As a practicing securities lawyer for more than thirty years, I have in the past advised boards of directors, including mutual fund boards, and I am well acquainted with the important work that you do. I also understand the essential role that independent directors play in ensuring good corporate governance. As fiduciaries, you play a critical role in setting the appropriate tone at the top and overseeing the funds’ business. Thus, I commend the Mutual Fund Directors Forum’s efforts in providing a platform for independent mutual fund directors to share ideas and best practices. Improving fund governance is vital to investor protection and maintaining the integrity of our financial markets.
Posts Tagged ‘FSOC’
Ever since the Treasury Department’s Office of Financial Research (“OFR”) released its report on Asset Management and Financial Stability in September 2013 (“OFR Report” or “Report”), the industry has vigorously opposed its central conclusion that the activities of the asset management industry as a whole make it systemically important and may pose a risk to US financial stability.
Several members of Congress have also voiced concern with the OFR Report’s findings, particularly during recent Congressional hearings, as have commissioners of the Securities and Exchange Commission (“SEC”). Further complicating matters, a senior official of the Office of the Comptroller of the Currency (“OCC”) recently expressed alarm about banks working with alternative asset managers or shadow banks on “weak” leveraged lending deals.
In a June 3, 2013 closed-door meeting, the Financial Stability Oversight Council (“FSOC”) voted to propose the designation of three financial services companies—American International Group (“AIG”), Prudential Financial and GE Capital—as the first systemically significant nonbank financial institutions (“nonbank SIFIs”) under section 113 of the Dodd-Frank Act.
The FSOC decision, announced by the Treasury Secretary, did not identify specific names, but all three companies publicly confirmed their proposed nonbank SIFI status. If these proposed designations become final, these three companies will become the first nonbank SIFIs to be subjected to stringent Federal Reserve Board oversight and supervision, as well as capital and other regulatory requirements, under Title I of the Dodd-Frank Act. In addition, these designations will bring to life the Dodd-Frank Act’s orderly liquidation authority that applies to systemically significant financial firms, in the event that one of these companies may fail or be in danger of failing in the future.
The FSOC’s action to begin the process of designating nonbank SIFIs has been long awaited—some would say long-overdue—and the identities of the three companies that have been proposed for SIFI designation come as no real surprise. Nonetheless, the FSOC’s action marks an important milestone in the implementation of the Dodd- Frank Act’s systemic regulation framework. While the actual significance of these designations likely will emerge more clearly in the coming weeks and months, the FSOC’s action brings into sharper focus the questions and challenges that the designated firms and their regulators will face.
Chairman McHenry, Ranking Member Green, and members of the Subcommittee, thank you for the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) on Sections 165 and 121 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Our testimony will focus on the FDIC’s role and progress in implementing Section 165, including the resolution plan requirements and the requirements for stress testing by certain financial institutions.
Section 165 of the Dodd-Frank Act
Under the Dodd-Frank Act, bankruptcy is the preferred resolution framework in the event of a systemic financial company’s failure. To make this prospect achievable, Title I of the Dodd-Frank Act requires that all large, systemic financial companies prepare resolution plans, or “living wills”, to demonstrate how the company would be resolved in a rapid and orderly manner under the Bankruptcy Code in the event of the company’s material financial distress or failure. This requirement enables both the firm and the firm’s regulators to understand and address the parts of the business that could create systemic consequences in a bankruptcy.
The FDIC intends to make the living will process under Title I of the Dodd-Frank Act both timely and meaningful. The living will process is a necessary and significant tool in ensuring that large financial institutions can be resolved through the bankruptcy system.
Treasury officials have recently suggested that the Financial Stability Oversight Council (FSOC) may soon designate the first round of systemically significant nonbank financial companies (Nonbank SIFIs). In March, Under Secretary for Domestic Finance Miller and Deputy Assistant Secretary for the FSOC Gerety stated that designations could occur “in the next few months.”
Moreover, the Board of Governors of the Federal Reserve System (Federal Reserve) recently finalized its rule on determining when a company is “predominantly engaged in financial activities,” thus making the company potentially subject to FSOC designation. The final rule is notable for stating that an investment firm that does not comply with the Merchant Banking Rule’s investment holding periods and routine management and operation limitations may nonetheless be determined, on a case- by-case basis, to be engaging in “financial activities.” In addition, the final rule rejected the argument that mutual funds — including money market mutual funds — are “not engaged in a financial activity” and therefore not capable of designation.
On a number of occasions since returning to the SEC as a Commissioner, I’ve spoken about the Commission’s priorities, both in terms of what the Commission is doing and what it should be doing in order effectively to carry out its mandate to protect investors, ensure fair and efficient markets, and facilitate capital formation. Needless to say, the Commission does not operate in a vacuum, and for various reasons, it’s not always easy to execute those priorities as we see fit. The constant stream of external influences on the Commission’s work serves as a significant impediment to its ability to focus on the core mission, including the vital, basic “blocking and tackling” of securities regulation. Therefore, I’d like to talk about the Commission’s origin and role as an expert, independent agency — as well as the challenges to that independence — in what has become in recent years a difficult environment for independent agencies.
