve the FSOC’s procedure and structure, particularly with respect to his position. He lamented the lack of explicit statutory authorities for his position and expressed his willingness to work with Congress to strengthen the role of his position so it can be more effective in contributing to the work of the FSOC.
Debbie Matz, Chairwoman, National Credit Union Administration
Matz, in her testimony, said the financial crisis made clear that financial markets could not quickly absorb the collapse of financial markets, and that the FSOC’s primary goal is to prevent another system-wide crisis. She defended the FSOC for recognizing the importance of transparency and public participation in its designation process, explaining that it has “moved deliberately” in developing the process for non-banks.
Melvin L. Watt, Director, Federal Housing Finance Agency
In his testimony, Watt emphasized the importance of the Federal Housing Finance Agency’s (FHFA) expertise in housing finance, especially considering that the most recent crisis had its roots in the unsafe and unsound housing finance decisions of “business entities and others.” He said the FHFA participates in all FSOC committees and deliberations, including designation processes for non-banks that include “extensive engagement” with the firms in question.
Martin J. Gruenberg, Chairman, Federal Deposit Insurance Corporation
Gruenberg, in his testimony, said the FSOC was established to address gaps in the regulatory framework that resulted from the inability of regulators to “see the whole picture” in the lead-up to the financial crisis. He said the FSOC facilitates information sharing, identifies risks, and promotes market discipline, and he touted the five FSOC annual reports and their demonstration of progress made since the crisis. He added that there are three areas of risk the FSOC is closely following that are of interest to the Federal Deposit Insurance Corporation (FDIC): 1) interest rate risk; 2) credit risk; and 3) cybersecurity.
Richard Cordray, Director, Consumer Financial Protection Bureau (CFPB)
In his testimony, Director Cordray stressed the “diminished” retirement and savings accounts and millions of jobs lost during the financial crisis. He continued that the FSOC and CFPB were created through congressional legislation, as well as the designation of some financial institutions as systemically important, to protect the financial markets and consumers, as market discipline and consumer protections are closely related.
Thomas J. Curry, Comptroller of the Currency, Office of the Comptroller of the Currency
Curry, in his testimony, explained that the duty of his office is to ensure that banks operate in a “safe and sound manner” and that the Office of the Comptroller of the Currency’s (OCC) primary focus is on prudential regulation. He continued that the OCC regulates different types of financial risk, to include liquidity, operational risk and credit, and that they also have expertise in asset management. Curry also commented that there have been “positive strides” in increasing the transparency for those institutions designated as systemically important.
Questions and Answers
SIFI Designation
Hensarling asked what harm there is in designating insurance companies as SIFIs. Woodall explained that the higher regulatory costs and higher priced products that result from the SIFI designation would put those companies designated in an “unlevel playing field” with competitors without the designation. He continued that financial activities should be used in the designation of SIFIs and non-bank SIFIs rather than just if financial distress within the company could threaten the U.S. financial system. Woodall commented that without using activities in SIFI designations, a SIFI could sell their risky activity to a company that is not designated, leaving the “lost” risk in the system.
Hensarling asked Matz whether an economic analysis was completed about what the SIFI designation would mean for policy holders prior to designating Prudential as such. Matz said there was not an analysis as “there wasn’t a mandate to do so,” but that the FSOC determined the company could pose an emerging threat.
Hensarling noted the 11 different factors to consider when designating a company as a SIFI and asked the extent to which leverage impacts the designation decision. Matz explained that the determination was based on how difficult the company’s financial activities, including derivatives, the extent of leverage, debt position and securities lending, would be to resolve should there be a problem.
Waters asked if legislative proposals that would rely on the FSOC to designate those other than “mega banks” for enhanced prudential standards would be ill-advised. Gruenberg said that the designation framework currently in place is “reasonable,” as it gives agencies discretion to tailor prudential standards to the size and/or complexity of the institution. He continued that the Fed has started to tailor banks under the $50 billion threshold while placing higher prudential standards on larger institutions.
Rep. Nydia Velazquez (D-N.Y.) asked if firms that have been designated as systemically important are able to meet with FSOC staff to review their status. Gruenberg said that firms are able to meet to reevaluate their designation.
Rep. Randy Neugebauer (R-Texas) asked if it is appropriate to set Basel standards and apply them to companies. Matz explained that “bright lines” have not been “drawn” regarding the standard and that the Council looks to see if there is material distress at a company that would have an impact on the U.S. financial system.
