[Senate Hearing 114-113]
[From the U.S. Government Publishing Office]
S. Hrg. 114-113
OVERSIGHT OF THE FINANCIAL STABILITY OVERSIGHT COUNCIL DESIGNATION
PROCESS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
SECURITIES, INSURANCE, AND INVESTMENT
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE FINANCIAL STABILITY OVERSIGHT COUNCIL DESIGNATION PROCESS
FOR NONBANK FINANCIAL COMPANIES THAT COULD POSE A THREAT TO THE
FINANCIAL STABILITY OF THE UNITED STATES
__________
JULY 22, 2015
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
MICHAEL CRAPO, Idaho SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois JON TESTER, Montana
DEAN HELLER, Nevada MARK R. WARNER, Virginia
TIM SCOTT, South Carolina JEFF MERKLEY, Oregon
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
JERRY MORAN, Kansas
William D. Duhnke III, Staff Director and Counsel
Mark Powden, Democratic Staff Director
Dawn Ratliff, Chief Clerk
Troy Cornell, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Securities, Insurance, and Investment
MIKE CRAPO, Idaho, Chairman
MARK R. WARNER, Virginia, Ranking Democratic Member
BOB CORKER, Tennessee JACK REED, Rhode Island
DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois JON TESTER, Montana
TIM SCOTT, South Carolina ELIZABETH WARREN, Massachusetts
BEN SASSE, Nebraska JOE DONNELLY, Indiana
JERRY MORAN, Kansas
Gregg Richard, Subcommittee Staff Director
Milan Dalal, Senior Economic Advisor
(ii)
C O N T E N T S
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WEDNESDAY, JULY 22, 2015
Page
Opening statement of Chairman Crapo.............................. 1
WITNESS
Patrick Pinschmidt, Deputy Assistant Secretary, Financial
Stability Oversight Council, Department of the Treasury........ 2
Prepared statement........................................... 24
(iii)
OVERSIGHT OF THE FINANCIAL STABILITY OVERSIGHT COUNCIL DESIGNATION
PROCESS
----------
WEDNESDAY, JULY 22, 2015
U.S. Senate,
Subcommittee on Securities, Insurance, and Investment,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 10:17 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. This hearing will come to order.
Today's hearing will focus on the Financial Stability
Oversight Council's designation process for nonbank financial
companies that could pose a threat to the financial stability
of the United States.
Last year, I requested that the Government Accountability
Office initiate a study to examine the process that FSOC uses
when designating nonbank financial institutions. The report
concluded that FSOC's process lacks transparency and
accountability, insufficiently tracks data, and does not have a
consistent methodology for determinations.
In February, FSOC approved supplementary procedures
designed to improve the SIFI designation process. I am
interested in learning how this improved the process and what
other changes are being considered by FSOC to improve
transparency, accountability, and communications.
One of the criticisms that I hear is that while lots of
information is being requested and reviewed by FSOC, there is
not a lot of meaningful opportunity for companies to correct or
contextualize information being evaluated and to contest
specific allegations of the threat that a company poses to the
financial stability.
In previous hearings, it has been suggested by some
witnesses that FSOC needs to pinpoint specific activities that
contribute to the company's systemic risk profile and provide a
process for a company to eliminate the identified risks before
being designated by FSOC.
In the April hearing that Senator Warner and I held, the
witnesses agreed that FSOC needed to have an off ramp to allow
designated SIFIs to de-risk and shed their designation level.
The goal of such reforms is to ensure that FSOC is more
transparent during the designation process about which
activities, together or separately, pose the greatest threat to
financial stability so a company has the opportunity to address
them.
Understanding that a process that involves nine regulatory
heads, an independent member, and five nonvoting members is
never simple, it is important to understand the timeline and
the details of the designation process and how we can ensure
there is sufficient transparency, accountability, and clarity.
I look forward to hearing from our witnesses on these issues
today.
With that, we have with us today Mr. Patrick Pinschmidt.
Mr. Pinschmidt will--excuse me. I am looking for your official
title here. He is Deputy Assistant Secretary of the Financial
Stability Oversight Council, and he will testify today from the
Department of the Treasury, and we appreciate your being here,
Mr. Pinschmidt. I know there is a lot of business going on this
morning, and so I expect you will see Senators floating in and
out. But we appreciate your taking the time here with us, and
you may have 5 minutes now to make your presentation. Your
entire written presentation will be made a part of the record,
and we ask you to try to summarize your comments in 5 minutes
so we will have plenty of time for questions. Please proceed.
STATEMENT OF PATRICK PINSCHMIDT, DEPUTY ASSISTANT SECRETARY,
FINANCIAL STABILITY OVERSIGHT COUNCIL, DEPARTMENT OF THE
TREASURY
Mr. Pinschmidt. Thank you very much, Mr. Chairman.
Chairman Crapo, Ranking Member Warner, and Members of the
Subcommittee, thank you for inviting me here today to discuss
the Financial Stability Oversight Council's nonbank
designations process.
The financial crisis taught us that we need a clear
accountability for the overall stability of the financial
system. Congress created the Council to bring together for the
first time the entire financial regulatory community to
identify and respond to potential threats to financial
stability.
Today the Council convenes regularly to monitor market
developments and to take action when needed to protect the
American people from potential threats to the financial system.
Our approach from day one has been data-driven and
deliberative, while providing the public with considerable
information regarding the Council's actions and views. As
Secretary Lew has made clear, Council members recognize that
the Council should be open to adapting its procedures and
engaging broadly with stakeholders. Just since last year, the
Council has demonstrated this commitment by enhancing its
transparency policy, strengthening its internal governance,
approving supplemental procedures to its nonbank financial
company designations process, and soliciting public comment on
potential risks from asset management products and activities.
You asked me here today to discuss the Council's
responsibility to designate nonbank financial companies for
enhanced prudential standards and supervision by the Federal
Reserve. The Council takes such action if it determines that a
company's material financial distress or activities could pose
a threat to U.S. financial stability.
This authority addresses a key weakness brought to light by
the financial crisis: that the failure of large, complex, and
interconnected companies without appropriate supervision could
pose risks to financial stability.
Designating a firm is not a decision the Council takes
lightly. Before making a final decision, the Council goes
through a lengthy, multistage, in-depth analysis. The review
covers every aspect of a company, including financial
statements, business activities, market dynamics, and existing
regulation.
The Council works with the company and its regulators to
understand how the firm's financial distress could affect the
broader financial system. Most of the companies the Council has
considered so far have not met the standard for designation,
but in four cases, after considerable and thoughtful
deliberation, the Council has found that a firm needs to be
held to a higher standard to protect the U.S. financial system.
The Council recently adopted supplemental procedures for
its designations process. These changes were informed by
extensive outreach with more than 20 stakeholders, including
trade groups, companies, and public interest organizations. We
also solicited input from each of the three companies then
subject to a designation.
Under the new procedures, companies will now know early in
the process where they stand, and they will have earlier
opportunities to engage with and provide input to the Council.
For example, the Council will notify a company when it first
comes under active review and provide it with the opportunity
to meet with staff, review the Council's primary sources of
public information, and provide information relevant to the
Council's review.
The Council is also providing companies with a clearer and
more robust annual review process. Company representatives are
now provided an opportunity to discuss the scope and process
for the review, and they can present information regarding any
change that may be relevant, including restructurings,
regulatory developments, market developments, or other factors.
In addition, the Council will provide each designated
company an opportunity for an oral hearing to contest its
designation every 5 years. These changes open the door to more
engagement with the Council following a designation to make
sure there is ample opportunity to discuss and address any
issues that a company wants to put before the Council.
Altogether, these and other changes strengthen the
Council's process while also addressing many of the suggestions
made by stakeholders.
