[Senate Hearing 116-23]
[From the U.S. Government Publishing Office]


                                                     S. Hrg. 116-23


       FINANCIAL STABILITY OVERSIGHT COUNCIL NONBANK DESIGNATION

=======================================================================

                                HEARING

                               BEFORE THE

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED SIXTEENTH CONGRESS

                             FIRST SESSION

                                   ON

EXAMINING VIEWS ON THE FSOC NONBANK DESIGNATION PROCESS, INCLUDING THE 
 STRENGTHS AND WEAKNESSES OF THE DESIGNATION PROCESS; COMMENTS ON THE 
 RECOMMENDATIONS MADE BY TREASURY IN ITS NOVEMBER 2017 REPORT ON FSOC 
      DESIGNATIONS; AND RECEIVE RECOMMENDATIONS ON LEGISLATIVE OR 
 ADMINISTRATIVE ACTIONS THAT COULD BE TAKEN TO CHANGE THE DESIGNATION 
                                PROCESS

                               __________

                             MARCH 14, 2019

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]


                Available at: https: //www.govinfo.gov /

                               __________
                               

                    U.S. GOVERNMENT PUBLISHING OFFICE                    
36-538 PDF                  WASHINGTON : 2019                     
          
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      MIKE CRAPO, Idaho, Chairman

RICHARD C. SHELBY, Alabama           SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania      JACK REED, Rhode Island
TIM SCOTT, South Carolina            ROBERT MENENDEZ, New Jersey
BEN SASSE, Nebraska                  JON TESTER, Montana
TOM COTTON, Arkansas                 MARK R. WARNER, Virginia
MIKE ROUNDS, South Dakota            ELIZABETH WARREN, Massachusetts
DAVID PERDUE, Georgia                BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina          CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana              CATHERINE CORTEZ MASTO, Nevada
MARTHA MCSALLY, Arizona              DOUG JONES, Alabama
JERRY MORAN, Kansas                  TINA SMITH, Minnesota
KEVIN CRAMER, North Dakota           KYRSTEN SINEMA, Arizona

                     Gregg Richard, Staff Director

                      Joe Carapiet, Chief Counsel

                Brandon Beall, Professional Staff Member

            Laura Swanson, Democratic Deputy Staff Director

                 Elisha Tuku, Democratic Chief Counsel

           Corey Frayer, Democratic Professional Staff Member

                      Cameron Ricker, Chief Clerk

                      Shelvin Simmons, IT Director

                    Charles J. Moffat, Hearing Clerk

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        THURSDAY, MARCH 14, 2019

                                                                   Page

Opening statement of Chairman Crapo..............................     1
    Prepared statement...........................................    22

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     3
        Prepared statement.......................................    23

                               WITNESSES

Douglas Holtz-Eakin, President, American Action Forum............     4
    Prepared statement...........................................    24
    Responses to written questions of:
        Senator Kennedy..........................................    61
        Senator Cortez Masto.....................................    62
Paul Schott Stevens, President and Chief Executive Officer, 
  Investment Company Institute...................................     6
    Prepared statement...........................................    28
    Responses to written questions of:
        Senator Toomey...........................................    63
        Senator Kennedy..........................................    64
        Senator Cortez Masto.....................................    64
        Senator Sinema...........................................    66
Jeremy C. Kress, Assistant Professor of Business Law, University 
  of Michigan Ross School of Business............................     7
    Prepared statement...........................................    52
    Responses to written questions of:
        Senator Toomey...........................................    66
        Senator Cortez Masto.....................................    67

              Additional Material Supplied for the Record

Statement submitted by Julie A. Spiezio, Senior Vice President 
  and General Counsel, The American Council of Life Insurers.....    70
Statement submitted by the Reinsurance Association of America....    74
Statement submitted by The Center for Capital Markets 
  Competitiveness, U.S. Chamber of Commerce......................   114

                                 (iii)

 
       FINANCIAL STABILITY OVERSIGHT COUNCIL NONBANK DESIGNATION

                              ----------                              


                        THURSDAY, MARCH 14, 2019

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:02 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Mike Crapo, Chairman of the 
Committee, presiding.

            OPENING STATEMENT OF CHAIRMAN MIKE CRAPO

    Chairman Crapo. This hearing will come to order.
    Today we welcome to the Committee three witnesses to 
testify on the Financial Stability Oversight Council, or FSOC, 
relating to nonbank designation processes: Dr. Douglas Holtz-
Eakin, president of the American Action Forum; Mr. Paul Schott 
Stevens, who is president and CEO of the Investment Company 
Institute; and Professor Jeremy Kress, assistant professor of 
business law at the University of Michigan's Ross School of 
Business.
    Each of these witnesses is knowledgeable about FSOC's 
designation process and policy, drawing from their experiences 
in industry, Government, and academia.
    The Dodd-Frank Act established FSOC to identify and respond 
to potential threats to U.S. financial stability.
    Dodd-Frank authorizes FSOC to subject nonbank financial 
companies to supervision by the Federal Reserve and prudential 
standards, if it deems a nonbank to pose such a threat.
    In the years after Dodd-Frank was enacted, FSOC evaluated 
individual companies for designation as systemically important 
and ultimately designated four nonbank financial companies: 
AIG, MetLife, Prudential, and GE Capital.
    At the outset, the process for nonbank designation was 
immeasurable and unclear, which was not only contrary to the 
long-established principles of our regulatory framework, but 
also led to legal uncertainty that undermined the very 
objective of FSOC.
    Several years ago, I requested a comprehensive study by the 
GAO on the nonbank designation process.
    The report concluded that FSOC's process lacks transparency 
and accountability, insufficiently tracks data, and does not 
have a consistent methodology for determinations.
    In recent years, FSOC voted to rescind three of those 
designations, while another's designation was overturned in 
court.
    FSOC's decisions have costly implications for designated 
companies, which inevitably translates into higher costs for 
consumers and to the overall economy.
    It is important that FSOC's designation process be clear, 
robust, and focused on addressing real underlying risks.
    The process should also take into account how the existing 
regulatory structure already addresses any potential risks 
before taking the drastic step of designating an individual 
company.
    In 2012, FSOC issued interpretive guidance that outlined 
its designation process, which begins with identifying 
individual companies over $50 billion in total assets for 
further scrutiny based on a set of five other quantitative 
thresholds and then gradually using more granular and company-
specific information along the way.
    In November of 2017, Treasury issued a report entitled, 
``Financial Stability Oversight Council Designations'', which 
provided recommendations to improve FSOC's designation process.
    One of Treasury's key recommendations was for FSOC to 
prioritize an activities-based approach to designation and work 
with relevant regulators to address any risks posed prior to 
considering designating a nonbank financial company.
    Among the other important recommendations made by Treasury 
for the nonbank designation process were: to only designate a 
nonbank financial company if the expected benefits to financial 
stability outweigh the costs of the designation; and provide a 
clear ``off-ramp'' for designated nonbank financial companies, 
including by identifying key risks that led to the designation 
and enhancing the transparency of FSOC's annual review process.
    At its meeting on March 6, FSOC proposed to replace its 
current interpretive guidance on the nonbank designation 
process with new interpretive guidance that would make several 
substantive changes.
    Some of those changes include: prioritizing an activities-
based approach to designation that would focus on identifying 
and addressing the underlying sources of risk and would only 
contemplate designating individual companies if a risk could 
not be addressed through an activities-based approach; 
conducting a cost-benefit analysis prior to designating a 
nonbank; eliminating the first of its three-stage process that 
focuses on applying quantitative thresholds to identify 
individual companies for further evaluation, and the six-
category framework used to analyze individual companies; and 
instituting several procedural changes to improve FSOC's 
engagement with companies and regulators, and clarifying off-
ramp opportunities for companies through risk mitigation 
efforts prior to or after designation.
    After FSOC issued the proposed guidance, Comptroller Otting 
expressed support for the proposal, saying, ``The proposal 
ensures FSOC continues to serve its primary function in a 
transparent, efficient, and effective manner.''
    The proposed guidance is a step in the right direction to 
improve FSOC's effectiveness, transparency, and analyses.
    Senators Rounds, Jones, Tillis, and Sinema have also 
introduced the Financial Stability Oversight Council 
Improvement Act, which would require FSOC to first determine 
that a different action would not address risks posed to 
financial stability prior to a vote on an initial nonbank 
designation.
    During this hearing, I look forward to discussing how an 
activities-based approach will more effectively address 
potential risks to U.S. financial stability; the appropriate 
framework for evaluating activities; and additional 
opportunities for improvements to the process.
    I again thank each witness for joining the Committee this 
morning.
    Senator Brown.

           OPENING STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman, for holding this 
hearing. Welcome to the three witnesses, including Ohioan 
Professor Kress. Nice to see you.
    Let us remember why FSOC matters. When Wall Street takes 
big risks, they do it with Americans' money.
    The financial system affects who gets loans. It affects 
whether people have enough money to retire or pay medical bills 
or send their children to college. When banks and other big 
financial firms take risks and they do not pay off, it is never 
the executives, it is never the CEOs who are left with nothing. 
It is never the executive and the CEOs who have to explain to 
kids, to their own children at the kitchen table what has 
happened. It is ordinary families who lose their jobs, who lose 
their homes, who lose their life savings.
    When too many financial institutions take too many risks at 
once, we all pay the price.
    Right now the risks to the financial system have increased, 
which means the risks are greater for families buying homes and 
saving for retirement and paying off student loans. The biggest 
Wall Street banks have gotten even bigger and bigger and more 
interconnected. The shadow banking system has grown; the shadow 
banking system is taking on more risk. The business cycle is 
extended and growth is slowing. The global economy faces 
uncertainty from Brexit and growing debt levels in China.
    And things look even worse when you look past Wall Street 
and look at ordinary families: Student loan debt has hit record 
levels. Seven million Americans are more than 3 months behind 
on their car payments--think about that. Seven million 
Americans are more than 3 months behind on their car payments. 
That is the highest in 19 years. For too many Americans who 
have not felt the benefits of economic recovery, decades of 
income and wealth inequality have made it harder. Yet this 
Committee, yet this Congress, yet this President seem not to 
care--in fact, are making it worse.
    This Administration is all too happy to look the other way 
as long as the risks affect families' bank accounts, not bank 
profits.
    That is what led to the crisis a decade ago.
    FSOC was created after large, interconnected firms--firms 
like Lehman, Bear Stearns, and AIG--wreaked havoc on the 
economy.
    These firms did not have strong rules in place to ensure 
they had enough liquidity or loss-absorbing capital in case of 
an economic shock. There was no single regulator monitoring the 
entire country and the entire company for systemic risks.
    It was so important to address this problem that the 
authors of Dodd-Frank created FSOC as Title I in the bill.
    Today FSOC appears to be closed for business. It recently 
rescinded the last remaining SIFI designation of the Obama 
administration. Prudential, the giant insurance company that 
grew larger and more complex after it was designated as 
systemically important, is apparently no longer in need of 
stronger safeguards and no longer a risk to financial 
stability.
    Just last week, FSOC issued proposed interpretive guidance 
to make it more difficult to designate nonbank financial firms. 
It shifts the burden back on the primary regulators to identify 
and solve systemic risks before FSOC can take any action.
    These are the same primary regulators that failed to 
identify the risks that led to the worst financial crisis since 
the Great Depression.
    Even more concerning is this approach gives unregulated 
shadow banks a free pass.
    If you still do not believe that this Administration is a 
threat to financial stability, look at how FSOC's staff has 
been literally cut in half. FSOC member agencies have fewer 
meetings; they spend less time considering financial stability 
risks. Treasury has cut a third of the staff of the Office of 
Financial Research, which is supposed to support the work of 
FSOC.
    The Financial Stability Oversight Council has all but given 
up its role as the agency tasked with identifying and 
constraining excessive risk in the financial system.
    Wall Street continues to push legislation that would 
further weaken FSOC and make it impossible for future 
Administrations to designate nonbank financial firms.
    We need to overcome this collective amnesia in this 
Committee and in this Congress. We should be strengthening 
FSOC; we should give it more authority to address risks; we 
should make sure it has the staff and resources to protect 
Americans' savings and homes from financial crisis. Instead the 
collective amnesia of this Administration, Wall Street, and the 
Senate will once again leave hardworking Americans and 
taxpayers holding the bag.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you, Senator Brown.
    We will proceed with the testimony now, and we will begin 
with you, Mr. Holtz-Eakin.

 STATEMENT OF DOUGLAS HOLTZ-EAKIN, PRESIDENT, AMERICAN ACTION 
                             FORUM

    Mr. Holtz-Eakin. Chairman Crapo, Ranking Member Brown, and 
Members of the Committee, it is a privilege to be here today to 
discuss the Financial Stability Oversight Council.
    It has a less than glorious track record in the business of 
nonbank SIFI designations, and this is probably not surprising 
given that it was given an almost impossible job as a systemic 
risk regulator. We cannot measure systemic risk, and if you 
cannot measure something, you probably cannot regulate it very 
well.
    As a result, the FSOC took the very strong authorities it 
was given in Dodd-Frank for designations and used those as its 
chief mechanism. Unfortunately, there were vague criteria for 
designation, and the processes by which designations were made 
turned out to be even less transparent than that. And so we had 
a series of designations that were not, I think, very well 
thought out and have been unwound. But that does not mean they 
did not have real consequences.
    AIG reported, for example, that it was relieved of about 
$150 million in costs by its de-designation, and in thinking 
about some designations that did not happen, asset managers, 
our research indicated that this could have profound impacts on 
their cost structures, and those would be passed forward onto 
customers, lowering the rate of return to retirement saving by 
something like 25 percent.
    So FSOC's activities are very important, and this is a 
great moment for the Committee to hold this hearing because at 
this point there are no nonbank SIFIs, and it is a good time to 
think about the criteria for designation and the processes by 
which they would be done.
    The key things in that regard I think have become pretty 
clear. The first is to move toward an activities-based 
designation and not to rely on entities. In effect, what 
happened with the FSOC is it simply gave a second prudential 
regulator to these nonbank entities, and having two prudential 
regulators is not better than having one that does its job. And 
moving to an activities-based designation would also remove the 
bias against simply picking large organizations. You would have 
to identify the activity that is producing the systemic risk, 
and that is an important step for the FSOC to take.
    The second thing that it would focus on is a disciplined 
benefit-cost analysis prior to designation. Benefit-cost 
analysis is not a panacea in the public policy process, but it 
forces a discipline on regulators to think through clearly 
those costs which will be incurred--and those are typically 
relatively easy to measure--and then to try to put the scale of 
the benefits, which in this case would be foregone financial 
problems, in perspective. That is something that is important 
to try to do because it often becomes clear that the costs are 
quite large and the benefits would have to be comparably large. 
And that discipline is something we need to do.
    Then, finally, it should be transparent and predictable, 
providing some way for remediation prior to designation and a 
clear off-ramp if someone has been designated. Those have been 
missing in the past.
    My take on the interpretive guidance that the FSOC just 
released is this is a good step in the right direction. It is 
not permanent. It could be changed again in the future. But it 
does, in fact, do four things that I think are important: turn 
to an activities basis and stipulate that an entity cannot be 
designated if it can be dealt with by dealing with its 
activities; doing a benefit-cost analysis, as the Chairman 
mentioned; assessing the likelihood that a firm will get into 
financial trouble. The operating procedure in the past has 
been, well, what if this firm got in trouble? What if it fell 
apart? That is a very different calculation than what is the 
probability that something will happen. A benefit-cost analysis 
would roll that right into it, and that is a very good thing.
    And then, finally, the information being provided to firms 
and primary regulators as to what is making the institution a 
risk to the financial system so that it can take steps to 
mitigate predesignation or to provide a clear chance for an 
off-ramp after designation.
    So I thank you for the privilege of being here today, and I 
look forward to the opportunity to answer your questions.
    Chairman Crapo. Thank you.
    Mr. Stevens.

STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT AND CHIEF EXECUTIVE 
             OFFICER, INVESTMENT COMPANY INSTITUTE

    Mr. Stevens. Thank you, Chairman Crapo, Members of the 
Committee. I am pleased to be before you once again today to 
testify.
    The registered funds that are ICI's members are major 
participants in U.S. and global financial markets, and they do 
so on behalf of more than 100 million American investors and 
millions more overseas. The stability of the financial system 
is, therefore, a matter of utmost concern to the institute and 
its members as we help our investors achieve their most 
important financial goals.
    To that end, ICI was an early supporter of proposals to 
form a council of regulators to share information and 
coordinate their activities. We believe that this convening 
authority can be FSOC's greatest strength.
    Ten years after the financial crisis, the financial system 
clearly is more robust and resilient, so the time is right to 
review the effectiveness of postcrisis reforms and to make 
tailored adjustments.
    I will make four points in my remarks today.
    First, designation of nonbank financial companies as a 
SIFI, a systemically important financial institution, is a 
blunt regulatory tool that should be reserved for extraordinary 
circumstances. FSOC's primary goal should be to reduce systemic 
risk, and there can be more effective, less burdensome, or more 
expedient ways to do so. FSOC itself in 2014 decided that a 
review of products and activities would be the first step in 
considering potential risks in the asset management industry.
    ICI welcomed this change in approach. We have long stressed 
that registered funds and fund advisers do not warrant 
designation as SIFIs. Thanks to their structure and regulation, 
registered funds simply do not pose risks to the financial 
system at large. Designation would bring banklike regulation 
that would be highly ill-suited to funds and their managers and 
would significantly harm fund investors.
    More generally, designation of specific firms can create 
significant market distortions, including increased moral 
hazard and reduced competition and reduced consumer choice. We 
believe there is and should be a very high bar for singling out 
individual companies as SIFIs.
    My second point is that SIFI designation should be reformed 
to address widely recognized shortcomings. Officials from both 
the current and prior Administrations have recognized the need 
to allow greater engagement with a company being considered for 
designation, a greater role for the company's primary financial 
regulator, more analytical rigor and attention to actual 
experience, and greater transparency to markets and the public.
    My third point is that policymakers are moving in the right 
direction. The Treasury Department's November 2017 report on 
FSOC offered a series of constructive recommendations for the 
designation process. Just last week, FSOC itself proposed to 
implement these recommendations. It has proposed prioritizing 
an activities-based approach to addressing systemic risk, while 
reserving SIFI designation as a last resort whenever necessary. 
We welcomed FSOC's request for public comments on these 
proposed amendments to its guidance.
    Despite these welcome developments, my fourth point is that 
Congress still must act to confirm in statute that SIFI 
designation is indeed intended as a tool of last resort and 
should be used only in extraordinary circumstances. Four 
members of this Committee--Senators Rounds, Jones, Tillis, and 
Sinema--have introduced bipartisan legislation to achieve this 
goal. S. 603, the Financial Stability Oversight Council 
Improvement Act of 2019, would require the Council to consider 
whether other steps could mitigate any potential risks posed by 
a nonbank financial company before voting to designate that 
company. These steps could include a different action by FSOC; 
action by the company's primary regulator, including 
industrywide regulation of products or activities; or de-
risking actions by the company itself.
    The legislation, in our view, would help ensure that the 
Council considers the full range of options available to 
mitigate risks and makes an informed decision rather than 
simply reaching for the hammer of designation in the first 
instance. The result would be an FSOC that is more effective in 
meetings its primary goal: reducing risk to the financial 
system. ICI urges the Committee to consider S. 603 and report 
it favorably to the full Senate.
    Mr. Chairman, Ranking Member Brown, thank you for your 
attention. I will be happy to address the Committee's 
questions.
    Chairman Crapo. Thank you.
    Professor Kress.

