Mike & Co. —
Practically without warning, a U.S. District Court Judge in Washington issued a ruling this morning that would impose the greatest limitation to the scope of Dodd-Frank in the law’s five-year history. MetLife had challenged the authority of the Financial Stability Oversight Council (FSOC) to designate the firm a SIFI (systemically important financial institution). Today’s ruling held that an insurance company cannot qualify for designation. It would appear also to apply to asset management and other firms.
As markets buoy MetLife’s stock and Dodd-Frank opponents applaud, the win is a modest one and provisional at that as an appeal from the ruling is near certain. But it raises old questions about the status of TBTF under the law.
Here, we’ll lay out the facts insofar as they are known about the ruling and its immediate implications for the SIFI designation process. Tomorrow, a broader look at the meaning of designation and the status of TBTF in the wake of today’s ruling.
A breakdown of the impact and history of this case is below:
While today’s decision marks a major setback against the federal government’s financial regulation scheme, the full impact of the ruling will be difficult to predict so long as District Court Judge Collyer’s full opinion remains under seal — probably for another week or so. Meanwhile markets have made their opinion on the matter known, with not only MetLife but also fellow SIFIs AIG and Prudential receiving boosts in share prices.
The ruling will certainly affect the other extant non-bank SIFIs: AIG and Prudential (not considering GE Capital, which is being spun off). It also has a broader impact on other non-bank financial institutions that may be large but, like MetLife, don’t necessarily carry out risky investment strategies — asset management firms come to mind. If the decision is not overturned on appeal, regulators will be forced to consider the structure of a firm, its lines of business, and the probability that it might cause systemic trouble when they make SIFI designations, rather than simply assessing dangers reflecting their relative size and interconnectedness.
Quick Appeal Likely
Whether government lawyers appeal today’s ruling is not in question, it’s only a matter of seeing how quickly they manage to do so. For the FSOC this appeal is an existential matter – if its SIFI designation cannot withstand a legal test then its efficacy will be greatly vitiated.
The ruling required that FSOC and MetLife meet and file by April 6, 2016 a decision as to how much, if any, of the sealed opinion will be made public – once that happens the impact of the court’s decision will be much clearer.
How Surprising? How Significant?
MetLife filed suit in the D.C. District Court on January 13, 2015, arguing that:
- its non-bank SIFI designation placed it at an unfair disadvantage against its competitors (only one other life insurance company, Prudential, was designated),
- FSOC relied on “vague standards” and “unsubstantiated speculation” in making its assessment that do not reflect real-world financial risks,
- FSOC denied MetLife access to data and materials used in the FSCO analysis
- FSOC did not account for the regulatory framework, in all 50 states, that MetLife exists within already
FSOC claimed that it conducted a thorough and rigorous analysis, with extensive engagement with the company and acted within its legal authority granted by Congress through DFA.
During oral arguments, Collyer seemed to lean in favor of MetLife’s case, questioning the rationale behind FSOC’s standards and analysis. Collyer singled out for criticism the manner in which the Council conducted stress tests, saying that it relies on the premise that “the world is falling apart.” The judge continued “[if] you start there the answer is as obvious as the nose on your face.”
The final ruling is rumored to set aside MetLife’s assertion that FSOC’s analysis does not adequately consider the effects of the company’s business strategy on its exposure to risk, nor the regulatory environment in which it already operates within individual states. It reportedly sides with the FSOC that there is no legal requirement for the regulator to share data and materials which cover how it analyses the riskiness of a financial institution.
Even after today’s victory MetLife will proceed with its plans to sell off underperforming assets, continuing a restructuring bid that aims to raise stock values and financial performance. When the plan was announced in January, the company was careful to emphasis that it was purely a “business decision,” and not a reaction to its lawsuit or SIFI designation – but it’s difficult to see that distinction.
For its part, General Electric has continued to sell off its financial arm, GE Capital, signaling strongly its opinion on being designated a non-bank SIFI. AIG has opted to streamline its operation, despite calls by regulators to break up into constituent parts – yet another instance of corporate reorganization in the face of regulatory efforts.
The Bottom Line
Today’s ruling was a rare defeat for federal regulators and lingering echoes of the infamous Business Roundtable case have sent shivers down the spines of some DFA advocates. In that case, the D.C Court of Appeals ruled that the SEC had failed adequately to consider the impact of one of its rules on “efficiency, competition, and capital formation.” It set a precedent in the minds of critics that regulators have some obligation to consider the economic impacts of their rules.
Right now the consensus of observers is that today’s decision will be overturned. If that happens, we may see yet another politically charged case come before the still-incomplete SCOTUS.
Until that happens, the ruling governs. That means that considerations of inherent riskiness of business lines trump the size and interconnectedness of large financial institutions for SIFI designation purposes. As AIG and Prudential begin to size up their chances in lawsuits of their own, FSOC and the regulatory landscape at large will need to fight just to maintain the progress they’ve made.