HFSC Oversight and Investigations Hearing on FSOC Non-Bank SIFI Designations
House
Financial Services Subcommittee on Oversight and Investigations
“Oversight
of the Financial Stability Oversight Council:
Due
Process and Transparency in Non-Bank SIFI Designations”
Thursday, November 19, 2015
Key
Topics & Takeaways
- Due Process:
Rep. Randy Hultgren (R-Ill.) also asked whether the FSOC provides adequate due
process. Scott stated that it does not, and that if the FSOC will not do so on
its own then Congress should act to require it.
- Plausible Risks:
Macey explained that any analysis in risk regulation should be based on two
factors: 1) the severity of an event; and 2) the probability of the event
occurring. He stated that the FSOC has asserted that because its statute does
not expressly incorporate a standard of likelihood, it can make decisions based
on risks “that lack even basic plausibility.”
- Asset Managers:
Rep. Ann Wagner (R-Mo.) stated that systemic designations are having a broad
impact, and noted that one estimate has suggested that designating asset
managers would cost investors as much as 25 percent of their returns over the
long-term.
Witnesses
- Jonathan R. Macey,
Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law,
Yale Law School
- Hal S. Scott,
Director, Program on International Financial Systems, Harvard Law School
- Adam J. White,
Visiting Fellow, The Hoover Institution
- Robert Hockett,
Edward Cornell Professor of Law, Cornell Law School
Opening Statements
In
his opening statement, Chairman Sean Duffy (R-Wis.) said the Dodd-Frank Act
gave more authority to the same regulators that missed the financial crisis and
that, in practice, the structure of the Financial Stability Oversight Council
(FSOC) allows the Treasury Secretary to override other financial regulators. He
expressed concern that the FSOC process is “riddled with opacity and
uncertainty” and that the process of designating firms as systemically
important financial institutions (SIFIs) may be unconstitutional. He also said
the process of non-bank SIFI designations violates separation of power
objectives by allowing the FSOC to be “judge, jury, and executioner,” and
voiced concern that the FSOC follows the lead of the Financial Stability Board
(FSB), which he said is “inconsistent with congressional intent.”
Ranking
Member Al Green (D-Texas.), in his opening statement, said there is a double
standard apparent when hard working Americans have to litigate their problems
in court but multi-billion dollar companies can litigate their issues in
Congress.
Rep.
Michael Fitzpatrick (R-Pa.) said transparency is what sets the U.S. apart from
the rest of the world and that it allows Congress to discover shortcomings in
government agencies and address them. He then called the FSOC an example of
“runaway bureaucracy.”
Testimony
Jonathan
R. Macey, Sam Harris Professor of Corporate Law, Corporate Finance and
Securities Law, Yale Law School
In
his testimony,
Macey said the FSOC was given the impossible task of regulating systemic risk,
which it cannot define, and that the Council is performing “very poorly.” He
stated that the FSOC is having difficulty coming up with objective regulations
that are non-idiosyncratic and not ad hoc.
Macey
explained that the regulator can make two types of mistakes: Type 1, in which a
financial institution is not labeled SIFI when it actually is, and Type 2, in
which an institution is labeled a SIFI when it actually is not. He said that
for a regulator there are no consequences for making a Type 2 error, apart from
less competition in the market and higher prices, but that a Type 1 mistake
would be “catastrophic.” Thus he said the “game will be tilted in favor or
over-designation.”
Macey also said the FSOC is in danger of increasing systemic risk because its
narrow criteria for determinations will lead to institutions “herding” into
certain risk strategies.
Hal
S. Scott, Director, Program on International Financial Systems, Harvard Law
School
In
his testimony,
Scott stated that: 1) the FSOC is an inadequate substitute for real reform of
the regulatory structure; 2) the FSOC’s role of designating non-banks as SIFIS
is ill-advised; and 3) the non-bank designation process should be revised to
provide adequate transparency including cost-benefit analysis. He said the FSOC
has no method of enforcing its decisions and that its ability to coordinate a
fragmented regulatory structure is limited.
Adam
J. White, Visiting Fellow, The Hoover Institution
White,
in his testimony,
said the FSOC raises significant concerns in the ways it does business, saying
it takes a narrow view and uses “secret evidence” to make determinations. He
said the problems seen today are symptoms of the breadth of power given to the
FSOC and that while efficiency is important, checks and balances are essential.