 STATEMENT OF JEREMY C. KRESS, ASSISTANT PROFESSOR OF BUSINESS 
      LAW, UNIVERSITY OF MICHIGAN ROSS SCHOOL OF BUSINESS

    Mr. Kress. Chairman Crapo, Ranking Member Brown, Members of 
the Committee, I am honored to appear before you to discuss the 
Financial Stability Oversight Council's nonbank systemically 
important financial institution designations. Nonbank SIFI 
designations are an essential policy tool for regulating 
systemic risk. I am, therefore, concerned that recent efforts 
to de-emphasize nonbank SIFI designations--or eliminate them 
altogether--would expose the financial system to many of the 
same dangers it experienced in 2008.
    I will make three points in my testimony today.
    First, nonbank SIFI designations are crucial for preventing 
catastrophic nonbank failures like the collapses of Bear 
Stearns, Lehman Brothers, and AIG. Nonbank SIFI designations 
protect the financial system by deterring nonbanks from 
becoming systemically important and by applying heightened 
safeguards to firms that nonetheless become excessively large, 
complex, or interconnected. By contrast, nonbanks' baseline 
regulatory regimes are generally not well suited to accomplish 
these goals.
    Second, criticisms of nonbank SIFI designations are 
unpersuasive. For example, despite critics' complaints, nonbank 
SIFI designations do not impose bank-centric rules on nonbanks. 
To the contrary, the Federal Reserve has gone to great lengths 
to recognize the distinct regulatory issues associated with 
nonbank financial companies and to tailor its approach 
accordingly. Moreover, to the extent that heightened 
regulations create an uneven playing field for designated 
nonbank SIFIs, this differential is a feature, not a bug. 
Enhanced safeguards for nonbank SIFIs ensure that companies 
have incentive to avoid becoming or remaining systemically 
important.
    Third, proposals to replace nonbank SIFI designations with 
an activities-based approach are deeply misguided. Activities-
based regulation, on its own, will not prevent systemic 
collapses like those we experienced in 2008. It is unrealistic 
to expect that regulators will identify and appropriately 
regulate all such activities ex ante, especially given 
financial companies' strong incentives to restructure or rename 
activities to avoid regulation. By contrast, policymakers are 
much more likely to consistently and accurately identify 
nonbank financial companies whose distress could threaten 
financial stability.
    A purely or predominantly activities-based approach to 
nonbank systemic risk will fail for yet another reason: the 
U.S. regulatory framework is not configured to implement 
effective activities-based regulation. The U.S. regulatory 
system is riddled with gaps in areas like insurance, hedge 
funds, and FinTech. Because FSOC lacks authority to implement 
activities-based rules directly, this pervasive jurisdictional 
fragmentation would undermine efforts to enact and enforce 
uniform, consistent activities-based rules throughout the 
financial system.
    To be sure, if configured appropriately, activities-based 
regulation could address some sources of nonbank systemic risk. 
But as currently configured, the U.S. regulatory framework is 
simply not conducive to effective activities-based nonbank 
regulation.
    Proponents of an activities-based approach to nonbank 
systemic risk contend that activities-based rules would merely 
supplement, rather than displace, nonbank SIFI designations. 
But make no mistake. The procedural barriers to nonbank SIFI 
designations that FSOC proposed last week would make it 
exceedingly difficult for the Council to designate new nonbank 
SIFIs and for any such designation to survive judicial review. 
Moreover, the Council's apparent enthusiasm for activities-
based nonbank regulation rings hollow given that the FSOC has 
not used its existing statutory authority to propose a single 
activities-based rule in more than 2 years under Secretary 
Mnuchin's leadership.
    In sum, I am deeply concerned about recent initiatives to 
roll back nonbank systemic risk regulation. Efforts to 
marginalize the Council by diminishing its legal authority, 
politicizing its work, and reducing its budget collectively 
increase risks to the financial system and ultimately threaten 
the real economy.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you very much.
    I want to start out with you, Dr. Holtz-Eakin, and just 
sort of an overall question. You address in your testimony the 
fact that the nonbank SIFI designations come with a cost.
    Mr. Holtz-Eakin. Yeah.
    Chairman Crapo. Could you describe that cost? And, you 
know, there has been a lot of talk about who is the beneficiary 
of addressing the regulatory burden that is imposed by this 
system. What is that cost? And who bears it?
    Mr. Holtz-Eakin. Well, there are two main costs that 
designation brings. The first is sheer compliance costs, which 
would be borne by the institution itself--the hiring of 
compliance personnel, the additional reporting requirements, 
compliance with stress tests and the like, all of which can be 
quite costly. Those costs never end up residing just in the 
institution. They will be passed on in some way, either to the 
customers in the form of higher prices, if it is an insurance 
company, for example, higher premiums on insurance, or in lower 
returns to the owners of the firm, the shareholders. But those 
costs are real, and they have proven to be quite significant.
    The second cost is really the requirement to hold more 
capital and to restrict the innovation in the scale and scope 
of the business practice. You have got now a new regulator who 
has decided they know how you can run your business. If you 
start trying to do something new, you are going to have to get 
their permission to do that, and you will not have the capital 
necessary to deploy it perhaps, and so you lose some of the 
sort of natural institutional vitality in the process.
    Chairman Crapo. And, ultimately, that impacts consumers and 
the economy.
    Mr. Holtz-Eakin. Yes. All of these costs are borne by U.S. 
citizens who use financial sector products.
    Chairman Crapo. All right. Thank you.
    Mr. Stevens--and I want to get to Professor Kress' comments 
on this as well--but do you agree with Professor Kress' point 
that focusing on an activities-based or a risk-based approach 
to regulation is just unrealistic to expect to be workable?
    Mr. Stevens. You know, I took particular note of the 
assertion in the testimony. I represent the mutual fund 
industry. We had a statute passed in 1940 by the Congress that 
has governed our industry from its birth, the modern fund 
industry. It is an activities- and product-based form of 
regulation that has been supervised by the SEC very 
successfully for many years now, and it gave rise to, I think, 
the 20th century's most prominent new formal financial 
intermediation. It actually was the formal financial 
intermediation which weathered the great financial crisis most 
effectively.
    So the idea that our regulation does not know how to deal 
with activities and practices and make them safe and sound and 
stable for the future is something that is simply 
unrecognizable from the point of view of our industry.
    Chairman Crapo. All right. Thank you.
    Professor Kress, if I understood you correctly, you were 
making--one of the points that you were making is that our 
regulatory system as it currently exists does not provide the 
appropriate, I guess I would say, seamless approach across the 
regulatory world to dealing with activities. Is that correct?
    Mr. Kress. That is correct.
    Chairman Crapo. How would you suggest that we--well, would 
you agree that it would be good for us, to improve our overall 
regulation system, to do that?
    Mr. Kress. Certainly. I acknowledge that activities-based 
regulation can combat some sources of systemic risk. In order 
for activities-based regulation to work, though, the regulatory 
system has to be set up for it to succeed.
    Chairman Crapo. Right. So how would we do that?
    Mr. Kress. I am concerned with gaps and overlaps in our 
system. When Congress mandates activities-based regulation, as 
it did with investment companies, it can work. A successful 
provision of the Dodd-Frank Act was mandatory derivatives 
clearing. That is an example of a congressionally mandated 
activities-based rule. But when it is left to the discretion of 
regulators who are fractured and overlapped, I am concerned 
about the consistency and uniformity with which activities-
based rules will be implemented.
    Chairman Crapo. So should Congress take away that 
discretion?
    Mr. Kress. I do not think so, but if you wanted to empower 
FSOC to write activities-based rules directly, rather than 
simply make recommendations for the fragmented primary 
regulators, I think that would strengthen FSOC's activities-
based approach to nonbank systemic risk.
    Chairman Crapo. All right. Thank you. I only have 20 
seconds left, and I would like to get both Dr. Holtz-Eakin's 
and Mr. Stevens' response to that. So could you really quickly 
say do you agree with the notion of giving FSOC regulatory 
authority over activities-based--the authority to issue 
rulemaking over activities-based--activities?
    Mr. Holtz-Eakin. I would not start there. I would start 
with the framework that is in the interpretive guidance and is 
also in the proposed legislation, which is identify activities 
which could be systemically dangerous and put the burden on the 
primary regulator of insulating that firm from the danger of 
that activity.
    Chairman Crapo. All right. Mr. Stevens, real quickly, 
please.
    Mr. Stevens. FSOC has lots of different members with vastly 
different forms of expertise. The idea that they could come 
together as a council and begin writing regulation for discrete 
parts of the financial system to me is implausible.
    Chairman Crapo. All right. Thank you.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    Professor Kress, FSOC was created to address risks to our 
economy posed by nonbank financial firms, like Lehman and Bear 
Stearns and AIG, as you know, whose risky bets contributed to 
the last financial crisis. Briefly, tell me why it is important 
that FSOC have the ability to designate nonbank financial 
companies as systemically important.
    Mr. Kress. Precrisis, there was a longstanding assumption 
that banks were the only types of financial companies that 
could pose systemic risk. As you noted, during the crisis that 
was proved untrue. Investment banks, insurance companies, other 
nonbanks precipitated the economic collapse.
    We still have nonbank systemic risk regulation that, at its 
baseline, addresses risks unrelated to financial stability, 
like consumer protection and investor protection. It is not 
directly targeted to limiting those nonbanks' systemic risk. So 
FSOC designations are important because they are the only way 
to ensure that large, complex, interconnected nonbanks are 
subject to enterprisewide safeguards, like consolidated capital 
and risk management requirements that are designed to limit the 
risks that those companies pose to the financial system and the 
broader economy.
    Senator Brown. Thanks. In the Obama years, there were four 
nonbank financial companies designated as systemically 
important, including AIG. It received a $182 billion Government 
bailout during the crisis. Today, as you know, there are zero.
    What kinds of insights into the workings of large nonbank 
financial companies is FSOC losing for lack of designation? And 
are other regulators stepping in?
    Mr. Kress. I am concerned that FSOC is losing substantial 
insight into the activities, risk exposures, and risk 
management of large systemically important nonbanks. Because of 
the gaps and fragments in our regulatory framework, there are 
in some cases--like in insurance holding company regulation--
maybe no regulatory authority has jurisdiction to step in and 
take FSOC's place.
    Senator Brown. OK. That is important.
    Last week, FSOC proposed to replace its existing nonbank 
designations process with a new activities-based approach that 
you were talking back and forth on, signaling the Council only 
designate a firm as a last resort. A couple of questions. How 
much time and difficulty would this add to the designation 
process?
    Mr. Kress. One of the parts of FSOC's proposed guidance 
that I think is so problematic is its proposal to designate 
nonbank SIFIs only in an emergency situation. SIFI designations 
are not an emergency response tool. SIFI designations are 
supposed to be prophylactic safeguards to prevent a nonbank 
from becoming--from transmitting----
    Senator Brown. Sorry to interrupt, but that suggests an 
earlier designation so they would have time to implement 
safeguards?
    Mr. Kress. Absolutely.
    Senator Brown. If the process described had been in place 
before the last crisis, what would have prevented or mitigated 
the damage to the financial system back a decade ago?
    Mr. Kress. A purely activities-based approach would not 
have prevented the financial crisis, and we know that because 
an activities-based approach did not prevent the financial 
crisis. We had a precursor to FSOC called the ``President's 
Working Group on Financial Markets'', which was compromised of 
many of the top regulators in the United States. The PWG had 
many of FSOC's activities-based authorities to identify and 
make recommendations for regulating systemically risky 
activities.
    If you were to go back and look at what the President's 
Working Group was doing in 2004, 2005, 2006, when risks were 
building in the mortgage market, PWG was focused on mutual 
funds and hedge funds and terrorism risk insurance, activities 
that were largely unrelated to the causes of the crisis.
    The President's Working Group eventually proposed enhanced 
rules for mortgages and securitizations and derivatives in 
March of 2008, one week before Bear Stearns failed. I strongly 
believe that asking regulators to predict ex ante what 
activities will cause systemic failures is a fool's errand.
    Senator Brown. Thank you, Professor Kress.
    Mr. Chairman, I think that from this discussion it is 
pretty clear that FSOC's proposed activities-based process is 
really just another effort to weaken the rules for Wall Street 
and let the largest institutions avoid requirements put in 
place to prevent another taxpayer-funded bailout. We have seen 
just in the last 2 weeks more and more weakening of regulation. 
We have heard several Members of this Committee talk about the 
collective amnesia of this Committee, of the majority in this 
Committee, and of the Trump regulators, and Senator McConnell 
and others in this institution, and the price that--
increasingly it looks like a price that we pay for this is 
something that we just do not want to happen.
    Thank you.
    Chairman Crapo. Thank you.
    Senator Rounds.
    Senator Rounds. Thank you, Mr. Chairman.
    Let me begin by just thanking the Chairman, Chairman Crapo, 
for calling this important hearing. Also, as Chairman Crapo 
indicated earlier, I am one of the sponsors of the FSOC 
Improvement Act, and I did this in conjunction with my 
colleagues Senators Jones, Tillis, and Sinema.
    Part of our job in the Senate is to provide oversight of 
Federal laws and regulations in order to make certain that they 
are in the best interest of the American people. While we may 
not all agree on whether Dodd-Frank was the right approach to 
banking regulation--and I personally do not--we can all agree 
that there is room to review and improve it.
    One of the foremost examples of this is Barney Frank's 
admission nearly 2\1/2\ years ago that the level of supervisory 
thresholds in Dodd-Frank was, and I quote, ``a mistake.'' 
Revisiting the nonbank SIFI designation process is a healthy 
conversation to be having, and it is the Senate's 
responsibility to be doing more of this type of oversight.
    The bipartisan legislation that I proposed simply suggests 
that FSOC consider nondesignation alternatives, like working 
with a company's primary regulator before voting on 
designation. It does nothing to detract from FSOC's emergency 
designation authority.
    I would also like to point out that much more robust 
legislation passed the House last Congress with more than two-
thirds of the chamber's support. A majority of Democrats on the 
House Financial Services Committee cosponsored that more robust 
approach. So it is my hope that the Senate Banking Committee 
can come together on this issue this year. With that, I would 
like to direct my first question to Mr. Stevens.
    Mr. Stevens, one of my primary motivations for sponsoring 
the FSOC Improvement Act was the impact of an unjustified SIFI 
designation on mom-and-pop retail investors, people that go to 
work every single day. Your organization has pointed out that 
nearly three in four Americans save and invest in public 
markets through a 401(k) or similar retirement plan. That means 
every penny in fees counts for the long-term outlook of Main 
Street's retirement savings. A small increase in unnecessary 
fees through an unjustified SIFI designation could amount to 
tens or hundreds of thousands of dollars in lifetime savings 
for the average American.
    From your perspective, why would it be important to think 
about how to make FSOC work more efficiently? And how does our 
legislation help?
    Mr. Stevens. Thank you for your question, Senator. Thank 
you also for the legislation that you have introduced.
    Professor Kress has said that the Federal Reserve has 
articulated these highly flexible and sensitive arrangements 
under which it would regulate a nonbank financial institution 
that was designated. To my knowledge, the Fed has not said a 
peep about how it would regulate a fund or a fund adviser. So 
we are thrown back on what Dodd-Frank says.
    What does Dodd-Frank say? Dodd-Frank says, oh, let us have 
an 8-percent capital requirement. Now, think about that in the 
context of a large S&P 500 index firm. You are setting aside 
presumably 8 percent to hold in cash. You have now created an 
8-percent tracking error against the S&P.
    Well, there is more because there is enhanced prudential 
supervision. So the Fed's people come in and essentially tell 
the fund manager how to run the fund. You know, money market--
mutual funds, rather, are largely not debtors to banks; they 
are creditors to banks. So in a banking crisis, that would mean 
presumably the Fed could come in and say you have to continue 
maintaining your lines of credit for a bank that is failing, 
not because it is good for your shareholders but because we 
think it is good for the system.
    So the fiduciary obligations of the fund's adviser have now 
been broached in favor of protecting the banking system. And if 
a bank actually goes down, that SIFI-designated fund, its 
investors would have to put money into a bailout fund, 
therefore having Main Street bail out Wall Street, which is 
precisely what Dodd-Frank was intended to avoid.
    My own view is that the market distortions that that would 
create are such that that particular fund or fund complex would 
not be too big to fail. It would be so regulated it could do 
nothing else but fail, because investors will say, ``Thank you 
very much. I do not want to be in that fund. I will go to 
another one.''
    So the costs are quite significant in terms of the way the 
market functions and the consequences for the individual 
investors in that fund.
    Senator Rounds. So in a way you have answered really my 
second question as well because this is--what I care about is 
whether or not a consumer or somebody who is using these funds 
and is investing that way and having professionals do it, they 
basically see--because of these types of activities, they see 
the possibility of a net return which is less because of these 
being paid and because of the additional guidelines that are 
laid in place that they then suffer with.
    Mr. Stevens. There is no question about that, Senator, in 
the event of designation.
    Senator Rounds. Thank you.
    Thank you, Mr. Chairman. My time has expired.
    Chairman Crapo. Thank you, Senator Rounds.
    Senator Jones.
    Senator Jones. Thank you, Mr. Chairman, and thanks for 
holding this hearing. Gentlemen, thank you all for being here 
today, and I want to kind of follow up with some questions 
about the legislation I have with Senator Rounds and others.
    You know, one think I think it is important to keep in mind 
is that Congress can pass all these laws, you know, but the 
enforcement of those laws is only as good as the people that 
are placed in those positions, whether it is FSOC, the SEC, the 
Department of Justice, or whatever.
    So with my questions with the bill that Senator Rounds and 
I have, I do not want to focus on this Administration or really 
a future potential Administration and take the politics. Let us 
just focus on the regulatory framework of what we have got 
here.
    One of the things that I think we are doing here is that we 
are trying to give these nonbanks an opportunity, should they 
be in a position, that they are either failing, on the verge, 
whatever the program is, to give them an opportunity for 
correction.
    So my first question with regard to our bill: Is there any 
reason why FSOC, before designating a firm as systemically 
important, is there any reason that they might not want to 
consult with a primary regulator before that designation? Let 
us just go down the panel.
    Mr. Holtz-Eakin. No. That would be entirely beneficial, and 
it is the step that has been missing.
    Senator Jones. All right.
    Mr. Stevens. It is absolutely imperative because that 
regulator is the entity on the Council that has the in-depth 
expertise about that organization.
    Senator Jones. They know those folks best.
    Mr. Stevens. Far better than any others.
    Senator Jones. All right. Yes, sir?
    Mr. Kress. FSOC issued a detailed framework for how it 
would consult with regulators in 2015, and my understanding is 
that it does as a matter of routine before considering any 
designation.
    Senator Jones. So from your perspective, Professor Kress, 
you do not have any objection to them consulting with the 
regulators before they make that designation?
    Mr. Kress. No. I think it is important.
    Senator Jones. All right. So the next question is: Is there 
any additional cost or time or things--are there any 
disadvantages? Let us look at it from a different perspective, 
and be very candid here. Let us look at the disadvantages--are 
there any disadvantages from that, looking at the regulators 
and letting regulators try to work with these entities before 
the designation?
    Mr. Holtz-Eakin. I do not think there are any 
disadvantages. I think there is a tremendous advantage. Let us 
just look at the history. We have these nonbank SIFIs, whether 
they are insurance companies or GE Capital. They are in front 
of the FSOC, and the FSOC says, ``You are systemically 
dangerous,'' and a natural question is: Why? The FSOC should 
have to state why they are dangerous and then be able to turn 
to their primary regulator and say, ``Can you take care of 
this?'' And there has not been in the past clear designation of 
why they are a danger. And there has never been the chance for 
their primary regulator to mediate that in any way. I think 
those are important.
    Senator Jones. Thank you.
    Mr. Stevens. One of the important things about your 
legislation, Senator, is that the timetable remains under the 
control of the FSOC. There is this sensible consequence of the 
legislation that they would have to at an early stage talk to 
the fundamental regulator. They would have to talk to the 
company, engage with the company, and, presumably, if there is 
risk in the company, find the most expedient, quickest ways of 
addressing it. But the idea that somehow or other this is going 
to entail such inordinate delay, there is nothing in the 
legislation that necessitates that. Our view is FSOC remains in 
control of the timetable, and it always has the emergency 
authority that Dodd-Frank provided it in the event of need.
    Senator Jones. All right. Professor.
    Mr. Kress. One of my concerns is that for many types of 
nonbanks, there is not an appropriate regulator who would have 
authority to address systemic risks under their jurisdiction. 
Insurance holding companies, hedge funds, you can consult with 
the supervisors of those entities, but do they have authority 
to implement risk-reducing activities-based regulations? In 
many cases, the answer is no.
    Senator Jones. All right. So the question I have got then, 
let us just stay with you, Professor. Is there a way, though--
because the problem I have got is, given my history as a lawyer 
and, you know, former U.S. Attorney, I always like to try to 
work with people before they get in trouble. And so for those 
folks that you just talked about, is there a way to create that 
process, either strictly with FSOC or someone else, that that 
issue could be addressed? In other words, they see the smoke 
clouds on the horizon, and they want to work with somebody to 
prevent this designation. What would be the answer for that if 
there is no regulator?
    Mr. Kress. Senator, I understand that the goal of the 
legislation is to increase collaboration among FSOC and primary 
regulators as well as increase collaboration among the Council 
and the company. The FSOC, under its existing interpretive 
guidance, has a very clear three-step process in which it 
increasingly coordinates with regulators and with the company 
to get whatever information the Council needs to decide whether 
to designate or to find alternative ways of addressing risk.
    Senator Jones. So for the people that you are concerned 
about, there is already a position in place, and ours would 
just work for the regulators. Is that what you are saying?
    Mr. Kress. I am concerned that adding additional 
requirements over and beyond what FSOC has already laid out 
would slow the process of designation, lead us to an emergency 
situation, and potentially make any future designation 
vulnerable to judicial review if a designated entity were to 
demonstrate any shortcomings in the process.
    Senator Jones. All right. Fair enough.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you.
    Senator Warren.
    Senator Warren. Thank you, Mr. Chairman.
    So the Financial Stability Oversight Council was set up 
after the financial crisis to help regulators spot the kind of 
big systemic risks that brought the economy to its knees and 
crushed working families. And some of those risks are really 
hard to imagine ahead of time, but others, like giant 
interconnected financial institutions, are pretty obvious.
    A few weeks ago, two big banks--SunTrust and BB&T--
announced that they are merging to create an even bigger bank, 
the first new too-big-to-fail bank since the financial crisis.
    Now, the Federal Reserve has to approve the merger before 
it can go through, and I want to talk about what the Federal 
Reserve should consider as they are thinking about this 
approval.
    Professor Kress, you used to work at the Fed, and the Fed's 
record on this, gee, kind of all goes in one direction. They 
have approved 100 percent of all mergers since before the 
financial crisis. Why is the approval rate so high?
    Mr. Kress. So that is correct, I was an attorney at the 
Federal Reserve here in Washington from 2010 to 2014. One of my 
responsibilities was analyzing bank mergers, advising the Board 
on legal permissibility under the Bank Holding Company Act. And 
I think there are largely two reasons why the approval rate is 
so high.
    One is potential bank merger applicants will have extensive 
back-and-forth communications with Fed staff before even 
striking a deal, let alone filing an application. And if at any 
point during that prefiling back-and-forth the staff raises 
concerns that perhaps staff would not be able to recommend 
approval to the Board, that early warning signal, for whatever 
reason--whether it is a pending enforcement action or other 
supervisory concerns--that will deter the bank applicant from 
even striking the deal in the first place.
    The same thing is also true that if staff does not raise 
early warning signals, in my experience, that can create some 
internal momentum for a deal, and the Fed----
    Senator Warren. And all this happens before the public has 
a chance to weigh in before other competitors, before the 
communities that will be affected, before the employees that 
will be affected. So all this is happening behind closed doors.
    Mr. Kress. That is correct, Senator.
    Senator Warren. OK. And you said there is another reason. 
Is that it? Oh, you were saying the internal momentum.
    Let me just ask you, people often talk to me when I am out 
and around, and they say that they are really worried in 
banking. Small businesses, minority-owned businesses, people 
who are doing work in rural communities, in small towns, say 
they have a lot of trouble with access to capital. Does the 
increasing concentration in the merger of these giants have 
anything to do with that?
    Mr. Kress. I have not seen strong evidence to that effect.
    Senator Warren. OK. So in 2008, we learned that when giant 
banks fail, they bring down whole communities with them. Since 
then, we have put in place additional regulatory and capital 
requirements to try to make these banks safer. So, Professor 
Kress, do too-big-to-fail banks still pose a risk to financial 
stability and ultimately to working families around the 
country?
    Mr. Kress. Absolutely. In addition to my research on FSOC 
and nonbanks, I research and write about the too-big-to-manage 
phenomenon in banking, and I think the literature is clear and 
our past experience shows that traditional corporate governance 
mechanisms do not work as well for very big banks as they do 
for nonfinancial institutions. Big banks are opaque. They are 
risky in that they are highly leveraged. They do not have the 
same market discipline as nonfinancial institutions, and size 
exacerbates all of those corporate governance challenges.
    So, yes, I worry that too-big-to-manage institutions pose 
risks both to financial stability and to consumers.
    Senator Warren. OK. That is very helpful. Too big to fail 
and too big to manage are problems here.
    Regulators should not have been blind to the risks that led 
to the 2008 financial crisis, but they were. And I hope that we 
are better at detecting risks than we were in 2008, but we 
still do not have a crystal ball here.
    This Administration has been actively dismantling the 
systems we put in place to catch the risks that we already know 
about. If regulators ignore the risks to our economy, like the 
giant banks and the big nonbank financial institutions, 
ordinary consumers are going to bear the brunt of this all over 
again. The Fed and the other regulators needs to be ready to do 
their jobs.
    Thank you.
    Chairman Crapo. Thank you.
    Senator Cortez Masto.
    Senator Cortez Masto. Thank you. Thank you for the hearing 
this morning. Gentlemen, welcome. Thank you.
    Professor Kress, let me start with you. You have written 
that regulating systemically risky activities like credit 
default swaps and securitizations is not enough to prevent 
nonbanks from failing. Why do you think entity-specific 
regulation is preferable?
    Mr. Kress. I think we need entity-based nonbank SIFI 
designations for several reasons. One is activities-based 
regulation looks at risks of isolated activities one by one. 
But risky activities, when combined within a single firm, 
collectively can pose more risks than when they are conducted 
in isolation.
    Only entity-based SIFI designations allow regulators to 
impose enterprisewide, consolidated capital requirements, 
liquidity requirements, risk management requirements that are 
very important to reduce the likelihood that a systemic 
institution will damage the real economy. Activities-based 
regulation on its own cannot do that.
    Senator Cortez Masto. In essence, you could be looking for 
patterns of risky behavior, right, that would lead to a larger 
comprehensive concern?
    Mr. Kress. Another benefit of SIFI designation is it gives 
regulators an insight into the activities going on within 
large, complex, interconnected firms. Without those 
designations and without that insight, I am concerned that 
identifying risky activities in the first place would be 
extraordinarily difficult.
    Senator Cortez Masto. So can I ask also then--banks have 
rules regarding risk-based capital requirements, liquidity 
rules, stress tests, and risk management standards. Which of 
those rules are nonbank firms subject to?
    Mr. Kress. Under Dodd-Frank, the expectation is that 
nonbanks will be subject to versions of the enhanced prudential 
standards in Section 165. The Federal Reserve has a statutory 
mandate to tailor those rules to the business models of 
designated nonbanks. FSOC--or, excuse me, the Federal Reserve 
proposed to do that with respect to insurance companies. It 
issued an advance notice of public rulemaking for designated 
nonbank SIFI insurance companies, which I think it should 
continue working on and finalize. And it would be expected to 
tailor its regulations for a mutual fund complex or for some 
different sort of nonbank if it were designated.
    Senator Cortez Masto. OK. So I am from Nevada, and I will 
tell you, as I sat here on the Committee for the last couple of 
years, it seems to me that this current Administration is 
removing the safeguards that we put in place during the worst 
crisis that we had seen in Nevada and across the country.
    I am curious, and this is for the panel. Would you agree 
that credit default swaps on mortgage bonds were only systemic 
in hindsight?
    Mr. Holtz-Eakin. So the credit default swaps at AIG were 
the important element in the crisis, and they reflected, in my 
view, more the poor internal management at AIG than a danger in 
the instrument itself. I was on the Financial Crisis Inquiry 
Commission, and when the AIG executives testified, their chief 
financial officer, who was also their chief risk officer, 
testified that he was unaware that Goldman Sachs could demand 
cash of $10 billion if those swaps declined in value. So that 
was just fundamental----
    Senator Cortez Masto. So it was systemic in hindsight.
    Mr. Holtz-Eakin. ----mismanagement.
    Senator Cortez Masto. That was hindsight.
    Mr. Holtz-Eakin. That is--but it is not systemic. It is a 
company, and it is bad.
    Senator Cortez Masto. OK.
    Mr. Stevens. Senator, I do not know that I can answer the 
question specifically, but I would say that we are faced with 
two differing views here on the panel.
    Senator Cortez Masto. Right.
    Mr. Stevens. One view essentially would take very, very 
large parts of the financial system and deliver it to the 
Federal Reserve for regulation. This has never been the model 
in the United States. It is a significant departure. We have 
had two models historically. There has been bank regulation and 
capital markets regulation, and we have benefited from both of 
them. Capital markets regulation and bank regulation do not sit 
very well together.
    I cannot speak to the insurance sector because I am talking 
really for the regulated funds for the asset management 
industry. That was not an industry that had proven to be 
lacking in any resilience during the crisis. Indeed, if in the 
crisis those credit default swaps, as Alan Greenspan said, had 
been held in a mutual fund, the investors in that fund would 
have lost money, but there would have been no bailout, there 
would have been no economic crisis because of the model that 
the fund industry follows.
    It is precisely because of that and the strengths that it 
has that we believe it is highly inappropriate to put an 
overlay of prudential regulation by bank regulators on top of 
the fund industry.
    But make no mistake. There was a headlong rush early on in 
the FSOC's experience to do precisely that, and that is why our 
industry has been so concerned about avoiding inappropriate 
forms of regulation for a part of the financial system that has 
been doing extraordinarily well on behalf of millions of 
ordinary Americans.
    Senator Cortez Masto. Thank you. And I know my time is up. 
Can I just follow up on that? Professor Kress, would you agree 
with that?
    Mr. Kress. I believe that the experience of the President's 
Working Group that I referenced earlier and our regulatory 
track record indicates that it was difficult to foresee the 
credit default swap storm coming.
    Senator Cortez Masto. OK. Thank you. Thank you, gentlemen.
    Chairman Crapo. Thank you.
    Senator Kennedy.
    Senator Kennedy. Thank you, Mr. Chairman.
    Gentlemen, do you honestly believe we can measure with any 
sort of accuracy systemic risk?
    Mr. Holtz-Eakin. Absolutely not.
    Mr. Stevens. I think it is particularly challenging, 
Senator, yes.
    Senator Kennedy. Professor.
    Mr. Kress. I will note that FSOC's job is not to measure 
systemic risk, and----
    Senator Kennedy. I know that, but we all talk around here 
about, you know, the level of safety that we have to reach. It 
is sort of like your cholesterol level. You know, if we can get 
it below that, we are going to live an extra 5 years. Do you 
really think you can measure that?
    Let me give you a specific example. I am not suggesting 
that we should not try, but we have spent all this time and 
effort and money and woman power and people power passing these 
bills. The Chinese economy right now, let us say, they have set 
a goal of growing at 6 percent. They say they are growing about 
6\1/4\. They are lying. It is probably about 5 percent, maybe 4 
percent, 4\1/2\. Let us suppose they go into negative growth. 
That is going to throw the world into a recession.
    Now, are our big banks going to survive that? That is a 
question.
    Mr. Holtz-Eakin. Yes, they are.
    Senator Kennedy. You believe that we have banks right now 
that are not too big to fail?
    Mr. Holtz-Eakin. There is a difference between being too 
big to fail and the probability of failure.
    Senator Kennedy. I understand.
    Mr. Holtz-Eakin. I think probably the figure is quite low 
in a demand-induced recession in the United States.
    Senator Kennedy. Well, if we are so good at this stuff--
and, please, I do not mean that to come--I did not mean for 
that to come out like it did. I am not trying to suggest that 
you are not all very smart and know what you are talking about. 
But if we are so good at this stuff, then how come we had 2008?
    Mr. Stevens. Senator, if I could just observe, that is one 
of the ironies here, isn't it? And I was struck by Senator 
Warren's comments. The idea of delivering larger and larger 
parts of the financial system for the regulation of the Federal 
Reserve would make sense if you conclude that the Federal 
Reserve does an extraordinarily stellar, sterling job about 
regulating the banking sector.
    I think that it is an imperfect model even for regulating 
the industry for which it is fashioned to regulate. The idea 
that it can then get up a learning curve about every other 
conceivable part of the financial system and do an even better 
job strikes me as a triumph of hope over experience.
    Senator Kennedy. You see, my concern--and I am going to 
come back to you, Doc. Excuse me. You go ahead.
    Mr. Holtz-Eakin. Let me just focus on things that are 
different now in a beneficial way. This is not all a negative--
--
    Senator Kennedy. I know, but let me stop----
    Mr. Holtz-Eakin. So the reason we had----
    Senator Kennedy. Let me stop you, Doc.
    Mr. Holtz-Eakin. OK.
    Senator Kennedy. And I do not want to get too far down in 
the weeds, OK? You guys know a lot more than I do, but I am 
going to look at this at a macro level for a second. We talk 
about measuring systemic risk, and we talk about the 
regulation, and that begs the question. OK, if we know how to 
do it, why weren't we doing it in 2008? And how do you measure 
systemic risk?
    I mean, I think that we have many banks--strike that. I 
think we have some banks that are still too big to fail, and I 
do not think we would let them fail. I think if Jamie Dimon 
called the President tomorrow and said, ``I hate to have to 
tell you this, but I am about to go belly up,'' I think we 
would bail him out.
    Why don't we just go the easy route and say to all our 
financial institutions--let us pick a number--``You have got to 
keep 8 percent equity''?
    Mr. Holtz-Eakin. So I will say three things quickly, and 
then your time is up.
    Number one, there is no substitute for equity in the 
financial system. It is the greatest buffer against failures.
    Senator Kennedy. Yeah.
    Mr. Holtz-Eakin. I am all with you on that.
    Number two, if Jamie Dimon were to call--and I say this 
lovingly--sure, if you want to bail out JPMorgan, that is fine, 
but he should lose his job. And that is what went wrong the 
last time we went through this. Nobody lost their job.
    Senator Kennedy. He did not lose it in 2008.
    Mr. Holtz-Eakin. No. I know that.
    And the third thing I would say is the thing that is 
different now about the large banks is they are subject to 
stress tests, so there is a macro view at their exposure to the 
Chinese recession that you discussed. That is a big improvement 
in the supervision----
    Senator Kennedy. But the stress test assumes----
    Mr. Holtz-Eakin. Let me finish----
    Senator Kennedy. ----that we can measure risk.
    Mr. Holtz-Eakin. No. It measures entity risk. So I am going 
to agree with you. We are better at measuring the entity risk 
posed by a large bank. We still do not know how to measure 
systemic risk. I agree with you on that.
    Senator Kennedy. Can I have 30 seconds?
    Other than--I am not recommending this. I am asking you. 
Other than a lot of folks losing their bonuses because they 
will not make as much money, why wouldn't we just say--if 
equity is nirvana, why wouldn't we just say, OK, all you folks 
are going to maintain 8 percent equity. I know you are not 
going to be able to take as much risk. Duh. That is the point.
    Mr. Holtz-Eakin. Any equity standard involves a tradeoff in 
higher costs to the consumers, and so all of the regulations 
about that tradeoff, it is safety versus the capacity to have 
lower-priced products.
    Senator Kennedy. Yeah, but think how much we would save on 
the regulation. Think how much you would save in compliance 
costs. You would not have Sherrod pounding on you every day.
    Mr. Holtz-Eakin. Are you sure about that?
    [Laughter.]
    Senator Kennedy. You are right about that. That part you 
are right about. I mean, you know, in the old days before--the 
real old days, banks held a lot more equity.
    Sorry, Mr. Chairman.
    Chairman Crapo. Thank you, Senator Kennedy, and that does 
conclude the questioning for today's hearing.
    Again, I appreciate all three of you coming and bringing 
your expertise and observations to us. We do need to seriously 
look at what the regulatory structure and system and 
authorities are, in my opinion, to effectively focus on a risk 
and the appropriate level of regulation.
    I see Senator Brown wants to make an observation.
    Senator Brown. Just one quick observation. Senator Kennedy, 
we will continue to work together to try to find a way on too 
big to fail to get you and me on board in the same place, as I 
did with your predecessor. So thank you.
    Chairman Crapo. All right. Thank you. And with that, again, 
thank you to our witnesses for coming, and that concludes our 
hearing. We stand adjourned.
    [Whereupon, at 11:08 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
    Today, we welcome to the Committee three witnesses to testify on 
the Financial Stability Oversight Council, or FSOC, nonbank designation 
process: Douglas Holtz-Eakin, President of the American Action Forum; 
Mr. Paul Schott Stevens, President and CEO of the Investment Company 
Institute; and Professor Jeremy Kress, Assistant Professor of Business 
Law at the University of Michigan's Ross School of Business.
    Each of these witnesses is knowledgeable about FSOC's designation 
process and policy, drawing from their experiences in industry, 
Government, and academia.
    The Dodd-Frank Act established FSOC to identify and respond to 
potential threats to U.S. financial stability.
    Dodd-Frank authorizes FSOC to subject nonbank financial companies 
to supervision by the Federal Reserve and prudential standards, if it 
deems a nonbank to pose such a threat.
    In the years after Dodd-Frank was enacted, FSOC evaluated 
individual companies for designation as systemically important and 
ultimately designated four nonbank financial companies: AIG, MetLife, 
Prudential, and GE Capital.
    At the outset, the process for nonbank designation was immeasurable 
and unclear, which was not only contrary to the long-established 
principles of our regulatory framework, but also lead to legal 
uncertainty that undermined the very objective of FSOC.
    Several years ago, I requested a comprehensive study by the GAO on 
the nonbank designation process.
    The report concluded that FSOC's process lacks transparency and 
accountability, insufficiently tracks data and does not have a 
consistent methodology for determinations.
    In recent years, FSOC voted to rescind three of those designations, 
while another's designation was overturned in court.
    FSOC's decisions have costly implications for designated companies, 
which inevitably translates into higher costs for consumers and to the 
overall economy.
    It is important that FSOC's designation process be clear, robust, 
and focused on addressing real underlying risks.
    The process should also take into account how the existing 
regulatory structure already addresses any potential risks before 
taking the drastic step of designating an individual company.
    In 2012, FSOC issued interpretive guidance that outlined its 
designation process, which begins with identifying individual companies 
over $50 billion in total assets for further scrutiny based on a set of 
five other quantitative thresholds, and then gradually using more 
granular and company-specific information along the way.
    In November 2017, Treasury issued a report entitled, ``Financial 
Stability Oversight Council Designations'', which provided 
recommendations to improve FSOC's designation process.
    One of Treasury's key recommendations was for FSOC to prioritize an 
activities-based approach to designation and work with relevant 
regulators to address any risks posed prior to considering designating 
a nonbank financial company.
    Among the other important recommendations made by Treasury for the 
nonbank designation process were to: only designate a nonbank financial 
company if the expected benefits to financial stability outweigh the 
costs of the designation; and provide a clear ``off-ramp'' for 
designated nonbank financial companies, including by identifying key 
risks that led to the designation and enhancing the transparency of 
FSOC's annual review process.
    At its meeting on March 6, FSOC proposed to replace its current 
interpretive guidance on the nonbank designation process with new 
interpretive guidance that would make several substantive changes.
    Some of those changes include: prioritizing an activities-based 
approach to designation that would focus on identifying and addressing 
the underlying sources of risk, and would only contemplate designating 
individual companies if a risk could not be addressed through an 
activities-based approach; conducting a cost-benefit analysis prior to 
designating a nonbank; eliminating the first of its three-stage process 
that focuses on applying quantitative thresholds to identify individual 
companies for further evaluation, and the six-category framework used 
to analyze individual companies; and instituting several procedural 
changes to improve FSOC's engagement with companies and regulators, and 
clarifying ``off-ramp'' opportunities for companies through risk 
mitigation efforts prior to or after designation.
    After FSOC issued the proposed guidance, Comptroller Otting 
expressed support for the proposal, saying, ``The proposal ensures FSOC 
continues to serve its primary function in a transparent, efficient and 
effective manner.''
    The proposed guidance is a step in the right direction to improve 
FSOC's effectiveness, transparency, and analyses.
    Senators Rounds, Jones, Tillis, and Sinema have also introduced the 
Financial Stability Oversight Council Improvement Act, which would 
require FSOC to first determine that a different action would not 
address risks posed to financial stability prior to a vote on an 
initial nonbank designation.
    During this hearing, I look forward to discussing how an 
activities-based approach will more effectively address potential risks 
to U.S. financial stability; the appropriate framework for evaluating 
activities; and additional opportunities for improvements to the 
process.
    Thank you to each witnesses for joining the Committee this morning.
                                 ______
                                 