As Congress contemplates additional changes to the
designations process, it is important that such changes do not
compromise the Council's fundamental ability to conduct its
work. We are particularly concerned with legislative proposals
that would dramatically lengthen an already long and
deliberative designation process, impose insurmountable
practical hurdles on the Council's work, and prevent the
Council from taking action to address potential threats to
financial stability.
As the President and Secretary Lew have both made clear, we
will not support legislation that weakens important taxpayer,
investor, and consumer protections by impeding the ability of
regulators to identify and respond to threats to financial
stability. U.S. markets and financial institutions are
constantly evolving, and we must remain alert and responsive to
new challenges in order to maintain the safety, soundness, and
resiliency of our financial system.
I thank the Subcommittee for the opportunity to discuss the
Council's nonbank designations process, and I look forward to
answering your questions.
Chairman Crapo. Thank you very much, Mr. Pinschmidt.
Senator Warner, did you want to make an opening statement?
Senator Warner. I will defer.
Chairman Crapo. All right. Thank you. Then we will go right
into questions.
Mr. Pinschmidt, the February supplemental procedures appear
to be a positive step toward increasing communication between
FSOC staff and firms under review. However, while lots of
information is being requested and reviewed, the process does
not seem to provide clarity to the companies about which
activities together or separately pose the greatest threat to
financial stability. So a company basically does not have an
effective opportunity to address these issues before and after
designation.
Can you please explain when in the designation process
companies are informed of the risks that FSOC believes they
pose?
Mr. Pinschmidt. Certainly. So you noted the supplemental
procedures that the Council approved in February. Essentially,
that opened up the process. Previously, it was a three-stage
process. It is still a three-stage process. Stage 1 was purely
mechanical based on certain mechanical thresholds. If you trip
one of those thresholds, you go into Stage 2.
Previously, Stage 2 was a preliminary internally facing
review by the Council internal facing. If it was a public
company, the Council would download the 10-K and 10-Q, do a
very preliminary analysis to determine if a company should be
considered in Stage 3. And Stage 3 was the more robust back-
and-forth period with the Council.
As a result of the supplemental procedures approved in
February, companies under consideration by the Council will now
be informed at the beginning of Stage 2 once an active review
commences on that company. So they will have an opportunity on
day one, once an active review is commenced, to come in, meet
with a Council analytical team, present information to Council
member staff, ask questions if they want to ask questions, and
also as part of Stage 2, get a sense for the type of materials
that the Council is reviewing during Stage 2 as it looks at the
company.
So that was an important facet of the supplemental
procedures allowing companies to engage earlier in the process,
raise questions, and review the type of materials that the
Council----
Chairman Crapo. But in that process as it begins, is there
a point at which the FSOC staff inform the company of which
factors and which concerns they are having, if they are having
any?
Mr. Pinschmidt. So, yeah, that is a very important point. I
think one thing to keep in mind is this is the beginning of the
process. This is the first time the Council member staff are
engaging with a company, so, you know, it is probably not
practical to assume that firm views and positions on the risk
will be developed in that process. The threshold consideration
in Stage 2 is: Are there enough questions here? Is there a
there there to advance the company to Stage 3 to do a deeper
dive and a drilldown with the company?
But that being said, as part of the new supplemental
procedures, to the extent that through Stage 2, through that
engagement, through that preliminary review that is conducted
by the Council, again, just relying on publicly available
information and information from regulators, there is no
provision to get nonpublic information from the company in
Stage 2. But based on that preliminary information available to
the Council, should the Council decide to advance a company to
Stage 3 for additional review, the Council will inform the
company at the beginning of Stage 3: Hey, this is what we
learned in Stage 2; these are the factors we are looking at;
this is what we expect to explore in Stage 3; we are going to
send you a list of questions asking very detailed questions;
these foot to these key concerns.
Chairman Crapo. So if I understand you right, the point at
which you are transitioning from Stage 2 to Stage 3 is the
point at which FSOC will tell the company that we have
identified these risks, and these risks, taken either together
or separately, are what is potentially going to cause a
designation?
Mr. Pinschmidt. I just want to be careful on that because
it is--you know, Stage 2 is preliminary. It does not benefit
from the robust back-and-forth that happens during Stage 3. It
does not benefit from nonpublic information that the company
provides to the Council. So any view at that stage of the
process at the end of that preliminary review is a high-level
sense of like, well, these are the potential risk areas we want
to drill down deeper on. It is not a firm view as to like these
are three things we are going after, we are worried about; you
know, these are the three threats to financial stability.
Chairman Crapo. So even at Stage 3, the company is not
going to be informed as to what the specific risks are.
Mr. Pinschmidt. Well, I guess what I would say, at the
beginning of Stage 3, if the company is advanced to Stage 3,
there is a rationale for that decision. The Council comes
together, evaluates the record in Stage 2. To the extent that
there are potential areas that have been highlighted and
Council members are concerned about these areas and want to
explore them more in Stage 3, those areas will be highlighted
to the company at the beginning of Stage 3.
You know, Stage 3 is a lengthy process. It lasts over a
year. It will probably last up to a year and a half going
forward. So, you know, that gives a company a sense of the
areas that the Council is interested in pursuing with the
company, and certainly there will be an opportunity for
significant engagement throughout Stage 3.
For example, one recent company had over a dozen meetings
with the Council staff. They submitted over 20,000 pages of
information. There are a lot of conversations. So as the
company goes through Stage 3 those preliminary areas of inquiry
will become much more crystallized for the company.
Chairman Crapo. All right. Thank you.
Just quickly, how many companies to date that have been
moved into Stage 3 have gone through Stage 3 without ultimately
being designated?
Mr. Pinschmidt. The Council has considered nine companies
in total. Of those nine companies, five were considered in
Stage 2, and the decision was made not to advance them to Stage
3. Of the four companies that advanced to Stage 3, the four
companies were designated.
Chairman Crapo. All right. Thank you.
Senator Warner.
Senator Warner. Thank you, Mr. Chairman. I wonder if I
could get an extra minute since I skipped my opening statement.
I just want to cite for the record that here we are 5 years
later, there are some very good things that have happened in
Dodd-Frank. There are things, I think, that still need
improvement. But I think if the record was ever written about
how this provision came about, let me just assure you that
there was robust discussion about whether nonbanks should be
SIFI designated.
I think one of the concerns that Senator Crapo, Senator
Corker, Senator Warren, and I have all had is that this
designation of SIFI should not be a Hotel California where you
can never de-designate. And I am going to ask some questions
about that. I just want to make a couple of comments.
So, first, I share a lot of my colleagues' concerns about
the transparency of the process and how we have moved. I think
there has not been enough transparency. I think Secretary Lew's
change last year made improvements. I think some of the
discussions about how firms are brought in, how much
information is shared now are moving in the right direction.
I also think we have seen in the case of--Senator Toomey
and I may disagree on this one, but on the money market issues,
what happened with the SEC moving and saying that size alone
should not be a factor was an interesting process. And one of
the things that I continue to believe is that size is not
necessarily the guiding factor on a SIFI designation. It should
be the underlying activities, not simply the size itself.
Now, we have got an example how this should work out with
GE. I would point out we saw the Fed's capital requirements I
think on Monday of this week. GE has made the business decision
to spin off a number of its GE Capital assets. As a matter of
fact, CEO Jeff Immelt said, when he announced that move, ``This
is exactly what was envisioned by the FSOC process.'' So you
got one of America's leading CEOs saying, you know, by making
this choice to bring down the size of his firm rather than
falling into the full SIFI designation, you know, he is making
a business decision that I think is both appropriate and will
lessen the amount of risk in the overall system.
As we look at GE, though, I would like to go through--let
me just read off a couple of questions, and then you can
respond. What risk would the failure of GE Capital pose today
in its current status? As GE Capital spins off some of its
assets, how does FSOC plan to monitor the transfer of those
assets throughout the financial system to ensure that they do
not end up at another firm that would inadvertently trigger
other systemic concerns? To what extent are GE's excessively
risky assets moving into any kind of shadow banking system? And
if they are in that shadow banking system, how would the FSOC
monitor? And do you believe that the FSOC and Federal Reserve
have the tools and authority necessary to address any existing
concerns that may arise with GE's de-risking process?
