A government panel voted on Monday to place large non-bank companies that pose risks to the financial system under stricter supervision.
The Financial Stability Oversight Council vote, which took place in a closed session, sets the stage for a major shift in the oversight of a broad swath of big companies that play in financial markets, including private equity firms and hedge funds. Firms designated as “systemically important” will come under the thumb of the Federal Reserve and face a new regulatory paradigm that could change the course of their business.
The 10-member council, headed by Treasury Secretary Jack Lew, did not name the firms it determined were systemically important. However, American International Group, GE Capital and Prudential acknowledged that they were among those designated.
“The council took another important step forward by exercising one of its principal authorities to protect taxpayers, reduce risk in the financial system and promote financial stability,” Lew said in a statement.
It has taken federal regulators nearly three years since the passage of the Dodd-Frank financial reform law to define which non-bank companies, if they were to fail, could threaten the integrity of the country’s financial system.
The named companies have 30 days to fight the decision, and Prudential said Monday that it may appeal. If Prudential forgoes the challenge, the council must finalize the designation with an additional vote within 10 days.
“The Company currently is evaluating whether to request a non-public evidentiary hearing before the Council to contest the proposed determination, as it is entitled to do under the applicable regulations,” Prudential said in a statement.
Monday’s vote is the first of many to come as the council considers whether to include several other non-bank firms, according to a source familiar with the process.
Life insurer MetLife has said it expects to be named at some point because of it is size, though chief executive Steve Kandarian has argued that the firm poses no threat to the financial system. In March, he cautioned that higher capital requirements could force firms to reduce or stop offering some products. Wall Street is keeping a close eye on the final decision, as a company designated by the government will face tougher capital standards, among other restrictions, that could squeeze profitabilityIt is unclear how burdensome the regulations will be because the Fed has not specified the capital requirements.
Industry officials and others following the process anticipate that the central bank will tailor capital standards and other rules for each business.Prudential and MetLife have implored the council not to apply banking rules to life insurance firms that have different operating models.
Designated firms could enjoy what markets perceive as an implicit guarantee that the government will rescue them if they run into trouble, analysts say. That perception could lower the cost of borrowing and create a competitive advantage, they say.
“We’ll have only a quasi-capitalist system if only the largest firms have a lower cost of debt because of the risk they pose,” said Cornelius Hurley, director of Boston University’s Center for Finance, Law and Policy. Hurley, a former counsel to the Fed, said Dodd-Frank failed to create meaningful structural reforms for the nation’s largest firms.
But Compass Point analyst Isaac Boltansky contends that the designation “grants regulators practical authority to police these big firms.”
He said the regulation “is meant to have all the regulators in the same room once a month looking at the overall risk of an institution, rather than one regulator having a more myopic view.”The panel had said it would include firms with more than $50 billion in assets and that derive at least 85 percent of their revenue or assets from financial activities.
The goal of the designations is to ensure that non-bank financial firms will not fall through the cracks of the regulatory system the way AIG did at the start of the financial crisis. Lawmakers called for tougher oversight of financial companies after the insurance giant received $182 billion in government aid to save it from collapse in 2008.