Senate Banking on the Role of the FSB
Senate Banking Committee
“The Role of the Financial Stability Board in the U.S. Regulatory Framework”
Wednesday, July 8, 2015
Key Topics & Takeaways
- FSB Transparency: Chairman Shelby (R-Ala.) noted that American regulators are required to follow certain public administrative processes, and asked if the FSB’s actions and decisions would pass legal muster in the U.S. Scalia responded that they would not because the FSB does not provide any notice or opportunity for the public to weigh in on proposals, nor a chance for companies to appeal designations.
- Designation of Asset Managers: Stevens said the designation of managed funds would not make them too-big-to-fail, but rather “too-burdened-to-succeed” by cutting returns on investments and hurting Americans trying to save for retirement.
- Off-Ramp from Designation: Scalia similarly called for regulators to disclose what must be done to be un-designated. He added that legal, empirical standards for designation are needed to ensure that firms are not subject to the FSOC’s “whims.”
Witnesses
- Dirk Kempthorne, President and CEO, American Council of Life Insurers
- Eugene Scalia, Gibson, Dunn & Crutcher
- Paul Schott Stevens, President and CEO, Investment Company Institute
- Peter Wallison, American Enterprise Institute
- Adam Posen, President, Peterson Institute for International Economics
Opening Statements
In his opening statement, Chairman Richard Shelby (R-Ala.) criticized the Financial Stability Board (FSB) for its lack of accountability to Congress or the American people. While Treasury Secretary Jacob Lew has testified that the FSB cannot designate firms as systemically important for the U.S., Shelby also noted that Lew could not recall any instances of the Financial Stability Oversight Council (FSOC) deviating from the FSB’s decisions. He questioned whether the FSB’s decisions have become a substitute for the independent judgment of U.S. regulators, and warned that its processes are “opaque and devoid of public participation.”
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) stressed the importance of international cooperation on financial regulation so that no market falls behind and permits the accumulation of unchecked risk. He said the U.S. has led global reforms in pushing for higher capital requirements, improving derivatives regulation, and building out resolution mechanisms, but that more must be done to address gaps in oversight and regulation of shadow banking, as recommended by the International Monetary Fund.
Testimony
Dirk Kempthorne – American Council of Life Insurers
Dirk Kempthorne, President and CEO of the American Council of Life Insurers, in his testimony offered three main observations: 1) the FSB should use an activities-based approach to identifying systemic risks rather than designating individual firms based on size; 2) the Federal Reserve should finalize its work on capital requirements in a way that is consistent with congressional intent; and 3) common sense and good policy should require that the U.S. write its own insurance capital standards before agreeing to any international standards.
Kempthorne commended the FSB and the FSOC for considering an activities-based approach with asset managers, but said he is troubled that no similar effort has been taken with insurers. He lamented that the FSB designated insurers as systemically important, with the FSOC then following suit without the insurers being given a chance to challenge the designations. He raised concerns that the FSB decisions have “overtaken” the FSOC’s own work.
Peter Wallison – American Enterprise Institute
In his testimony, Peter Wallison of the American Enterprise Institute said the FSB and Federal Reserve have made it clear that they want to impose prudential regulation on the shadow banking system, including broker-dealers, asset managers, mutual funds and any other financial firms not regulated as banks. He warned that the Fed and FSB are trying to control risk-taking in capital markets by controlling complex chains of financial transactions. He stressed that the Committee must act to reign in the FSOC if it does not want to see prudential regulation of America’s capital markets.
Paul Schott Stevens – Investment Company Institute
Paul Schott Stevens, President and CEO of the Investment Company Institute (ICI), said in his testimony that ICI has made numerous submissions to the FSB, including in consultations on asset managers, but that its experience in these consultations and in general with the FSB raise serious concerns. He pointed out that the FSB asserts a very broad mandate, yet most of its members and nearly its entire leadership consist of central bankers and finance ministers.
Stevens pointed out that the FSB describes its efforts in asset management as a review of “shadow banking,” and he called this a “disparaging term” that reflects FSB bias that all financial activity outside of banks is inadequately regulated and therefore is risky because it is not subject to bank standards. He also stated that the FSB has a lack of expertise in capital markets and “insufficient regard for empirical evidence on the regulated fund industry” that result in a methodology on designations that is based on “flawed assumptions and conjecture.”