White stressed that it is crucial to reform the FSOC now before the agency’s
structure becomes the “new normal.”
Robert
Hockett, Edward Cornell Professor of Law, Cornell Law School
In
his testimony,
Hockett said the FSOC is a pragmatic way of dealing with the dilemmas of: 1)
how to reconcile efficiency with government constraint; and 2) reconciling
regulatory depth with regulatory breadth. He added that the FSOC conducts
its operations “entirely in keeping” with the norms of the Administrative
Procedures Act (APA) and is “not an outlier” when it comes to the actions of
other regulators.
Questions and Answers
Due
Process
Duffy
began by asking if it is fair to firms to go through the designation process
without being able to confront evidence through a hearing process and asked
what the benefit is of withholding evidence. White replied that the designation
process is not fair and that it would be best to have an “adversarial” process
that allows both sides to be tested. White added that he does not see a benefit
to withholding evidence from firms being considered for designation. Macey noted
that he was not able to obtain access to the information that the FSOC used to
make its designation determinations, saying this situation is “perplexing and
unfair.”
Rep.
Scott Tipton (R-Colo.) asked whether Congress should be involved in the
rulemaking process. White answered that it “absolutely” should be involved and
warned against putting too much trust in regulators.
Rep.
Bruce Poliquin (R-Maine) stated that the U.S. is a country of laws and firms
should expect due process. He asked whether the SIFI designation process
provides proper due process. Scott answered that it does not.
Rep.
Randy Hultgren (R-Ill.) also asked whether the FSOC provides adequate due
process. Scott stated that it does not, and that if the FSOC will not do so on
its own then Congress should act to require it.
Rep.
Emanuel Cleaver (D-Mo.) noted that one of Macey’s concerns was that the FSOC
does not distinguish between plausible and implausible risks. Macey explained
that any analysis in risk regulation should be based on two factors: 1) the
severity of an event; and 2) the probability of the event occurring. He stated
that FSOC has asserted that because its statute does not expressly incorporate
a standard of likelihood, it can make decisions based on risks “that lack even
basic plausibility.”
Rep.
Ann Wagner (R-Mo.) noted that Dodd-Frank does not require the FSOC to justify
its designations based on a substantial likelihood of failure. White responded
that Congress should put such a standard on the FSOC, and that Congress must
identify more specific standards.
Interconnectedness
Fitzpatrick
raised Section 113 of the Dodd-Frank Act, which he said lays out ten factors
the FSOC must consider when evaluating non-bank entities for designation. He
asked if the FSOC explains how it weights these factors. Scott replied that the
FSOC does not explain its weights, but that there is a general methodology that
is aimed at the idea of interconnectedness.
Fitzpatrick
asked if non-bank companies pose an interconnectivity risk. Scott answered that
that while they are interconnected, this alone does not provide justification
for designation. He insisted that all firms in the financial sector are
connected. Macey agreed and added that connectedness alone does not say much
about whether one firm’s failure will lead to other failures.
Wagner
stated that systemic designations are having a broad impact, and noted that one
estimate has suggested that designating asset managers would cost investors as
much as 25 percent of their returns over the long-term.
Wagner
noted that the FSOC has said it will try an activities-based approach for
determining systemic risks in the asset management industry, and asked whether
it should do the same for insurers. Macey answered that regulatory initiatives,
from a single risk regulator, that hurt diversification increase systemic risk
by diminishing the societal benefits of heterogeneity.
Poliquin
also raised the 25 percent estimate of lost returns that Wagner mentioned, and
commented that at a time when many Americans are struggling to save for
retirement, the government should want to make sure it is helping small
investors. He rejected the idea that asset managers can pose a systemic risk to
the economy and argued that designating them as SIFIs and hurting investor returns
“does not make sense.”
Poliquin
asked if firms should have clear written criteria for what would lead them to
being designated, as well as clear off-ramps from designation. Macey replied
that the lack of any such guidelines is a significant concern.
Diversification
Tipton
stated that he is very concerned that Dodd-Frank is incentivizing a broader set
of regulations. Macey replied that Dodd-Frank is going against the traditional
idea of risk regulation that recognized the “virtue of diversification” and is
instead putting all the risks in one basket and depending on the regulators too
heavily to watch it. Scott added that he does not have confidence in the FSOC
to reach the right decisions and that the consequences of designation should be
known before the decision is made.