Neugebauer asked whether the 11 factors used in determining whether a non-bank is systemically important are appropriate and criticized this approach since banks are only designated based on their size. Matz and Watt agreed that the factors are appropriate for non-banks.
Rep. Randy Hultgren (R-Ill.) questioned the determination of insurance companies as systemically important. Matz commented that balance sheet activities are interconnected with other systemically important indicators. Regarding state supervision of insurance companies, she continued that while state insurers are not “ineffective,” the FSOC is mandated to analyze how activities can impact U.S. financial stability, adding that their staff conducted independent analysis.
Rep. Dennis Ross (R-Fla.) asked why the FSOC designated insurance companies as systemically important when the insurance expert on the Council disagreed with that decision, and he also inquired how insurers might pose a threat to the stability of the U.S. financial system. Woodall explained that it was a “professional disagreement” that included a “hearty debate.” Matz commented that the Council looks at a company’s derivatives positions and activities that are on and off the balance sheet.
Ross asked why asset managers have been designated as systemically important. Cordray noted that they have not been designated as SIFIs yet.
Rep. David Schweikert (R-Ariz.) asked Matz where exposure was found in the designation of insurance companies as systemically important. Matz explained that the derivatives position interconnected with other financial institutions created exposure. Garrett commented to Matz that “citing interconnectedness isn’t enough criteria.”
Rep. Mick Mulvaney (R-S.C.) asked Matz how she was briefed on the different designations of insurance companies. Matz explained that her staff and the FSOC staff briefed her and other FSOC members well in advance of the decision.
Global Impacts
Neugebauer referred to an Office of Financial Research (OFR) report that concluded the least global systemically important bank (G-SIB) was several times more systemic than major U.S. banks, and asked why U.S. banks still fall under the requirement for enhanced prudential standards due to their asset size. Matz and Watt said they were not familiar with the report.
Rep. Keith Rothfus (R-Pa.) raised concern that U.S. regulators are transferring “power” to the Financial Stability Board (FSB) and asked if foreign regulators should be “taking lead” on protecting financial institutions. Woodall answered that European insurers have a different background, accounting system and products, but that they are “united with sovereignty.”
Total Loss Absorbing Capacity
Rep. Gregory Meeks (D-N.Y.) raised the concern that the Total Loss Absorbing Capacity (TLAC) proposal requires banks to take on debt just as the Fed is about to raise interest rates. Gruenberg explained that the debt requirement is important as it lets banks fail without making taxpayers bail them out.
Impacts on Small and Community Banks
Rep. Steve Stivers (R-Ohio) asked the panel how many hours each agency spends discussing regulatory conflicts and “unnecessary regulations” that may harm small and community banks. Panelists did not have exact numbers but explained that staff members have discussions on the topic.
Garrett questioned the “secrecy” of FSOC meetings and asked the panelists if they would allow their commissioners to attend future meetings. Panelists did not answer.
Liquidity
Rep. Andy Barr (R-Ky.) noted that domestic liquidity standards are more stringent than international requirements when it comes to capital surcharges, the supplemental leverage ratio and TLAC. He asked if the potential lack of liquidity due to regulation could leave the financial markets with less capacity to endure shocks. White noted the concern of reduced liquidity in the markets and commented that the regulations “may be causing it.” She continued that there is an analysis being conducted to determine whether the Volcker Rule has had a negative impact on liquidity.
Rep. Bill Posey (R-Fla.) explained that Dodd-Frank mandates such as the Volcker Rule and Basel III’s capital regulations are “draining liquidity” from the fixed income markets. Cordray said that it is a “fair point” that different regulations and structures can adversely impact on liquidity, and added that the impacts on international competitiveness and liquidity in markets should be considered.
Posey then asked whether FSOC should be mandated to mitigate the risk of illiquidity in the bond market if there is compelling evidence that the regulations are creating systemic risk. Cordray answered that “if it does demonstrate that, it is fair game.”
GSEs
Barr asked if government-sponsored enterprises (GSEs) will be exempt from liquidity rules. Watt stated that GSEs are in a conservatorship and are currently exempt.
Minority Inclusion
Rep. Keith Ellison (D-Minn.) asked what policies GSEs can have post-conservatorship to include minorities in borrowing. Watt commented that “a lot can be done” depending on how GSE reform is conducted, but that price uncertainty for lenders is part of the “challenge” to the conservatorship, adding that the GSEs will need capital available to them.