              PREPARED STATEMENT OF SENATOR SHERROD BROWN
    Thank you Senator Crapo for holding this hearing.
    Let's remember why FSOC matters. When Wall Street takes big risks, 
they're doing it with Americans' money.
    The financial system affects who can get loans. It affects whether 
people have enough money to retire, or pay medical bills, or send kids 
to college. When banks and other big financial firms take risks and 
they don't pay off, it's never the executives and the CEOs who are left 
with nothing--it's ordinary families who lose their jobs, lose their 
homes, lose their life savings.
    And when too many financial institutions take too many risks at 
once, we all pay the price.
    Right now the risks to the financial system have increased--which 
means the risks are greater for families buying homes and saving for 
retirement and paying off student loans. The biggest Wall Street banks 
have gotten even bigger and more interconnected. The shadow banking 
sector has grown and is taking on more risk. The business cycle is 
extended and growth is slowing. The global economy faces uncertainty 
from Brexit and growing debt levels in China.
    And things look even worse when you look past Wall Street, and look 
at ordinary families: student loan debt has hit record levels. Seven 
million Americans are more than 3 months behind on their car payments--
the highest level in 19 years. And for too many Americans who haven't 
felt the benefits of economic recovery, decades of income and wealth 
inequality have made it even harder.
    This Administration is all too happy to look the other way, as long 
as the risks affect families' bank accounts, not bank profits.
    That's what led to the last crisis.
    The FSOC was created after large, interconnected firms--firms like 
Lehman, Bear Stearns, and AIG--wreaked havoc on the economy.
    These firms didn't have strong rules to ensure they had enough 
liquidity or loss-absorbing capital in case of an economic shock. And 
there was no single regulator monitoring the entire company for 
systemic risks.
    It was so important to address this problem that the authors of 
Dodd-Frank created FSOC in Title I of the bill.
    But now, FSOC appears to be closed for business.
    It recently rescinded the last remaining SIFI designation of the 
Obama administration. Prudential, the giant insurance company that grew 
larger and more complex after it was designated as systemically 
important, is apparently no longer in need of stronger safeguards and 
no longer a risk to financial stability.
    Just last week, the FSOC issued proposed interpretive guidance to 
make it more difficult to designate nonbank financial firms. And it 
shifts the burden back on the primary regulators to identify and solve 
systemic risks before FSOC can take any action.
    These are the same primary regulators that failed to identify the 
risks that led to the worst financial crisis since the Great 
Depression.
    Even more concerning is that this approach gives unregulated shadow 
banks a free pass.
    If you still don't believe that this Administration is a threat to 
financial stability, look at how FSOC's staff has been cut in half. The 
FSOC member agencies have fewer meetings and spend less time 
considering financial stability risks. The Treasury has cut a third of 
the staff of the Office of Financial Research, which is supposed to 
support the work of the FSOC.
    The Financial Stability Oversight Council has all but given up its 
role as the agency tasked with identifying and constraining excessive 
risk in the financial system.
    And Wall Street continues to push legislation that would further 
weaken FSOC, and make it impossible for future Administrations to 
designate nonbank financial firms.
    We should be strengthening FSOC, giving it more authority to 
address risks, and making sure it has the staff and resources to 
protect Americans savings and homes from financial crisis. Instead the 
collective amnesia of this Administration, Wall Street, and the Senate 
will once again leave hardworking Americans and taxpayers holding the 
bag.
    Thank you, Mr. Chairman.
                                 ______
                                 
               PREPARED STATEMENT OF DOUGLAS HOLTZ-EAKIN
                    President, American Action Forum
                             March 14, 2019
    Chairman Crapo, Ranking Member Brown, and Members of the Committee, 
thank you for convening this hearing and providing me with the 
opportunity to appear today and share my views on the Financial 
Stability Oversight Council (FSOC) nonbank designation process. I had 
the honor and privilege of addressing the Committee on this exact topic 
in 2015. Although so much in the world has changed since then, FSOC's 
designation process has not. As a result, my comments will have a tenor 
similar to my previous testimony. \1\
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     \1\ https://www.americanactionforum.org/testimony/fsoc-
accountability-nonbank-designations/
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    Ten years after the financial crisis, Prudential Financial has shed 
its designation as a systemically important financial institution 
(SIFI). \2\ As a result, no nonbank financial companies (NBFCs) remain 
designated as SIFIs. This raises questions as to the future role of 
FSOC in the regulation of systemically important institutions across 
the economy.
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     \2\ https://www.treasury.gov/initiatives/fsoc/designations/
Documents/Prudential%20Financial%20Inc.pdf
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    In my testimony I wish to make two main points:

    FSOC was given a challenging, if not impossible, mandate 
        and responded by significantly hampering U.S. NBFCs and 
        increasing costs for consumers without demonstrably improving 
        the safety or soundness of the U.S. financial system; and

