Banking and Finance Law Daily Wrap Up, FINANCIAL STABILITY—Industry groups comment on methodologies for identifying non-bank non-insurer global SIFIs, (Apr 9, 2014)

By Thomas G. Wolfe, J.D.

The Financial Services Roundtable (FSR) and the U.S. Chamber of Commerce’s Global Risk and Governance Initiative (GRGI) have each submitted comment letters to the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) in response to their “Consultative Document” for assessing methodologies in identifying non-bank non-insurer global systemically important financial institutions (NBNI G-SIFIs). Notably, the FSR believes that the proposed framework should be revised to utilize a risk-based approach, rather than an approach based primarily on asset size, and the GRGI recommends that the international policymakers withdraw the present “Fund Methodology” for evaluating investment funds as NBNI G-SIFIs.

Background. In January 2014, the FSB, in consultation with IOSCO, issued the Consultative Document: Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions—Proposed High-Level Framework and Specific Methodologies (Consultative Document). The Consultative Document was initially requested by G20 Leaders at the Cannes Summit in November 2011, and the desired undertaking was reaffirmed in September 2013 at the G20 Summit in St. Petersburg.

Generally, the Consultative Document sets out the proposed assessment methodologies for identifying NBNI G-SIFIs, extending the SIFI framework that currently covers banks and insurers to all other financial institutions. According to the document itself, this presents a significant challenge because “the high-level framework and specific methodologies have to capture a wide range of business models and risk profiles, while maintaining broad consistency with the methodologies for banks and insurers.” Moreover, “unlike banks and insurers, the NBNI financial entities generally face limitations in data availability.”

The Consultative Document indicates that the overarching objective in developing the methodologies was “to identify NBNI financial entities whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the global financial system and economic activity across jurisdictions.”

The FSB and IOSCO invited public comments on the Consultative Document, and the FSR and GRGI submitted their respective comment letters by the April 7, 2014, deadline.

FSR comment letter. While recognizing the challenging task undertaken by the FSB and IOSCO to meet the G20 Leaders’ request, the FSR’s April 7, 2014, letter sets forth several recommendations concerning the Consultative Document:

1. The Consultative Document should be revised to “utilize a risk-based approach,” as opposed to an approach based primarily on asset size, and should focus the assessment methodologies on those factors that clearly strengthen the transmission channels.

2. An over-reliance on “supervisory judgment” in the assessment process may result in an inconsistent application of the methodologies across jurisdictions.

3. The NBNI entities assessed under the methodology should be given greater opportunities to participate in the designation process.

4. The assessment methodologies should account for existing laws and regulations that “already mitigate the potential risks captured by the proposed indicators.”

5. In connection with the Consultative Document’s directive to consolidate an assessed entity’s balance sheet under certain circumstances, the assets and liabilities held by subsidiaries and affiliates not engaging in the pertinent financial activities should not be consolidated.

6. The definitions of “finance company” and “market intermediary” should be “narrowed to reflect the fact that different types of finance companies and market intermediaries present significantly different risk profiles.”

7. In connection with the assessment methodology for investment funds, focus is correctly placed on individual funds; the scope of the assessment should not be expanded to include families of funds or asset managers.

8. If additional types of NBNI entities are eventually proposed for assessment, then the FSB and IOSCO “should develop and submit for public consultation specific methodologies and indicators for each type…”

In addition, the FSR provides specific comments on the indicators in the Consultative Document, including where the indicators: (i) should be clarified; (ii) are poor measures of systemic risk; or (iii) do not reflect “the changes in the regulatory environment since the last financial crisis.”

GRGI comment letter. Similarly, the April 7, 2014, GRGI comment letter states that the GRGI appreciates and supports the efforts of the FSB and IOSCO to monitor and manage systemic risk on a national and global level. At the same time, the GRGI voices its concern about several of the proposals contained in the Consultative Document.

The Consultative Document proposes a methodology (“Fund Methodology”) for evaluating investment funds for designation as NBNI G-SIFIs. The GRGI underscores the fact that the proposed Fund Methodology “targets U.S. registered funds only, without providing any empirical evidence that U.S registered funds pose a risk to the global financial markets or considering the adequacy of existing U.S. regulation of U.S. registered funds.” Since U.S.-based investment funds—registered as investment companies with the Securities and Exchange Commission—are “already subject to potential domestic systemic risk designation and regulation” under the Dodd-Frank Act, these companies would appear to be “the only entities eligible for an NBNI G-SIFI designation,” the GRGI asserts. Consequently, from GRGI’s perspective, the matter is not truly “global in nature” and falls outside the ambit of the FSB and IOSCO. Consequently, the comment letter recommends that the FSB and IOSCO “withdraw the Fund Methodology.”

Under the proposed Fund Methodology, investment funds with over $100 billion in assets would be evaluated for a potential NBNI G-SIFI designation. According to the GRGI, applying this criterion “would result in NBNI G-SIFI consideration for approximately 14 U.S. registered funds.” The GRGI maintains that the Consultative Document skips an important first step because it “does not provide any explanation or rigorous analysis of why the FSB and the IOSCO believe that such funds may reasonably be viewed as presenting a threat to global financial stability.”

The GRGI’s comment letter recommends that the analyses and actions taken by the FSB and IOSCO be consistent with the regulatory principles and authorities of the pertinent “implementing country.” While the GRGI generally supports the need of domestic and international regulatory bodies to deal with systemic risk and to respond to global issues and resolve cross-border matters in a coordinated manner, the GRGI believes that “the scope of activities” contained in the Consultative Document “does not fit that construct.”

Further, the letter recommends that the FSB and IOSCO look to “sectoral activities-based national enhancements” rather than to the proposed “entity-based NBNI G-SIFI” approach. According to the GRGI, the “sectoral activities-based national enhancements” approach would be more “consistent with the Document’s acknowledgment that NBNI financial entities often have different legal forms, business models, and profiles that make it difficult for the FSB and IOSCO to apply consistent standards for identifying G-SIFIs, let alone regulating them.” Likewise, the comment letter contends that “[s]uch an approach should also account for the high degree of substitutability and competition in the investment fund industry, existing regulatory frameworks in different countries, and the extent to which they already address those activities that pose systemic risk.”

In closing, the GRGI letter specifically responds to a series of questions purposefully posed in a section of the Consultative Document itself.

Companies: Financial Services Roundtable; U.S. Chamber of Commerce

IndustryNews: CapitalBaselAccords DoddFrankAct FinancialStability SecuritiesDerivatives