Update 209 — FSOC’s De-Designation Decision:
AIG De-Listing Leaves Only One Nonbank SIFI
The Update takes its own “tax holiday” to look at last Friday’s Financial Stability Oversight Counsel under-the-radar vote to de-designate AIG as a Systemically Important Financial Institution (SIFI) and the rationales provided by seven of the ten FSOC members.
The council’s 68-page report — the most comprehensive snapshot of the current financial regulatory leadership and administration’s thinking on systemic risk — attributes the decision to material changes in the company’s size, complexity, and risk profile since its designation. Now only one non-bank financial company, Prudential Financial, maintains its SIFI designation.
Was this decision merely the operation of law or is it the result of a clear Trump agenda to diminish or eliminate FSOC’s impact? What does the vote breakdown tell us? More below.
The Council voted 6-3 to rescind its 2013 designation of AIG as a SIFI. All four Trump appointees on the FSOC voted in favor of delisting, while the Obama-era appointees were split. SEC chairman Jay Clayton recused himself from Friday’s vote in order to avoid a conflict of interests, raising a key legal question about the vote. Fed Chair Janet Yellen voted in favor.
• All Those In Favor
— Keith A. Noreika, Acting Comptroller of the Currency: Noreika, an Obama-era appointee, voted in favor of rescission. He does not believe non-bank financial institutions should be regulated as SIFIs.
— J. Mark McWatters, Chairman of the National Credit Union Administration: McWatters voted in favor of rescission on the grounds that AIG today is a far different company than in 2009 when he examined the company as part of the Congressional TARP Oversight Committee. Notably, he fails to acknowledge that AIG’s baseline SIFI designation occurred in 2013, not 2009.
— J. Christopher Giancarlo, Chairman of the Commodities Futures Trading Commission: Giancarlo explains AIG’s decreased derivatives liabilities, lending liabilities, capital markets downsizing, and ceasing of swaps activity led to his decision to vote yes.
— S. Roy Woodall, Jr., the Independent Member Having Insurance Expertise: Woodall, an Obama appointee, criticized FSOC’s rescission document as confusing and deviant from the statutory test to determine whether the company poses a risk to financial stability. On the grounds of this statutory test, however, he does not believe AIG to be a SIFI, writing that it is half the size it was during the crisis.
— Janet Yellen, Chair of the Federal Reserve: Fed Chair Janet Yellen, the most prominent Obama-era appointee on the Council, voted in favor of rescission on the grounds that AIG’s downsizing efforts render is no longer too big to fail.
Steven Mnuchin, Treasury Secretary: Mnuchin praised FSOC’s decision of rescind AIG’s designation, claiming that it showed the Council’s commitment to removing companies that are no longer systemically risky.
• The Dissenters
— Richard Cordray, Director of the Bureau of Consumer Financial Protection: As a member of the 2013 Council, Cordray does not believe AIG has made true reduction changes based on planning but has shrunk due to a failed business model and weakened financial market.
— Martin J. Gruenberg, Chairman of the Federal Deposit Insurance Corporation: Dissented for three reasons — an increase of liabilities/assets in other areas of AIG like life insurance and annuities, an inconsistent determination of the Council, and continued irresolvability due to AIG’s size and operations.
— Melvin L. Watt, Director of the Federal Housing Finance Agency: the two legal standards for FSOC designation were not given independent reviews. If FSOC reviewed AIG under the other standard (size, scope, etc.,) then the Council would have found AIG is still in need of enhanced supervision.
AIG’s Material Changes
Many see FSOC’s decision as a manifestation of Trump’s deregulatory agenda. The FSOC here was fulfilling its legal obligation to re-evaluate its designations annually. At the time of designation, the FSOC concluded that AIG posed significant systemic risk primarily because of its exposure to financial intermediaries, its inability to conduct an orderly liquidation of its assets, the company’s “financial contagion” risk in insurance markets, and its general complexity.
Friday’s announcement comes after more than a year of interaction between AIG and FSOC and an official request for de-designation on July 7, 2017. FSOC’s re-evaluation focused on “material changes” since the Council’s previous review.
Since 2012, AIG has:
— decreased its debt by 58 percent since 2012
— decreased its asset size from $547 to $498 bn
— divested billions including $30 billion with divestiture of ILFC assets
— sold non-core operations and businesses including ILFC, AIG Advisor Group, and United Guaranty Corporation
FSOC based its determination of designation of AIG in 2013 on three transmission channels of negative effects on the financial market:
Exposure: material impact on creditors, counterparties, investors, etc.
Asset liquidation: liquidation in such a way that asset prices and markets are affected.
Critical function/service: entity no longer provides services that are relied upon.
At that time, AIG produced negative risk most frequently and powerfully through excessive exposure and asset liquidation. The decision to rescind the company’s designation was due to the reconstruction and reduction of various high-risk practices.
Capital market/institutional exposures lead to a cascading effect if a non-bank experiences distress later on. Therefore, AIG reduced its total assets, total debt outstanding, short-term debt, and securities lending from their 2012 levels. Also, the complexity of AIG rendered it irresolvable in 2013. The Council considered that the company has simplified its total assets, multi-jurisdictional operations, and global financial impact in order to address this. Yet, it maintained that the entity is still complex and requires further efforts.
State of Play
• One Last Shadow Banking SIFI
After Friday, Prudential Financial is only nonbank financial company to bear a SIFI designation. The institution is the largest nonbank by by asset size at $784 billion — over $285 billion larger than AIG. As FSOC must re-evaluate all designations each year, we could soon see the announcement of its de-designation.
• Trump Decision on MetLife Appeal Expected
Metlife challenged its SIFI designation and won de-designation in court. President Obama’s justice department appealed the decision. The Trump could announce that it will not move forward with the appeal at any point.
• Two-Thirds Requirement Satisfied?
Clayton’s recusal might be legally significant. Section 113(d) of DFA requires two thirds of serving FSOC members to vote yes for a SIFI rescission. If Clayton is considered to be a serving voting member FSOC, then FSOC has ten serving members. Six of ten is not a two thirds majority. This would open up a question about the legal standing of AIG’s de-designation.