    The exit of the last NBFC from SIFI designation, while 
        welcome, has demonstrated that FSOC lacks relevance in NBFC 
        regulation. For FSOC to remain relevant, it must significantly 
        overhaul its operating procedures, beginning with a philosophy 
        of activities-based rather than entity-specific regulation.
Safety and Soundness
    Title I, Subtitle A, of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act) established FSOC, outlined 
FSOC's powers, and introduced factors that must be considered when 
designating NBFCs as SIFIs. Because banking companies with over $50 
billion in assets are automatically considered SIFIs in the Dodd-Frank 
Act, the key issues involving designation revolve around nonbanks.
    Specifically, Section 113 of the Dodd-Frank Act gives FSOC the 
authority by two-thirds vote (including the chairperson) to bring a 
NBFC under increased supervision and regulation by the Federal Reserve 
Board (FRB) if FSOC determines that ``material financial distress at 
the U.S. nonbank financial company, or the nature, scope, size, scale, 
concentration, interconnectedness, or mix of the activities of the U.S. 
nonbank financial company, could pose a threat to the financial 
stability of the United States.'' \3\ In making that determination, the 
Dodd-Frank Act lists 10 criteria for FSOC to consider along with ``any 
other risk-related factors that FSOC deems appropriate.'' \4\ As such, 
FSOC has broad authority statutorily when evaluating companies for SIFI 
designation.
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     \3\ 12 U.S.C. 5323 (a)(1).
     \4\ 12 U.S.C. 5323 (a)(2)(K).
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    The three-stage evaluation process FSOC developed is intended to 
narrow the pool of companies potentially subject to designation by 
applying specific thresholds based on 11 criteria included in Section 
113 of the Dodd-Frank Act. The 11 criteria have been incorporated into 
six overarching framework categories that FSOC considers: (1) size, (2) 
interconnectedness, (3) leverage, (4) substitutability, (5) liquidity 
risk and maturity mismatch, and (6) existing regulatory scrutiny. \5\
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     \5\ 12 U.S.C. 5323 (a)(2), (b)(2).
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    Some 30 U.S. banks were captured under the Dodd-Frank Act; FSOC 
exercised its authority to additionally designate insurers AIG, 
Metlife, and Prudential, and General Electric's financing arm, GE 
Capital.
Implications
    SIFIs are subject to ``enhanced prudential standards'' with three 
key elements: first, higher capital requirements; second, the 
requirement to undergo annual stress testing; and third, enhanced 
reporting requirements including the creation of recovery and 
resolution plans or ``living wills.'' The impact of these additional 
requirements is clear: SIFIs must set aside more capital, significantly 
increase compliance staff, and increase technology and data capture 
processing. As a result, SIFI designation is a significant cost.
    AIG estimated that de-designation would save the company $150 
million a year in compliance costs once FSOC de-designated it as a SIFI 
in 2017. \6\ Additionally, previous research by the American Action 
Forum (AAF) found that ``SIFI designation of asset managers or funds 
will be costly for investors. In some cases, investors could see their 
returns reduced by as much as 25 percent (approximately $108,000) over 
the long term, forgoing several multiples of their initial principal in 
lost returns over the course of a working life.'' \7\ These additional 
costs are, of course, passed on to consumers. \8\
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     \6\ https://www.ft.com/content/31b36b9a-a662-11e7-93c5-
648314d2c72c
     \7\ https://www.americanactionforum.org/research/the-investor-
cost-of-designating-investment-funds-as-systemically-important/
     \8\ http://responsibleregulation.com/wpcontent/uploads/2013/05/
Pricing-impact-study-Oliver-Wyman-April-10-2013.pdf
---------------------------------------------------------------------------
Criticisms and Policy Recommendations
    The safety and soundness of the financial system is clearly a 
fundamental goal. FSOC was however tasked with a difficult mandate in 
that the concept of ``systemic risk'' has never been adequately defined 
and cannot be measured (let alone a ``safe'' level of systemic risk). 
FSOC's response to this challenge has been to create an environment 
where NBFCs were laden with excessive regulation, and increased 
compliance costs, that were necessarily passed on to consumers. All 
this, and there was no evidence that either the NBFCs designated were a 
risk to the stability of the financial sector or that enhanced 
prudential measures demonstrably decreased such a risk.
    The following analysis underpins the need for wholesale reform:
    1. FSOC's focus on entities that might contribute to systemic risk 
does not pursue the goal of systemic risk itself. Having identified 
banks and insurers as potential contributors to systemic risk, FSOC 
indicated it would then focus on asset managers. To date FSOC has 
declined to give the asset management industry in a clear case of 
picking regulatory winners and losers. Even if FSCO had given asset 
managers appropriate scrutiny this would still miss the key issue of 
what drives systemic risk itself.
    In 2017, the White House directed Treasury to review FSOC's 
designation procedures. The key recommendation of the resulting report 
(the 2017 Treasury Report) \9\ was that FSOC prioritize industrywide 
approaches to systemic risk, and moving from entity-specific 
designation to monitoring the specific activities that increase 
systemic risk across the financial system.
---------------------------------------------------------------------------
     \9\ https://www.treasury.gov/press-center/press-releases/
Documents/PM-FSOC-Designations-Memo-11-17.pdf
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    Activity-based regulation is more comprehensive, as it will 
identify all of the market participants engaged in an activity that 
could pose a threat to stability. This approach is substantially better 
than singling out one or a few large firms or funds for designation, 
which creates disparities in regulation across firms and sectors that 
could have a very real and unintended economic costs.
    2. Size is not a useful indicator of risk. It seems clear that the 
primary factor for designation is the bluntest: the size of the 
organization. Size does not necessarily correlate to risk, and larger 
organizations tend to be better diversified and more capable of 
absorbing systemic shock.
    FSOC has not indicated that it has appropriately considered the 
riskiness of the insurance industry at all. Insurers receive systemic 
risk--they do not drive it. Liquidity is rarely an insurance concern, 
as assets are matched at long rather than short terms. Insurers do not 
lend to other insurers and are not as interrelated as banks. We will 
never see a run on an insurer. AIG failed because it had come to 
contain an unregulated hedge fund; risk did not stem from its insurance 
activities. In his dissent from the FSOC's SIFI designation of 
Prudential Financial, Roy Woodall, appointed by President Obama as 
FSOC's independent member with insurance expertise, noted his concerns 
stating, ``The underlying analysis utilizes scenarios that are 
antithetical to a fundamental and seasoned understanding of the 
business of insurance.'' \10\
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     \10\ https://www.treasury.gov/initiatives/fsoc/council-meetings/
Documents/September%2019%202013%20Notational%20Vote.pdf
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    The 2017 Treasury Report noted the lack of academic backing for 
FSOC's determinations and recommended that FSOC ``increase the 
analytical rigor of designation analyses.''
    3. Lack of transparency. The factors used to determine SIFI status 
are not weighted, and the decision-making process is extremely opaque. 
The Government Accountability Office (GAO) has at several junctures 
reproached FSOC for its lack of transparency. \11\ The decision to 
designate (or de-designate) requires only the support of two-thirds of 
FSOC, and the decision to designate both MetLife and Prudential was 
made despite objections from the FSOC members with insurance experience 
and after a lack of consultation with State insurance regulators. \12\ 
GAO is not alone in suggesting more open communication with the public 
and companies under consideration--the Bipartisan Policy Center and 
many others have echoed such concerns. \13\ Designation decisions 
available to the public should reflect the shared goal of minimizing 
systemic threats; if there is a specific activity or subsidiary of a 
designated firm that poses an acute threat, the final decision should 
disclose it.
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     \11\ https://www.gao.gov/products/GAO-15-51
     \12\ http://www.treasury.gov/initiatives/fsoc/council-meetings/
Documents/September192013NotationalVote.pdf; http://www.treasury.gov/
initiatives/fsoc/council-meetings/Documents/
December182014MeetingMinutes.pdf
     \13\ http://bipartisanpolicy.org/library/report/Dodd-Frank's-
missed-opportunity-road-map-more-effective-regulatory-architecture
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    4. FSOC's focus has been to punish, not to remediate. As a company 
moves through FSOC's three-stage evaluation process, FSOC does not 
inform companies of what changes could be made to either their 
structure or operations to avoid designation. In the supplemental 
procedures adopted in 2015, FSOC made some effort toward increasing the 
amount of communication between firms under consideration and FSOC 
staff. Yet ultimately, FSOC does not encourage companies to work with 
the Office of Financial Research and FSOC staff to clearly define a 
potential systemic threat through data and modeling and then explore 
lower cost alternatives to designation. In meeting its aim of financial 
stability, FSOC should consider all the tools available instead of 
quickly moving to designation.
    5. The designation process has never involved a cost-benefit 
analysis. FSOC should attempt to fully assess the economic effect, both 
costs and benefits, of designating only certain nonbanks as SIFIs. This 
means producing a convincing model that a firm's failure, its financial 
distress, or its activities could destabilize the financial system. In 
such a way, FSOC can demonstrate what is at stake and how a designation 
will help, and then justify the costs. Preventing the next financial 
crisis may undoubtedly have enormous benefit, but FSOC has not clearly 
outlined how each firm or industry segment it has scrutinized poses an 
actual threat to stability. Since the economic cost of eliminating 
systemic risk entirely is prohibitive, FSOC's goal must be to find the 
``right'' amount of risk, a difficult feat since FSOC can neither 
measure its progress nor know its target. Because of the difficulty of 
regulating entities posing only a potential systemic threat, 
designations should be firmly rooted in sound economic analyses that 
explore all costs and benefits (as well as alternatives to designation) 
and be substantially justified by applicable Dodd-Frank Act statutes.
    The 2017 Treasury Report recommended that FSOC revise its guidance 
to specifically require a cost-benefit analysis.
    6. FSOC and its staff must continue actively to engage the public, 
experts, and stakeholders to examine comprehensively potential systemic 
threats, firm types, and changes in the financial economy environment 
as well as areas for FSOC procedural improvement. In 2015, FSOC began 
the process of reviewing and evaluating its SIFI designation process 
for nonbanks, seeking input from stakeholders and assessing potential 
changes. Ultimately, this process led to the adoption of a number of 
positive steps toward increasing communication between FSOC staff and 
firms under review and adding transparency to the process. If anything, 
this change should encourage FSOC to continue to collaborate with 
stakeholders, seek input from the public, and continue to advance 
efforts that open up its opaque process. As FSOC considers increasingly 
different potential threats, firms, and industry changes, engagement 
with outside experts will be integral and may substantially improve 
public confidence in its efforts.
FSOC Proposes Amending Interpretive Guidance
    It is in this context that last week FSOC voted unanimously to 
amend its interpretative guidance relating to the designation of NBFCs. 
FSOC has stated its intent to dedicate itself to a new approach that 
would replace entity-based designation with activities-based 
supervision. FSOC will also ``enhance the analytical rigor and 
transparency of the Council's process for designating nonbank financial 
companies'' and commit to the performance of cost-benefit analyses. 
\14\ This revision to the interpretative guidance, and all future 
revisions to internal procedures, will be made available for public 
comment--a welcome demonstration of willingness to continue engaging 
with all stakeholders.
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     \14\ https://home.treasury.gov/news/press-releases/sm621
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Conclusions
    The nonbank designation process is arbitrary, inconsistent, and 
opaque. Four years later the only thing that has changed is the exit of 
the last unwilling participant from this system. Now FSOC must consider 
its role as a regulator. The passing of the Economic Growth, Regulatory 
Relief, and Consumer Protection Act (S. 2155) \15\ demonstrated the 
need and an appetite to redress the overreach of the Dodd-Frank Act. 
FSOC must redefine its mission, which must involve a shift from entity-
specific regulation to activities-based regulation, or be disbanded as 
a regulator. FSOC's decision to amend its interpretative guidance is to 
be welcomed and we look forward to seeing how policy will evolve in 
this area.
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     \15\ https://www.congress.gov/bill/115th-congress/senate-bill/
2155/text
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                                 ______
                                 
               PREPARED STATEMENT OF PAUL SCHOTT STEVENS
  President and Chief Executive Officer, Investment Company Institute
                             March 14, 2019




Introduction
    Financial stability is a matter of the utmost concern to ICI and 
its members. As major participants in U.S. and global financial markets 
on behalf of over 100 million American investors, registered funds and 
their managers have every reason to support policy measures that 
promote the robustness and resiliency of those markets. Our investors 
are counting on their registered fund investments to help them achieve 
their most important financial goals, such as saving for college, 
purchasing a home, or providing for a secure retirement.
    Since the financial crisis, ICI and its members have engaged 
actively in U.S. and global policy discussions concerning systemic 
designation of nonbank financial companies, particularly as they relate 
to asset management, and whether there are potential risks to financial 
stability from asset management products or activities. We have made 
detailed submissions to the Financial Stability Oversight Council (FSOC 
or Council), the Office of Financial Research (OFR), the Financial 
Stability Board (FSB), and numerous other bodies. ICI has testified 
before Congress on several occasions; we have engaged in extensive 
public commentary; and we have sought to inform the policymaking 
process by providing empirical research about registered funds and 
their investors. \1\
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     \1\ A compendium of selected ICI work on financial stability (with 
links to comment letters, speeches, research papers, Congressional 
testimony, and other commentary) is available at https://www.ici.org/
pdf/misc_18_finstability_compendium.pdf.
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    Ten years after the financial crisis, the financial system clearly 
is more robust and resilient. ICI and its members believe that this is 
an appropriate time for policymakers to review postcrisis reforms and 
make tailored adjustments where needed to fix unintended consequences 
and achieve balanced regulation. Let me underscore that point--we 
advocate for using the experience of the past several years to inform 
tailored adjustments that increase regulatory efficiency and 
effectiveness, not measures that would undermine the progress that has 
been made toward a more resilient financial system.
    The Dodd-Frank Wall Street Reform and Consumer Protection Act 
(Dodd-Frank Act), by design, provides FSOC and its member agencies with 
an array of regulatory tools, including SIFI designation authority. The 
Council, for example, has a risk monitoring mandate and the authority 
to identify gaps in regulation and make recommendations to financial 
regulators. As the Council observed in its proposal just last week on 
the SIFI designation process, the Dodd-Frank Act provided FSOC with 
broad discretion as to how to employ its range of authorities.
    This Committee held a hearing 4 years ago to examine the SIFI 
designation process and consider ways to improve transparency and 
accountability. Testifying at that hearing, I advised that, to truly 
advance financial stability, that process must be open to the public, 
analytically based, and grounded in the historical record. I reiterate 
that message in my testimony today. Indeed, these principles should 
apply not just to SIFI determinations but across the whole of FSOC's 
work.
    In 2017, the Treasury Department issued a thoughtful and thorough 
report that included specific recommendations on how to recalibrate the 
SIFI designation process. The report also considered--appropriately, in 
my view--how the SIFI designation process should fit into the broader 
context of the Council's authorities and recommended in effect that 
SIFI designation be a regulatory tool of last resort. FSOC has now 
issued a proposal to implement the Treasury recommendations. Based on 
our preliminary review, there is much to commend in the proposal. ICI 
will evaluate the proposal closely in consultation with our members, 
and we look forward to commenting on behalf of the registered fund 
industry.
    Even if FSOC adopts such reforms, as we hope it will, ICI firmly 
believes that legislation is necessary to provide a more durable 
solution. We believe Congress should confirm that SIFI designation of 
nonbank financial companies should be used by the Council only in rare 
circumstances, where no other regulatory action suffices to address the 
potential risk to financial system stability. So long as FSOC's 
statutory authority remains unchanged, nonbank financial companies 
(including regulated funds and their managers) will continue to face 
the risk, even if remote, of inappropriate SIFI designation.
    In Section II, we discuss the limitations of SIFI designation and 
why its use should be reserved for extraordinary circumstances. We note 
our continuing concern that FSOC at some future time might proceed with 
the designation of a registered fund or fund manager, and we describe 
why this course of action would be unwarranted and harmful to fund 
investors. In Section III, we explain that reform of the SIFI 
designation process is necessary in several key areas: greater 
engagement with a company being considered for possible designation; a 
greater role in the process for the company's primary financial 
regulator; more rigorous analysis of the company and its potential to 
pose risk to U.S. financial system stability; and greater transparency 
to the financial markets and market participants. In Section IV, we 
discuss the Treasury Department's 2017 recommendations for improving 
the SIFI designation process and FSOC's proposal, issued just last 
week, to implement those recommendations. We also observe that the 
global Financial Stability Board likewise is considering improvements 
in how it conducts its work, following a review of its processes and 
transparency. In Section V, we urge the Committee's support for 
legislation to confirm that SIFI designation is intended to be a 
regulatory ``tool of last resort.'' Finally, Section VI briefly 
outlines our recommendations for Congress.
SIFI Designation Is a Blunt Regulatory Tool, and Its Use Should Be 
        Reserved for Extraordinary Circumstances
    ICI's support for improving the U.S. Government's capability to 
monitor and mitigate risks across the financial system--including by 
creating a new council of financial regulators--dates from the 
beginning of the legislative debate over financial services regulatory 
reform in the wake of the financial crisis. \2\ Then, as now, we saw 
the value of bringing together diverse perspectives and expertise from 
across the spectrum of financial services to consider emerging risks. 
The coordination of regulatory policies is altogether important in 
light of the size and complexity of the financial system and the sheer 
number of Government entities involved in overseeing it. Ever since 
Congress created FSOC as part of Title I of the Dodd-Frank Act, we have 
continued to believe that the convening and coordinating power of the 
Council is its greatest strength.
---------------------------------------------------------------------------
     \2\ See, e.g., Testimony of Paul Schott Stevens, President and 
CEO, ICI, Before the Committee on Banking, Housing, and Urban Affairs, 
United States Senate, on Establishing a Framework for Systemic Risk 
Regulation (July 23, 2009).
---------------------------------------------------------------------------
    Title I also gave FSOC the authority to designate nonbank financial 
companies as SIFIs, and our early views concerning the use of this 
power likewise remain unchanged. \3\ It is fundamentally important to 
view SIFI designation authority in context--recognizing that it is just 
one regulatory tool among many afforded to financial regulators under 
the Dodd-Frank Act to address abuses and excessive risk taking by 
financial market participants, and that in many cases such designation 
is merely an addition to other preexisting powers. We continue to 
emphasize to the Committee that there are numerous reasons why the 
Council should invoke this extraordinarily potent, but blunt, legal 
authority only in very limited circumstances. As we indicated 
previously, these reasons include:
---------------------------------------------------------------------------
     \3\ See, e.g., Letter from Paul Schott Stevens, President and CEO, 
ICI, to FSOC, dated Nov. 5, 2010, available at https://www.ici.org/pdf/
24696.pdf.

    The inherent difficulty of trying to predict in advance 
        whether a given nonbank financial company is, or may prove to 
---------------------------------------------------------------------------
        be, systemically significant

    The potential mismatch between the remedies that the Dodd-
        Frank Act prescribes for designated companies (i.e., 
        consolidated supervision by the Federal Reserve Board and 
        enhanced prudential standards, such as capital requirements, 
        that largely reflect banking regulation concepts) and the risks 
        that FSOC has identified as the basis for designation \4\
---------------------------------------------------------------------------
     \4\ We elaborate on this point later in this section of the 
testimony.

    Uncertainty about the reaction of markets and market 
        participants to a company's designation--which could result in 
---------------------------------------------------------------------------
        a competitive advantage, or disadvantage, for the company

    Increased moral hazard, if market participants succumb to 
        the temptation to relax their own due diligence with respect to 
        a designated company based on the expectation that the 
        Government is monitoring and preventing risks

    Reduced competition and consumer choice--for example, if 
        companies exit certain businesses, or reduce their 
        participation in those businesses, to avoid designation by FSOC

    To the preceding list, we would add that SIFI designation authority 
necessarily requires FSOC to single out individual companies--even 
though other companies may have similar structures or engage in similar 
activities. As all this suggests, there is and should be a very high 
bar for determining that a single company has the potential to threaten 
the stability of the U.S. financial system.
    These challenges, potential negative consequences, and shortcomings 
of the SIFI designation tool are why we repeatedly have advised that 
the use of this tool should be reserved for extraordinary 
circumstances. By this, we mean those (presumably quite limited) 
circumstances when FSOC has determined that a specific company clearly 
poses significant risks to the financial system that cannot otherwise 
be adequately addressed through other means. Moreover, use of the tool 
should reflect FSOC's determination that the regulatory regime 
presented by Title I of the Dodd-Frank Act is the appropriate response 
to address the identified risks.
    Our long-standing position is in line with views expressed by 
senior Government officials directly involved in the formation of FSOC 
and its early years of operation. With foresight, as we have noted 
previously, former Federal Reserve Board Chairman Ben Bernanke 
expressed his expectation that use of the SIFI designation tool would 
be limited. \5\ And in hindsight, former Treasury Under Secretary for 
Domestic Finance Mary Miller recently lamented that she now believes 
that during the time she was involved, FSOC spent too much time on 
designations and not enough on regulatory coordination. \6\
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     \5\ During a Congressional hearing in connection with the 
development of the Dodd-Frank Act, Chairman Bernanke was asked 
expressly for his views on the number of firms that might be considered 
to be ``systemically significant, too big to fail, too interconnected 
to fail.'' He responded: ``A very rough guess would be about 25. But I 
would like to point out that virtually all of those firms are organized 
as bank holding companies or financial holding companies, which means 
the Federal Reserve already has umbrella supervision. So, I would not 
envision the Fed's oversight extending to any significant number of 
additional firms.'' See ``Regulatory Perspectives on the Obama 
administration's Financial Regulatory Reform Proposals, Part II'': 
Hearing before the House Committee on Financial Services (Serial No. 
111-68), 111th Congress (2009), p. 47 (question by Rep. Campbell).
     \6\ Remarks by Mary Miller at Functions and Firms: Using Activity 
and Entity-based Regulation to Strengthen the Financial System, 
conference cosponsored by the Office of Financial Research and the 
University of Michigan Center on Finance, Law and Policy (Nov. 15-16, 
2018, Washington, DC) (Functions and Firms Conference) (``with the 
hindsight of now 4 years out of the Government and back in the real 
economy and Main Street, I would say that we probably spent too much 
time on the designation work and not enough time on another very 
important role that FSOC can play, which is regulatory coordination. 
And I think if we could have done that differently we would have moved 
some things through the pipeline sooner, we might have gotten more buy-
in on some very important concepts that followed the financial crisis 
that we should have jumped on.''), available at http://
financelawpolicy.umich.edu/conferences/functions-and-firms-using-
activity-and-entity-based, video for day 2, panel 6 at approximately 
12:35 to 13:10. See also ``Is Dodd-Frank Oversight Council Still 
Relevant?'' by John Heltman, American Banker (March 5, 2019) (noting 
the observation by former Treasury official David Portilla that FSOC's 
success ``will be in the power of convening the body and ensuring the 
regulators talk to each other and are sharing information and . . . not 
leaving [risks] unaddressed.'').
---------------------------------------------------------------------------
    Underpinning our views about limiting the use of SIFI designation 
is the simple notion that FSOC's primary goal should be to reduce 
systemic risk, and that there can be more effective, less burdensome, 
and/or more expedient ways to do so. Even those who argue for broader 
use of SIFI designation as a regulatory tool acknowledge that it is not 
a panacea. \7\
---------------------------------------------------------------------------
     \7\ A key ``take away'' from the discussion at the Functions and 
Firms Conference was that several of the participants view activities-
based and entity-based approaches as complementary--as even the full 
name of the conference suggests. See conference video, supra n. 6.
---------------------------------------------------------------------------
Designation of a Registered Fund/Fund Manager Would Be Unwarranted and 
        Harmful to Fund Investors
    ICI and its members consistently have called for improvements to 
the SIFI designation process that will help avoid the risk of 
inappropriate designations. We remain concerned that FSOC at some 
future time might proceed with the designation of a registered fund or 
fund manager. Why would such a designation be inappropriate? Because 
registered funds don't fail like banks do--fund investors bear any 
investment losses, so there's no need for a Government bailout. \8\ 
Unlike banks, fund managers act solely as agents, providing investment 
services to a fund by contract. The registered fund structure and 
comprehensive regulation of funds and their managers under the Federal 
securities laws already limit risks and risk transmission. And, as more 
than seven decades of historical experience demonstrates, registered 
fund investors do not panic or redeem heavily in the face of market 
downturns or turmoil. \9\
---------------------------------------------------------------------------
     \8\ See, e.g., Investment Company Institute, ``Orderly Resolution 
of Mutual Funds and Their Managers'' (July 15, 2014), available at 
https://www.ici.org/pdf/14_ici_orderly_resolution.pdf.
     \9\ For more detail on this experience, see ``Regulated Fund 
Shareholders' Reaction to Market Turmoil, 1944-January 2019'', at 
Appendix A to this testimony.
---------------------------------------------------------------------------
    Testifying in the House of Representatives years ago, William 
McNabb, then ICI Chairman and Chairman and CEO of the Vanguard Group, 
pointed to press reports that FSOC was evaluating two large asset 
management firms for possible designation. He warned:

        If the FSOC continues down this path, it could result in 
        extension of the Federal Reserve's supervisory authority to 
        companies whose business is rooted in the capital markets and 
        which the Federal Reserve does not have the expertise to 
        regulate. And it could mean the application of bank regulatory 
        standards that are entirely out of keeping with the way in 
        which [registered] funds and their managers are structured, 
        operated and currently regulated and with the expectations of 
        investors and the capital markets. \10\
---------------------------------------------------------------------------
     \10\ See Statement of F. William McNabb III, Chairman and CEO, The 
Vanguard Group, and Chairman, ICI, on ``Examining the Dangers of the 
FSOC's Designation Process and Its Impact on the U.S. Financial 
System'' (May 20, 2014) at 2, available at https://www.ici.org/pdf/
14_house_fsoc.pdf. The testimony highlights several ways in which 
registered funds and their managers are fundamentally different from 
banks. It explains why SIFI designation of a fund manager is 
unwarranted and why even the very largest registered funds likewise are 
not SIFIs. And it discusses the investor harm and market distortion 
that would stem from such a SIFI designation.

    It is important for the Committee to bear in mind what is at stake. 
Of greatest concern are the harms that SIFI designation would bring to 
fund investors by applying measures that are designed to moderate bank-
like risks and are ill-suited to registered funds and their managers. 
These measures include capital and liquidity requirements, along with 
prudential supervision by the Federal Reserve Board. Designated funds 
or managers also would have to pay additional fees or assessments to 
defray Federal Reserve supervisory costs and FSOC and OFR expenses. And 
a designated fund could be assessed to cover costs associated with the 
resolution of a distressed financial institution deemed systemically 
important. Stated more plainly, this means that fund investors could 
have to help bail out a distressed, ``too big to fail'' financial 
institution--even though a major goal of the Dodd-Frank Act was to 
prevent ``Main Street'' from having to bail out ``Wall Street.''
    Based on these requirements, designated funds would face higher 
costs resulting in lower investment returns for individuals saving for 
retirement, education, and other life goals. The resulting competitive 
imbalances would distort the fund marketplace, potentially reducing 
investor choice. Designation also could have far-reaching implications 
for how a fund's portfolio is managed, depending on how the Federal 
Reserve exercises its supervisory charge under the Dodd-Frank Act to 
``prevent or mitigate'' the risks presented by large, interconnected 
financial institutions. As I have explained in previous Congressional 
testimony, regulated funds and their managers could be subject to a 
highly conflicted form of regulation, pitting the interests of banks 
and the banking system against those of millions of investors. \11\
---------------------------------------------------------------------------
     \11\ See Statement of Paul Schott Stevens, President and CEO, ICI, 
on ``FSOC Accountability: Nonbank Designations'' (March 25, 2015) (2015 
FSOC Testimony), available at https://www.ici.org/pdf/
15_senate_fsoc.pdf, at 15-18 (discussing in greater detail the highly 
adverse consequences of inappropriate designations to investors and the 
capital markets). See also Paul Schott Stevens, ``Designation's Vast 
Reach Into Investor Portfolios'', ICI Viewpoints (March 24, 2015), 
available at https://www.ici.org/viewpoints/view_15_designation.
---------------------------------------------------------------------------
    While the prospect of such an ill-suited designation does not 
currently loom as large as it did in 2014, there are improvements that 
can be made to the SIFI designation process and to the Council's 
designation authority that would help avoid such an outcome in the 
future. I discuss those areas for improvement in the remainder of my 
testimony.
The SIFI Designation Process Should Be Redesigned in Light of ``Lessons 
        Learned''
    Calls for reform of the SIFI designation process are not new. And 
these calls have not come just from industry stakeholders. They have 
come from the Government Accountability Office, in reports dating back 
to 2012. \12\ They have come from Republican and Democratic members of 
Congress in letters to FSOC. \13\ And they have come most emphatically 
from members of the House of Representatives from both parties, with 
the April 2018 passage of H.R. 4061, the FSOC Improvement Act, by a 
bipartisan vote of 297 to 121.
---------------------------------------------------------------------------
     \12\ See, e.g., 2015 FSOC Testimony at n. 4.
     \13\ Id. at n. 3.
---------------------------------------------------------------------------
    The Council itself has recognized shortcomings in its own process. 
By this, I do not mean just the current FSOC, but also the Council as 
constituted under the prior Administration. In November 2014, just 2\1/
2\ years after adopting its rule and guidance outlining the designation 
process, FSOC staff convened roundtable discussions including academics 
and various stakeholders, including ICI. In early 2015, FSOC principals 
endorsed a set of ``supplemental procedures'' designed to improve the 
Council's engagement with companies and other regulators and increase 
transparency to the public. \14\
---------------------------------------------------------------------------
     \14\ See FSOC, ``Supplemental Procedures Relating to Nonbank 
Financial Company Determinations'' (Feb. 4, 2015), available at https:/
/www.treasury.gov/initiatives/fsoc/designations/Documents/Supplemental-
Procedures-Related-to-Nonbank-Financial-Company-Determinations-
February-2015.pdf.
---------------------------------------------------------------------------
    In my 2015 FSOC Testimony, I explained that ICI welcomed those 
changes as an initial positive first step toward providing greater 
fairness and clarity in the designation process. But I also advised 
that more needed to be done to achieve that goal.
    My message today, 4 years later, is much the same. The SIFI 
designation process is still in need of reforms in several key areas:

    Greater engagement with a company being considered for 
        possible designation;

    A greater role in the process for the company's primary 
        financial regulator;

    More rigorous analysis of the company and its potential to 
        pose risk to U.S. financial system stability; and

    Greater transparency to the financial markets and market 
        participants.

