Mike & Co. —
Last week Treasury Secretary Jack Lew wrote an opinion piece in the Wall Street Journal explaining why he is leading the FSOC to take a look at asset management firms for SIFI designation. He had a larger purpose in mind. In light of the MetLife v FSOC ruling it was seen as a challenge;: commenters had already decided that the ruling put the brakes on FSOC overreach and maybe even on designations for now.
In reality the ruling reaffirms the FSOC’s ability to determine what firms are systemically important and Secretary Lew knows that. Bringing up asset management firms, Lew was tacitly acknowledging that MetLife confirmed his and FSOC’s authority over insurers et al.
More on the victory in disguise the case represents and other underreported aspects of the decision below.
Apologies for an errant subject line yesterday. I had trouble with the transmission — let me know if you did not get yesterday’s update.
In Like a Lion, out Like a Lamb?
After the March 30th ruling that MetLife’s SIFI designation must be rescinded a great deal of news ink was spilled in writing on a supposed regulator calamity. While the full opinion remained sealed, the commentariat attempted to analyze the court’s decision based on courtroom events and press releases, and came to the conclusion that not only MetLife, but possibly entire portions of the financial industry would be immune from SIFI designation. That’s not the case.
On April 7, the same day that the MetLife v. Financial Oversight Stability Council ruling was unsealed, a Treasury spokesman announced that the government plans to appeal the court’s decision. What became clear that day is this: Collyer’s opinion that FSOC has an obligation to consider the costs of its regulations on business exposes the council to a more complex operational mandate, but it does not rule out insurance companies or any other from SIFI status.
The Decision’s Points
First things first: Judge Rosemary Collyer writes in her opinion that “The court concludes as an initial matter that MetLife is eligible for designation.” So any idea that this ruling will expressly or explicitly limit the scope of FSOC’s designation power only to certain industries or companies should be put to rest.
Secondly, Judge Collyer’s decision hinges on two separate issues: 1) that FSOC ignored its own rules for the designation process and did not inform MetLife that it was doing so, and 2) that Michigan v. EPA set a precedent requiring that regulators consider the costs of their regulations on businesses, which FSOC failed to do in the case of MetLife.
For the first point in the ruling, FSOC has two possible criterion for making a SIFI designation as set forward in Dodd-Frank, called the first and second determination standards. To wit:
First Determination Standard: that material financial distress at the nonbank financial company could pose a threat to the financial stability of the United States
Second Determination Standard: that the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company could pose a threat to the financial stability of the United States.
The council determined through the use of the first standard that MetLife met the SIFI threshold, but Judge Collyer decided that the standard also requires FSOC to analyze the likelihood that MetLife would undergo “material financial distress” in the first place. FSOC did not do so, which Collyer claims violated its own guidance on the matter.
Collyer took pains to emphasize that the business practices of MetLife are fundamentally less risky than those of, say, an investment bank. Because of that, regulations on MetLife have a greater relative cost than they do with riskier firms – and because FSOC has an obligation to consider costs the council’s designation of MetLife as a SIFI was done without an adequate analysis of the firm’s activities.
Even Wall Street commenters have expressed the sentiment that Collyer missed the mark on the latter point of her decision – DFA Section 113(a)(2) reads that FSOC should include in its analysis “(K) any other risk-related factors that the Council deems appropriate.” As a matter of interpretation the phrase “deems appropriate” is a critical one – the Council is at liberty to make the decision about what is and is not an appropriate risk-related factor.
The opinion does not restrict FSOC from naming other non-bank firms as systemically important, nor does it prevent the council from re-designating MetLife as a SIFI. Some have claimed that the decision puts the brakes on any new designations or rulings from FSOC, but that may not be the case. Certainly it isn’t stopping Secretary Lew from going after big funds and the ruling doesn’t even stop the council from re-designating MetLife as a SIFI during the council’s annual analysis of financial firms.
The opinion itself is so narrow that it amounts to something more akin to an administrative remand than a regulatory limitation: this is a matter of FSOC not checking the proper boxes when it designated MetLife a SIFI. The opinion leaves no question that the council can still designate MetLife a SIFI – that was cleared in the first few pages of Collyer’s opinion.
The Appeals Court has not yet scheduled a date for arguments to begin but if the trial runs into the latter part of the national election, the issue might come to the front of the political stage. Part of that discussion is going to be about the broader implications of the decision but mostly it will be simply a clarion bell for both DFA supporters and critics.
The ruling is a chance for FSOC to make its standards streamlined, efficient, and unimpeachable. The council can address criticisms of opacity by turning to transparency, it can counter being called aloof by working in tandem with firms to make sure they know exactly how to move out of SIFI status.
As the government’s lawyers prepare for the appeals fight, has the council already set its sights on new prey, asset management firms. This may be the next big challenge for FSOC, as it pushes forward with a long-standing plan to take on what it sees as new risks in that sector. Look for substantive action on that front in the coming months, possibly in the form a draft rule that addresses leverage or liquidity risks.