On November 13, 2012, the Financial Stability Oversight Council (FSOC), faced with a Securities and Exchange Commission (SEC) that has been deadlocked over whether or how to address concerns about money market funds (MMFs), voted unanimously to propose three MMF reforms. The vote was the FSOC’s first exercise of its power under section 120 of the Dodd-Frank Act to recommend heightened regulatory standards to financial regulatory agencies. If finalized, today’s proposal will result in a recommendation that the SEC act on at least one of the reforms. 
Last August, SEC Chairman Mary Schapiro, in a controversial decision, tabled proposed rulemaking on MMFs because of the lack of support from three Commissioners of the SEC. In a letter sent in late September, Treasury Secretary Timothy Geithner urged the FSOC members at their November meeting to take up MMF reform through their section 120 powers. According to Secretary Geithner at today’s meeting, the FSOC’s decision was taken on the recommendation of Chairman Schapiro.
The proposal from the FSOC presents three options for MMF reform, two of which were before the SEC in August, and requests public comment during the 60 days following publication of the proposal in the Federal Register. The FSOC does not regard the three options as mutually exclusive and thus could recommend more than one to the SEC. The three options are as follows:
As one would expect of a piece of legislation that has sixteen titles and runs 849 pages in the Statutes at Large, the Dodd-Frank Wall Street Reform and Consumer Protection Act ranges widely in addressing problems both directly and indirectly associated with the financial crisis. Taken as a whole, though, the primary aim of those 849 pages can fairly be read as a reorientation of financial regulation towards safeguarding “financial stability” through the containment of “systemic risk,” phrases that both recur dozens of times throughout the statute. The law, explicitly in many provisions and implicitly in many others, directs the bank regulatory agencies to broaden their focus beyond the soundness of individual banking institutions, and the market regulatory agencies to move beyond their traditional focus on transaction-based investor protection.
This emphasis on financial stability and systemic risk is hardly surprising in light of the damage done by the financial crisis and the ensuing Great Recession, from which we continue to recover only slowly. Indeed, concern about financial stability and systemic risk has at times been a crucial impetus for financial reform in the United States. Much of the New Deal legislation that defined the financial regulatory structure for more than 40 years was in direct response to what we would today call systemic concerns, including banking panics and excessive leverage in equity markets. Twenty years before the New Deal, the creation of the Federal Reserve had been intended at least as much as a financial stability measure as an instrument of monetary policy.
Implementation of the Dodd-Frank Act: Measures to Address Systemic Risk
The economic dislocations we have experienced in recent years, which have far exceeded those associated with any recession since the 1930s, were the direct result of the financial crisis of 2007-08. The reforms enacted under the Dodd-Frank Act were aimed at addressing the root causes of the crisis. Foremost among these reforms were measures to curb excessive risk-taking at large, complex banks and non-bank financial companies, where the crisis began. Title I of the Dodd-Frank Act includes new provisions that enhance prudential supervision and capital requirements for systemically-important financial institutions (SIFIs), while Title II authorizes a new orderly liquidation authority that significantly enhances the ability to resolve a failed SIFI without contributing to additional financial market distress.
SIFI Resolution Authorities
The most important new FDIC authorities under the Dodd-Frank Act are those that provide for enhanced resolution planning and, if needed, the orderly resolution of SIFIs. Prior to the recent crisis, the FDIC’s receivership authorities were limited to federally insured banks and thrift institutions. There was no authority to place the holding company or affiliates of an insured institution or any other non-bank financial company into an FDIC receivership to avoid systemic consequences. The lack of this authority severely constrained the ability of the government to resolve a SIFI and contributed to the excessive risk taking that led to the crisis.
On April 3, 2012 the Financial Stability Oversight Council issued its final rule and interpretive guidance governing its process for designating a nonbank financial company as a systemically important financial institution under the Dodd-Frank Act. The adoption of the Final Rule marks the completion of the highly anticipated standards for designating SIFIs, a process that first began in October 2010. While there have been changes made to the process, much remains to be understood how the FSOC will use its authority to determine whether a nonbank financial company should be supervised and subject to prudential standards. It is widely anticipated that designations of some SIFIs will be made before year-end, making us wonder whether the designation process has been underway without final rules being in place.
Section 113 of the Dodd-Frank Act  authorizes the Financial Stability Oversight Council (“FSOC”) to designate a nonbank financial company to be supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and be subject to prudential standards.  The FSOC will make a designation after determining that material financial distress at the company or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company could pose a threat to the financial stability of the United States.