Rep. Joyce Beatty (D-Ohio) noted Section 342 of the Dodd-Frank Act and asked the panel how they include minorities in decisions. Curry explained that his agency has an advisory committee that oversees issues facing minorities and that they enforce the Committee Reinforcement Act that has an impact on low to moderate income communities. Cordray commented that his agency enforces the Equal Credit Opportunity Act, and Gruenberg said that his agency enforces minority deposit institutions.
Rep. John Carney (D-Del.) asked the FSOC members what emerging systemic risks they can identify. Gruenberg stressed that cybersecurity is a “critical issue” and that there is a “significant role” for Congress to work with law enforcement and other entities to share information with each other, noting the cybersecurity information sharing legislation that Congress is working to pass out of conference. Curry agreed, adding that it is “imperative” that banks are able to repel cyber attacks and respond immediately. White mirrored the other members’ comments, adding that she “can’t emphasize enough the cyber risk.”
Innovation
Schweikert asked if innovation in the financial markets is “safer and more robust” than a centralized banking system. Curry commented that he is interested in the impact of innovation on the delivery of banking services.
Legislative Fixes
Rep. Robert Pittenger (R-N.C.) noted the lack of “adequate” transparency with the FSOC agencies and shared that legislation he will introduce today would provide greater transparency to the public by requiring the Council to testify semiannually before Congress and allow lawmakers to attend FSOC meetings, regardless if they are open to the public. Watt argued that the requirements were “not reasonable” and White added that the FSOC should be responsible to testify to Congress without the bill.
Rep. Luke Messer (R-Ind.) explained that H.R.3857 would prevent the FSOC from designating any other non-banks until 90 days after certain requirements are met, including that the Fed would have to establish prudential standards that would apply to systemically important non-banks, and that the FSOC would have to reevaluate in 2016 each previous SIFI designation and rescind designations that are no longer necessary. Woodall commented that more clarity on the “exit ramp” for SIFIs is needed.
Adequacy of Information for Decision Makers
Rep. Ruben Hinojosa (D-Texas) applauded the Council’s “progress to date” and emphasized the need to have a “bird’s eye” understanding of systemic risks posed by the financial services sector. He referenced the oft-criticized OFR report on the financial stability risks posed by asset managers to the financial system, noted that critics claim that asset managers do not pose systemic risk, and then asked why the SEC extended regulation of money market funds if the OFR analysis was so flawed. White explained that the SEC “independently” proceeded with a rule on money market funds, not necessarily in response to the OFR analysis.
Hinojosa also asked whether the deliberative materials provided to members of FSOC adequately prepare them to make informed decisions on designation issues. Curry responded that the “extensive” materials provided, coupled with a “fairly elaborate process” by which such designation materials are developed, and the three-stage process for systemic designation do provide adequate communication and analysis of the records.
Hinojosa asked whether FSOC is examining the aggregate levels of debt in the economy as a potential driver of systemic risk. Cordray explained that the FSOC has looked at how debt and leverage could transmit risk throughout the financial system, which he argued is an important factor for the Council to examine.
Lack of Insurance Expertise
Luetkemeyer expressed concern about the data and analysis used to make decisions on non-bank designations, given the lack of insurance experts at other FSOC member agencies. Luetkemeyer pointed to information provided by the Government Accountability Office (GAO) that claimed that member agencies have limited insurance expertise to draw on. Matz refuted the allegation, and asserted that the NCUA has two staffers working on these issues, which she then admitted are “not experts in insurance.” Still, Matz explained that the designation of insurers is based only on the “financial services part of the business,” not the insurance portion. Cordray also acknowledged that he is “not an insurance expert” but explained that the staffs of FSOC and member agencies share expertise. He cautioned that focusing on insurance paints “only a partial picture” of the analysis and resources they have at their disposal. Massad noted that the GAO’s information on CFTC staff levels were outdated, since he took over the helm after the GAO report.
Process and Transparency Concerns
Clay asked whether the FSOC’s supplemental procedures announcement in February 2015 addressed GAO’s recommendations to improve processes and transparency. White explained that the Secretary of the Treasury, as Chairman of the FSOC, responded to the GAO-specific recommendations on process and transparency improvements, which she asserted “address a number of those” concerns expressed by the GAO. Gruenberg elaborated that the process changes provided opportunities for firm to engage in the process when proceeding from stage 1 to stage 2 analysis, as well as for those firms advancing from stage 2 to stage 3. Such procedural changes, he claimed, provide “greater insight for the firm” and offer “greater opportunity” for engagement between the firm and the regulators. Cordray argued that these changes demonstrate the FSOC’s responsiveness to congressional concerns about transparency issues, and he explained that transparency is “developing and evolving” within the agency, noting that is a relatively new body.