    I discuss each of these areas briefly below.
Greater Engagement With a Company Being Considered for Possible 
        Designation
    Meaningful dialogue between a company being considered for SIFI 
designation and FSOC and its staff is of utmost importance. To be 
meaningful, such a dialogue needs to begin as early as possible in the 
process. If a company is given an early indication as to why FSOC has 
selected it for review, the company is in a position to provide 
pertinent information about its business, structure and operations. 
With a more complete picture of the company and its risk profile, the 
Council and its staff can engage in a more informed review of the 
company or determine that no further investigation is necessary. This 
benefits FSOC by allowing it to make smart use of its limited 
resources, and it provides a fairer process for the company.
    To its credit, FSOC recognized early on the value of more robust 
engagement with companies under review. Its 2015 supplemental 
procedures include several measures designed to increase communications 
with the company at various stages of the designation process. But 
these are not guaranteed protections, because FSOC issued them 
informally. Unless and until FSOC incorporates these procedures into 
its interpretive guidance through a public notice and comment process, 
they will remain ``supplemental'' and thus subject to amendment or 
rescission at the Council's discretion. \15\
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     \15\ Last week, FSOC adopted a rule stating that the Council shall 
not amend or rescind its interpretive guidance on nonbank financial 
company determinations, which appears in Appendix A to 12 CFR part 
1310, without providing the public with notice and an opportunity to 
comment consistent with the Administrative Procedure Act. FSOC, 
``Authority To Require Supervision and Regulation of Certain Nonbank 
Financial Companies'', RIN 4030-AA03 (March 6, 2019), available at 
https://home.treasury.gov/system/files/261/Final-Rule-Regarding-Notice-
and-Comment.pdf. The 2015 supplemental procedures are not part of 
Appendix A to 12 CFR part 1310.
---------------------------------------------------------------------------
Greater Role for the Company's Primary Financial Regulator
    The current process calls for consultation with a company's primary 
financial regulator prior to any final designation of the company. This 
is merely a recitation of the requirement in Section 113(g) of the 
Dodd-Frank Act. The supplemental procedures contemplate that the 
Council will notify and consult with the primary regulator at an 
earlier stage of the process but, as mentioned above, those procedures 
are not currently incorporated into the existing guidance and thus are 
subject to amendment or rescission at the Council's discretion.
    ICI strongly believes that the designation process should expressly 
require early and robust involvement by the primary regulator. A 
company's primary financial regulator has its own regulatory tools, 
some of which may provide another, possibly better avenue to address 
identified risks than SIFI designation. In addition, a primary 
financial regulator can evaluate whether an identified risk at one 
company exists more broadly and therefore would be more effectively 
handled on an industrywide or cross-industry basis.
    Working with a primary financial regulator in this manner gives 
FSOC more flexibility to address identified risks. Importantly, FSOC 
would retain control of the designation process and would still be able 
to make systemic designations when necessary.
More Analytical Rigor and Attention to Actual Experience
    It has long been ICI's view that such an important and 
consequential regulatory decision as SIFI designation must be based on 
a robust, empirical analysis that considers all of the factors that 
Congress enumerated in Section 113 of the Dodd-Frank Act, including the 
degree to which a firm is already regulated and the prospects of using 
that preexisting regulatory structure to address perceived risks. In my 
2015 FSOC Testimony, I called for this analysis to be thorough and 
objective, and to include consideration of the company's structure, 
activities and historical experience. I also observed that requiring a 
consideration of the costs and benefits of designation would put the 
Council's decision making on par with the Administrative Procedure 
Act's requirements for significant rulemakings and the Obama 
administration's executive orders regarding rulemaking processes. \16\
---------------------------------------------------------------------------
     \16\ Exec. Order No. 13563, 76 FR 3821 (Jan. 21, 2011) (requiring 
certain agencies to engage in cost-benefit analysis before rulemaking); 
Exec. Order 13579, 76 FR 41585 (July 14, 2011) (encouraging independent 
regulatory agencies to engage in cost-benefit analysis before 
rulemaking).
---------------------------------------------------------------------------
    Regrettably, the Council's analysis in many instances has fallen 
well short of these standards. This was seen, for example, in the 
Council's stated basis for designating Prudential Financial, Inc. as a 
SIFI in 2014. The independent member with insurance expertise on the 
Council at the time, Roy Woodall, dissented from that decision, 
observing that FSOC's ``underlying analysis utilizes scenarios that are 
antithetical to a fundamental and seasoned understanding of the 
business of insurance, the regulatory environment, and the state of 
insurance company resolution and guaranty fund systems.'' \17\
---------------------------------------------------------------------------
     \17\ See ``Views of the Council's Independent Member Having 
Insurance Expertise'' (Sept. 19, 2013), available at https://
www.treasury.gov/initiatives/fsoc/council-meetings/Documents/
September%2019%202013%20Notational%20Vote.pdf.
---------------------------------------------------------------------------
    The same has been true outside the SIFI context. Following a 
lengthy review of asset management products and activities, the Council 
released an April 2016 public update discussing what it found to be 
financial stability risks stemming from liquidity and redemption risks 
in mutual funds, particularly in funds invested in less liquid assets. 
ICI was disappointed by the Council's findings, because they largely 
ignored the extensive data and analysis that ICI and other commenters 
had provided to the Council in early 2015 on these very questions. 
ICI's letter highlighted the tremendous growth in both stock and bond 
funds since the mid-1940s, the several episodes of severe market stress 
occurring over the same seven decades--and the lack of any empirical 
evidence of destabilizing redemptions by stock and bond funds during 
those episodes. ICI's 2015 letter also explained why the historical 
data paint a consistent picture--i.e., because mutual funds' historical 
experience is grounded in their comprehensive regulatory framework, the 
nature of their investor base, and the realities of fund portfolio 
management. \18\ In announcing its findings of potential financial 
stability risks, however, the Council cited no evidence that long-
established, historical patterns of mutual fund investor behavior have 
changed or are likely to do so. In effect, its observations about ``the 
potential for outflows [from mutual funds] to cause fund distress, and 
hence broader stress'' amounted to mere conjecture.
---------------------------------------------------------------------------
     \18\ See, e.g., Letter to FSOC from Paul Schott Stevens, President 
and CEO, ICI, dated March 25, 2015 (March 2015 Letter), available at 
https://www.ici.org/pdf/15_ici_fsoc_ltr.pdf. As explained in detail on 
pp. 14-36 of the letter, the ``realities'' of registered fund portfolio 
management include the following: funds have sources of cash to meet 
redemptions, other than through sales of portfolio assets; funds 
typically have multifaceted liquidity management practices; portfolio 
rebalancing in accordance with stated investment strategies helps keep 
funds' cash ratios relatively stable, irrespective of market events; 
and funds can vary their purchases and sales of portfolio securities to 
accommodate redemptions.
---------------------------------------------------------------------------
    To underscore the importance of rigorous empirical analysis as a 
basis for sound policymaking, ICI undertook a case study of the 
scenario that seemed to concern FSOC the most--the prospect of 
destabilizing redemptions from mutual funds invested in less liquid 
assets. Using publicly available data about high-yield bond funds and 
their experience from early 2014 to early 2016 (a period that included 
significant stress in the high-yield bond market), ICI's chief 
economist tested the predictions about destabilizing redemptions that 
had been suggested by the Council and by other policymakers and 
academics. The result? Contrary to those predictions, the data show 
that investors were purchasing (as well as selling) shares in high-
yield bond funds, and in the underlying bonds, during this period of 
market stress. And, on a net basis, trading volumes of high-yield bonds 
actually rose when the high-yield bond market was under the greatest 
degree of stress. We submitted this analysis to the Council and urged 
it to reexamine its hypotheses about mutual funds in accordance with 
ICI's findings. \19\
---------------------------------------------------------------------------
     \19\ For further detail, see Letter from Paul Schott Stevens, 
President and CEO, ICI, to FSOC, dated July 18, 2016 (commenting on 
FSOC Update on Review of Asset Management Products and Activities), and 
accompanying analysis in Appendix B to the letter, available at https:/
/www.ici.org/pdf/16_ici_fsoc_ltr.pdf.
---------------------------------------------------------------------------
    Fortunately, recent analyses by the Council appear to be putting 
greater weight on evidence and less on conjecture. In its 2017 decision 
to rescind the designation of American Insurance Group (AIG), for 
example, the Council made clear that it had reexamined one of its key 
theories. When FSOC designated AIG as a SIFI, one of the arguments it 
used was that if AIG ever came under financial distress, ``there could 
be a forced, rapid liquidation of a significant portion of AIG's assets 
as a result of [insurance] policyholder surrenders or withdrawals that 
could cause significant disruptions to key markets, including corporate 
debt and asset-backed securities markets.'' In other words, the Council 
postulated that if AIG experienced financial distress, its 
policyholders could behave like depositors at a bank, causing a ``run'' 
on AIG that would cascade through the financial markets. But in 
determining to rescind AIG's designation, the Council reconsidered that 
view. Based upon ``additional consideration of incentives and 
disincentives for retail policyholders to surrender policies, including 
analysis of historical evidence of retail and institutional investor 
behavior,'' the Council determined that there was ``not a significant 
risk that asset liquidation by AIG would disrupt trading in key markets 
or cause significant losses or funding problems for other firms with 
similar holdings.'' \20\ ICI welcomes this development, because more 
precise and accurate analysis is essential to sound policy outcomes.
---------------------------------------------------------------------------
     \20\ For further detail, see Sean Collins, ``Applying Evidence to 
Theories on Regulated Funds'', ICI Viewpoints (Oct. 12, 2017), 
available at https://www.ici.org/viewpoints/view_17_fsoc_aig.
---------------------------------------------------------------------------
Greater Transparency to Financial Markets and Market Participants
    In the four cases in which FSOC voted to designate a nonbank 
financial company as a SIFI, the company received a lengthy, detailed 
report discussing FSOC's findings and conclusions, and only a very 
abbreviated summary was made available to the public. These summaries 
did not give other companies and the broader public sufficient insight 
into FSOC's concerns about systemic risk or the business practices 
giving rise to those risks. ICI has long believed that a more detailed 
public report--perhaps a redacted version of FSOC's report to the 
company--could offer these insights while still maintaining the 
confidentiality of sensitive, proprietary information about the 
designated company.
    Greater transparency from FSOC also would be helpful in areas other 
than SIFI designation, and we have two suggestions to offer in that 
regard. First, while we welcome FSOC's practice of issuing prompt 
``readouts'' after closed-door meetings, the readouts and subsequent 
minutes from those meetings provide the public with little insight into 
FSOC's observations and areas of focus or concern. ICI recommends that 
FSOC release detailed minutes shortly after its closed meetings, as is 
the practice of the Federal Reserve Board's Federal Open Market 
Committee.
    Second, as a matter of good Government, FSOC should inform the 
public about which staff members at the different agencies are involved 
in FSOC work. This information, which is not currently available, would 
promote engagement by stakeholders and other interested parties with 
the appropriate staff members on issues relevant to the FSOC agenda. 
Among other benefits, such engagement can provide educational 
opportunities and information resources to staff of agencies that do 
not otherwise possess expertise with respect to a particular financial 
industry sector.
Proposed Reforms Would Promote FSOC's Pursuit of Its Mission
    As we have established, there has been growing recognition of the 
continuing need for reforms to address the areas highlighted above. 
Recent developments in this regard are significant and promising. Most 
notably, in November 2017, the U.S. Treasury Department published a 
report making recommendations for improving FSOC's nonbank SIFI 
designation process (FSOC Report). \21\ And at an open meeting just 
last week, FSOC voted to issue for public comment a proposal to 
implement those recommendations and other changes. \22\ There also are 
encouraging signs in the global financial stability policy realm--a 
related area of interest to the Committee. \23\ We discuss these 
developments below.
---------------------------------------------------------------------------
     \21\ Department of the Treasury, ``Financial Stability Oversight 
Council Designations'' (Nov. 2017), available at https://
www.treasury.gov/press-center/press-releases/Documents/PM-FSOC-
Designations-Memo-11-17.pdf. The report came in response to a 
Presidential Memorandum that is available at https://
www.whitehouse.gov/the-press-office/2017/04/21/presidential-memorandum-
secretary-treasury.
     \22\ FSOC, ``Authority To Require Supervision and Regulation of 
Certain Nonbank Financial Companies'', RIN 4030-ZA00 (March 6, 2019) 
(FSOC Proposal), available at https://home.treasury.gov/system/files/
261/Notice-of-Proposed-Interpretive-Guidance.pdf.
     \23\ For example, in July 2015, the Committee held a hearing on 
``The Role of the Financial Stability Board in the U.S. Regulatory 
Framework'' at which I testified. See https://www.banking.senate.gov/
hearings/the-role-of-the-financial-stability-board-in-the-us-
regulatory-framework.
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FSOC Report
    ICI welcomed the release of the FSOC Report as an important step in 
the right direction. \24\ This thorough and thoughtful report reviews 
the purposes, composition, and authorities of the Council and 
articulates five policy goals--in our view, laudable and appropriate 
ones--that Treasury believes FSOC's processes should be designed to 
achieve:
---------------------------------------------------------------------------
     \24\ See ICI News Release, ``ICI Applauds FSOC Reforms of SIFI 
Designation Process'' (March 6, 2019), available at https://
www.ici.org/pressroom/news/19_news_sifi.

    Leverage the expertise of primary financial regulatory 
---------------------------------------------------------------------------
        agencies;

    Promote market discipline;

    Maintain a level playing field among firms;

    Appropriately tailor regulations to minimize burdens; and

    Ensure the Council's designation analyses are rigorous, 
        clear, and transparent.

    The report discusses the effects and efficacy of nonbank financial 
company designations in achieving the Council's purposes. It 
acknowledges many of the concerns ICI and others have been raising for 
almost a decade and offers a series of constructive recommendations for 
improvements. The recommendations and related discussion in the report 
reflect a solid understanding of the lessons learned from experience to 
date and seek to address the areas highlighted in the previous section 
of this testimony.
    The FSOC Report followed on the heels of another Treasury 
Department report--one that reviewed the U.S. regulatory structure for 
asset management and insurance (Asset Management Report). \25\ 
Consistent with ICI's long-held views, the Asset Management Report 
acknowledged that entity-based systemic risk evaluations generally are 
not the best approach for mitigating risks arising from asset 
management. Presaging aspects of the FSOC Report, Treasury recommended 
that Federal regulators focus on risks arising from asset management 
products and activities and on implementing regulations that strengthen 
the asset management industry as a whole.
---------------------------------------------------------------------------
     \25\ Department of the Treasury, ``A Financial System That Creates 
Economic Opportunities: Asset Management and Insurance'' (Oct. 2017), 
available at https://www.treasury.gov/press-center/press-releases/
Documents/A-Financial-System-That-Creates-Economic-Opportunities-
Asset_Management-Insurance.pdf. The report made recommendations--
including with respect to asset management and systemic risk--to better 
align the current regulatory structure with the Administration's ``Core 
Principles'' for regulation of the U.S. financial system. Exec. Order 
No. 13772 (Feb. 3, 2017).
---------------------------------------------------------------------------
    For its part, the FSOC Report recommends that FSOC:

    Prioritize an activities-based or industrywide approach to 
        addressing risks to U.S. financial stability. The report 
        indicates that prioritizing an activities-based approach would 
        have many benefits. It would: (a) enable FSOC to ``identify the 
        underlying sources of risks to financial stability, rather than 
        addressing risks only at a particular nonbank financial 
        company''; (b) ``address some of the potential limitations that 
        could arise from designations'' (e.g., competitive 
        disadvantages and unnecessarily burdensome regulatory 
        requirements); and (c) ``preserve the option to consider 
        designation in the rare instance, such as the historical case 
        of Fannie Mae and Freddie Mac, where it was clear that 
        individual institutions could pose a threat to financial 
        stability, but a primary regulator has not taken or cannot take 
        adequate steps to address the risk.'' \26\
---------------------------------------------------------------------------
     \26\ FSOC Report at 19.

    Increase the analytical rigor of designations analyses. The 
        report recognizes the ``considerable and continuing uncertainty 
        among market participants about how the Council makes its 
        decisions, which factors the Council views as most relevant in 
        identifying a company that could pose risks to financial 
        stability, and how a company can take action to avoid 
        designation.'' \27\ According to the report, increased 
        analytical rigor would promote certainty in FSOC's conclusions 
        and increase transparency to firms and the public. The report 
        makes several specific recommendations in this regard, 
        including that FSOC evaluate the likelihood of the company's 
        material financial distress as a threshold question and conduct 
        a cost-benefit analysis.
---------------------------------------------------------------------------
     \27\ FSOC Report at 23.

    Improve engagement and transparency in the designation 
        process. The report recommends enhancements to FSOC's 
        engagement with companies under review, engagement with primary 
---------------------------------------------------------------------------
        regulators, and public transparency.

      Engagement with Companies Under Review. The report 
        recommends that FSOC explain to a company at an earlier stage 
        the key risks that have been identified. The report notes: 
        ``[i]f a company is aware of the potential risks the Council 
        has identified during its preliminary review, the company can 
        take action to mitigate those risks'' prior to designation, 
        thus helping achieve the goal of addressing potential risks to 
        U.S. financial stability. \28\
---------------------------------------------------------------------------
     \28\ Id. at 30.

      Engagement with primary regulators. The report describes 
        several benefits of deep engagement with a nonbank financial 
        company's primary financial regulator and recommends that FSOC 
        (i) actively solicit the regulator's views regarding risks at 
        the company and potential mitigants, (ii) share its preliminary 
        views regarding potential risks at the company, and request 
        that the regulator provide information regarding those risks 
        and whether they are adequately mitigated, e.g., by existing 
        regulation or the company's business practices, and (iii) 
        during the designation process, continue to encourage the 
        regulator to use its existing authorities to address any risks 
---------------------------------------------------------------------------
        to U.S. financial stability.

      Public transparency. The report recommends that FSOC 
        release publicly the full explanation of its basis for any 
        future nonbank financial company designations or rescissions of 
        designations (redacting confidential information), to give the 
        public the greatest possible understanding of FSOC's reasons 
        for its actions.

    Provide a clear ``off-ramp'' for designated nonbank 
        financial companies. The report recommends, for example, that 
        FSOC's explanation of the final basis for any designation 
        highlight the key risks that led to the designation and the 
        factors that were most important, which would make clear to the 
        company the steps it could take to address the Council's 
        concerns.

    ICI strongly supports the Treasury recommendations. If implemented 
appropriately, they will bolster substantially the effectiveness and 
integrity of FSOC's work while minimizing the potential for unsound 
policy outcomes.
FSOC Proposal
    Since the release of the Treasury FSOC Report, ICI and its members 
have been urging prompt action to implement the recommendations. At the 
same time, we recognize that the subject matter is complex and 
determining how to implement the recommendations effectively and 
appropriately--and to the satisfaction of the range of FSOC members--
involves challenges. Further, we commend FSOC for making known early on 
its intent to handle this matter through a notice and comment process. 
Given the important themes underlying many of the recommendations, FSOC 
should proceed in a transparent and accountable manner.
    Consistent with its plan, FSOC last week proposed for public 
comment revised guidance to govern the nonbank SIFI designation 
process. \29\ ICI is reviewing the proposal carefully and looks forward 
to submitting comments. Our preliminary reaction is very positive, as 
it appears that FSOC has hewed closely to the recommendations in the 
Treasury report. Under the proposal:
---------------------------------------------------------------------------
     \29\ FSOC Proposal, supra n. 22. FSOC also adopted a rule 
requiring that any future changes to the guidance be subject to a 
notice and comment process. See supra n. 15.

    FSOC has firmly committed to addressing risks through an 
        activities-based approach and would only consider designating 
---------------------------------------------------------------------------
        entities as SIFIs as a last resort--as we have long urged.

    If FSOC did decide to pursue designation, that process 
        would be more transparent, accountable, and rigorous.

    The proposed changes seek to facilitate more constructive--
        and appropriate--engagement between nonbank financial companies 
        and the Council.

    The proposed changes would elevate the crucial role of 
        primary regulators, who are best suited to work with the 
        company under review to mitigate potential risks before 
        imposing the costly burden of SIFI designation.