Stevens said a sector-wide appraisal of activities is the best way to assess any potential risks in asset management, and commended the International Organization of Securities Commissions (IOSCO) for suggesting that a review of asset management activities take precedence over designation of individual firms. He suggested that the FSB would be far better informed if it were reconstituted to accord capital markets regulators an “equal place at the table” with banking regulators. He further suggested that the FSOC should give markets regulators more authority and provide firms under consideration the opportunity to de-risk prior to designation.
Eugene Scalia – Gibson, Dunn & Crutcher
In his testimony, Eugene Scalia of Gibson, Dunn & Crutcher said the FSB should give firms it is considering for designation a chance to present their cases just as litigants are entitled to a tribunal. He also stressed that the designation process of the FSOC cannot serve as a forum for implementing decisions already made by the FSB, and that it must follow procedures established by the Dodd-Frank Act. Scalia also expressed doubts about whether designation decisions from the FSOC provide a full account of what drives the decision-making process.
Adam Posen – Peterson Institute for International Economics
Adam Posen, President of the Peterson Institute for International Economics said in his testimony that international coordination serves American interests, and that the FSB is largely a product of U.S. efforts with the American voice remaining dominant. He credited the FSB for major contributions to diminishing regulatory arbitrage, and while he admitted that mistakes have been made, as with the designation of insurers, he denied that there are “inherent problems” with processes at the FSB and FSOC.
Question and Answer
Shelby asked the witnesses to elaborate on their concerns regarding the FSB’s process, accountability and transparency. Kempthorne argued that the close connection between the FSOC and the FSB should be investigated to promote greater transparency and communication with designated firms. Wallison agreed that more transparency is needed in the FSB process and expressed concern that U.S. capital markets might be put under prudential regulation. Stevens called for full records of the comments the FSB receives because there is no transparency in what influences the organization’s decisions.
Shelby then noted that American regulators are required to follow certain public administrative processes, and asked if the FSB’s actions and decisions would pass legal muster in the U.S. Scalia responded that they would not because the FSB does not provide any notice or opportunity for the public to weigh in on proposals, nor a chance for companies to appeal designations.
Sen. Robert Menendez (D-N.J.) asked Stevens how he would improve the FSB’s processes. Stevens answered that the FSB’s membership and leadership should be reconstituted to include insurance and securities regulators. Otherwise, he warned, the dominance of bank regulators would lead to bank capital rules being imposed on all industries.
Sen. Mark Kirk (R-Ill.) asked about the effects of changing the FSB process to allow for applying notice and comment procedures. Scalia responded that firms would be able to speak for themselves and promote more fairness.
While the FSB does not have the authority to dictate regulations, Sen. Elizabeth Warren (D-Mass.) said it does impact domestic rulemakings and so its processes should be transparent and data-driven.
Sen. Jeff Merkley (D-Ore.) expressed concern that international standard-setting bodies could possibly diminish the quality of U.S. regulations, and questioned the sufficiency of U.S. representation on the FSB. Kempthorne stressed that the FSB comprises mainly central bankers, is on a learning curve, and needs more expertise on insurance companies.
Importance of International Cooperation
Brown commented that regulators before the crisis fell victim to “cognitive capture,” in which they held the same worldview as the companies they oversaw and were less strict in regulation. He said one of the benefits of international regulation is that it helps to avoid regulatory arbitrage through any single nation protecting its own companies. Posen replied that banks and regulators were “pulling in the same direction” in the lead-up to the financial crisis, with both groups supporting the principle of self-regulation or less regulation in a “clear failure of regulation and supervision.” He said the FSB has been successful in breaking down such arbitrage by letting regulators challenge each other’s assumptions and ensure proper regulation.
Menendez said international coordination is not easy, but remains important. He said harmonization of regulation is needed to prevent risks from flowing to “dark corners” and credited the FSB for working to close gaps along jurisdictional lines.
Warren stated that financial institutions, because they can “move assets around in the blink of an eye,” effectively choose which country regulates many of their riskiest transactions. She explained that this is why global regulatory coordination is necessary, and that the FSB is critical as the main forum for such coordination.