Clay asked about firms’ due process rights in the systemic designation process, to which Gruenberg responded that the procedures provide assurance that companies can submit information and engage with the FSOC’s staff on information being considered.
Clay also noted that General Electric (GE) Capital announced that it will shed assets and take other actions necessary to be de-designated as SIFI in collaboration with their regulators, and asked how the FSOC will work with GE in this respect. Curry explained that the regulator has an “ongoing dialogue” with the company with regard to their strategic changes, and that a decision on de-designation would be made once those plans are actually “executed.”
Oversight and Information Sharing
Rep. Sean Duffy (R-Wis.) asked the panel if they agreed that Congress is entitled for perform oversight of the FSOC, to which all witnesses raised to their hands. However when he asked if Congress is entitled to receive non-public information used to make designation determinations, none of the witnesses raised their hands.
Gruenberg said there is a line when it comes to dealing with confidential supervisory information and how much the FSOC can share with Congress, saying they must “strike a balance.”
Duffy noted that Congress receives non-public information from the FBI on terrorist threats that are matters of life and death, and said Congress should be able to receive information from the FSOC, who’s work does not affect the safety of Americans.
Massad said that, as general matter, transparency and accountability is important but regulators must think carefully about sharing non-public information.
Duffy then expressed concern about potential political considerations involved in SIFI determinations, citing that some have said certain firms are not designated due to their political clout.
Huizenga noted that all testifying members of FSOC believe that Congress should provide oversight of the body, but then noted that members were reluctant to provide deliberative materials to Congress on how the FSOC makes designation determinations. Massad responded that Congress is entitled to information that it desires, however he would need to check with staff to ensure they treat non-public, confidential information as such. Gruenberg explained that confidential supervisory information is generally not shared, however Congress generally gets the information it requests. Woodall noted that one confidential memorandum in the MetLife case has been made public. Watt explained that he would not make a “unilateral decision” to turn over such deliberative materials to Congress without conferring first with the other agencies, since the FSOC is a “collaborative body.” Huizenga then reiterated his interest in coming up with a “collaborative way” to get Congress access to those materials.
Stressed vs. Normal Market Conditions
Maloney asked why the FSOC analyzes whether a company is systemically important based on whether it would destabilize in stressed market conditions, rather than in normal times. Gruenberg explained that this approach was a product of the 2008 crisis experience, and added that regulators aim to provide a realistic stress scenario to understand the impact of a firm failure. White explained that the Council shared its approach in looking at a stress period in its regulatory guidance, and she added that policies that work in times of non-stress “don’t work so well in times of stress.” Curry explained that regulators have to assume that it is a period of stress to understand how risks would be transmitted across interconnected aspects of the financial system. He added that the regulators look at a range of historical experiences, but that the 2008 crisis “certainly stands out” in terms of its significance and breadth. Watt asserted that the specific wording in the statute requires the FSOC to examine the impact of “material financial distress at nonbank financial companies.”
Maloney asked whether it was appropriate for the FSOC to tell companies what actions they needed to take in order to be de-designated as a SIFI. In particular, Maloney asked whether it is the FSOC’s role to make “core business decisions” for the company or whether companies should make independent decisions for how to eliminate the risk. White agreed that maximum transparency in the process is “important” but agreed that the “FSOC should not be telling companies how to run or structure their business.”
FSB
Rep. Brad Sherman (D-Calif.) said that the Financial Stability Board (FSB) does not answer to the American people and asked how Congress can be sure that the FSB does not push the U.S. to take unnecessary actions regarding asset managers.
White noted that the Treasury, Federal Reserve, and SEC are on the Steering Committee of the FSB and stressed that “whatever comes out of the FSB” is not binding on the U.S., especially in areas of overlapping regulatory jurisdiction.
FSOC Designation Process
Sherman then asked if the FSOC focuses on liabilities and contingent liabilities in addition to assets when making designation decisions, including off-balance sheet items such as credit default swaps.
White said the FSOC looks at “all of the above.”
