Congress wants to know what a company has to do to prove it doesn’t pose a threat to the financial system.
That is the clear message that top lawmakers sent to Treasury Secretary Jack Lew Wednesday on Capitol Hill.
Lew is the head of the Financial Stability Oversight Council, the super-group of all the top federal financial regulators created after the financial crisis to detect financial risks to the economy in places that individual agencies might not look.
The council has the power to name any firm “systemically important” and require that they have higher capital levels and oversight by the Federal Reserve. It has done that to four companies: The finance arm of General Electric and three insurers, including American International Group, whose 2008 failure threatened Wall Street and led to the council’s creation.
Some of those companies have resisted the designation. And with the council now looking into asset managers such as BlackRock and Fidelity, the industry and members of both parties wanted to know Wednesday how they could avoid it.
“Does a company know how to avoid designation or know how to be un-designated?” asked Sen. Richard Shelby, the Alabama Republican who is chairman of the powerful Senate Banking Committee.
Since the council was proposed as part of the 2010 Dodd-Frank law, Republicans have criticized it as overly powerful, unaccountable and lacking transparency. Shelby said Wednesday that “when you give such a body extraordinary powers, those powers must be exercised with requisite care.”
The council, which includes Lew, Federal Reserve Chairwoman Janet Yellen and other top policymakers, has already acknowledged that it needs to be more transparent in deciding which companies will be targeted for added regulation. Earlier this year it moved toward becoming more transparent when it is considering labeling a company systemically important and communicating with that firm earlier in the process.
“It’s a young organization,” Lew said Wednesday, defending the council from the widespread criticisms.
The financial industry and Republicans have suggested a number of changes to the council, ranging from requiring burdensome cost-benefit analysis to tweaks to the process.
But what senators most clearly advocated Wednesday was an assurance that there was an “off-ramp” for companies the council is investigating that don’t want extra regulations and would be willing to drop risky lines of business to avoid it.
And once they are added to the list of “systemically important” non-banks, firms want assurance that it is not, in the words of one senator, a “Hotel California” that they can never leave.
“Think of our system of criminal justice. You have to know what you’re being charged with to defend yourself,” said Tim Cameron, managing director and head of the Asset Management Group at the Securities Industry and Financial Markets Association, an industry group.
In other words, if Lew and company determine that they are doing something risky, the firms want a chance to drop that business before they are labeled a threat to the financial system.
“They don’t know if there’s an off-ramp,” said Sen. Dean Heller, R-Nevada.
Heller was just one of several senators to voice that concern. Sen. Elizabeth Warren of Massachusetts, a Democrat known as one of the staunchest supporters of Dodd-Frank, pressed Lew on whether companies could do anything to drop the systemic label once they had been given it.
Yes, Lew answered. “It’s not like you’re designated and we never look again. It’s an annual review.”
The question had heightened relevance as Wednesday was the deadline for asset management firms to respond to the council’s request for comments on whether the products or activities of asset managers could pose systemic threats.
The industry argued that asset managers are already face stepped-up oversight from the Securities and Exchange Commission and that added regulation would only increase the cost of saving for investors.
“Asset managers do not own client assets and do not bear the risk of the investments,” the Financial Services Roundtable wrote in a comment. The group warned that “the cost of any new regulatory burdens likely would be passed on to investors and, thereby, would inherently reduce net savings.”
Even though asset managers argue that they can simply return funds to investors in the case of emergency, regulators have suggested that their business models could pose system-wide risks in other ways.
“For example, there are a growing share of assets under management that provide liquidity to the investors, and yet hold primarily illiquid assets,” Yellen said at a congressional hearing in February. The council’s notice for comment asked about four ways asset managers could pose systemic risks.
The industry this week tried to convince them that those risks, including the one mentioned by Yellen, were not worth the systemic label.
“Hedge funds are unlikely to engage in forced selling (aka: fire sales) due to investor redemption requests and distributions,” the Managed Fund Association wrote in part of its comment provided Wednesday. “Investors agree to limit capital withdrawals and provide advance notice, allowing hedge funds time to manage more orderly asset sales.”