Asset Managers
Shelby asked about the difference between banks and managed funds. Stevens replied that funds operate under different models that use little leverage, and that they act as agents rather than principles for the assets they manage. He said funds are also very transparent in their disclosures and that there is extensive regulation for them already.
Shelby asked Posen about his concerns regarding the FSB interfering in the U.S. financial system’s strength and diversity. Posen answered that his concerns are more theoretical than practical, but that it is important that U.S. regulators make it clear that capital markets and risk-taking are a good thing. He stated that the FSB may be rushing to judgments in some areas.
Stevens said the designation of managed funds would not make them too-big-to-fail, but rather “too-burdened-to-succeed” by cutting returns on investments and hurting Americans trying to save for retirement.
Sen. Dean Heller (R-Nev.) stated that rather than working to decrease systemic risks, regulators seem to be more preoccupied with just designating more firms. He asked the witnesses for their thoughts on Shelby’s regulatory relief bill, S. 1484, which includes reforms to the designation process. Kempthorne said having an “off-ramp” for systemic designations is critical, and that a clear process could help companies understand how to avoid designation in the first place. Stevens agreed that the bill would improve the designation process because the FSOC should be able to be specific in articulating what creates systemic risk.
Warren asked whether there is a process to reverse a designation from the FSB. Kempthorne said he had no knowledge of any such off-ramp, but that it would be very helpful for firms. He said he would support changes that add greater transparency to the FSB and promote more communication with firms.
Warren concluded that firms should have the opportunity to show that they do not pose systemic risks so that they can become un-designated by the FSB, as is allowed under FSOC designations.
Shelby expressed doubts about the practical ability of firms to be un-designated because there is no explicit process or transparency behind the original designation decision. Wallison agreed that if a firm does not understand why it was designated in the first place, then there is no way to exercise the off-ramp. Scalia similarly called for regulators to disclose what must be done to be un-designated. He added that legal, empirical standards for designation are needed to ensure that firms are not subject to the FSOC’s “whims.”
For more information on this hearing, please click here.
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Senate Banking Committee
“The Role of the Financial Stability Board in the U.S. Regulatory Framework”
Wednesday, July 8, 2015
Key Topics & Takeaways
- FSB Transparency: Chairman Shelby (R-Ala.) noted that American regulators are required to follow certain public administrative processes, and asked if the FSB’s actions and decisions would pass legal muster in the U.S. Scalia responded that they would not because the FSB does not provide any notice or opportunity for the public to weigh in on proposals, nor a chance for companies to appeal designations.
- Designation of Asset Managers: Stevens said the designation of managed funds would not make them too-big-to-fail, but rather “too-burdened-to-succeed” by cutting returns on investments and hurting Americans trying to save for retirement.
- Off-Ramp from Designation: Scalia similarly called for regulators to disclose what must be done to be un-designated. He added that legal, empirical standards for designation are needed to ensure that firms are not subject to the FSOC’s “whims.”
Witnesses
- Dirk Kempthorne, President and CEO, American Council of Life Insurers
- Eugene Scalia, Gibson, Dunn & Crutcher
- Paul Schott Stevens, President and CEO, Investment Company Institute
- Peter Wallison, American Enterprise Institute
- Adam Posen, President, Peterson Institute for International Economics
Opening Statements
In his opening statement, Chairman Richard Shelby (R-Ala.) criticized the Financial Stability Board (FSB) for its lack of accountability to Congress or the American people. While Treasury Secretary Jacob Lew has testified that the FSB cannot designate firms as systemically important for the U.S., Shelby also noted that Lew could not recall any instances of the Financial Stability Oversight Council (FSOC) deviating from the FSB’s decisions. He questioned whether the FSB’s decisions have become a substitute for the independent judgment of U.S. regulators, and warned that its processes are “opaque and devoid of public participation.”
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) stressed the importance of international cooperation on financial regulation so that no market falls behind and permits the accumulation of unchecked risk. He said the U.S. has led global reforms in pushing for higher capital requirements, improving derivatives regulation, and building out resolution mechanisms, but that more must be done to address gaps in oversight and regulation of shadow banking, as recommended by the International Monetary Fund.