Sherman then asked if the FSOC has a good process to allow de-designation, to which White said there is a good process in place and that the FSOC is looking to enhance it.
Basel III Leverage Ratio
Rep. Frank Lucas (R-Okla.) expressed concern with the impact of the Basel III leverage ratio on derivatives clearing services, saying it will negatively impact the ability of his constituents to hedge risk related to farming and energy production. He asked how margin affects clearing members’ exposure to clearing houses.
Massad said that margin reduces exposure of clearing members, adding that while he generally supports the supplemental leverage ratio (SLR) and strong capital requirements, he has narrow concerns with it and wants to ensure that the rule is measuring exposure accurately. White agreed that the impacts need to be measured.
Curry stated that the main concern of his agency is to ensure that banks are strongly capitalized and that capital ratios are a fundamental part of safety and soundness. He explained that the leverage ratio is not a risk based measure, by definition, and that it would be “inconsistent” to use measure of risks in it. Gruenberg agreed with Curry and noted that since central counterparties (CCPs) ask intermediary banks to guarantee client positions and that potential losses from derivatives could greatly exceed posted margin, capital is needed to protect against downside risk.
Small Bank Regulatory Relief
Rep. Stephen Lynch (D-Mass.), said that he and some of his colleagues have been working with FDIC Vice Chairman Thomas Hoenig on a proposal to provide regulatory relief for small banks. He said the group has not accepted all of Hoenig’s recommendations but are focused on “a number” of them, specifically that to be eligible for relief a bank must: 1) not hold trading assets; 2) not be engaged in derivatives, except for interest rate and foreign exchange swaps; and 3) have a ratio of equity to assets of no less than 10 percent [under generally accepted account principles (GAAP) rules]. If a bank is eligible, he noted, it would be exempt from: 1) Basel risk-based standards; 2) stress tests, in some cases, or be tested every 18 months rather than annually; and 3) several call reports schedules. He then asked if the panel would be receptive to these ideas.
Gruenberg said he is sympathetic to the core concept that if a small institution is has a strong leverage ratio and does not engage in high risk activities, it would make sense to reduce its risk based capital standards and he explained that he is “open to pursuing this approach.”
Cordray noted that the CFPB tiered their mortgage rules for qualified mortgages and the ability to repay and made special provisions for smaller banks. He added that this is appropriate because default rates on loans from smaller creditors have had lower rates of default.
Rep. Scott Tipton (R-Colo.) asked how much time is spent concentrating on issues of community banks. Curry said that most of the institutions under the purview of the OCC are community banks and that regulators are looking at burdens that can be reduced, such as call report and capital requirements, so that smaller banks can continue to be viable.
FSOC Creating Systemic Risk
Rep. Ed Royce (R-Calif.) said that the FSOC is ignoring certain risk management strategies and directing institutions toward other ones and asked if such regulatory actions are creating systemic risk and how that can be avoided.
Curry said the FSOC is looking at some of the consequences of changes in the marketplace as some intuitions have changed their businesses, saying that risks created by changing institutions “warrant monitoring.” White said the FSOC needs to constantly keep in mind what impact their rules have and what mitigation actions may be needed.
OFR
Royce then asked the panel if there is any reason why all reports from the Office of Financial Research (OFR) should not be open for a public notice and comment process. No witnesses offered a reason not to allow this.
DOL Fiduciary
Rep. David Scott (D-Ga.) expressed concern about the Department of Labor’s (DOL) fiduciary rule, saying he is not sure that President Obama has been “properly advised” on how “devastating” the rulemaking will be on African-American families ability to build wealth. He said that education, financial advice, and the complexity and diversity of investment options affect wealth building and that the DOL’s rule would negatively impact the ability to access education about investments. He added that SEC Chair White has ceded its authority to promulgate a rule in this area, under Section 913 of Dodd-Frank to the DOL, and said the DOL should work with the SEC and the Financial Industry Regulatory Authority (FINRA).
Rep. Ann Wagner (R-Mo.) encouraged the witnesses to speak with the President about the DOL’s “misguided” rule, saying the President did not seem concerned with her views when she spoke to him the previous night.
Scott said there is a terrible problem with European regulators not coming to an agreement with U.S. regulators on equivalency determinations for CCPs. He said this situation will have a “devastating” effect on end-users, exchanges, and clearing houses. He asked for an update on the status of negotiations.
Massad said that European regulators have “pushed out the immediate deadline” and that their differences have narrowed. He said equivalence should have been granted “some time ago” but that both sides are working hard to resolve their issues.
