“FSOC Accountability: Nonbank Designations”
Oral Testimony of Paul Schott Stevens
President and CEO
Investment Company Institute
U.S. Senate Committee on Banking, Housing, and Urban Affairs
March 25, 2015
As prepared for delivery.
Thank you, Chairman Shelby, Ranking Member Brown, and members of the Committee. I am grateful for the opportunity to appear here today to discuss the transparency and accountability of the Financial Stability Oversight Council or “FSOC.”
ICI and its fund members do understand the importance of appropriate regulation, and we support U.S. and global efforts to enhance stability in the financial system.
To this end, however, the FSOC process must be:
- Understandable to the public,
- Based on empirical analysis that takes into account all the factors specified in the Dodd-Frank Act, and
- Well-grounded in the historical record.
Such a process would allay any concerns that U.S. stock and bond funds or their managers pose risks to the financial system that require SIFI designation. Indeed, throughout the 75-year history of the modern fund industry, these funds have exhibited extraordinary stability in comparison to other parts of the financial system – certainly they did so throughout the recent financial crisis.
Is such an open, analytical review in the offing? Unfortunately, the FSOC’s current designation process raises several serious concerns in this regard.
First, like other observers we are concerned that the FSOC is ignoring the range of tools given to it by the Dodd-Frank Act and instead is seeking to use its designation authority broadly. Congress envisioned SIFI designation as a measure designed for rare cases in which an institution poses outsized risks that cannot be remedied through other regulatory action. The Council’s record to date raises serious questions about its adherence to this this statutory construct.
Second, in none of its non-bank SIFI designations has the FSOC explained the basis of its decisions with any particularity. The opacity of the Council’s processes and reasoning means that no one—not the designated firm, other financial institutions, other regulators, the Congress, nor the public—can understand what activities the FSOC believes are especially risky. This is an odd result, as the very object of the exercise is to identify and eliminate or minimize major risks to the financial system.
Third, instead of the rigorous analysis one would expect in connection with significant regulatory action, the FSOC’s approach to SIFI designation is predicated on what one member of the FSOC has called “implausible, contrived scenarios.” Together, the opacity of the process and this conjectural approach to identifying risks have made SIFI-designation appear to be a result-oriented exercise in which a single metric (a firm’s size) dwarfs all other statutory factors and mere hypotheses are used to compel a predetermined outcome – i.e., that designation is required. Presumably, “systemic risk” must consist of more than just a series of speculative scenarios designed to justify expanding the jurisdiction of the Federal Reserve over large non-bank institutions.
Fourth, the consequences of inappropriate designation would be severe—particularly for regulated funds and their investors. The bank-style regulatory remedies set forth in Dodd-Frank would penalize fund shareholders; distort the fund marketplace; and compromise funds’ important role in financing a growing economy. It also would introduce a conflicted form of regulation: a designated fund or manager would have to serve two masters – with the Fed’s focus on preserving banks and the banking system trumping the interests of fund investors who are saving for retirement or other long-term goals.
The Fed’s reach could be extremely broad. The Financial Stability Board recently proposed thresholds for identifying funds and asset managers that it expects automatically would be considered for SIFI designation. Under these thresholds, more than half of the assets of U.S. regulated funds—almost $10 trillion—could be subject to “prudential market regulation” by the Federal Reserve.
Similarly, more than half of the assets in 401(k) and other defined contribution retirement plans could be designated for Fed supervision.
We do not believe that any Member of Congress anticipated that Dodd-Frank Act could give the Fed this extraordinary authority.
How can Congress address these concerns? What we recommend is quite straightforward:
- First, the FSOC’s recent informal changes to its designation process are a good first step, but more is required. To assure greater predictability and certainty in the process, Congress should codify these changes in statute.
- Second, Congress should require the FSOC to allow the primary regulator of a targeted firm an opportunity to address the identified risks prior to final designation. Primary regulators have the necessary authority, and greater expertise and flexibility, to address these risks.
- Third, a firm targeted for SIFI designation also should have an opportunity to “de-risk” its business structure or practices. Such an “off-ramp” from designation may be the most effective way to address and reduce identified systemic risks.
- Finally, Congress should revisit the “remedies” proposed for designated nonbank firms—particularly regulated funds and their managers. Let me emphasize: we do not believe that funds or fund managers merit SIFI designation. But if the FSOC chooses to designate them nonetheless, then Congress should look to the SEC, and not to the Federal Reserve, to conduct enhanced oversight.
Mr. Chairman, thank you for the opportunity to present our views, and I look forward to the Committee’s questions.