The Financial Stability Oversight Council (FSOC) approved on Tuesday afternoon the criteria it will use for determining whether an insurer is “systemically significant” and thereby suitable for stricter federal regulation. The FSOC unanimously approved the rule, which itself is consistent with the regulation the FSOC proposed in November.
The final regulation establishes a three-step screening process for determining whether a non-bank such as an insurer should be subject to regulation by the Federal Reserve Board as well as state regulators because, under the criteria established under the Dodd-Frank Act, it represents a potential risk to the stability of the U.S. financial system.
Brian Gardner, an analyst for Keefe, Bruyette & Woods, Inc., New York, says the final rule establishes a process in which the second and third steps that will enable the FSOC to narrow down which firms will ultimately designated as posing a potential material risk to the U.S. financial system.
He said the last two stages will be more qualitative than first step. Ultimately, it will be a judgment call as to whether a non-bank poses a material risk to the U.S. financial system.
Gardner cautioned that SIFI designation will be a very long process, and an uncertain one by design. “The SIFI designation “will ultimately not be reduced to simple rules and calculations,” he said.
“This does not provide a lot of clarity in the ultimate determination,” Gardner said, but “it does provide a little clarity as to how process will work.”
He said the Treasury Department is trying to get this process finalized by the end of the year, but it would not be a one-time exercise. This would be a fluid process in which companies could be designated as SIFI and later lose that designation..
Schuman, a life analyst also with Keefe, Bruyette & Woods, said that the first thing he noticed about the final rule is that the Stage 1 screen proposed last fall has been maintained.
“The implications are similar,” Schuman said, but he noted that the final rule provides more detail as to how the FSOC will apply those screens.
He said the final rule also clarified some details about the metrics that will be used, including calculation of derivative liabilities.
Schuman also said that the final rule indicates FSOC examiners will “take an expansive view of defining a company’s debt.”
That means that besides calculating holding company debt, some operating debt will also be involved in the calculations as to potential systemic risk, Schuman said.
A key change in the final rule from the proposal is that it clarifies the applicability of the confidentiality provisions to information collected by the FSOC as part of the determination process.
This was a key request of insurers through the notice-and-comment process prompted by the FSOC’s decision to re-propose the rule last November.
It ends a process for establishing the guidelines that began in the fall of 2010, soon after passage of the Dodd-Frank financial services law that created the FSOC and the additional oversight of financial institutions deemed necessary to avert a rerun of the 2007-2009 financial crisis.
The final rule satisfies a key demand of insurers: that a qualitative measuring system be used as the initial screen to determine whether a non-bank should be designated as SIFI.
At the center of this qualitative screening method is the standard that a nonbank financial company will be subject to further evaluation if it has at least $50 billion of total consolidated assets and meets or exceeds any one of the following thresholds:
- $30 billion in gross notional credit default swaps outstanding for which the nonbank financial company is the reference entity;
- $3.5 billion in derivative liabilities;
- $20 billion of total debt outstanding;
- 15 to 1 leverage ratio, as measured by total consolidated assets (excluding separate accounts) to total equity; or
- 10 percent ratio of short-term debt (having a remaining maturity of less than 12 months) to total consolidated assets.
The second stage will be an analysis of the nonbank financial companies identified in Stage 1 using a broad range of information available to the FSOC primarily through existing public and regulatory sources.
The third stage will be for the FSOC to contact each nonbank financial company that the Council believes merits further review to collect information directly from the company that was not available in the prior stages.
Each nonbank financial company that is reviewed in Stage 3 will be notified that it is under consideration and be provided an opportunity to submit written materials related to the FSOC’s consideration of the company for a proposed determination.
Under the FSOC final rule, companies will receive written notice and an opportunity to contest the continuation of the determination. “Institutions will indeed have a chance to appeal,” a Treasury official who declined to be identified by name said.
The official said that the FSOC hopes to have the SIFI determination process ready to go by the end of the year.
The official also confirmed that the FSOC is coordinating with International Association of Insurance Supervisors so that the rules are aligned.
Regulators are hopeful of having International SIFI, the so-called “G-SIFI,” designated at the earliest in first quarter of 2013, the official said. Federal Insurance Office director Michael McRaith is on the executive committee of the IAIS.
At the same time, Treasury officials said that, even if a nonbank meets none of those criteria, the FSOC still has the authority to designate it as a SIFI.
The FSOC must do so in writing, with an accompanying letter to Congress, that thoroughly justifies such a decision.
In addition, the FSOC “may consider any nonbank financial company for a determination if the agency believes the company could pose a threat to U.S. financial stability,” the proposal says.