Mr. Pinschmidt. Thank you very much, Senator.
In terms of GE Capital, as I am sure you can appreciate, it
is probably not appropriate for me to get into too much of the
details of the company's ongoing restructuring.
Senator Warner. Well, any particular firm, as you take
assets that may be risky, if they could go into the shadow
banking, or if they simply moved to other firms, how do you
monitor that process?
Mr. Pinschmidt. Yeah, I think as a general matter, you
know, this has been an area, again, speaking generally in terms
of the migration of activities or assets from one space to
another space, that the Council is very well positioned to
monitor, because the Council brings together regulators from
across the regulatory community, looking at different types of
institutions, looking at different types of markets, and is in
a very good position to understand what is driving this. Are
there business issues? Are there competitive issues? Are there
regulatory issues? And what are the potential consequences in
terms of financial stability?
So, more broadly, this is an issue that the Council
continues to monitor. It has highlighted this issue in its
Annual Report and this will obviously remain a focus going
forward.
I think in terms of GE Capital, I mean, clearly there is a
process in place. The company alluded to that in terms of them
pursuing their de-designation strategy with the Council. This
process was elaborated on in the February supplemental
procedures. It is very clear, to the extent a company wants to
pursue this strategy, there is an off ramp available, and there
is a process that they can engage with at the Council. They can
ask questions. They can get responses to those questions and
the purpose is to be as transparent as possible to give
companies the right information to make decisions.
Senator Warner. Let me just in my last remaining moments
say that another area of great concern has been the whole
question around insurance designations--obviously AIG, one of
the firms that caused the crisis in 2008. What have you learned
from the designation of AIG that helped guide you when you went
through the same process with Prudential and MetLife?
Obviously, I believe Roy Woodall offered a dissenting opinion
on that issue. Could you explain why you disagree with Mr.
Woodall's dissent? And just on a more general basis, under what
circumstances do you believe an insurance firm could pose
systemic risk? And can you see any kind of hypotheticals going
forward since this is going to be an area that I know a number
of my colleagues have concerns about as well?
Mr. Pinschmidt. So I think generally, in terms of the
Council's approach to the three insurance companies designated,
these were company-specific analyses, you know, that took over
a year on each of them, sometimes as much as 2 years. So, you
know, I think each company is different, and each company poses
a different set of potential risks, not in their standard
operations but should they encounter financial distress in
terms of what that impact would be on broader market
functioning. That was, of course, the threshold decision by the
Council.
I think generally speaking, across the three firms, the
Council's analysis--which is outlined on the public bases on
the Council's Web site, providing a summary of the rationale
for each of the designations. But I think speaking generally,
the focus of the Council was on the exposure of broader
financial markets directly and indirectly to each company and
also the asset liquidation channel in the sense that if the
company got into trouble, had to liquidate assets, what would
be the consequences of that liquidation on broader market
functioning? So I think, you know, generally speaking, because
of these companies' size, interconnectedness, not necessarily
their vanilla or straightforward insurance operations, but, you
know, other operations that are not really in that category,
the decision was made to designate them.
Senator Warner. Thank you, Mr. Chairman. I would just
simply close by saying that I know there is great reluctance
from the administration about codifying any changes with the
process. I understand some of your concerns, but I do think
there have been some movements in the right direction on
transparency and ensuring that those transparency requirements
are going to last into future administrations. I look forward
to--if it is not legally codified, how can we ensure that? So
that might be for a future round of questions.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Corker.
Senator Corker. Thank you, Mr. Chairman. I thank you and
the Ranking Member for having this hearing, and you, sir, for
your testimony.
Look, with FSOC, my sense is we have a number of people in
the Senate that would like for FSOC not to designate anybody as
a SIFI. There are probably some people, on the other hand, that
think FSOC is working just fine the way that it is.
But my guess is there is a pretty large group of folks that
would like to see the process be improved, and my guess is even
you would like to see the process get better as it moves along.
So I want to ask one long question for you to respond.
There are three areas where I think there could be a lot of
consensus around improvement. One would be the disclosure prior
to designation--I know that you talked a little bit about that
in answering Senator Crapo's question--but really being more
transparent about the analysis that is given, and give people
the opportunity on the front end to more fully understand.
Second, as they are moving into the upper stages, as you
alluded to in your comments, giving them a predesignation off
ramp so that before they are designated, they can off-ramp,
they can just go ahead and share with you, and you can work
with them toward that end to make sure in advance of being
designated they have the opportunity to off-ramp. My sense is--
you alluded to GE just a minute ago. Maybe there was not that
opportunity for them even though it appears that they have
certainly done a lot to make sure they are not a SIFI. You can
decide whether they have or not.
And then after that, especially Section 113 of Dodd-Frank
says that the FSOC will reevaluate each determination at least
once a year. It seems to me that if we could work more fully to
understand how you could have a post designation off ramp,
there would be a lot of consensus on this Committee toward
supporting that. And I wonder if you might just lay out whether
you agree that some of those types of things would be helpful,
and if so, what those things might be that we could come around
legislatively.
Mr. Pinschmidt. Yes, and, certainly, I think you raise some
good questions, and I would like to sort of tick through them,
and please interrupt me if I am not addressing it the way you
wanted me to address it.
So in terms of disclosure throughout the process and
getting companies as much information so they know where they
stand as they are going from Stage 2 to Stage 3 and within
Stage 3, I would reiterate that this is a very lengthy process.
There is a lot of engagement. There is a lot of paper going
back and forth. There are a lot of meetings. And that being
said, as part of the supplemental procedures we put out in
February, we recognize that to the extent the Council has
formed views or has questions, that information will be shared
with companies sooner in the process. For example, in Stage 2,
allowing the company to come in and meet with Council member
staff, allowing the company to present anything it wants to
present, and basically allowing the company to ask the Council
member staff what information are you using in your analysis
today. So I think----
Senator Corker. If I could, just on that point, so when
they do that, if Company X says, ``Look, I will just unload my
entire financial arm. I am a manufacturing operation, an
industrial operation. I will just unload my entire financial
arm,'' which a particular company has done, would you all then
say, ``OK, well, if you will do that, then forget it, we will
not designate you''? Does that kind of process occur?
Mr. Pinschmidt. So what I would say is that the Council
will always consider any information or requests brought to it
by companies under consideration. So of the four companies that
the Council has designated, there was never one specific issue
that triggered the designation. So there was----
Senator Corker. But if you are not in the financial
business, I would think that would be a pretty big clue that
maybe they are not a threat to the financial system. Would that
be the case in one particular--and I do not want to drive home
one company, but if you are an industrial company, you say I am
going to be out of the financial business, would that keep you
from being designated as systemically risky to the financial
system? I just think it would.
Mr. Pinschmidt. I was referring--it was not the industrial
company that was designated. It was the sub. And if you look at
the basis that was posted publicly for that decision, it was a
confluence of different factors that drove that decision. I
guess what I am referring to is hypothetically, let us say it
is Company X and they have this business that is doing
something that is very scary, and that is the reason they are
going to be designated. So if that company wanted to come to
the Council and say, look, we have a proposal to deal with
this, that is certainly a conversation that can happen within
the current process. It just has not happened with the four
companies that were previously designated because there was no
one factor that triggered it.
Senator Corker. But there is a clear opportunity for them,
though, to present and say, look, if this is of concern to you,
it is not worth it to us to be identified in this way, it hurts
our investors, so we will do away with this. There is a clear
process laid out where they can do that and be off-ramped.
Mr. Pinschmidt. Yeah. Certainly, we are talking about a 2-
year process from beginning to end for a designation. So that
is a lot of time, and there are certainly a lot of
opportunities for the company to bring information, the primary
regulator to bring information that would be considered by the
Council.