Federal Home Loan Banks
Rep. Denny Heck (D-Wash.) said he is “deeply disappointed” that there was not more attention paid to the issue of equitable distribution of affordable housing after the forced merger of the Seattle and Des Moines Federal Home Loan Banks. He also expressed concern with a proposed rule to limit membership of Federal Home Loan Banks (FHLBs) and said it is time for Congress to look at the basic structure of FHLBs because they have not changed in over eighty years. He said it is up to Watt and his agency to come up with ideas on how to change the system.
Watt agreed that it is an ongoing obligation for Congress to look at every aspect of the financial markets and housing industry and that there are important needs in the home loan system that can be looked at.
FSOC Designation Impacts
Rep. Stevan Pearce (R-N.M.) said that SIFI designation will have an effect on the insurance market itself and that there will be “downstream” effects from the actions taken by the FSOC. Woodall agreed that if regulations are increased, business expenses will increase which impacts how these companies operate in the market. Massad said he “wouldn’t characterize it that way” and that the FSOC considers how it can protect people.
Pearce also asked if the FSOC itself could be contributing to systemic risk and how the FSOC assesses such downside risks. White said that the FSOC has to carry out its mission to assess risk to the financial system and that they directly consider all the impacts of their actions using a wide range of factors.
Wagner asked which U.S. agency agreed to an international SIFI designation of Prudential before there was a hearing. Woodall said it was Treasury.
When Wagner asked how U.S. businesses can be confident that these decisions are made by U.S. agencies and not international policymakers, Woodall said the domestic and international decisions are “technically separate” but are not in practice. He noted that the FSB was not created by a treaty approved by Congress but, rather, an ad hoc self-appointed group.
Asset Managers
Rep. Bruce Poliquin (R-Maine) asked Matz if there is anything the SEC should be doing to regulate asset managers and if she did not have other ideas for what they should do, why did she vote for their designation as SIFIs.
Matz said that she has great confidence in Chair White and explained that she noted to have the FSOC staff look at the activities of asset managers to see if they may be systemically important, not to designate them.
Poliquin said the FSOC should “move on” from looking at asset managers and said that designation could reduce the long term rate of return for investors.
FSOC Metrics
Rep. French Hill (R-Ark.) said there is a lack of transparency in the SIFI designation process and expressed concern that processes for routine decisions for non-bank determinations are not written down. Gruenberg said that the FSOC established a process for SIFI designations including a set of metrics and thresholds that an institution must pass to be designated that “any company can calculate.”
SIFI Threshold
Rep. Mia Love (R-Utah) noted that Curry previously stated that bank asset size is a “starting point” but not the sole determinant for tailoring supervision and asked what changes when a bank with simple operations goes from being $49 billion to $50 billion in assets. Curry noted that heighted capital and liquidity standards are triggered at that threshold.
Love asked if this automatic trigger makes sense, to which Curry replied that the asset threshold has value as a “first screen” and that the OCC focuses on risks presented by banks and then uses tailored supervision based on an analysis of this risk.
FSOC Judgment
Hill asked whether Dodd-Frank requires the Commission of the SEC to vote on an issue before the Chair votes at the FSOC if there are opposing views. White said that she consults with her fellow Commissioners and listens to differing points of view but that there is no formal requirement for a vote.
Hill then asked if another Commissioner could join the Chair to an FSOC meeting if he/she has another point of view. White said that according to protocol FSOC members can bring a “plus one,” which is usually a staff member, and that the current structure does not allow for an additional vote.
Rep. Tom Emmer (R-Minn.) asked Massad if he had concerns that the FSOC, which includes banking and housing regulators, has the ability to intervene in the CFTC’s markets and substitute their judgment for the CFTC’s. Massad said the FSOC does not substitute his judgment, as FSOC does not vote on things such as CFTC enforcement matters or rules, but rather brings together regulators to share information, which is beneficial to the overall financial system.
Emmer then asked if other CFTC commissioners have recourse for differences in opinion on topics considered at the FSOC. Massad said he tries to have good dialogue on FSOC issues with his fellow commissioners.
Emmer said Congress has the power of the purse but that the FSOC and OFR are funded by assessments on bank holding companies with $50 billion or more in assets which are placed into the Financial Research Fund, saying this money is given without oversight. He said he has a bill that would subject the FSOC and OFR to Congressional oversight.
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