For
more information on this hearing, please click here.
House
Financial Services Subcommittee on Oversight and Investigations
“Oversight
of the Financial Stability Oversight Council:
Due
Process and Transparency in Non-Bank SIFI Designations”
Thursday, November 19, 2015
Key
Topics & Takeaways
- Due Process:
Rep. Randy Hultgren (R-Ill.) also asked whether the FSOC provides adequate due
process. Scott stated that it does not, and that if the FSOC will not do so on
its own then Congress should act to require it. - Plausible Risks:
Macey explained that any analysis in risk regulation should be based on two
factors: 1) the severity of an event; and 2) the probability of the event
occurring. He stated that the FSOC has asserted that because its statute does
not expressly incorporate a standard of likelihood, it can make decisions based
on risks “that lack even basic plausibility.” - Asset Managers:
Rep. Ann Wagner (R-Mo.) stated that systemic designations are having a broad
impact, and noted that one estimate has suggested that designating asset
managers would cost investors as much as 25 percent of their returns over the
long-term.
Witnesses
- Jonathan R. Macey,
Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law,
Yale Law School - Hal S. Scott,
Director, Program on International Financial Systems, Harvard Law School - Adam J. White,
Visiting Fellow, The Hoover Institution - Robert Hockett,
Edward Cornell Professor of Law, Cornell Law School
Opening Statements
In
his opening statement, Chairman Sean Duffy (R-Wis.) said the Dodd-Frank Act
gave more authority to the same regulators that missed the financial crisis and
that, in practice, the structure of the Financial Stability Oversight Council
(FSOC) allows the Treasury Secretary to override other financial regulators. He
expressed concern that the FSOC process is “riddled with opacity and
uncertainty” and that the process of designating firms as systemically
important financial institutions (SIFIs) may be unconstitutional. He also said
the process of non-bank SIFI designations violates separation of power
objectives by allowing the FSOC to be “judge, jury, and executioner,” and
voiced concern that the FSOC follows the lead of the Financial Stability Board
(FSB), which he said is “inconsistent with congressional intent.”
Ranking
Member Al Green (D-Texas.), in his opening statement, said there is a double
standard apparent when hard working Americans have to litigate their problems
in court but multi-billion dollar companies can litigate their issues in
Congress.
Rep.
Michael Fitzpatrick (R-Pa.) said transparency is what sets the U.S. apart from
the rest of the world and that it allows Congress to discover shortcomings in
government agencies and address them. He then called the FSOC an example of
“runaway bureaucracy.”
Testimony
Jonathan
R. Macey, Sam Harris Professor of Corporate Law, Corporate Finance and
Securities Law, Yale Law School
In
his testimony,
Macey said the FSOC was given the impossible task of regulating systemic risk,
which it cannot define, and that the Council is performing “very poorly.” He
stated that the FSOC is having difficulty coming up with objective regulations
that are non-idiosyncratic and not ad hoc.
Macey
explained that the regulator can make two types of mistakes: Type 1, in which a
financial institution is not labeled SIFI when it actually is, and Type 2, in
which an institution is labeled a SIFI when it actually is not. He said that
for a regulator there are no consequences for making a Type 2 error, apart from
less competition in the market and higher prices, but that a Type 1 mistake
would be “catastrophic.” Thus he said the “game will be tilted in favor or
over-designation.”
Macey also said the FSOC is in danger of increasing systemic risk because its
narrow criteria for determinations will lead to institutions “herding” into
certain risk strategies.
Hal
S. Scott, Director, Program on International Financial Systems, Harvard Law
School
In
his testimony,
Scott stated that: 1) the FSOC is an inadequate substitute for real reform of
the regulatory structure; 2) the FSOC’s role of designating non-banks as SIFIS
is ill-advised; and 3) the non-bank designation process should be revised to
provide adequate transparency including cost-benefit analysis. He said the FSOC
has no method of enforcing its decisions and that its ability to coordinate a
fragmented regulatory structure is limited.
Adam
J. White, Visiting Fellow, The Hoover Institution
White,
in his testimony,
said the FSOC raises significant concerns in the ways it does business, saying
it takes a narrow view and uses “secret evidence” to make determinations. He
said the problems seen today are symptoms of the breadth of power given to the
FSOC and that while efficiency is important, checks and balances are essential.