Senator Corker. And the other two issues--I realize I have
run over my time, but we will send you a question so you can
give us some information about the post-designation off ramp
and what you are doing to make sure that companies have a route
to be undesignated. And I guess that process exists somewhat
today. Yes or no?
Mr. Pinschmidt. Yes. I would be happy to discuss it quickly
if you wanted me to.
Senator Corker. Well, I do not know if the Chairman is that
lenient today, but thank you.
Chairman Crapo. Thank you.
Senator Donnelly.
Senator Donnelly. Mr. Chairman, in the interest of my
colleagues' questions, are you in that mood today, sir? Just
kidding.
Thank you very much for being here, sir. One of the
questions I wanted to ask is: Based on your participation at
recent FSOC meetings, one of the other things that you have
responsibility for is what are some of the emerging threats
that you see in the economies, whether here or overseas, that
are most concerning? Obviously, first and foremost I wonder
about here. One of the things I have always tried to do is say,
OK, what might be out there that might lead toward a similar
situation that we had in 2008 and how do we prevent it?
Mr. Pinschmidt. Thank you. So that goes to the core of what
the Council does. I know a lot of focus is always on----
Senator Donnelly. I know it goes to the core. I am just
asking what are the things you are looking at right now that
have you most concerned.
Mr. Pinschmidt. So the Council's Annual Report highlights
the key risks that the Council believes are in the current
financial system and the best recommendations to address those.
I think this year's Annual Report, consistent with prior years,
highlighted cybersecurity. I think that one remains at the top
of everybody's list in terms of fostering greater information
sharing between Government and the private sector, making sure
that technological capabilities are in place, and just
understanding the threat and how it would potentially play out
in terms of responding to that threat and recovering from that
threat. So that is a key area of focus for the Council.
I think given the current economic backdrop, one recurring
theme throughout the report is the reach for yield dynamic. You
know, we have had interest rates low for a long time, and it is
only natural that some investors and some market participants
will reach for yield, whether it is on a looser credit quality,
whether it is taking on much more risk for incremental gain,
and that is an area for market participants and regulators to
be very focused on going forward.
I think two areas that were highlighted in this year's
Annual Report that were not highlighted in previous reports. I
think central clearinghouses as Dodd-Frank is implemented--and
certainly Dodd-Frank anticipated this--clearinghouses are
playing a much bigger role in terms of providing transparency
and stability to the system. But because of that rule and the
more transactions that are going through them, it is important
that regulators continue to remain vigilant as to how these
entities are being run, how they are being risk-managed. There
is certainly a lot going on. There continues to be a lot going
on on that front. But it is a very strong focus.
And I think, finally, another new area that was highlighted
in the Annual Report was--and this is something we are hearing
a lot about lately--emerging market structures across different
asset classes. You have seen an increase in electronification.
You have seen structural changes in how markets operate and
understanding how those changes are impacting market
functioning and to the extent that they could pose any
potential risks.
Senator Donnelly. Let me ask you a question I have been
asked by folks back home, as well as in other places, and that
is, for mutual funds, which many of us have used for 401(k) or
for other purposes. So you have a mutual fund that gets in
$1,000 and invests $1,000 into the market or into bonds or
wherever for you, that they are not running margins, that they
do not--you know, you give them 10 bucks, they invest 10 bucks,
period. Where is the systemic risk in that?
Mr. Pinschmidt. So, yeah, I think you are absolutely right
when you think about traditional mutual funds. They are a
different animal in terms of how they invest and how they
operate. They do not have the balance sheet. They do not have
the leverage. It is an agency model. They are not investing
their own money.
But I think, broadly speaking--and this is why the Council
is doing some work on this front. There has been incredible
change in that space, and there are certain activities across
the industry that there are a lot of legitimate questions on in
terms of certain products, for example, ETFs and certain
liquidity features of certain products.
The Council right now is not focused on individual
companies. The Council is prioritizing a review of industry
activities and products, and issued a Federal Register notice
last December with a series of questions, just trying to get
more information from the industry and other stakeholders,
including information on some of the issues you are raising.
Senator Donnelly. So if you have not--and I apologize if
you already did make a list of--you mentioned ETFs. If you have
put out a list of here are the things we are concerned about so
that companies have an idea of what to avoid if they want to
avoid being systemically designated.
Mr. Pinschmidt. So let me just clarify that. I think it is
premature to say the Council is concerned about any one thing
right now. What the Council did in December was issue a Federal
Register notice highlighting four key areas for exploration.
Senator Donnelly. What I think is important is: How do you
know what to avoid if you are not being told here are the
things we want you to avoid?
Mr. Pinschmidt. So what I would say is the Council has not
really--has not finished its process in terms of understanding
if there are even legitimate risks there. It is an ongoing
process. It is engaging with the industry. The Council is
focusing on four areas: liquidity and redemption risk,
leverage, operational risk, and resolution. And within each of
those four areas, the Federal Register notice asked a series of
questions, probably eight questions in each section, and points
out potential areas of concern to explore. And we are trying to
get information, understand the nature of potential risks. And
to the extent there are risks, then, there will be a dialogue
about those risks. But I think it is premature to point out to
any one single feature rising to a certain level at this
juncture.
Senator Donnelly. Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Scott.
Senator Scott. Thank you, Mr. Chairman. Good morning, Mr.
Pinschmidt.
Mr. Pinschmidt. Good morning.
Senator Scott. I personally think it is highly unlikely
that asset managers pose a systemic risk, honestly. But Federal
Reserve Governor Tarullo recently suggested that activities-
based designation in the asset management industry would be
preferred to entity-based designation. Can you please commit
that if the FSOC goes down this path with asset management
activities, it will revisit the entity-based designation of the
insurance SIFIs and consider an activities-based designation
for them as well?
Mr. Pinschmidt. Thank you for your question. So you are
right that for asset management the Council is currently taking
an activities-based approach. The Council made a decision back
in July of last year, asking staff to prioritize an industry
review focused on asset management products and activities. But
I think in terms of the larger question here, in terms of
entity review versus industry-wide review, it is really not an
either/or question.
I think where there are risks at individual firms based on
their size, interconnectedness, and the consequences of their
failure to the financial system, the Council has taken action.
Where there are broad-ranging questions regarding certain
activities or products, the Council has also sought to get
answers to those.
Neither approach precludes the other option. So to the
extent that you are looking at industry activities, it does not
mean you cannot look at individual companies. And to the extent
you are looking at individual companies, it does not mean you
cannot look at industry activities.
I think, in the case of insurance, certainly in the Annual
Report, the Annual Report has talked about areas whether it is
captive reinsurance, whether it is the ``reach for yield''
dynamic I referred to earlier, that there are certainly ongoing
questions on an industry-wide basis that the Council needs to
explore.
Senator Scott. Dodd-Frank turned 5 years old yesterday, and
in an interview with the Wall Street Journal with the bill's
author, former House Financial Social Security Committee
Chairman Barney Frank said, ``I do think there is a tendency
for an overreach by the FSOC. I do not think straightforward
insurance companies or money managers should be covered and
regulated as SIFIs.'' Do you agree or do you disagree with
Chairman Frank?
Mr. Pinschmidt. So I certainly have the utmost respect for
Chairman Frank. I guess what I would say is the Council was
created 5 years ago to bring together regulators from across
the regulatory system with a common responsibility to identify
and respond to threats to financial stability. The rationale
for that was a recognition that threats evolve over time.
Financial institutions and markets are not static and, thus,
risks evolve over time.
So to the extent 5 years ago there were certain risks folks
were worried about, those risks have changed over the past 5
years, and they will change again over the next 5 to 10 years.
I will say in the case of the Council's review of insurance
companies, it has not been the straightforward dynamics or the
vanilla dynamics of the insurance companies that triggered the
designation. These were large, highly interconnected companies
whose failure could potentially pose a threat to financial
stability.
