April 2 (Bloomberg) -- The U.S. Treasury Department and regulators will move one step closer tomorrow to designating some companies as posing a risk to the country’s financial system in the event of their failure.
The Financial Stability Oversight Council will hold a meeting at which it will finalize criteria for singling out non-bank financial companies as systemically important and thus subject to greater supervision, the U.S. Treasury Department said.
The final rule is FSOC’s second attempt to define metrics and a procedure for designating non-bank companies as systemic. Federal Reserve Chairman Ben S. Bernanke said March 29 that FSOC’s designation tool is a way regulators have become more prepared for a crisis.
FSOC “can designate any institution which it views as not being adequately regulated to come under the supervision of the Federal Reserve,” Bernanke said in a March 29 lecture. “And that’s a process that’s going on now, so there will not be any more large, complex, systemically critical firms that have no oversight.”
The FSOC, headed by Treasury Secretary Timothy F. Geithner, proposed a rule in October that set standards for determining which non-bank firms require Federal Reserve scrutiny. Banks with over $50 billion in assets were automatically deemed risky to the financial system in the event of their failure.
Final Rule
The final rule regulators will approve tomorrow will be largely unchanged from that proposed in October, said officials familiar with the deliberations who spoke on condition of not being further identified. The wording, however, can be changed until the vote is taken.
“It is an important step in the whole Dodd-Frank reform,” said Edward Hida, the global leader of risk and capital management for Deloitte & Touche LLP. “Systemic risk is one of the most important elements of the Dodd-Frank reform and building that into the oversight of regulation through FSOC and designation is the cornerstone.”
Under the October proposal, regulators will evaluate non-bank financial companies with more than $50 billion in assets if they meet any one or more of the following thresholds: A 15-to-1 leverage ratio; $3.5 billion in liabilities on derivatives contracts; $20 billion of outstanding loans borrowed and bonds issued; $30 billion in gross notional credit-default swaps outstanding; or a 10 percent ratio of short-term debt to assets.
Under a three-step process, the council will use additional data, including size, interconnectedness and liquidity risk to identify a subset of non-bank financial companies. The council will use publicly available figures to analyze the companies, and then regulators will contact the firm in question to collect more information.
FSOC will retain a provision that the panel will have the flexibility to designate any company as systemically important even it doesn’t meet any of the criteria, according to the people familiar with the deliberations.
Geithner said Feb. 2 that the first non-bank companies to be deemed systemically risky will be named this year.
Under the Dodd-Frank act, once the FSOC designates companies as systemic, the Fed would then subject these firms to heightened standards, including raising capital and reducing risky practices. The companies also would have to file “living wills” so they could be unwound in an orderly way if they failed.
Risky Firms
Plans to designate systemically risky firms were set back after lawmakers and industry executives complained that the initial proposed criteria, released in January 2011, were too vague. FSOC responded in October with a new proposal with metrics for designation.
Even after the rule is final, it is unclear how long it will take FSOC to begin designations.
“They probably need to proceed carefully because there could be court challenges, there could be other procedural hurdles.” said Satish Kini, co-chairman of the banking group at law firm Debevoise & Plimpton LLP. “Congress is going to be interested in how they go about this.”
“They know this is a task that is not going to make any friends for the administration,” said Ernest Patrikis, a partner at the law firm White & Case LLC and a former general counsel at the Federal Reserve Bank of New York. “Politically it’s not an easy task because even if you meet certain criteria there are going to be significant costs.”