    For the benefit of the Committee, we include a more detailed 
summary of the FSOC proposal in Appendix B.
Similar Recalibration at FSB
    In testimony before this Committee in July 2015, I discussed the 
role of the FSB in the U.S. regulatory framework. \30\ Like FSOC, as 
part of its postcrisis agenda, the FSB trained its focus on the asset 
management sector and on large registered U.S. funds and fund managers. 
At first, the FSB set out to develop methodologies to identify global 
systemically important funds or fund managers, closely following a 
pattern it had established in the banking and insurance sectors. It 
later put this work on pause while conducting a review of potential 
``structural vulnerabilities'' in asset management. My testimony 
illustrated that the work of the FSB related to asset management 
exhibited many of the same fundamental problems that have pervaded 
FSOC's work. \31\ These problems included: a tendency to view the asset 
management sector through a banking lens; an inadequate role for 
subject matter experts; reliance on conjecture and theory rather than 
empirical data and actual experience; indications that desired results, 
rather than the public record, might be driving the FSB's work; and 
insufficient transparency and accountability in the FSB's consultation 
and designation process.
---------------------------------------------------------------------------
     \30\ See Statement of Paul Schott Stevens, President and CEO, 
``ICI on The Role of the Financial Stability Board in the U.S. 
Regulatory Framework'' (July 8, 2015), available at https://
www.ici.org/pdf/15_senate_banking_fsb.pdf.
     \31\ For details, see id. See also Statement of Paul Schott 
Stevens, President and CEO, ICI, Before the U.S. House of 
Representatives Committee on Financial Services Subcommittee on 
Monetary Policy and Trade, on The Financial Stability Board's 
Implications for U.S. Growth and Competitiveness (Sept. 27, 2016), 
available at https://www.ici.org/pdf/16_house_fsc_fsb.pdf.
---------------------------------------------------------------------------
    I am pleased to report some signs of progress on the FSB front. For 
example, consistent with ICI's urging, the FSB properly entrusted the 
implementation of several of the policy recommendations that emerged 
from its asset management review to the International Organization of 
Securities Commissions (IOSCO)--a body with a deep well of relevant 
subject matter expertise.
    More generally, late last year, after conducting a review of its 
processes and transparency, the FSB agreed to take certain actions--
including actions to improve communication and engagement with external 
stakeholders along the lines ICI has recommended. \32\ In addition, the 
FSB has turned some of its focus to evaluating the effectiveness and 
efficiency of reforms that have been implemented and considering 
whether any adjustments are needed.
---------------------------------------------------------------------------
     \32\ See Letter from Paul Schott Stevens, President and CEO, ICI, 
to the Secretariat of the FSB, dated Sept. 21, 2016 (responding to 
Consultative Document; ``Proposed Policy Recommendations to Address 
Structural Vulnerabilities from Asset Management Activities''), 
available at https://www.ici.org/pdf/16_ici_fsb_ltr.pdf, at 40.
---------------------------------------------------------------------------
    Some of these changes appear to reflect the direction in which the 
new FSB chairman, Federal Reserve Board Vice Chairman for Supervision 
Randal Quarles, is seeking to steer the organization. Based on his 
recent inaugural speech as FSB chairman, there is reason to be 
encouraged. \33\ His remarks focused on the core principles he believes 
should guide the FSB's future work: engagement, including improved 
outreach and transparency with a broad range of constituencies; rigor, 
so that assessment of financial sector vulnerabilities is based on 
``cutting edge thinking and a disciplined methodology''; and analysis, 
including critical analysis of the effects of reforms to determine if 
there are improvements that can be made--for example, to achieve 
resiliency in less burdensome and more efficient ways.
---------------------------------------------------------------------------
     \33\ See ``Ideas of Order: Charting a Course for the Financial 
Stability Board'', Remarks by Randal K. Quarles, Vice Chairman for 
Supervision, Board of Governors of the Federal Reserve System, Chair, 
Financial Stability Board, at Bank for International Settlements 
Special Governors Meeting, Hong Kong (Feb. 10, 2019), available at 
http://www.fsb.org/wp-content/uploads/Quarles-Ideas-of-order-Charting-
a-course-for-the-Financial-Stability-Board.pdf.
---------------------------------------------------------------------------
    I believe Chairman Quarles' leadership and policy approach will 
serve the interests of all who participate in and benefit from a robust 
financial system, including millions of Americans who invest in 
registered funds to meet their most important financial goals.
A Legislative Solution Is Still Appropriate and Necessary
    In the release explaining its proposal, the Council emphasizes that 
the Dodd-Frank Act gives it broad discretion to determine how to 
respond to potential threats to financial stability. As we indicate 
above, our initial analysis of the proposal is quite positive. ICI 
believes that the Council has outlined a sound approach to using its 
range of authorities, from information sharing to SIFI designation. 
Nevertheless, we continue to believe that Congress should confirm in 
statute that SIFI designation is intended to be a regulatory ``tool of 
last resort.''
    Bipartisan legislation recently introduced by Members of this 
Committee--Senators Mike Rounds (R-SD), Doug Jones (D-AL), Thom Tillis 
(R-NC), and Kyrsten Sinema (D-AZ)--would do just that. S. 603, the 
``Financial Stability Oversight Council Improvement Act of 2019'', 
would add a modest but important step to the SIFI designation process. 
It would require that, before voting on a proposed designation, the 
Council must consider whether the potential threat posed by a nonbank 
financial company could be mitigated through other means--a different 
action of the Council; action by the company's primary regulator (which 
could include implementing standards/safeguards pursuant to Council 
recommendations under Section 120); or action by the company itself, as 
detailed in a written plan submitted promptly to the Council. If the 
Council determines that such other means are impracticable or 
insufficient to mitigate the potential threat, the Council may proceed 
with a proposed designation.
    The bill preserves maximum flexibility for the Council. While it 
requires the Council to consult with the primary regulator and the 
company, it does not dictate how the Council should do so. Nor does the 
bill preclude the Council from proceeding expeditiously. What it does 
do is help to ensure that the Council consider the range of options 
available and make an informed decision about how to address the 
potential threat to financial stability.
    S. 603 comports well with the current requirements of the Dodd-
Frank Act. Section 113(g) of the Act already requires FSOC to consult 
with the primary regulator for a company that is being evaluated for 
possible designation. The bill simply would specify that this 
consultation must happen at an early stage of the process--that is, 
before FSOC votes on a proposed designation. And, importantly, S. 603 
affirmatively preserves the Council's emergency powers as outlined in 
Section 113(f).
    ICI accordingly urges this Committee to consider S. 603 and report 
it favorably to the full Senate.
Recommendations
    ICI is pleased to offer its recommendations for addressing the 
matters we discuss above.

    Congress should encourage FSOC's current effort to 
        implement the Treasury Department's FSOC reform recommendations 
        through the pending proposal and a public notice and comment 
        process.

    Congress should enact legislation, such as S. 603, to 
        codify in statute that FSOC's nonbank SIFI designation 
        authority is intended to be used only in extraordinary 
        circumstances, as a regulatory tool of last resort.

    Congress should continue to monitor U.S. involvement in the 
        FSB. It also should support Chairman Quarles in his reform 
        efforts which, if successful, will benefit U.S. investors.

    I appreciate the opportunity to share these views with the 
Committee. ICI looks forward to continued engagement with Congress on 
these important matters.






