I think his comments also referenced mutual funds. As I
just alluded to earlier, the Council has not designated any
mutual funds. The Council is focused on products and activities
across the industry--engaging with the industry to better
understand the nature of potential risks, which are albeit very
different from other risks in the financial system.
Senator Scott. Thank you.
Senator Warner. [Presiding]. Senator Toomey.
Senator Toomey. Thanks, Mr. Chairman.
[Laughter.]
Senator Warner. You get used to that.
Senator Toomey. Yes, never mind.
[Laughter.]
Senator Toomey. I want to pursue this discussion that,
well, almost everybody has been talking about. You have
acknowledged that there is a focus in the asset management
space on activities and products, but you also seem to suggest
that that is not to be understood to be an alternative to
entity designation. So I just want to be--first of all, let me
be clear. Let me ask you, are you telling us today that entity-
based designations are still on the table and that it is still
entirely possible that individual asset management firms will
be designated as SIFIs as such?
Mr. Pinschmidt. So I was responding generally to the
question on terms of activities versus entity-based reviews.
Senator Toomey. Right.
Mr. Pinschmidt. I think the Council has been very clear.
The Council has been evaluating risks in the asset management
space for some time. And after about a year of work in multiple
different work streams on that front, across different areas,
the Council directed staff to prioritize a review of asset
management products and activities. So that certainly is the
focus of the Council.
Senator Toomey. I understand. That did not even come close
to answering my question. My question is: Has the FSOC taken
off the table entity-based designations? Or is it still
entirely possible that the FSOC will decide to designate asset
managers as SIFIs per se?
Mr. Pinschmidt. I cannot speak to the Council in terms of
what it may decide down the road----
Senator Toomey. Wait a minute. You cannot answer the
question of whether or not you have taken off the table entity-
based designations and substituted exclusively activity-based
designation? You cannot tell us whether that is your criteria?
Mr. Pinschmidt. What I can say is the Council is firmly
focused on products and activities across the industry, and a
broad review informed that focus by the Council. So I think the
Council is very committed to this. They issued a Federal
Register notice for comment. They are engaged in a back and
forth with the industry and other stakeholders, designed at
understanding the risks. And I think what triggered that is a
recognition that asset management firms are different. You
know, they----
Senator Toomey. Yeah, we know that. But I got to tell you,
this--you know, the opacity with which the FSOC has been
operating is extremely disturbing, and when you come here today
and you continue to obfuscate about a very fundamental and
basic question, that is extremely problematic.
Senator Donnelly raised the question: How can a firm choose
not to be systemically risky if it does not know what
activities you consider to be systemically risky? I do not
understand how it is defensible not to have a clear, objective,
public description of the activities that you think give rise
to systemic risk so that a firm could decide to note engage in
them and know in advance that thereby it will avoid this
designation. How can that be unreasonable?
Mr. Pinschmidt. Senator, I think that is completely
reasonable. I mean, I----
Senator Toomey. Except you do not do it.
Mr. Pinschmidt. I guess my point is the Council is in its
risk identification phase. It really has not, you know, come to
conclusions on risks in the asset management----
Senator Toomey. It seems to be pretty far down the path of
designating individual firms.
Mr. Pinschmidt. Again, I think the Council was very clear a
year ago that it is focusing on products and activities rather
than individual firms, and to the extent the Council arrives at
some decisions in terms of potential risks, those decisions
will obviously be shared with the public.
Senator Toomey. So can we be assured that no firm will be
designated until the Council has reached the decision about
what activities give rise to systemic risk?
Mr. Pinschmidt. I mean, certainly, the process now is not
looking at individual firms. It is looking at activities and
products across the industry. And to the extent there are
specific activities and products that concern the Council that
pose risks, the Council will then obviously engage further in
terms of the specific concerns----
Senator Toomey. Well, here is another problem we have. If
you guys decide a particular activity deserves to be
designated, one of the things that is still entirely unclear is
how the Fed will choose to regulate a nonbank that gets drawn
into this web.
It seems to me that the only way that a firm can make an
informed decision about whether or not it wants to exit an
activity that is the source of its designation would be to know
how that activity is going to be treated. So can we be assured
that we will not have any designations until the Fed also comes
out and publicly discloses how it intends to regulate these
activities?
Mr. Pinschmidt. So the role of the Council and the Fed is
clearly different here. The Council is responsible for risk
identification. The Fed is responsible for addressing that risk
with enhanced prudential standards.
What I would say--and, again, I am sort of speaking for the
Fed on this. What they have said previously and certainly how
they have approached it with some of the prior designations is
they recognize each industry is different and the players
within industries are different. So their view and their
approach has been to tailor the enhanced prudential standards
for the risks posed by individual firms. And I think that in
order to tailor, you need to understand what the nature of the
risk is first, so, therefore, there is kind of a sequencing
there.
Senator Toomey. Well, and the sequence should include that
all of that should be very well known and understood and
publicly debated before anyone is subject to this regulation
that they had no way to avoid but might well have chosen to
avoid.
Thanks, Mr. Chairman.
Chairman Crapo. [Presiding]. Thank you, Senator Toomey.
Senator Heller.
Senator Heller. Mr. Chairman, thank you, and to the Ranking
Member also. I am not a Member of this Subcommittee, but this
is a fascinating discussion, and probably in my home State one
of the--probably one of the biggest issues that I get
questioned on constantly. This financial downturn did not help
the State of Nevada by any means, and most people are very
aware of the amount of unemployment. We lost a lot of banking
entities in the State. We probably lost more than half of our
local banks, community banks, over the last 5 or 6 years, and
it has been pretty devastating to the economy. So that is why I
am here today, and I want to thank our witness today also for
taking time and answering our questions. I know sometimes it is
a little uncomfortable, but it does help this process move
forward. So thank you for being here today.
I do have a few questions, and, again, it is along the line
of everybody else, but I think this is important to the banking
industry and the nonbanking industry to get clarification on
some of these questions.
I guess my first question is: Is it your belief that no
firm should ever be undesignated as a SIFI?
Mr. Pinschmidt. Oh, certainly not, no. There is a clear
process in place. If a company decides to pursue a de-
designation strategy, that is available to that company.
Senator Heller. See, that is the argument. The argument is
that there is not a clear process, and so that is why I asked
you that question. This is what these entities are coming to me
saying, OK, if there is a designation, how can we avoid it?
Again, this is the same question everybody else is asking, but
I guess we are really trying to get down to the basic answers
on this.
You are saying that there is a clear path--a clear path--
that a company can come to you and be told specifically what it
takes or an off ramp if, in fact, a SIFI designation were to
occur?
Mr. Pinschmidt. Yes. So, look, I will walk you through
that. So after a designation is made, the Council subjects
every company to an annual review process, and the basic--the
process there is to evaluate what has changed at that company
since the designation, and to the extent there have been
changes, are those material that would warrant a potential
rescission of the designation?
As part of the supplemental procedures we put out in
February, we put some more meat on the bone on this in terms of
kind of letting companies know what their rights are and how we
would expect to conduct the process, because bear in mind we
have not really gone through this process a lot because we just
had the first round of designations just 2 years ago.
But the way it is set up now at the beginning of the
process we will send a letter out to the company inviting them
to come in, meet with Council member staff, and that is their
opportunity to raise any questions they have, to highlight any
changes in their business. Our view is that each company that
has been designated, they receive a 200-, 300-page document
from the Council outlining the key factors as to why they are
designated. So our view is companies know why they are
designated and what risks the Council is concerned with.
But to the extent that they have questions on that, to the
extent they have--well, you cited these factors, if we did this
to that, what would that mean? This is a forum to allow that
sort of dialogue.
Senator Heller. Help me understand--I am sorry to interrupt
because I do not have a lot of time, but help me understand
what it means when you say that you are still going through the
risk identification phase. Does that impact a company's ability
to exit a SIFI designation?
