US regulators outline new rules to toughen financial oversight of non-banks

Top US financial regulators on Friday announced a series of proposals to strengthen the process by which investment managers, insurers and other nonbank financial groups are swept into a more stringent regulatory regime.

The new guidance from the Financial Stability Oversight Council — a group of the country’s top financial regulators led by the Treasury department — details how it would go about singling out individual non-bank financial entities for supervision by the Federal Reserve, which would mean closer scrutiny.

The designation would hinge on FSOC’s determining that “material financial distress at the company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company” posed a threat to US financial stability.

The guidance was accompanied by a second proposal that, for the first time, outlined the analytic framework that FSOC would use to identify, evaluate and respond to potential risks.

“Today’s proposals are important to ensuring the council has a rigorous approach to identify, assess, and address risks to our financial system,” Treasury secretary Janet Yellen said on Friday.

Jay Powell, the Federal Reserve chair, said the changes would “create a balanced approach” to managing potential risks and ensure that “all tools available to the FSOC will remain on equal footing”.

The proposals come on the heels of the worst banking turbulence since the global financial crisis more than a decade ago. To stem fears of contagion, government authorities stepped in to shore up the sector, ensuring that uninsured depositors were paid back and rolling out an emergency lending facility to make sure banks could meet their depositors’ needs.

The Biden administration has called for reversing congressional changes made during the Trump administration, which loosened liquidity and capital requirements for banks with between $100bn and $250bn in assets. The Fed, which followed through on those changes in 2019, has said it will consider changes to its supervisory practices as it relates to midsize lenders.

Yellen and other regulators maintain the banking system is sound and resilient — in large part because of changes implemented via the 2010 Dodd-Frank financial reform. But on Friday she reiterated that regulators’ “work is not yet done”.

“The authority for emergency interventions is critical. But equally as important is a supervisory and regulatory regime that can help prevent financial disruptions from starting and spreading in the first place,” she said in remarks delivered at the FSOC meeting.

Gary Gensler, head of the Securities and Exchange Commission, also endorsed the proposals, flagging the need for further action to enhance the resilience of the US Treasury market as well as money market funds.

FSOC’s process for imposing additional scrutiny and regulation on large non-banks has been politically and legally fraught since it was created as part of Dodd-Frank.

Three large insurers, AIG, Prudential and MetLife, plus GE Capital were initially designated as “systemically important financial institutions” or Sifis, under the Obama administration.

MetLife fought back, and won when a judge ruled in 2016 that its Sifi designation had been “arbitrary and capricious”. AIG and GE Capital, which had both taken federal bailout money during the 2008 crisis, were released from the designation in 2016 after downsizing, and the Trump administration freed Prudential from additional oversight in 2018.

Yellen said the new framework “provides for strong procedural protections. This includes significant engagement and communication with companies under review”. She added that changes in 2019 by the Trump administration had “created inappropriate hurdles as part of the designation process”.

“Some are based on a flawed view of how financial crises begin and the costs that they impose,” she said, noting that under current guidance, the process to finalise any designation could take up to six years.

“That is an unrealistic timeline that could prevent [FSOC] from acting to address an emerging risk to financial stability before it’s too late.”

The proposals drew a sharp response from groups representing the firms that could be affected, which said that regulators should focus on specific activities, rather than investment managers and insurers as entities.

“The designation of a registered fund or fund manager would be the wrong answer,” said Eric Pan, chief executive of the Investment Company Institute.

FSOC on Friday said it would monitor risks from a broad range of asset classes, companies and activities focusing specifically on issues pertaining to leverage, liquidity risk and maturity mismatch as well as inadequate risk management, among others.

A Treasury official said FSOC would work with regulators to evaluate vulnerabilities to determine whether further review or action was needed.

Both proposals will be subject to a public comment period before final rules are issued.