                 PREPARED STATEMENT OF JEREMY C. KRESS
Assistant Professor of Business Law, University of Michigan Ross School 
                              of Business
                             March 14, 2019
    Chairman Crapo, Ranking Member Brown, Members of the Committee, I 
am honored to appear before you to discuss the Financial Stability 
Oversight Council's nonbank systemically important financial 
institution (SIFI) designations. Nonbank SIFI designations are an 
essential policy tool for regulating systemic risk. I am therefore 
concerned that recent efforts to de-emphasize nonbank SIFI 
designations--or eliminate them altogether--would expose the financial 
system to many of the same dangers it experienced in 2008.
    I will make three points in my testimony today. \1\ First, nonbank 
SIFI designations are crucial for preventing catastrophic nonbank 
failures like the collapses of Bear Stearns, Lehman Brothers, and AIG. 
Nonbank SIFI designations protect the financial system by deterring 
nonbanks from becoming systemically important and by applying 
heightened safeguards to firms that nonetheless become excessively 
large, complex, or interconnected. By contrast, nonbanks' baseline 
regulatory regimes are generally not well suited to accomplish these 
goals.
---------------------------------------------------------------------------
     \1\ Portions of this testimony are adapted from Jeremy C. Kress, 
Patricia A. McCoy, and Daniel Schwarcz, ``Regulating Entities and 
Activities: Complementary Approaches to Nonbank Systemic Risk'', 92 S. 
Cal. L. Rev. (forthcoming 2019).
---------------------------------------------------------------------------
    Second, criticisms of nonbank SIFI designations are unpersuasive. 
For example, despite critics' complaints, nonbank SIFI designations do 
not impose bank-centric rules on nonbanks. To the contrary, the Federal 
Reserve has gone to great lengths to recognize the distinct regulatory 
issues associated with nonbank financial companies, and to tailor its 
approach accordingly. Moreover, to the extent that heightened 
regulations create an uneven playing field for designated nonbank 
SIFIs, this differential is a feature, not a bug. Enhanced safeguards 
for nonbank SIFIs ensure that companies have incentive to avoid 
becoming or remaining systemically important.
    Third, proposals to replace nonbank SIFI designations with an 
activities-based approach are deeply misguided. Activities-based 
regulation, on its own, will not prevent systemic collapses like those 
we experienced in 2008. It is unrealistic to expect that regulators 
will identify and appropriately regulate all such activities ex ante, 
especially given financial companies' strong incentives to restructure 
or rename activities to avoid regulation. By contrast, policymakers are 
much more likely to consistently and accurately identify nonbank 
financial companies whose distress could threaten financial stability.
    A purely or predominantly activities-based approach to nonbank 
systemic risk will fail for yet another reason: the U.S. regulatory 
framework is not configured to implement effective activities-based 
regulation. The U.S. regulatory system is riddled with gaps in areas 
like insurance, hedge funds, and FinTech. Because FSOC lacks authority 
to implement activities-based rules directly, this pervasive 
jurisdictional fragmentation would undermine efforts to enact and 
enforce uniform, consistent activities-based rules throughout the 
financial system.
    To be sure, if configured appropriately, activities-based 
regulation could address some sources of nonbank systemic risk. As 
currently structured, however, the United States' regulatory framework 
is simply not conducive to effective activities-based nonbank 
regulation.
    Proponents of an activities-based approach to nonbank systemic risk 
contend that activities-based rules would merely supplement, rather 
than displace, nonbank SIFI designations. But make no mistake: the 
procedural barriers to nonbank SIFI designations that FSOC proposed 
last week would make it exceedingly difficult for the Council to 
designate new nonbank SIFIs and for any such designation to survive 
judicial review. Moreover, the Council's apparent enthusiasm for 
activities-based nonbank regulation rings hollow given that the FSOC 
has not used its existing statutory authority to propose a single 
activities-based rule in more than 2 years under Secretary Mnuchin's 
leadership.
    In sum, I am deeply concerned about recent initiatives to roll back 
nonbank systemic risk regulation. Efforts to marginalize the Council by 
diminishing its legal authority, politicizing its work, and reducing 
its budget collectively increase risks to the financial system and 
ultimately threaten the real economy.
Background on Nonbank SIFI Designations and Proposed Procedural 
        Barriers
A. The Financial Crisis, Nonbank Systemic Risk, and the FSOC
    The 2008 financial crisis demonstrated unequivocally that nonbank 
financial institutions can threaten U.S. and global financial 
stability. The failures of Bear Stearns, Lehman Brothers, and AIG 
proved that nonbanks--like banks--are capable of propagating risk 
throughout the financial system. Yet, traditionally, investment banks, 
insurance companies, and other nonbank financial companies generally 
have not been subject to macroprudential regulation designed to limit 
the risks these firms pose to the financial system and the broader 
economy.
    After the crisis, Congress created FSOC to address the problem of 
nonbank systemic risk. \2\ The Dodd-Frank Act gave FSOC two tools to 
achieve this goal. First, under section 113 of Dodd-Frank, FSOC may 
designate an individual nonbank SIFI for enhanced regulation if the 
Council determines that the firm's material financial distress or ``the 
nature, scope, size, scale, interconnectedness or mix of [its] 
activities'' could pose a threat to U.S. financial stability. \3\ Any 
nonbank entity that FSOC designates as a SIFI becomes subject to 
consolidated supervision and regulation by the Federal Reserve, 
including risk-based capital, leverage, liquidity, and risk-management 
requirements. \4\ This is FSOC's so-called ``entity-based'' approach. 
Second, under section 120 of Dodd-Frank, FSOC may recommend that the 
primary financial regulatory agencies adopt ``new or heightened 
standards or safeguards'' for any financial activity that could 
propagate systemic risks. \5\ This is FSOC's ``activities-based'' 
approach.
---------------------------------------------------------------------------
     \2\ My views about FSOC have been shaped by excellent scholarship 
on the Council and nonbank systemic risk. See, e.g., Hilary J. Allen, 
``Putting the `Financial Stability' in Financial Stability Oversight 
Council'', 76 Ohio St. L. J. 1087 (2015); Jeffrey N. Gordon, ``Dynamic 
Precaution in Maintaining Financial Stability: The Importance of 
FSOC'', in Ten Years After the Crash (Sharyn O'Halloran and Thomas 
Groll, eds., forthcoming 2019); Patricia A. McCoy, ``Systemic Risk 
Oversight and the Shifting Balance of State and Federal Authority Over 
Insurance'', 5 U.C. Irvine L. Rev. 1389 (2015); Daniel Schwarcz and 
David Zaring, ``Regulation by Threat: Dodd-Frank and the Nonbank 
Problem'', 84 U. Chi. L. Rev. 1813 (2017); Christina Parajon Skinner, 
``Regulating Nonbanks: A Plan for SIFI Lite'', 105 Geo. L. J. 1379 
(2017); Robert F. Weber, ``The FSOC's Designation Program as a Case 
Study of the New Administrative Law of Financial Supervision'', 36 Yale 
J. Reg. 359 (2019).
     \3\ 12 U.S.C. 5323(a)(1).
     \4\ 12 U.S.C. 5365(b)(1)(A).
     \5\ 12 U.S.C. 5330(a).
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B. Nonbank SIFI Designations and De-Designations
    At first, FSOC embraced its SIFI designation authority. The Council 
promulgated, through notice-and-comment rulemaking, formal procedures 
for evaluating a nonbank's systemic importance. \6\ Then, in 2013 and 
2014, the Council designated three insurance-focused companies--
Prudential, AIG, and MetLife--and General Electric's captive finance 
subsidiary, GE Capital, as nonbank SIFIs. FSOC concluded, through 
increasingly detailed analyses, that material financial distress at any 
of these four companies could pose a threat to U.S. financial stability 
and that enhanced oversight was therefore appropriate for each firm.
---------------------------------------------------------------------------
     \6\ ``Authority To Require Supervision and Regulation of Certain 
Nonbank Financial Companies'', 77 FR 21,637 (Apr. 11, 2012).
---------------------------------------------------------------------------
    But now, just 5 years later, FSOC has reversed all of its original 
nonbank SIFI designations. To be sure, the Council's unanimous 
rescission of GE Capital's SIFI status in 2016 was well warranted. 
After its SIFI designation, GE Capital substantially reduced its 
systemic footprint, shrinking by more than half and reducing its 
reliance on risky short-term funding. \7\ GE Capital's designation, 
restructuring, and consequent de-designation demonstrate that nonbank 
SIFI designations, when used appropriately, are effective deterrents 
against firms becoming and remaining systemically important.
---------------------------------------------------------------------------
     \7\ See Ted Mann and Joann S. Lublin, ``Why General Electric Is 
Unwinding Its Finance Arm'', Wall St. J. (Oct. 13, 2015), https://
www.wsj.com/articles/why-general-electric-is-unwinding-its-finance-arm-
1444784781.
---------------------------------------------------------------------------
    Each of the Council's three subsequent de-designations, however, 
was hasty and ill-conceived. After Treasury Secretary Steven Mnuchin 
became Chair of the Council, FSOC rescinded AIG's SIFI status by a 
contested 6-3 vote. AIG's de-designation was considerably more 
controversial than GE Capital's, as AIG--one of the primary culprits of 
the financial crisis--did not appreciably reduce its systemic footprint 
following its designation. \8\ Then, after MetLife prevailed in its 
lawsuit contesting its SIFI designation on procedural grounds, the 
Council abruptly reversed its litigation position and dropped its 
appeal of MetLife's case. \9\
---------------------------------------------------------------------------
     \8\ See Gregg Gelzinis, ``Deregulating AIG Was a Mistake'', Ctr. 
for Am. Progress (Oct. 11, 2017), https://www.americanprogress.org/
issues/economy/reports/2017/10/11/440570/deregulating-aig-mistake/.
     \9\ Interestingly, FSOC's decision to drop its appeal in the 
MetLife case was supported by a majority of FSOC's voting members, 
rather than the two-thirds of voting members that would have been 
required to formally rescind MetLife's designation. See Press Release, 
Dept. of Treasury, Secretary Mnuchin Statement on the MetLife, Inc. v. 
Financial Stability Oversight Council Appeal (Jan. 18, 2018), https://
home.treasury.gov/news/press-releases/sm0254.
---------------------------------------------------------------------------
    Most troublingly, FSOC de-designated Prudential in October 2018, 
even though Prudential had increased in size and complexity since 
becoming a SIFI. \10\ The Council's rescission of Prudential's SIFI 
status was not only unwise, it was also illegal. \11\ When it de-
designated Prudential, FSOC (1) violated its formal procedures by 
second-guessing the Council's original assessment of Prudential's 
systemic importance, (2) performed misleading quantitative analyses 
while dismissing more reliable indicators of Prudential's systemic 
importance, and (3) ignored its statutory mandate to consider 
Prudential's existing regulatory scrutiny. \12\ These shortcomings 
substantially undermine the Council's conclusion that Prudential is not 
systemically important and render FSOC's action arbitrary and 
capricious. \13\ Unfortunately, in contrast to MetLife, which had an 
unambiguous statutory right to contest its SIFI designation, it is 
unclear whether individual citizens or public interest groups have 
standing to sue FSOC when the Council illegally de-designates a SIFI. 
\14\
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     \10\ Prudential had grown by more than $100 billion in assets 
since its designation. Meanwhile, Prudential's complexity and 
interconnectedness with other financial companies also increased. Its 
notional derivatives exposures and repurchase agreements rose by more 
than 30 percent after its designation. See Jeremy Kress, ``Prudential 
Hasn't Earned the Right To Shed SIFI Label'', Am. Banker (March 13, 
2018), https://www.americanbanker.com/opinion/prudential-hasnt-earned-
the-right-to-shed-sifi-label.
     \11\ See Jeremy C. Kress, ``The Last SIFI: The Unwise and Illegal 
Deregulation of Prudential Financial'', 71 Stanford L. Rev. Online 171 
(2018).
     \12\ See id.
     \13\ An agency's decision is arbitrary and capricious if the 
agency did not rely on the factors Congress intended or the decision 
runs counter to the evidence before the agency. See Motor Vehicle Mfrs. 
Ass'n v. State Farm Mut. Auto. Ins. Co. 463 U.S. 29, 42-43 (1983). In 
addition, an agency may not ``simply disregard rules that are still on 
the books.'' FCC v. Fox Television Stations, Inc., 556 U.S. 502, 515 
(2009).
     \14\ See Weber, supra n. 2, at 425-32.
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C. Proposed Procedural Barriers to New Nonbank SIFI Designations
    These de-designations appear to be part of a concerted effort by 
the Trump administration and some members of Congress to de-emphasize--
or permanently eliminate--nonbank SIFI designations as a regulatory 
tool. In November 2017, the Treasury Department published a report 
deriding nonbank SIFI designations as a ``blunt instrument'' and 
proposing procedural barriers to new nonbank SIFI designations. \15\ 
For example, the Treasury Department would require FSOC to assess a 
potential designee's likelihood of financial distress and perform a 
quantitative cost-benefit analysis of each designation. Just last week, 
FSOC proposed to adopt these procedural barriers through amendments to 
its interpretive guidance. \16\
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     \15\ U.S. Dep't of the Treasury, Financial Stability Oversight 
Council Designations, ``Report to the President of the United States 
Pursuant to the Presidential Memorandum Issued April 21, 2017''.
     \16\ Notice of Proposed Interpretive Guidance Regarding Nonbank 
Financial Company Determinations (March 6, 2018), https://
home.treasury.gov/system/files/261/Notice-of-Proposed-Interpretive-
Guidance.pdf.
---------------------------------------------------------------------------
    If enacted, these new policies would substantially undermine FSOC's 
ability to designate nonbank SIFIs in the future. First, consider the 
proposed requirement that FSOC assess a company's likelihood of 
financial distress. As a threshold matter, this proposal directly 
conflicts with the text of the Dodd-Frank Act, which instructs FSOC to 
assume that a firm is in distress and analyze whether that distress 
could pose a threat to U.S. financial stability. \17\ Even setting 
statutory considerations aside, however, this proposed requirement is 
seriously misguided. As FSOC's prior experience demonstrates, it can 
take years for the Council to evaluate a nonbank for potential 
designation, for the Federal Reserve to establish regulations 
appropriately tailored to a nonbank SIFI's business model, and for a 
designated nonbank SIFI to bring itself into compliance with those 
safeguards. Thus, waiting to designate a nonbank until it is vulnerable 
to distress could be too late. By the time the relevant capital, 
liquidity, and other safeguards associated with designation go into 
effect, the nonbank SIFI may already have collapsed. \18\
---------------------------------------------------------------------------
     \17\ 12 U.S.C. 5323(a)(1).
     \18\ Moreover, conditioning a firm's designation on its 
vulnerability could actually hasten its collapse. Any SIFI designation 
issued under this standard would signal that FSOC views the company as 
unstable, potentially triggering a run and creating the instability 
SIFI designations are designed to prevent.
---------------------------------------------------------------------------
    Subjecting nonbank SIFI designations to quantitative cost-benefit 
analyses would be equally unwise. Quantifying the costs and benefits of 
nonbank SIFI designations poses serious analytical challenges. For 
example, the stability-enhancing benefits of financial regulations are 
notoriously difficult to calculate accurately. As many scholars have 
recognized, quantifying the benefit of a crisis averted is nearly 
impossible. \19\ Moreover, because of the infrequency of financial 
crises, financial regulatory cost-benefit analyses are highly sensitive 
to crude economic loss and discount rate assumptions. For these 
reasons, empirical cost-benefit analysis of the Council's nonbank SIFI 
designations would be susceptible to ex post second-guessing by a 
reviewing court, thereby creating litigation risk for the Council and 
deterring it from attempting to use its SIFI designation authority in 
the first place.
---------------------------------------------------------------------------
     \19\ See, e.g., John C. Coates IV, ``Cost-Benefit Analysis of 
Financial Regulation: Case Studies and Implications'', 124 Yale L. J. 
882, 960-69 (2015); Jeffrey N. Gordon, ``The Empty Call for Benefit-
Cost Analysis in Financial Regulation'', 43. J. Legal Stud. S351, S373-
75 (2014).
---------------------------------------------------------------------------
    In lieu of nonbank SIFI designations, FSOC now purports to 
prioritize an activities-based approach to nonbank systemic risk. In 
its proposed interpretive guidance, the Council states that it will 
consider using its SIFI designation authority ``only if a potential 
risk or threat cannot be addressed through an activities-based 
approach.'' Under this activities-based approach, the Council would 
coordinate with various Federal and State financial regulatory agencies 
and encourage them to address risks arising from specific activities, 
either informally or through the Council's formal section 120 
recommendation authority. \20\
---------------------------------------------------------------------------
     \20\ Interestingly, the Council states that it will ``make 
recommendations under section 120 of the Dodd-Frank Act only to the 
extent that its recommendations are consistent with the statutory 
mandate of the relevant primary financial regulatory agency.'' Notice 
of Proposed Interpretive Guidance Regarding Nonbank Financial Company 
Determinations, supra n. 16, at 14. It is not clear how FSOC intends to 
address stability risks within the jurisdiction of agencies, like the 
Securities and Exchange Commission and State insurance regulators, that 
lack a statutory financial stability mandate.
---------------------------------------------------------------------------
    Parallel initiatives in Congress would codify similar procedural 
barriers to nonbank SIFI designations and formally prioritize FSOC's 
activities-based approach. For example, the Financial Stability 
Oversight Council Improvement Act would prohibit FSOC from voting on a 
proposed nonbank SIFI designation unless the Council determines that a 
different approach would be impracticable or insufficient to mitigate 
the threat the company could pose to U.S. financial stability. \21\ For 
the reasons explained below, these administrative and legislative 
efforts to de-emphasize nonbank SIFI designations are ill-advised and, 
if enacted, would recreate the same feeble approach to nonbank systemic 
risk that proved woefully inadequate in 2008.
---------------------------------------------------------------------------
     \21\ S. 3577, 115th Cong. (2018).
---------------------------------------------------------------------------
Nonbank SIFI Designations Are Critical for Preventing Systemic Nonbank 
        Insolvencies
    Retaining nonbank SIFI designations as a viable regulatory tool is 
necessary to prevent catastrophic nonbank failures like Bear Stearns, 
Lehman Brothers, and AIG. FSOC's nonbank SIFI designation authority 
achieves two essential regulatory objectives: the threat of designation 
deters nonbanks from becoming systemically important, and tailored 
Federal Reserve regulation safeguards companies that nonetheless become 
excessively large, complex, or interconnected.
    First, the prospect of nonbank SIFI designation serves as a 
powerful deterrent against nonbanks becoming systemically important. 
Ordinarily, a nonbank has strong incentive to expand its systemic 
footprint. That is because any financial company perceived as 
systemically important can borrow at favorable rates if the market 
believes that the Government would bail out the firm, rather than allow 
it to fail. \22\ FSOC's nonbank SIFI designation authority, however, 
counteracts this incentive. Because designation subjects a company to 
potentially costly regulation, the threat of designation dissuades 
firms from seeking to become systemically important. Thus, as 
Professors Daniel Schwarcz and David Zaring have written, ``the FSOC 
designation regime incentivizes nonbanks to eschew activities and 
strategies that they anticipate would subject them to designation.'' 
\23\ Moreover, as GE Capital's experience demonstrates, this incentive 
is even stronger for companies ultimately designated as nonbank SIFIs. 
Indeed, such firms have especially powerful motivation to simplify or 
shrink themselves in an effort to escape their designations.
---------------------------------------------------------------------------
     \22\ See, e.g., Viral V. Acharya et al., ``The End of Market 
Discipline? Investor Expectations of Implicit Government Guarantees'' 
35 (Munich Personal RePEc Archive, Working Paper No. 79700, 2016).
     \23\ Schwarcz and Zaring, supra n. 2, at 1851.
---------------------------------------------------------------------------
    Second, in the event that a nonbank becomes and remains 
systemically important, FSOC's nonbank SIFI designation authority 
enables the Council to subject the firm to appropriately tailored 
safeguards and thus protect the broader financial system. The Federal 
Reserve's macroprudential regulatory tools are uniquely suited to limit 
the risk that a designated nonbank SIFI will experience a systemic 
failure. For example, consolidated risk-based capital and leverage 
limits ensure that SIFIs maintain a sufficient capital cushion to 
absorb potential losses. Liquidity rules require SIFIs to hold a 
minimum amount of liquid assets to protect against funding runs. Stress 
tests simulate adverse economic conditions to ensure that SIFIs can 
withstand a severe downturn. Corporate governance reforms focus on 
improving enterprise risk management across SIFI's operations. Finally, 
ex ante resolution planning is crucial if a systemically important 
nonbank must be liquidated through Dodd-Frank's Orderly Liquidation 
Authority.
    To be clear, these macroprudential safeguards are necessary because 
most traditional nonbank regulatory regimes lack reliable financial 
stability regulatory tools. Insurance regulation is the most 
straightforward example. In the United States, insurance regulation has 
long been the responsibility of the States, with little Federal 
involvement. But the State-based system of insurance regulation suffers 
from serious flaws with respect to systemic risk regulation. Most 
critically, the U.S. insurance regulatory system lacks well developed 
consolidated regulation and supervision of insurance holding companies. 
\24\ And, in most States, the insurance commissioner is subject to a 
narrow regulatory mandate to protect an insurance subsidiary's 
policyholders, not to limit financial stability risks. In sum, absent 
nonbank SIFI designations and ensuing Federal Reserve oversight, some 
systemically important nonbanks will not be subject to consolidated, 
macroprudential supervision and regulation that is necessary to prevent 
a repeat of the 2008 crisis.
---------------------------------------------------------------------------
     \24\ While the States have attempted to improve groupwide 
supervision of insurance holding companies since 2008, they still have 
not implemented consolidated capital requirements and other critical 
regulatory tools. Moreover, the efficacy of these State-level reforms 
is speculative because they largely have not been tested since the 
financial crisis.
---------------------------------------------------------------------------
Criticisms of Nonbank SIFI Designations Are Unpersuasive
    Critics of FSOC's nonbank SIFI designation authority have long 
complained that SIFI designations impose bank-centric rules on 
nonbanks, create an uneven playing field, are opaque, and are driven by 
international advisory bodies. None of these criticisms is convincing. 
Some critiques were overblown from the start; others have been 
addressed through reforms adopted by FSOC and the Federal Reserve. In 
any event, these arguments have little merit.
    First, despite critics' complaints, nonbank SIFI designations do 
not result in the imposition of bank-centric rules on nonbanks. To the 
contrary, policymakers have taken several steps to tailor nonbank SIFI 
regulation to the distinct regulatory issues associated with designated 
nonbank financial companies. For example, Congress passed The Insurance 
Capital Standards Clarification Act of 2014, which specifically 
authorized the Federal Reserve to tailor its capital standards for 
insurers to the distinctive risks posed by each firm. And, in fact, the 
insurance SIFI capital standards the Federal Reserve proposed in 2016 
reflect thoughtful consideration of the differences between bank and 
insurance company business models. \25\ Moreover, the Federal Reserve 
has established a specialized team of insurance-focused experts to 
supervise nonbank SIFIs.
---------------------------------------------------------------------------
     \25\ ``Capital Requirements for Supervised Institutions 
Significantly Engaged in Insurance Activities'', 81 FR 38,631 (June 14, 
2016).
---------------------------------------------------------------------------
    Second the fact that nonbank SIFI designations create an uneven 
playing field for designated firms is by design. Heightened capital, 
liquidity, and other rules help to ensure that nonbank firms have 
incentive to avoid being designated in the first place, and to shed 
their status quickly if they are so designated. Further, the costs of 
being designated are less unfair than critics suggest, as they help 
offset the funding advantages that come along with being perceived as 
systemically important.
    Third, FSOC has taken numerous steps to enhance the transparency of 
the nonbank SIFI designation process. For example, it developed a 
formulaic quantitative test to select only a small subset of all 
nonbank financial firms for potential designation. \26\ The Council 
began informing firms earlier when they were being considered for 
designation, and it established a formal process for reevaluating such 
designations. \27\ FSOC also began releasing more detailed explanations 
for its designation decisions that provide clearer indications of how 
firms can achieve de-designation. Thus, while FSOC can surely further 
improve the transparency of its designation process, critics' concerns 
about opacity are overblown.
---------------------------------------------------------------------------
     \26\ Financial Stability Oversight Council Guidance for Nonbank 
Financial Company Determinations, 12 CFR pt. 1310, app. A., III.a 
(2018)
     \27\ See Examining Insurance Capital Rules and FSOC Process: 
Hearing Before the Senate Subcomm. on Securities, Insurance, and 
Investments, 114th Cong. 7-8 (2015) (testimony of Daniel Schwarcz, 
Professor, University of Minnesota Law School).
---------------------------------------------------------------------------
    Finally, in contrast to critics' complaints, the Council's nonbank 
SIFI designation decisions are not driven by international advisory 
bodies. FSOC alone selects firms to evaluate for potential designation, 
and the Council makes its own, independent judgment about whether a 
firm meets the criteria for SIFI designation. While international 
advisory groups like the Financial Stability Board (FSB) have processes 
for evaluating financial institutions' systemic importance, their 
evaluations are not binding on the Council. Indeed, FSOC reversed the 
designations of AIG and MetLife even though the FSB considered those 
firms to be global systemically important insurers. \28\ Thus, while 
the FSB and other advisory bodies facilitate global coordination, they 
do not detract from the independence of FSOC's nonbank SIFI 
designations.
---------------------------------------------------------------------------
     \28\ Fin. Stability Bd., 2016 List of Global Systemically 
Important Insurers (G-SIIS) (Nov. 21, 2016), http://www.fsb.org/wp-
content/uploads/2016-list-of-global-systemically-important-insurers-G-
SIIs.pdf.
---------------------------------------------------------------------------
    In sum, criticisms of FSOC's nonbank SIFI designation authority are 
wholly unconvincing. Critics' complaints were either exaggerated from 
the outset or have been largely addressed by reforms policymakers 
adopted to improve the SIFI designation process. Accordingly, 
opponents' critiques should hold little weight in the continued debate 
over the appropriateness of nonbank SIFI designations.
An Activities-Based Approach, On Its Own, Would Not Prevent a 
        Recurrence of the 2008 Crisis
    Recent efforts to prioritize an activities-based approach to 
nonbank systemic risk--by codifying a preference for activities-based 
regulation or erecting procedural barriers to nonbank SIFI 
designations--are deeply misguided. Proponents of this approach assume 
that by regulating systemically risky activities, policymakers can 
prevent the systemic failures of nonbank entities. This assumption, 
however, is wrong. Activities-based regulation, on its own, cannot 
prevent catastrophic nonbank failures like Bear Stearns, Lehman 
Brothers, and AIG. Instead, a purely activities-based approach would 
recreate the conditions that led to the last financial crisis.
    Legislative and regulatory proposals to prioritize an activities-
based approach are problematic for three distinct reasons. First, 
activities-based regulation is poorly suited to prevent systemically 
important nonbanks from imperiling financial stability. Second, even if 
activities-based regulation could work in theory, an effective 
activities-based approach is impossible in practice, given the current 
U.S. regulatory framework. Finally, prioritizing an activities-based 
approach would slow the process of designating nonbank SIFIs and 
thereby increase the likelihood of a catastrophic nonbank collapse.
A. An Activities-Based Approach Will Not Prevent Systemic Nonbank 
        Failures
    On its own, an activities-based approach is insufficient to stop 
nonbanks from propagating risks throughout the financial sector. That 
is because policymakers are unlikely to identify and appropriately 
regulate all potentially systemic activities ex ante. Moreover, even if 
regulators were to issue appropriate activities-based rules, a purely 
activities-based approach ignores the unique and potentially dangerous 
ways in which individual activities might interact when combined within 
a single financial institution.
    First, an activities-based approach is inherently grounded in an 
unrealistic expectation that policymakers will identify and 
appropriately regulate all potentially systemic activities ex ante. As 
the 2008 crisis demonstrated, numerous known and unknown activities can 
create systemic risk. In the last crisis alone countless activities and 
products--subprime mortgages, mortgage-backed securities, 
collateralized debt obligations, repurchase agreements, commercial 
paper, and securities lending, among others--contributed to systemic 
risk. The prospect that policymakers will identify and properly 
regulate all such systemic activities ex ante seems far-fetched. A 
purely activities-based approach is especially unlikely to succeed 
given financial companies' incentives to restructure or rename 
activities to avoid regulation.
    The experience of the President's Working Group on Financial 
Markets (PWG) in the lead-up to the 2008 financial crisis exemplifies 
the difficulty of identifying systemically risky activities. President 
Reagan formed the PWG in 1988 to coordinate financial market oversight 
across various jurisdictions. \29\ Comprised of the heads of the major 
U.S. regulatory agencies, the PWG was essentially a precursor to FSOC, 
with a mandate to address systemically risky activities. \30\ While the 
financial sector amassed mortgage-related risks during the mid-2000s, 
however, the PWG focused on issues entirely unconnected to the looming 
crisis. Indeed, at the time, the PWG was primarily concerned with hedge 
funds, mutual funds, and terrorism risk insurance. It was not until 
March 2008 that the PWG finally recommended improved standards for 
mortgage origination, securitizations, and derivatives--the week before 
Bear Stearns failed. \31\ This is not to fault the PWG for failing to 
anticipate the crisis--few people foresaw the market crash. But PWG's 
experience during the mid-2000s underscores that regulators face 
serious challenges in identifying the specific activities that will 
transmit systemic risks.
---------------------------------------------------------------------------
     \29\ See Exec. Order No. 12,631, 3 CFR 559 (1988).
     \30\ In contrast to FSOC, the PWG lacked authority to designate 
systemically risk entities for enhanced regulation or supervision.
     \31\ See The President's Working Group on Financial Markets, 
Policy Statement on Financial Market Developments (2008), https://
www.treasury.gov/resource-center/fin-mkts/Documents/
pwgpolicystatemktturmoil_03122008.pdf.
---------------------------------------------------------------------------
    By contrast, policymakers are much more likely to consistently and 
accurately identify nonbank entities whose distress could threaten 
financial stability. As FSOC has demonstrated through its analytical 
framework, it is relatively straightforward to predict which nonbank 
entities could plausibly transmit systemic risks and which would not. 
Furthermore, nonbank SIFI designations need not perfectly distinguish 
between nonbanks that are systemically significant and those that are 
not. To the contrary, FSOC can deter nonbanks from seeking out systemic 
importance as long as the designation process is even roughly accurate. 
The mere prospect of being designated as a SIFI creates uncertainty, 
which a firm will likely seek to avoid by reducing its size and 
complexity.
    Furthermore, even if policymakers could identify and regulate each 
potentially risky activity, that alone would not be enough to prevent a 
systemically important nonbank from failing. That is because an 
activities-based approach is designed to limit risks associated with 
individual financial activities or products, in isolation. But a 
financial institution's risk profile is the product of all of the 
firm's activities and how they interact with one another. AIG is a 
classic example. AIG's failure was not solely attributable to its now-
infamous credit default swaps on mortgage-related assets. Instead, 
AIG's failure was also due to its securities lending activities, in 
which the firm invested collateral in mortgage-backed securities. \32\ 
AIG's credit default swaps and securities lending activities posed 
highly correlated risks--the firm suffered significant losses from both 
activities when mortgage assets declined in value and counterparties 
demanded payouts. A purely activities-based approach, however, is blind 
to these types of interactions among all of a firm's activities.
---------------------------------------------------------------------------
     \32\ See Daniel Schwarcz and Steven L. Schwarcz, ``Regulating 
Systemic Risk in Insurance'', 81 U. Chi. L. Rev. 1569, 1585-86 (2014).
---------------------------------------------------------------------------
    In sum, a purely or predominantly activities-based approach will 
not prevent a recurrence of the systemic nonbank failures the financial 
sector experienced in 2008. Entity-based nonbank SIFI designations, by 
contrast, are well suited to safeguard systemic nonbanks. Nonbank SIFI 
designations address the interrelationship of a firm's activities 
through enterprise-level safeguards like capital requirements, 
liquidity rules, and risk management standards. And, as noted above, 
policymakers are much more likely to be able to identify nonbank SIFIs, 
rather than trying to predict the precise activities through which such 
firms might transmit systemic risk. Accordingly, proposals to 
prioritize an activities-based approach while erecting procedural 
barriers to nonbank SIFI designations will weaken regulators' ability 
to prevent another financial crisis.
B. Effective Activities-Based Regulation Is Impossible in the Current 
        U.S. Regulatory Framework
    Proposals to shift to an activities-based approach suffer from 
another critical drawback: even if activities-based regulation could 
work in theory, effective activities-based regulation is not possible 
in the current U.S. legal and regulatory framework. FSOC faces two 
significant obstacles in carrying out an activities-based approach to 
nonbank systemic risk.
    1. Effective Activities-Based Regulation Is Impossible Because FSOC 
Lacks Authority To Mandate Activities-Based Rules
    First, FSOC lacks legal authority to implement activities-based 
reforms. Instead, the Council's section 120 activities-based power is 
strictly precatory. FSOC may recommend that an agency adopt new 
activities-based rules. But an agency has no legal obligation to 
actually implement such rules. \33\ And, in fact, there are many 
reasons why an agency might resist implementing activities-based 
regulations at FSOC's urging. For example, the agency might be captured 
by the financial sector it regulates, or it might try to protect its 
regulatory turf against intrusion by the Council. Thus, it is 
inadvisable to rely heavily or exclusively on an activities-based 
approach to nonbank systemic risk because FSOC's activities-based 
powers are extremely weak.
---------------------------------------------------------------------------
     \33\ If an agency elects not to adopt an FSOC recommendation under 
section 120 of the Dodd-Frank Act, it must only ``explain in writing'' 
why it chose not to implement the rule. 12 U.S.C. 5330(c)(2).
---------------------------------------------------------------------------
    The feebleness of FSOC's activities-based approach is especially 
concerning because the Council proposes to forfeit its one credible 
threat when an agency declines to adopt activities-based rules at 
FSOC's urging. Ordinarily, if an agency refuses an FSOC recommendation, 
the Council may respond by designating firms within the agency's 
jurisdiction as nonbank SIFIs. In fact, the Council threatened to do 
just that in 2012, after the SEC initially resisted enacting enhanced 
regulations on money market mutual funds. \34\ Because agencies fear 
losing authority over companies within their jurisdiction, the threat 
of SIFI designation may encourage an agency to adopt FSOC's recommended 
rules. \35\ Indeed, that is what happened when the SEC ultimately 
implemented MMMF reforms after the Council threatened to designate 
certain MMMFs or their advisors. Now, however, FSOC essentially 
proposes to take the threat of nonbank SIFI designations off the table. 
By enacting onerous procedural barriers, FSOC will make the threat of 
SIFI designations noncredible. In sum, creating new hurdles for nonbank 
SIFI designations further decreases the likelihood that an activities-
based approach will work in practice.
---------------------------------------------------------------------------
     \34\ See Allen, supra n. 2, at 1118-19; Schwarcz and Zaring, supra 
n. 2, at 1862-63.
     \35\ Schwarcz and Zaring, supra n. 2, at 1860-64.
---------------------------------------------------------------------------
    2. Jurisdictional Fragmentation in U.S. Financial Regulation Would 
Make an Activities-Based Approach Unworkable
    The second obstacle to effective activities-based regulation is the 
jurisdictional fragmentation that pervades the U.S. regulatory system. 
This fragmentation prevents policymakers from overseeing and regulating 
systemically important activities on a systemwide basis. In some cases, 
the regulatory system suffers from problematic gaps, where no 
regulatory agency has authority over particular conduct. For instance, 
in areas like insurance, hedge funds, and FinTech, even if the Council 
were to recommend heightened macroprudential rules, it is not clear 
that any Federal agency would have jurisdiction to implement those 
recommendations. In other cases, the U.S. regulatory system features 
complicated overlaps, where multiple agencies share responsibility for 
certain financial activities. This happens in areas like mortgages, 
securities, and derivatives. These overlaps would unduly complicate 
efforts to enact and enforce uniform, consistent activities-based rules 
throughout the U.S. financial system.
    None of this is to say that a well-designed activities-based 
approach cannot help preserve financial stability. To the contrary, 
activities-based regulation has the potential to combat some--but not 
all--sources of nonbank systemic risk, if configured appropriately. For 
example, an activities-based approach is uniquely well-suited to 
address systemic risks that may arise from correlations across numerous 
different nonbanks' investment activities, risk management practices, 
or product features. An activities-based approach may also be better 
designed to address certain risks arising from complex relationships 
among firms that require regulators or other market actors to mediate 
intercompany relationships through market infrastructure, such as 
clearinghouses and exchanges.
    As currently configured, however, the fragmented U.S. regulatory 
framework is not designed to realize these potential benefits of 
activities-based regulation. To operationalize an effective activities-
based approach, Congress would need to dramatically reform the U.S. 
regulatory system. For example, Congress could create a single 
stability regulator with authority to oversee activities spanning 
different segments of the financial sector, similar to the regulatory 
structure in Australia and other ``multi-peaked'' systems. A regulator 
of this sort would obviate many of the structural problems with 
activities-based regulation. Absent these reforms, however, an 
activities-based approach to nonbank systemic risk will not succeed in 
the current U.S. regulatory framework.
C. Prioritizing an Activities-Based Approach Would Slow the Process of 
        Nonbank SIFI Designations
    Finally, proposals to prioritize an activities-based approach--and 
consider nonbank SIFI designations only as a last resort--could 
dramatically slow the process of designating a nonbank SIFI, even when 
conditions clearly warrant such a designation. The designation process 
that FSOC and some members of Congress envision would involve multiple 
rounds of consultation and coordination among the relevant regulatory 
agencies before the Council could potentially resort to nonbank SIFI 
designations. This multistep process would take so long in practice 
that by the time FSOC even considered addressing escalating risks 
through nonbank SIFI designations, it could be too late. \36\ The SIFI 
designation process is already lengthy, with extensive evaluation and 
ample opportunity for the relevant company to present evidence to the 
Council. Moreover, it takes additional time for the Federal Reserve to 
develop appropriately tailored rules for any company designated as a 
nonbank SIFI, and even more time for the company to bring itself into 
compliance with those safeguards. Further delaying the designation 
process by mandating that the Council first exhaust all activities-
based remedies is therefore highly inadvisable.
---------------------------------------------------------------------------
     \36\ This is especially true if, as the Council proposes, it only 
designates nonbanks it determines to be vulnerable to financial 
distress.
---------------------------------------------------------------------------
    Proponents of an activities-based approach mistakenly view nonbank 
SIFI designations as an emergency response to be used if activities-
based regulation fails to address systemic risks. Indeed, the Council's 
proposed amendments to its interpretive guidance commit that FSOC will 
consider a nonbank SIFI designation ``only in rare instances such as an 
emergency situation.'' \37\ This view gravely misconstrues the purpose 
of nonbank SIFI designations. A nonbank SIFI designation is not an 
emergency tool; instead, it is a prophylactic strategy to protect a 
systemically important nonbank from experiencing distress in the first 
place. \38\ In order for the capital, liquidity, resolution planning, 
and other safeguards associated with nonbank SIFI designations to have 
their intended effect, FSOC must proactively use nonbank SIFI 
designations as an ex ante crisis-prevention strategy, not as a belated 
crisis response.
---------------------------------------------------------------------------
     \37\ ``Notice of Proposed Interpretive Guidance Regarding Nonbank 
Financial Company Determinations'', supra n. 16, at 27.
     \38\ See Gregg Gelzinis, ``Don't Put SIFI Designations on the Back 
Burner'', Am. Banker (Jan. 29, 2018), https://www.americanbanker.com/
opinion/dont-put-sifi-designations-on-the-back-burner.
---------------------------------------------------------------------------
Conclusion
    In sum, it is critical that FSOC retain nonbank SIFI designations 
as a viable regulatory tool. Recent proposals to de-emphasize or 
eliminate nonbank SIFI designations--either formally or through onerous 
procedural requirements--ignore the unique ways in which SIFI 
designations can prevent catastrophic nonbank failures. Moreover, these 
proposals overlook the serious practical challenges that an activities-
based approach would face in the United States' fragmented regulatory 
framework. Nonbank SIFI designations are therefore essential to 
mitigate nonbank systemic risk and prevent the next Bear Stearns, 
Lehman Brothers, or AIG from triggering another financial crisis.
       RESPONSES TO WRITTEN QUESTIONS OF SENATOR KENNEDY
                    FROM DOUGLAS HOLTZ-EAKIN

Q.1. Please discuss the potential threats posed by ILC's to 
safety and soundness because their commercial owners are exempt 
from consolidated supervision.

A.1. I do not see any particular issue with the safety and 
soundness of an ILC per se, as they have been regulated 
successfully by the FDIC and States for a number of years.

Q.2. Should a handful of States be allowed to unilaterally 
determine national financial regulatory and economic policy?

A.2. The U.S. has typically embraced a fair amount of Federal-
State heterogeneity in its regulatory structure without having 
any single State force the Federal Government's hand. 
Presumably the same outcome can prevail in this instance.

Q.3. Are you concerned that if the FDIC approves Square's 
application to become an insured depository institution, other 
FinTech companies like Amazon or Google or Paypal that have 
extensive commercial interests will also attempt to become 
banks?