Mr. Pinschmidt. So I think the risk identification phase,
what you are referring to, is in Stage 2, and that is kind of
at the preliminary--the beginning of the process----
Senator Heller. But you are still saying you are going
through this process?
Mr. Pinschmidt. Not in terms of the annual reevaluation. So
the annual reevaluation reflects--comes after the designation.
It comes after the company receives a lengthy 200-, 300-page
document from the Council outlining the key risks and the
concerns of the Council. So the company, in that position,
comes into that meeting post their designation with a long
document outlining the risks, and this is an opportunity for
the company to talk to Council staff and say, look, this is
what we are thinking, this is what we have been doing, these
are potential other ideas. What were you thinking when you said
this? What were you thinking about this? And just have that
dialogue, because we feel it is important, to the extent a
company wants to pursue an off ramp, there are many different
ways to go about doing it. And the company is in the best
position, the management team is in the best position to assess
the relative pros and cons of those options, and we want to
provide as much information.
Senator Heller. Let me add one thing. I guess the confusion
and the comments that I am receiving--there is a lot of
dialogue. There is a lot of dialogue. But what they do fear is
that there is not enough action. In other words, they talk and
talk and talk, and very rarely are there instances where
decisions are actually made. I do not know how you change that,
but that is a concern and a reflection right now of what the
Council is doing.
Mr. Pinschmidt. So what I would say is, again, we have not
been through this process a lot yet because just for the
timeline in terms of when companies were designated. But, I
think dialogue is a precursor to action, and to the extent a
company is motivated to pursue a de-designation strategy, there
is a pathway forward to do that. There is a mechanism and a
process to allow it. And to the extent a company wants to
contest their designation, if the Council votes not to rescind
that designation, the Council will respond in writing, giving a
rationale and reasons. And that is very valuable information to
the company, and ultimately if a company--again, this is part
of our supplemental procedures. If a company feels that they
are still not being heard, there is an opportunity for an oral
hearing with the entire Council regarding that designation.
Senator Heller. Mr. Pinschmidt, thank you.
Mr. Chairman, thank you for allowing me to be here today.
Chairman Crapo. You are welcome. Thank you.
We will do one more round for those who want to ask
questions. We are going to try to wrap up here by half past the
hour. I think we can do that.
Mr. Pinschmidt, as you can see, there is some frustration
up here, and the frustration, the way I would describe it is
that we consistently hear that there just does not seem to be a
way to get specifics from the FSOC process when a company is
being evaluated so that the company can know what specific
activities is it or are they that are creating the risk concern
that could result in a designation. And as you give your
answers, I do not seem to see the answer to that question.
There is obviously a lot of document production. There are
opportunities to get together and sit down between the FSOC
staff and the staff of the company that is being evaluated. But
in that process, is there ever a time at which the FSOC says
these are the activities that this company is engaging in that
we believe present potential risk to the system?
Mr. Pinschmidt. Yes, I would say there is, and I think
obviously it is an analytical process. The information and the
Council's understanding and views of the risks evolve over time
as there is more information, particularly in Stage 3 when you
are dealing with nonpublic information and you are actually
having meetings with the management team on a regular basis.
But what I would say is that the new process, when we did
the supplemental procedures in February, we talked to a lot of
people. We talked to the companies that were previously
designated. We talked to industry groups. We talked to the GAO.
We talked to congressional staff. And we heard a lot of
different things, and it made sense for us to assess what
improvements we can make in the process that allow for that
engagement, allow for that back and forth. And that is what
precipitated the 17 changes in February. One of those areas,
again, to your point in terms of knowing earlier in the process
where they stand, Stage 2 is no longer an internal FSOC
process. It is open to the company. The company is notified.
They have the opportunity to come and present. They have the
opportunity to ask what information the Council is considering.
And at the end of that process, should the company--and, again,
this is just based on preliminary information, publicly
available information. At the end of Stage 2, if the Council
should decide to move a company to Stage 3, the Council will
let that company know, well, hey, these are the factors we are
kind of looking in on, you can expect questions on this,
questions on that, this is what we want to explore and drill
down with you in the next year as we do a Stage 3 evaluation.
And then as we move through Stage 3, if there is a decision to
make a proposed designation to a company, so before a final
vote by the Council, the company under consideration--again,
before a final vote on designation--they are given a 200-, 300-
page basis for a proposed determination which outlines in very
specific detail the Council's view, the Council's concerns, and
the rationale for a proposed decision on designation.
Chairman Crapo. And at that point, do you agree that there
should be an opportunity for an off ramp? In other words, if at
that point when the decision apparently has been made and the
risks have been identified, the activities have been
identified, should not the company at that point have an
opportunity to evaluate its business model and structure and
determine whether to adjust it?
Mr. Pinschmidt. Well, what I would say is if there was one
specific area that the Council was focusing on, they would know
long before that proposed designation document was given to the
company. So, I mean, there would be an opportunity for
dialogue. But, again, there has not ever been in the cases of
the four companies designated where there was one specific
thing that could be addressed in sort of an expedited manner.
Chairman Crapo. Well, let us take a case of one of the four
companies or a hypothetical fifth company that does get
designated. So the process is finished. The company is
designated. Should there be an off ramp?
Mr. Pinschmidt. Absolutely, absolutely. And that is why the
supplemental procedures made it very clear that, to the extent
companies have questions, to the extent a company is determined
to pursue an off-ramp strategy, there is a path there. And it
is, you know, not a simple endeavor, because as I noted before,
there is never really one or two things or there has not been
in the past----
Chairman Crapo. But in that case--and I am interrupting
because we are running a long time, but in that case, should
not the FSOC have a responsibility to work with the company to
help them identify what the proper elements of an off ramp
should be?
Mr. Pinschmidt. Absolutely. I think it is very important
that companies--I mean, this is a big decision for a company.
They need to have the best information. There are pros and cons
to weigh. The key point here is there is an off ramp; there are
multiple different lanes. The company should be able to choose
which lane they want to pursue based on the best available
information. We have a process in place to allow companies to
do that.
Chairman Crapo. All right. Thank you.
Senator Warner.
Senator Warner. Well, thank you, Mr. Chairman, and I want
to, frankly, continue this line of questioning.
The Chairman and I work very closely together. We may not
come at this from exactly the same direction. I actually think
FSOC has improved its performance. I think there clearly are
cases of nonbank financials who are systemically important. But
I really urge, Mr. Pinschmidt, that you kind of be more
collaborative with us because there does still seem to be this
transparency issue.
One of the things just this week with the Fed setting some
of these new capital rules, having a company being able to more
fully evaluate the cost of designation is important. So that is
a step in the right direction as well. And I think all of us
will be watching very closely GE's process to see whether the
off ramp works.
But what I do not hear is a disagreement that
predesignation, at some point along the way, there ought to be
enough clarity for a company to make the decision to spin off
whatever component of its business that causes the systemic
risk.
Senator Corker and I worked deeply on Title 5 years ago,
and we always envisioned that there would be this off ramp. And
I guess what my question is, we need your help working through
this, or I think you are going to end up seeing Congress
without the full amount of information and experience that you
have gone through, learning this process in 5 years,
potentially take action, and that might not be the right--this
would be much better done collaboratively. I do not think there
is a difference of opinion that there ought to be an off ramp
predesignation and there ought to be even after designation,
then the ability on the annual review to have an off ramp. If
we want to send the signal that for those on the Committee on
both sides who think we have not ended too big to fail in
whatever connotation, bank or nonbank, I think we would like
nothing more than the ability to show, now, look, this is the
way out.
Can you just speak to that a little bit? And why can't we
get to a common place here that either is codified in law or
codified in rules? Because who can predict what the next
Secretary--I think Secretary Lew has moved appropriately and
aggressively to try to work through this, and I think the
process has improved. But if it is all left with this lack of
clarity, a future Secretary from either party could veer
dramatically off the course that has been set.