White stressed that it is crucial to reform the FSOC now before the agency’s
structure becomes the “new normal.”
Robert
Hockett, Edward Cornell Professor of Law, Cornell Law School
In
his testimony,
Hockett said the FSOC is a pragmatic way of dealing with the dilemmas of: 1)
how to reconcile efficiency with government constraint; and 2) reconciling
regulatory depth with regulatory breadth. He added that the FSOC conducts
its operations “entirely in keeping” with the norms of the Administrative
Procedures Act (APA) and is “not an outlier” when it comes to the actions of
other regulators.
Questions and Answers
Due
Process
Duffy
began by asking if it is fair to firms to go through the designation process
without being able to confront evidence through a hearing process and asked
what the benefit is of withholding evidence. White replied that the designation
process is not fair and that it would be best to have an “adversarial” process
that allows both sides to be tested. White added that he does not see a benefit
to withholding evidence from firms being considered for designation. Macey noted
that he was not able to obtain access to the information that the FSOC used to
make its designation determinations, saying this situation is “perplexing and
unfair.”
Rep.
Scott Tipton (R-Colo.) asked whether Congress should be involved in the
rulemaking process. White answered that it “absolutely” should be involved and
warned against putting too much trust in regulators.
Rep.
Bruce Poliquin (R-Maine) stated that the U.S. is a country of laws and firms
should expect due process. He asked whether the SIFI designation process
provides proper due process. Scott answered that it does not.
Rep.
Randy Hultgren (R-Ill.) also asked whether the FSOC provides adequate due
process. Scott stated that it does not, and that if the FSOC will not do so on
its own then Congress should act to require it.
Rep.
Emanuel Cleaver (D-Mo.) noted that one of Macey’s concerns was that the FSOC
does not distinguish between plausible and implausible risks. Macey explained
that any analysis in risk regulation should be based on two factors: 1) the
severity of an event; and 2) the probability of the event occurring. He stated
that FSOC has asserted that because its statute does not expressly incorporate
a standard of likelihood, it can make decisions based on risks “that lack even
basic plausibility.”
Rep.
Ann Wagner (R-Mo.) noted that Dodd-Frank does not require the FSOC to justify
its designations based on a substantial likelihood of failure. White responded
that Congress should put such a standard on the FSOC, and that Congress must
identify more specific standards.
Interconnectedness
Fitzpatrick
raised Section 113 of the Dodd-Frank Act, which he said lays out ten factors
the FSOC must consider when evaluating non-bank entities for designation. He
asked if the FSOC explains how it weights these factors. Scott replied that the
FSOC does not explain its weights, but that there is a general methodology that
is aimed at the idea of interconnectedness.
Fitzpatrick
asked if non-bank companies pose an interconnectivity risk. Scott answered that
that while they are interconnected, this alone does not provide justification
for designation. He insisted that all firms in the financial sector are
connected. Macey agreed and added that connectedness alone does not say much
about whether one firm’s failure will lead to other failures.
Wagner
stated that systemic designations are having a broad impact, and noted that one
estimate has suggested that designating asset managers would cost investors as
much as 25 percent of their returns over the long-term.
Wagner
noted that the FSOC has said it will try an activities-based approach for
determining systemic risks in the asset management industry, and asked whether
it should do the same for insurers. Macey answered that regulatory initiatives,
from a single risk regulator, that hurt diversification increase systemic risk
by diminishing the societal benefits of heterogeneity.
Poliquin
also raised the 25 percent estimate of lost returns that Wagner mentioned, and
commented that at a time when many Americans are struggling to save for
retirement, the government should want to make sure it is helping small
investors. He rejected the idea that asset managers can pose a systemic risk to
the economy and argued that designating them as SIFIs and hurting investor returns
“does not make sense.”
Poliquin
asked if firms should have clear written criteria for what would lead them to
being designated, as well as clear off-ramps from designation. Macey replied
that the lack of any such guidelines is a significant concern.
Diversification
Tipton
stated that he is very concerned that Dodd-Frank is incentivizing a broader set
of regulations. Macey replied that Dodd-Frank is going against the traditional
idea of risk regulation that recognized the “virtue of diversification” and is
instead putting all the risks in one basket and depending on the regulators too
heavily to watch it. Scott added that he does not have confidence in the FSOC
to reach the right decisions and that the consequences of designation should be
known before the decision is made.
For
more information on this hearing, please click here.