A.3. We have seen interest from Walmart, SoFi, and others. It 
is entirely conceivable that there could be additional 
applications for an ILC charter. Opposition to Walmart 
obtaining a charter was for the most part motivated not by any 
fears of the safety and soundness of the financial system at 
large but more by dislike of Walmart itself and fears of the 
competitive advantages such a large institution would enjoy. 
Any inherent advantages Walmart could have offered consumers--
particularly those with less or no access to credit--would have 
necessarily lowered the prices of banking services across the 
system.

Q.4. Would you agree that holding companies are created to 
strengthen safety and soundness, not weaken it?

A.4. Holding companies are usually created to better organize 
connected financial institutions, to the enjoy the benefits of, 
for instance, economies of scale or a centralized 
administration. Holding companies enjoy protection from losses. 
Holding companies usually confer considerable tax advantages on 
the entities in the group. I would not agree that safety and 
soundness--particularly of the industry of a whole--are 
considerations when the decision is made to incorporate.

Q.5. Without consolidated supervision, how can regulators 
effectively enforce the source of strength doctrine for 
commercial ILC holding companies?

A.5. The pervasive use of bank holding companies as the vehicle 
for Federal financial regulation was greatly expanded during 
the financial crisis when Goldman Sachs and other investment 
banks were essentially forced to become bank holding companies. 
That might suggest that this one-size-fits-all approach is not 
needed and that the key is to avoid a financial crisis.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
         SENATOR CORTEZ MASTO FROM DOUGLAS HOLTZ-EAKIN

Q.1. How do the regulators for insurance companies and hedge 
funds become fully informed of all the activities in which 
insurance companies participate?

A.1. There is no substitute for the experience gained as a 
result of being a financial institution's primary regulator. It 
is for this reason that any action by a nonprimary regulator--
in this case FSOC--will usually be an inferior substitute, as 
action is taken without the benefit of this experience. Key to 
the development of an effective activities-based regulatory 
framework will be the requirement that the FSOC consult first 
with primary regulators, particularly before making any future 
designations.

Q.2. Could a large complex nonbank financial entity engage in 
risky activities completely unbeknownst to its board or 
regulator? Do you have historic examples of regulators being 
unaware that a regulator was unaware of risky investments or 
activities by a nonbank large and complex financial 
institution?

A.2. It is possible but unlikely that a nonbank financial 
entity engage in risky activities completely unbeknownst to its 
regulator. It is even less likely that the entity's board is 
completely unaware. Instead the more likely scenario is that an 
activity is known but that the scope or riskiness of that 
activity is not adequately measured (to the extent that such 
things can be adequately measured). Responsibility is shared by 
the financial entity (for a failure in internal controls or a 
failure to adequately disclose), its auditor (for a failure to 
adequately test the entity's assumptions), and its primary 
regulator (for permitting activities it is not itself capable 
of supervising).
    The best example of failure on the part of entity, auditor, 
and regulator is of course the role of American Insurance Group 
(AIG) in the 2008 financial crisis. A London-based division of 
AIG insured collateralized debt obligations (CDOs) against 
possibility of default via a credit default swap. Although 
insurance is the primary business of AIG credit default swaps 
are complex contract/derivatives that have more in common with 
banking products. The CDOs AIG insured involved the failure of 
an additional actor in this space, credit rating agencies, 
which inadequately assessed the risk of these highly complex 
instruments. It is not clear that AIG's primary regulator in 
the U.S., the U.K., or at group level was aware of the 
riskiness of this portfolio. We do however note that the 
difficulties with AIG stem from it effectively acting as an 
unregulated hedge fund rather than an insurer.

Q.3. Do you think the FSOC as it is currently comprised has 
both the expertise and the authority to appropriately assess 
nonbank significantly important financial institutions?

A.3. One cannot expect a third-party regulator such as the FSOC 
to somehow have better information than the involved parties, 
especially in light of the dearth of insurance experience on 
the FSOC. A single voting member with dedicated insurance 
expertise is not sufficient to assess these large, complex, but 
not inherently unsafe institutions. That is even if the advice 
of the insurance expert is taken. As noted in my written 
statement, the FSOC independent member with insurance 
expertise, Roy Woodall, dissented from the decision to 
designate Prudential Financial a systemically important 
financial institution.
    The alternative is to ensure that FSOC procedures ensure 
the accumulation of a sufficient body of evidence and expertise 
to support any decision to designate.

Q.4. What progress has the G20 made in terms of adopting 
reforms that allow for a resolution framework in their 
jurisdictions?

A.4. This is not an area of personal expertise, but I will note 
that since the adoption of the series of Basel Accords 
resolution frameworks for U.S. and other jurisdictions are more 
alike than different. There also does not seem to be appetite 
at the level of G20 for significant regulatory advancement at 
this point on resolution frameworks--even Basel IV is seen as 
simply the final implementation of the Basel III framework.

Q.5. What more needs to be done in terms of cross-border 
cooperation on orderly resolution of globally significant 
financial institutions--both banks and nonbanks?

A.5. To a large extent this is already embedded as policy 
within resolution frameworks. When vetting and approving 
resolution plans domestic regulators are instructed to look 
closely at a bank's activities, regardless of jurisdiction. 
Hence there does not seem to be any crucial gap that needs to 
be filled.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                    FROM PAUL SCHOTT STEVENS

Q.1. Your testimony expresses support for moving to an 
activities-based or industrywide approach to addressing risks 
to financial stability.
    Could such an approach expose small firms that pose no 
systemic risk to increased regulatory burdens? How should we 
mitigate such an outcome?

A.1. The Dodd-Frank Act provided FSOC with authority to 
evaluate systemic risk on an entity and/or an activity basis. 
An activities-based approach may be more appropriate where 
potential risky activity is spread across parts of the 
financial system. Rulemakings by the relevant financial 
regulator(s) should be tailored to the potential risks 
identified by FSOC, and done in accordance with the 
Administrative Procedures Act and applicable protections to 
help mitigate burdens to small firms.

Q.2. Does an activities-based approach to designation pose a 
risk to industry competition and innovation?
    What additional steps should be taken to ensure consumers 
continue to benefit from a competitive and innovative 
marketplace?

A.2. An activities-based approach is less likely to present 
risks to industry competition and innovation. By targeting 
activities, problematic behavior can be curtailed across the 
board. No one firm will operate at a disadvantage vis-a-vis its 
competitors.
                                ------                                


       RESPONSES TO WRITTEN QUESTIONS OF SENATOR KENNEDY
                    FROM PAUL SCHOTT STEVENS

Q.1. Please discuss the potential threats posed by ILC's to 
safety and soundness because their commercial owners are exempt 
from consolidated supervision.
    Should a handful of States be allowed to unilaterally 
determine national financial regulatory and economic policy?
    Are you concerned that if the FDIC approves Square's 
application to become an insured depository institution, other 
FinTech companies like Amazon or Google or Paypal that have 
extensive commercial interests will also attempt to become 
banks?
    Would you agree that holding companies are created to 
strengthen safety and soundness, not weaken it? Without 
consolidated supervision, how can regulators effectively 
enforce the source of strength doctrine for commercial ILC 
holding companies?

A.1. The Investment Company Institute (ICI) is the leading 
association representing regulated funds, including mutual 
funds, exchange-traded funds (ETFs), closed-end funds, and unit 
investment trusts (UITs) in the United States, and similar 
funds offered to investors in jurisdictions worldwide. ICI is 
not involved in matters related to ILCs and is not in a 
position to answer your questions.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
         SENATOR CORTEZ MASTO FROM PAUL SCHOTT STEVENS

Q.1. How do the regulators for insurance companies and hedge 
funds become fully informed of all the activities in which 
insurance companies participate?

A.1. The Investment Company Institute is the leading 
association representing regulated funds, including mutual 
funds, exchange-traded funds (ETFs), closed-end funds, and unit 
investment trusts (UITs) in the United States, and similar 
funds offered to investors in jurisdictions worldwide.
    While a number of ICI members are affiliated with insurance 
companies, ICI is not expert in matters involving the 
regulation of insurance companies and hedge funds. Accordingly, 
I am not in a position to comment on how regulators oversee 
their activities.

Q.2. Could a large complex nonbank financial entity engage in 
risky activities completely unbeknownst to its board or 
regulator? Do you have historic examples of regulators being 
unaware that a regulator was unaware of risky investments or 
activities by a nonbank large and complex financial 
institution?

A.2. It is widely recognized that in the most recent financial 
crisis, regulators were caught off guard by excessive risk 
taking in various areas--by banks as well as by nonbanks. The 
Dodd-Frank Act aimed to solve for these gaps and shortcomings 
in part by raising the regulatory bar (for example, through 
increasing capital and liquidity requirements for banks and 
overhauling the derivatives markets) and in part by creating 
the Financial Stability Oversight Council. FSOC provides a 
forum for financial regulators to share information, identify 
potential risks to financial stability, promote market 
discipline, and respond to emerging threats.

Q.3. Do you think the FSOC as it is currently comprised has 
both the expertise and the authority to appropriately assess 
nonbank significantly important financial institutions?

A.3. As a former chief of staff to the National Security 
Council, I agree that convening a forum of experts with diverse 
perspectives can serve an important function. Given the 
multiagency structure of our financial regulatory system, the 
mere creation of the FSOC, to bring together the many U.S. 
financial regulators, is worthwhile. Section 113 of the Dodd-
Frank Act clearly gives FSOC the authority to assess nonbank 
financial companies for potential designation as systemically 
important financial institutions (SIFIs). Based on the makeup 
of the U.S. regulatory system, however, banking regulators 
outnumber capital markets regulators on the FSOC. FSOC should 
take care to avoid any bank-centric bias as it analyzes firms 
and activities. Legislation ICI supports, S. 603, the FSOC 
Improvement Act, would assure early involvement by a nonbank 
financial company's primary regulator in assessing potential 
risks and how best to address them. For the mutual fund 
industry, our primary regulator is the Securities and Exchange 
Commission. The SEC has the expertise to properly assess 
companies under its jurisdiction and should play a leading role 
in any FSOC analysis of companies and activities over which it 
has authority.

Q.4. What progress has the G20 made in terms of adopting 
reforms that allow for a resolution framework in their 
jurisdictions?

A.4. The Financial Stability Board is made up of the national 
financial authorities from the G20 and several other 
jurisdictions around the globe, as well as various 
international standard-setting bodies such as the International 
Organization of Securities Commissions. Resolution has been a 
key area of focus for the FSB. According to a November 2018 
progress report by the FSB, \1\ jurisdictions have made the 
most progress on a resolution regime for global systemically 
important banks (G-SIBs), and all G-SIBs have resolution plans 
in place. The report notes that only some jurisdictions have 
introduced similar plans for insurers, and more work remains to 
be done.
---------------------------------------------------------------------------
     \1\ FSB 2018 Resolution Report: ``Keeping the Pressure Up'', 
available at https://www.fsb.org/wp-content/uploads/P151118-1.pdf.
---------------------------------------------------------------------------
    Resolution planning is of critical importance for banks. If 
a bank fails, taxpayers would be on the hook to meet the bank's 
obligations to depositors. In sharp contrast, resolution 
planning is simply not necessary for ICI's member funds.
    Mutual funds do not experience ``disorderly failure.'' 
Mutual funds do not guarantee returns to investors, and 
investors know a fund's gains or losses belong to them alone. 
Unlike banks, mutual funds typically use little to no leverage. 
Without leverage, it is virtually impossible for a fund to 
become insolvent, i.e., for its liabilities to exceed its 
assets. A fund that does not attract or maintain sufficient 
assets ordinarily will be merged with another fund or 
liquidated through an established and orderly process.
    Several features of the structure and regulation of mutual 
funds, along with the dynamic and competitive nature of the 
fund management business, facilitate ``orderly resolution'' of 
funds and their managers. These features include the 
independent legal character of a fund and Investment Company 
Act provisions concerning separate custody of fund assets, 
restrictions on affiliated transactions, and board oversight. 
The industry is very competitive, and mutual funds and their 
managers are highly substitutable. No single mutual fund or 
fund manager is so important or central to the financial 
markets or the economy that the Government would need to 
intervene or offer support to protect financial stability.

Q.5. What more needs to be done in terms of cross-border 
cooperation on orderly resolution of globally significant 
financial institutions--both banks and nonbanks?

A.5. As discussed in response to your first question, ICI is 
the leading trade association for regulated funds. Given the 
unnecessary resolution planning for funds described in response 
to Question 4, it is not within our expertise to comment on 
cross-border cooperation on orderly resolution of globally 
significant financial institutions.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SINEMA
                    FROM PAUL SCHOTT STEVENS

Q.1. In addition to alternate actions by FSOC and the nonbank's 
primary regulator, your testimony contemplates actions by the 
companies themselves to mitigate systemic risk. How does the 
FSOC Improvement Act improve the precision and accuracy of the 
FSOC's analysis, which as you alluded to in your testimony, 
improves overall policy outcomes?

A.1. The FSOC Improvement Act helps to ensure that the Council 
consider the range of options available and make an informed 
decision about how to address a particular potential threat to 
financial stability. Meaningful dialogue between a company 
being considered for SIFI designation and FSOC and its staff is 
of utmost importance. If a company is given an early indication 
as to why FSOC has selected it for review, the company is in a 
position to provide pertinent information about its business, 
structure, and operations. With a more complete picture of the 
company and its risk profile, the Council and its staff can 
engage in a more informed review of the company and its 
activities. In some situations, it may be possible for the 
company to take steps, such as making changes to a line of 
business, that would address the Council's concerns. Whether or 
not such action is sufficient, of course, would remain a matter 
of sole discretion for the Council.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                      FROM JEREMY C. KRESS

Q.1. What impact would designating a particular mutual fund as 
a nonbank SIFIs have on that fund's investors?
    Would you expect a designation to cause investors to move 
their investments to other, nondesignated mutual funds?

A.1. It is not accurate to assume that the designation of a 
mutual fund as a nonbank SIFI would cause the funds' investors 
to move their investments to nondesignated mutual funds. The 
Federal Reserve is responsible for developing prudential 
standards for companies that FSOC designates as nonbank SIFIs. 
Congress has directed the Federal Reserve to tailor prudential 
standards for nonbank SIFIs, taking into account their unique 
capital structure and activities, among other factors. \1\ The 
Federal Reserve must specifically consider differences between 
nonbank SIFIs and bank holding companies when developing such 
standards. \2\
---------------------------------------------------------------------------
     \1\ 12 U.S.C. 5365 (a)(2)(A).
     \2\ 12 U.S.C. 5365 (b)(3)(A).
---------------------------------------------------------------------------
    Consistent with this statutory mandate, the Federal Reserve 
has gone to great lengths to recognize the distinct regulatory 
issues associated with nonbank financial companies, and to 
tailor its approach accordingly. For example, the insurance 
SIFI capital standards the Federal Reserve proposed in 2016 
reflect thoughtful consideration of the differences between 
bank and insurance company business models. \3\
---------------------------------------------------------------------------
     \3\ ``Capital Requirements for Supervised Institutions 
Significantly Engaged in Insurance Activities'', 81 FR 38,631 (June 14, 
2016).
---------------------------------------------------------------------------
    If the FSOC were to designate a mutual fund, the Federal 
Reserve would be required to tailor its prudential standards to 
mutual funds' unique regulatory issues. Until the Federal 
Reserve develops such standards, it would be presumptuous to 
draw any conclusions about how mutual funds' investors would be 
affected, or how such investors would react.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
           SENATOR CORTEZ MASTO FROM JEREMY C. KRESS

Q.1. How do the regulators for insurance companies and hedge 
funds become fully informed of all the activities in which 
insurance companies participate?

A.1. Regulators are inherently limited in their oversight of 
insurance holding companies and hedge funds because they lack 
well-defined legal authority to oversee such firms on a 
consolidated, enterprisewide basis.
    In the United States, insurance regulation has long been 
the responsibility of the States, with little Federal 
involvement. But the State-based system of insurance regulation 
suffers from serious flaws. Most critically, although State 
insurance commissions regulate insurance subsidiaries, 
insurance conglomerates like AIG, MetLife, and Prudential 
traditionally have not been regulated at the holding company 
level. This critical gap in insurance regulation may allow 
insurance holding companies to engage in activities or amass 
risks without detection, as AIG did by issuing credit default 
swaps out of an unregulated, non-insurance, affiliate before 
the Financial Crisis. While some States now purport to 
supervise insurance holding companies on a groupwide basis, it 
is doubtful that State supervisors have the resources or 
incentives to appropriately police insurance conglomerates' 
worldwide activities. \1\
---------------------------------------------------------------------------
     \1\ See Jeremy Kress, ``Prudential Hasn't Earned the Right to Shed 
SIFI Label'', Am. Banker (March 13, 2018), https://
www.americanbanker.com/opinion/prudential-hasnt-earned-the-right-to-
shed-sifi-label.
---------------------------------------------------------------------------
    Hedge fund regulation suffers from similar limitations. 
Hedge funds have traditionally been exempt from prudential 
regulation and supervision. In 1998, this lack of oversight had 
disastrous consequences, when the country's largest hedge fund, 
Long-Term Capital Management, collapsed, necessitating a 
Government-orchestrated bailout. Although the Dodd-Frank Act 
enhances the SEC's ability to collect information from hedge 
fund advisers, it did not authorize the SEC to adopt 
meaningful, risk-reducing regulations for hedge funds and their 
advisers. \2\
---------------------------------------------------------------------------
     \2\ See Cary Martin Shelby, ``Closing the Hedge Fund Loophole: The 
SEC as the Primary Regulator of Systemic Risk'', 58 B.C. L. Rev. 639 
(2017).
---------------------------------------------------------------------------
    In sum, I am concerned that the baseline regulatory regimes 
for insurance companies and hedge funds are not well suited to 
identifying and appropriately regulating the potentially risky 
activities in which such firms engage.

Q.2. Could a large complex nonbank financial entity engage in 
risky activities completely unbeknownst to its board or 
regulator? Do you have historic examples of regulators being 
unaware that a regulator was unaware of risky investments or 
activities by a nonbank large and complex financial 
institution?

A.2. AIG is the most prominent example of a large, complex 
nonbank financial institution that engaged in risky activities 
without appropriate oversight by its board or regulators. AIG's 
collapse in 2008 stemmed, in large part, from its issuance of 
credit default swaps on mortgage-linked securities out of its 
subsidiary AIG Financial Products (AIGFP). Neither AIG's board 
nor its regulators appreciated the risks of this activity. The 
board of directors was ``too removed from the activities on the 
ground to understand the risks.'' \3\ Moreover, no agency had 
authority to supervise--let alone regulate--AIG's credit 
default swap activities because AIGFP was a noninsurance 
subsidiary.
---------------------------------------------------------------------------
     \3\ See Edward Simpson Prescott, ``Too Big To Manage? Two Book 
Reviews'', 99 Econ. Q. 143, 157 (2013). See id. at 143 (``[U]nder the 
Sullivan regime, there is evidence that AIG's senior management was 
unaware of the risks that AIGFP was actually taking.'').

Q.3. Do you think the FSOC as it is currently comprised has 
both the expertise and the authority to appropriately assess 
---------------------------------------------------------------------------
nonbank significantly important financial institutions?

A.3. In general, I believe that FSOC has appropriate authority 
to assess the systemic importance of individual nonbank 
financial institutions. Section 113 of the Dodd-Frank Act 
authorizes FSOC to designate a nonbank financial company if the 
firm ``could pose a threat to the financial stability of the 
United States'' in one of two ways: (1) in the event of its 
``material financial distress'' or (2) based on ``the nature, 
scope, size, scale, interconnectedness, or mix of [its] 
activities.'' \4\ In 2012, FSOC issued, through notice-and-
comment rulemaking, a three-step formal process for evaluating 
a nonbank's systemic importance. \5\ As outlined in this 
process, FSOC generally has the legal authority it requires to 
identify nonbank SIFIs.
---------------------------------------------------------------------------
     \4\ 12 U.S.C. 5323(a)(1).
     \5\ ``Authority to Require Supervision and Regulation of Certain 
Nonbank Financial Companies'', 77 FR 21,637 (Apr. 11, 2012).
---------------------------------------------------------------------------
    I am deeply concerned, however, that the FSOC, as it is 
currently comprised, does not have the requisite authority to 
implement the activities-based approach to nonbank systemic 
risk that the Council proposed in March 2019. Under section 120 
of the Dodd-Frank Act, FSOC may recommend that the primary 
financial regulatory agencies adopt new or heightened standards 
for any financial activity. \6\ FSOC now proposes to rely 
primarily or exclusively on this authority, in lieu of its 
nonbank SIFI designation power.
---------------------------------------------------------------------------
     \6\ 12 U.S.C. 5330(a).
---------------------------------------------------------------------------
    But in practice, FSOC lacks the ability to implement even a 
minimally effective activities-based approach. Critically, 
FSOC's authority to recommend activities-based rules is 
nonbinding. Thus, even if FSOC were to propose new regulations 
on certain financial activities--for example, derivatives 
trading or securities lending--the primary financial regulatory 
agencies would have no obligation to adopt the Council's 
recommendation. There are many reasons why an agency might 
resist implementing activities-based regulations at FSOC's 
urging. For example, the agency might be captured by the 
financial sector it regulates, or it might try to protect its 
regulatory turf against intrusion by the Council. Furthermore, 
even if agencies wanted to adopt FSOC's activities-based 
recommendations, jurisdictional gaps or overlaps could prevent 
them from enacting and enforcing uniform, consistent 
activities-based rules. \7\ As I suggested in response to 
Chairman Crapo's question at the hearing on March 14, Congress 
could mitigate these problems by giving FSOC direct rule-
writing authority.
---------------------------------------------------------------------------
     \7\ My written testimony contains a more complete analysis of the 
limitations of FSOC's activities-based authority.
---------------------------------------------------------------------------
    Finally, I am also concerned that FSOC currently lacks the 
expertise to appropriately monitor systemic risks because of 
misguided budget and staffing cuts by the Council and Office of 
Financial Research. \8\ Systemic risk prevention is of the 
utmost importance. The Trump administration's unwise decision 
to slash the budgets and staffs of these critical agencies 
leaves the financial system vulnerable to another financial 
crisis.
---------------------------------------------------------------------------
     \8\ See, e.g., Ryan Tracy, ``Washington's $500 Million Financial-
Storm Forecaster Is Foundering'', Wall St. J. (Feb. 19, 2018), https://
www.wsj.com/articles/washingtons-500-million-financial-storm-
forecaster-is-foundering-1519067903.

Q.4. What progress has the G20 made in terms of adopting 
reforms that allow for a resolution framework in their 
---------------------------------------------------------------------------
jurisdictions?

A.4. Cross-border resolution is outside the scope of my 
expertise. I would be happy to speak with your staff to suggest 
other financial regulatory scholars who would be better 
equipped to opine on this topic.

Q.5. What more needs to be done in terms of cross-border 
cooperation on orderly resolution of globally significant 
financial institutions--both banks and nonbanks?

A.5. Cross-border resolution is outside the scope of my 
expertise. I would be happy to speak with your staff to suggest 
other financial regulatory scholars who would be better 
equipped to opine on this topic.
              Additional Material Supplied for the Record
  STATEMENT SUBMITTED BY JULIE A. SPIEZIO, SENIOR VICE PRESIDENT AND 
         GENERAL COUNSEL, THE AMERICAN COUNCIL OF LIFE INSURERS
         
         
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

     STATEMENT SUBMITTED BY THE REINSURANCE ASSOCIATION OF AMERICA
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

STATEMENT SUBMITTED BY THE CENTER FOR CAPITAL MARKETS COMPETITIVENESS, 
                        U.S. CHAMBER OF COMMERCE
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]