Mr. Pinschmidt. Thank you. I guess what I would say is I
think it is important to allow the supplemental process changes
that the Council approved in February to work through. I mean,
we are just now beginning the first round of annual
reevaluations post the supplemental procedures.
But that being said, in terms of kind of the predesignation
off ramp that you were referring to, the Council will consider
any proposal from any company at any stage of the process. So
while it is not formally in the current process for
designations before a decision is made on designations, that is
not to preclude down the road a company presenting a proposal,
a regulator presenting a proposal, and having a mechanism to
discuss that within the Council.
So what I would say in terms of, I think, the legislation
before this Committee, what it creates is it effectively
creates a situation that would essentially double the length of
a designation.
Senator Warner. I do not support that component.
Mr. Pinschmidt. OK. So we go from 2 years to 4 years, and I
think when you are thinking about a 4-year analysis, that
essentially becomes unworkable, and it would just basically
hamper the Council's ability to identify and respond to risks.
But I think, certainly to the extent that there are other
proposals out there that work within our current process, if we
can do a better job sort of making clear how this will work, we
are certainly happy to do that and work with you.
Senator Warner. Let me just interrupt you for 1 second
because, again, I want to be sensitive and let Senator Donnelly
get his question in. I simply want to say it has gotten better
since some of the changes, but when we hear company after
company say we are not being told how to get off, what to do,
and you understand when we say we have to continue to protect
the confidentiality of the process, we are only getting one
side of the story. And that is troubling.
Mr. Pinschmidt. If I could just answer that question real
quickly, I think one thing to keep in mind here is that these--
the supplemental procedures were approved in February. We have
not really entered in the post-supplemental procedures annual
reevaluation phase yet. So I think some of what you may be
hearing is based on the view of the process previously. We have
made some changes. I think they are very good changes, and they
are going to dramatically improve the level of engagement and I
think get the information to companies that they need to make
decisions regarding a potential off ramp. And I think we need
time to let that work out, and then to the extent that there
are concerns or things to address, we are very happy to do
that.
Chairman Crapo. Senator Donnelly.
Senator Donnelly. Thank you, Mr. Chairman.
I used to serve in the House. I served on the House
Financial Services Committee, and Barney Frank was my Chairman.
I was there during the time that Dodd-Frank passed, and
Chairman Frank helped write the bill. And, I do not want to put
words in Barney's mouth. I am just following what he was quoted
as saying. His quote was--Frank did not believe that asset
managers or insurance companies that just sell insurance are
systemically important and should not be labeled as
systemically important financial institutions. And when Mr.
Scott asked you about that, you said, well, that was 5 years
ago, and so we have to determine what threats have evolved over
time in that space.
So if you could tell me what threats have evolved in
insurance companies who just sell insurance or something like a
mutual fund that just gets in a dollar and sends out a dollar,
I would like to know what those additional threats are.
Mr. Pinschmidt. Yeah, so let me clarify my comment. I was
not--the Council has not designated any companies based on--any
insurance companies based on straightforward insurance
products.
Senator Donnelly. Barney was the Chairman of the Committee
that helped write the legislation.
Mr. Pinschmidt. Yeah, but what I would say, you know,
pointing to the three designations for insurance companies,
none of those designations were made based on straightforward
insurance activities.
Senator Donnelly. OK. I am just saying when you look at
this, the hard part to understand is: How can you avoid a
systemically important designation, how can you make sure you
do not wind up with that if they do not know what the rules
are, if you do not know what the judgment is going to be of how
these are determined? And so if you are running a business, you
cannot make decisions unless you know what the rules of the
road are. And for the FSOC not to let them know, it just makes
no sense to me.
Mr. Pinschmidt. Look, I agree with you that it is very
important to let companies and let industries know how they are
being evaluated. And I think certainly the nonbank designations
rulemaking that was done in 2012 reflected three rounds of
public comment, including comments by industry folks about the
standards the Council is looking at in Stage 1, Stage 2, and
Stage 3. And that process worked for the companies the Council
designated, but it was only natural to sort of step back and
say, well, look, we have gone through this process with a few
companies, there are areas to improve it, to improve the
information flow from the Council to companies, and that is why
the Council----
Senator Donnelly. I just want to make two other points.
This is not just about mutual fund companies or insurance
companies. What happens is so you run a small business, and you
set up a 401(k), and you send your money to the mutual fund
company, and you hope that you get a decent return so you can
retire and you can have a nice little condo, have a chance to
go fishing on the dock, and enjoy life and see your grandkids.
Your annual return is going to be less each year if a portion
of the money you send in to that mutual fund company has to be
set aside because they have been designated as systemically
important, and all of a sudden there is less money. This is
about the ultimate family at the end of the day. It is not so
much just about the mutual fund company. It is about their
customers, the millions and millions and millions of Americans
that our job is not make it so that their return winds up to be
lower at the end of the day. If it is just as safe and they can
get a higher return, what are we doing?
Mr. Pinschmidt. So I think two things on that point. The
Council is not focused on individual mutual funds in terms of
the designation, and I think there is also--I do not think
anybody would want to see, if there was an issue with a
designation, that bank-like standards would be imposed on
certain nonbank companies that do not have bank
characteristics. So I think some of the studies out there that
sort of hypothesize as to what the consequences of designation
would be are based on faulty data and I think, frankly, just do
not reflect the record in terms of where the Council is
focusing. They are focusing on products and activities, not
individual entities within the mutual fund space.
Senator Donnelly. And then the last question I will ask is
this: If you are company and you do not know what the rules
are, and then the rules finally come out and you get told, OK,
you are now going to be designated as systemically important,
do they have a grace period to try and get a fix so that the
areas that you do not want them in they can get out of?
Mr. Pinschmidt. So I think----
Senator Donnelly. Because if you do not know the rules and
then you are told, well, this part is what does not work for
us, if I was running a business, I would say, OK, give me a
month or two, let me get that squared away so I will not be in
it anymore.
Mr. Pinschmidt. Look, the Council endeavors to be very
transparent regarding the factors that it is looking at. I
mean, a lot of it is spelled out in terms of the nonbanks
process, and it has been improved upon by the supplemental
procedures in February.
To the extent companies are not aware of what they are
being looked at, there is an opportunity for them to engage in
a dialogue and answer questions.
Senator Donnelly. But wouldn't it also be incumbent on you
to let them know these are the areas we are looking at, to make
it public to everybody?
Mr. Pinschmidt. There should be no surprises in terms of
what the factors are and how the Council is looking at
individual industries or more generally specific companies. But
the framework for that--a lot of that is public.
Senator Donnelly. OK. Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Senator Donnelly, and thank you
for being here with us, Mr. Pinschmidt. As you can see, there
is a lot of interest on the Committee about getting this right,
and I know you have given us a lot of assurances that the
process needs to be given a chance to play out and see how it
works, that we will be focusing on it very carefully.
It just seems to me that at Stage 2, which is now open and
publicly engaged in, we ought to be able to very quickly see
the companies and the FSOC be able to come to an understanding
of what the issues and activities and risks are that are being
evaluated and be able to engage in analysis and discussion
about how to deal--first of all, how to analyze those risks and
those activities to determine whether there is a systemic risk;
and, B, understand what the FSOC's conclusions are as they move
along so that options for addressing it can be engaged in. It
seems to me that would be a much more positive outcome for the
economy, for the ultimate consumer, and, frankly, for the
country and the individual companies.
So I encourage you to take these concerns back to the FSOC
folks and let them know that there really is a high level of
concern here about whether we have got it right. And most
importantly, we want to get to the transparency and to the
right outcomes. And if it takes more legislation to do that,
then we want to know how to get it right.
In any event, we appreciate you taking the time to be here
with us today. I am sure there will be follow-up from Members
of the Committee. I would appreciate it if you and your office
would respond promptly if there are follow-up questions.
Mr. Pinschmidt. Absolutely. Thank you.
Chairman Crapo. Thank you. This hearing is adjourned.