Testimony
Dirk Kempthorne – American Council of Life Insurers
Dirk Kempthorne, President and CEO of the American Council of Life Insurers, in his testimony offered three main observations: 1) the FSB should use an activities-based approach to identifying systemic risks rather than designating individual firms based on size; 2) the Federal Reserve should finalize its work on capital requirements in a way that is consistent with congressional intent; and 3) common sense and good policy should require that the U.S. write its own insurance capital standards before agreeing to any international standards.
Kempthorne commended the FSB and the FSOC for considering an activities-based approach with asset managers, but said he is troubled that no similar effort has been taken with insurers. He lamented that the FSB designated insurers as systemically important, with the FSOC then following suit without the insurers being given a chance to challenge the designations. He raised concerns that the FSB decisions have “overtaken” the FSOC’s own work.
Peter Wallison – American Enterprise Institute
In his testimony, Peter Wallison of the American Enterprise Institute said the FSB and Federal Reserve have made it clear that they want to impose prudential regulation on the shadow banking system, including broker-dealers, asset managers, mutual funds and any other financial firms not regulated as banks. He warned that the Fed and FSB are trying to control risk-taking in capital markets by controlling complex chains of financial transactions. He stressed that the Committee must act to reign in the FSOC if it does not want to see prudential regulation of America’s capital markets.
Paul Schott Stevens – Investment Company Institute
Paul Schott Stevens, President and CEO of the Investment Company Institute (ICI), said in his testimony that ICI has made numerous submissions to the FSB, including in consultations on asset managers, but that its experience in these consultations and in general with the FSB raise serious concerns. He pointed out that the FSB asserts a very broad mandate, yet most of its members and nearly its entire leadership consist of central bankers and finance ministers.
Stevens pointed out that the FSB describes its efforts in asset management as a review of “shadow banking,” and he called this a “disparaging term” that reflects FSB bias that all financial activity outside of banks is inadequately regulated and therefore is risky because it is not subject to bank standards. He also stated that the FSB has a lack of expertise in capital markets and “insufficient regard for empirical evidence on the regulated fund industry” that result in a methodology on designations that is based on “flawed assumptions and conjecture.”
Stevens said a sector-wide appraisal of activities is the best way to assess any potential risks in asset management, and commended the International Organization of Securities Commissions (IOSCO) for suggesting that a review of asset management activities take precedence over designation of individual firms. He suggested that the FSB would be far better informed if it were reconstituted to accord capital markets regulators an “equal place at the table” with banking regulators. He further suggested that the FSOC should give markets regulators more authority and provide firms under consideration the opportunity to de-risk prior to designation.
Eugene Scalia – Gibson, Dunn & Crutcher
In his testimony, Eugene Scalia of Gibson, Dunn & Crutcher said the FSB should give firms it is considering for designation a chance to present their cases just as litigants are entitled to a tribunal. He also stressed that the designation process of the FSOC cannot serve as a forum for implementing decisions already made by the FSB, and that it must follow procedures established by the Dodd-Frank Act. Scalia also expressed doubts about whether designation decisions from the FSOC provide a full account of what drives the decision-making process.
Adam Posen – Peterson Institute for International Economics
Adam Posen, President of the Peterson Institute for International Economics said in his testimony that international coordination serves American interests, and that the FSB is largely a product of U.S. efforts with the American voice remaining dominant. He credited the FSB for major contributions to diminishing regulatory arbitrage, and while he admitted that mistakes have been made, as with the designation of insurers, he denied that there are “inherent problems” with processes at the FSB and FSOC.
Question and Answer
Shelby asked the witnesses to elaborate on their concerns regarding the FSB’s process, accountability and transparency. Kempthorne argued that the close connection between the FSOC and the FSB should be investigated to promote greater transparency and communication with designated firms. Wallison agreed that more transparency is needed in the FSB process and expressed concern that U.S. capital markets might be put under prudential regulation. Stevens called for full records of the comments the FSB receives because there is no transparency in what influences the organization’s decisions.