[Whereupon, at 11:28 a.m., the hearing was adjourned.]
[Prepared statement supplied for the record follows:]
PREPARED STATEMENT OF PATRICK PINSCHMIDT
Deputy Assistant Secretary, Financial Stability Oversight Council,
Department of the Treasury
July 22, 2015
Chairman Crapo, Ranking Member Warner, and Members of the
Subcommittee, thank you for inviting me here today to discuss the
Financial Stability Oversight Council's (Council) process for nonbank
financial company designations.
The financial crisis taught us that we need clear accountability
for the overall stability of the financial system. Five years ago this
month, Congress responded with the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Wall Street Reform), which established the
Council. The creation of the Council brought together, for the first
time, the entire financial regulatory community with a collective
responsibility to work together to identify and respond to potential
threats to financial stability. This new mission required regulators to
break out of their silos to strengthen the stability of the U.S.
financial system.
Over the past 5 years, the Council has demonstrated a sustained
commitment to working collaboratively to fulfill its statutory mission
in a transparent and accountable manner. We built a new organization
and developed strong working relationships among Council members and
their staffs to provide a forum for candid conversations; share
confidential, market-sensitive information; and ask tough questions
that will help make our financial system safer.
Today, the Council convenes regularly to monitor market
developments, to consider a wide range of potential risks to financial
stability, and, when necessary, to take action to protect the American
people against potential threats to the financial system. Our approach
from day one has been data-driven and deliberative, while providing the
public with considerable information regarding the Council's actions
and views. The Council fosters interagency engagement on a daily basis,
including through staff-level committees that discuss financial market
developments, regulatory policy developments, and emerging risk topics.
The Council has published five annual reports that describe its past
work and future priorities in great detail; regularly opened its
meetings to the public; published minutes of all of its meetings that
include a record of every vote the Council has ever taken; and
solicited public input both on areas of potential risk and on its
procedures for evaluating potential risks.
As Secretary Lew has made clear, Council members recognize that the
Council should be open to adapting its procedures when stakeholders
raise good ideas. Just since last year, the Council has demonstrated
this commitment by enhancing its transparency policy, strengthening its
internal governance, adopting supplemental procedures to its nonbank
financial company designations process, and soliciting public comment
on potential risks from asset management products and activities.
One of the duties Wall Street Reform gave to the Council is to
designate a nonbank financial company for enhanced prudential standards
and supervision by the Board of Governors of the Federal Reserve System
(Federal Reserve), if the Council determines that the company's
material financial distress or activities could pose a threat to U.S.
financial stability. The Council's nonbank designations address a key
weakness brought to light by the financial crisis: that large, complex,
and interconnected nonbank financial companies, without appropriate
supervision, could contribute to bringing our financial system to a
halt.
Since Wall Street Reform was enacted, the Council has designated
four nonbank financial companies following a thorough, rigorous, and
fact-based process with extensive engagement directly with each company
and its regulators. Before considering any company for designation, the
Council voluntarily adopted a rule and interpretive guidance in 2012,
after soliciting three separate rounds of public comment, to provide as
much transparency as possible regarding how the Council would evaluate
companies. That guidance explains both the process that the Council
follows for designations and the substantive framework for how it
assesses risks.
As a result of these efforts, each designated company had extensive
opportunities to engage with the Council and its staff during the
process and the opportunity to understand and respond to the factors
underpinning the Council's analysis before the Council's vote on a
final designation. These designated companies are now subject to
consolidated supervision by the Federal Reserve, which is currently
working to develop enhanced prudential standards for these companies,
taking into account their specific businesses, risks, and existing
regulation.
Designating a firm is not a decision the Council takes lightly.
Before making a final decision about any designation, the Council goes
through a lengthy, multistage, in-depth analysis, during which it
reviews every aspect of a company--including a company's financial
statements, business activities, market dynamics, and existing
regulation--and works with the company and its regulators to understand
how the firm's financial distress could affect the broader financial
system. The most recent designation followed a year and a half of
engagement with the company. Most of the companies the Council has
considered so far have not met the standard for designation. But in
four cases, after considerable and thoughtful deliberation, the Council
has found that a firm needs to be held to a higher standard to protect
the U.S. financial system. Of the four firms the Council has
designated, none were designated for a single reason--they are all
large, interconnected, and complex firms.
The Council's recent adoption of changes to the nonbank financial
company designations process is a prime example of the way the Council
should go about supplementing its processes without compromising its
fundamental ability to conduct its work. Last year, before making any
changes, the Council conducted extensive outreach with a wide range of
stakeholders. The Council's Deputies Committee--senior staff who
coordinate the Council's activities--hosted a series of meetings in
November with more than 20 trade groups, companies, consumer advocates,
and public interest organizations. The Council also solicited input
from each of the three companies then subject to a designation. The
Council discussed the findings from this outreach and proposed changes
during a public meeting in January before subsequently adopting the
procedures in February. Having the administrative flexibility for the
Council to adapt its own procedures allowed us to respond quickly to
stakeholder feedback.
The supplemental procedures address the areas that stakeholders
were most interested in and formalize a number of existing Council
practices regarding engagement with companies. Under the new
procedures, companies will now know early in the process where they
stand, and they will have earlier opportunities to engage with and
provide input to the Council. For example, the Council will notify a
company when it first comes under active review and provide it with the
opportunity to meet with staff, review the Council's primary sources of
public information regarding the company, and provide information
relevant to the Council's review. If a company advances to the next
stage of review, staff will meet with the company to explain the
evaluation process and the framework for the Council's analysis, as
well as any specific issues identified.
Regarding transparency, the changes will provide the public with
more information about the process, while still allowing the Council to
meet its obligation to protect sensitive, nonpublic company
information. First, if a company publicly announces that it is under
review by the Council, the Council intends, upon the request of a third
party, to confirm the status of the company's review. Second, the
Council will continue its recent practice of including more information
in its public bases for designations, to provide the public with a
deeper understanding of the Council's analysis. Third, the Council has
started to publish more information in its annual reports about its
designations work, including the numbers of companies in each stage of
the review process. And fourth, the Council last month published
further details explaining how staff calculate the quantitative
thresholds that the Council applies as a screening mechanism to
identify companies for consideration.
The Council is also providing companies with a clearer and more
robust annual review process. Company representatives are now provided
an opportunity to discuss the scope and process for the review, and
they can present information regarding any change that may be relevant,
including a company restructuring, regulatory developments, market
changes, or other factors.
If a company contests its designation in an annual review, the
Council will vote and provide the company with a written explanation of
any decision not to rescind the designation. In addition, the Council
will provide each designated company an opportunity for an oral hearing
to contest its designation every 5 years. These changes open the door
to more engagement with the Council following a designation to make
sure there is ample opportunity to discuss and address any issues that
a company wants to put before the Council.
Altogether, the changes that the Council has made strengthen the
Council while also addressing many of the suggestions made by
stakeholders.
As Congress contemplates additional changes to the designations
process, it is important that such changes do not compromise the
Council's fundamental ability to conduct its work. We are particularly
concerned with legislative proposals that would dramatically lengthen
an already long and deliberative designation process, impose
insurmountable practical hurdles on the Council's work, and prevent the
Council from taking action to address potential threats to financial
stability that it has identified. Such proposals ignore the lessons of
the financial crisis and would impede the Council's ability to fulfill
the duties Congress gave it. As the President and Secretary Lew have
made clear, we will not support legislation that weakens the important
taxpayer, investor, and consumer protections by impeding the ability of
regulators to identify and respond to threats to financial stability.
U.S. markets and financial institutions are constantly evolving, and we
must remain alert and responsive to new challenges in our dynamic
system, toward the ultimate goal of maintaining the safety, soundness,
and resiliency of our financial system.
I thank the Subcommittee for the opportunity to discuss the
Council's process for nonbank financial company designations and look
forward to answering your questions.
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