Shelby then noted that American regulators are required to follow certain public administrative processes, and asked if the FSB’s actions and decisions would pass legal muster in the U.S. Scalia responded that they would not because the FSB does not provide any notice or opportunity for the public to weigh in on proposals, nor a chance for companies to appeal designations.
Sen. Robert Menendez (D-N.J.) asked Stevens how he would improve the FSB’s processes. Stevens answered that the FSB’s membership and leadership should be reconstituted to include insurance and securities regulators. Otherwise, he warned, the dominance of bank regulators would lead to bank capital rules being imposed on all industries.
Sen. Mark Kirk (R-Ill.) asked about the effects of changing the FSB process to allow for applying notice and comment procedures. Scalia responded that firms would be able to speak for themselves and promote more fairness.
While the FSB does not have the authority to dictate regulations, Sen. Elizabeth Warren (D-Mass.) said it does impact domestic rulemakings and so its processes should be transparent and data-driven.
Sen. Jeff Merkley (D-Ore.) expressed concern that international standard-setting bodies could possibly diminish the quality of U.S. regulations, and questioned the sufficiency of U.S. representation on the FSB. Kempthorne stressed that the FSB comprises mainly central bankers, is on a learning curve, and needs more expertise on insurance companies.
Importance of International Cooperation
Brown commented that regulators before the crisis fell victim to “cognitive capture,” in which they held the same worldview as the companies they oversaw and were less strict in regulation. He said one of the benefits of international regulation is that it helps to avoid regulatory arbitrage through any single nation protecting its own companies. Posen replied that banks and regulators were “pulling in the same direction” in the lead-up to the financial crisis, with both groups supporting the principle of self-regulation or less regulation in a “clear failure of regulation and supervision.” He said the FSB has been successful in breaking down such arbitrage by letting regulators challenge each other’s assumptions and ensure proper regulation.
Menendez said international coordination is not easy, but remains important. He said harmonization of regulation is needed to prevent risks from flowing to “dark corners” and credited the FSB for working to close gaps along jurisdictional lines.
Warren stated that financial institutions, because they can “move assets around in the blink of an eye,” effectively choose which country regulates many of their riskiest transactions. She explained that this is why global regulatory coordination is necessary, and that the FSB is critical as the main forum for such coordination.
Asset Managers
Shelby asked about the difference between banks and managed funds. Stevens replied that funds operate under different models that use little leverage, and that they act as agents rather than principles for the assets they manage. He said funds are also very transparent in their disclosures and that there is extensive regulation for them already.
Shelby asked Posen about his concerns regarding the FSB interfering in the U.S. financial system’s strength and diversity. Posen answered that his concerns are more theoretical than practical, but that it is important that U.S. regulators make it clear that capital markets and risk-taking are a good thing. He stated that the FSB may be rushing to judgments in some areas.
Stevens said the designation of managed funds would not make them too-big-to-fail, but rather “too-burdened-to-succeed” by cutting returns on investments and hurting Americans trying to save for retirement.
Sen. Dean Heller (R-Nev.) stated that rather than working to decrease systemic risks, regulators seem to be more preoccupied with just designating more firms. He asked the witnesses for their thoughts on Shelby’s regulatory relief bill, S. 1484, which includes reforms to the designation process. Kempthorne said having an “off-ramp” for systemic designations is critical, and that a clear process could help companies understand how to avoid designation in the first place. Stevens agreed that the bill would improve the designation process because the FSOC should be able to be specific in articulating what creates systemic risk.
Warren asked whether there is a process to reverse a designation from the FSB. Kempthorne said he had no knowledge of any such off-ramp, but that it would be very helpful for firms. He said he would support changes that add greater transparency to the FSB and promote more communication with firms.
Warren concluded that firms should have the opportunity to show that they do not pose systemic risks so that they can become un-designated by the FSB, as is allowed under FSOC designations.
Shelby expressed doubts about the practical ability of firms to be un-designated because there is no explicit process or transparency behind the original designation decision. Wallison agreed that if a firm does not understand why it was designated in the first place, then there is no way to exercise the off-ramp. Scalia similarly called for regulators to disclose what must be done to be un-designated. He added that legal, empirical standards for designation are needed to ensure that firms are not subject to the FSOC’s “whims.”
For more information on this hearing, please click here.