U.S. Watchdogs Propose Tighter Oversight of Nonbanks Posing Systemic Risk

The top U.S. financial regulators proposed strengthening tools for addressing threats to financial stability, including changes to Trump-era guidance that have made it difficult to tag nonbank firms as systemically important institutions.

On Friday, U.S. Treasury Secretary Janet Yellen announced a proposal by the Financial Stability Oversight Council (FSOC) that would revise the way nonbank firms are designated.

“The existing guidance—issued in 2019—created inappropriate hurdles as part of the designation process,” Yellen said Friday. “These additional steps are not legally required by the Dodd-Frank Act. Nor are they useful or feasible. Some are based on a flawed view of how financial crises begin and the costs that they impose.”

She said such a designation process could take six years to complete—“an unrealistic timeline that could prevent the council from acting to address an emerging risk to financial stability before it’s too late.”

Yellen’s comments, delivered during an FSOC meeting, mark a long-anticipated shift under the Biden administration of how closely federal regulators scrutinize the biggest nonbank firms.

The proposed new guidance is likely to encourage those who worry that financial regulation grew too lax under the Trump administration, while instilling fear across portions of Wall Street over the dreaded “systemic risk” label, which brings tough oversight and steep compliance costs.

Firms that could attract scrutiny include insurers, private equity players, hedge funds, and mutual funds, as well as newer industries such as crypto. These businesses were already on alert that regulators might tag them.

“Alternative asset managers do not pose a systemic risk and are already subject to the SEC’s robust regulatory regime,” Bryan Corbett, president and CEO of the Managed Funds Association (MFA), said in a statement Friday. “MFA is carefully reviewing the proposed analytic framework and entity designation process laid out today to make sure it accurately addresses systemic risk and does not pull in non-systemically risky entities.”

The Framework

The FSOC, in a fact sheet, laid out a two-stage process by which it would evaluate and analyze nonbanks for designation. During the first, the council would conduct a preliminary analysis based on available public and regulatory data. The company would be notified and given the opportunity to submit relevant information. The second stage would involve a more in-depth evaluation for nonbanks selected for additional review and would consider information collected directly from the company.

Companies could request a hearing if FSOC makes a proposed designation, after which the council could vote on a final designation. The council would conduct annual re-evaluations of prior designations, during which the company would be able to plead its case to the council and explain changes it could make to address risks that have been identified.

The FSOC is also proposing a new framework for financial-stability risk identification, assessment, and response.

“Overall, I believe that the changes proposed by the council will create a balanced approach to addressing a potential risk to the U.S. financial stability and ensure all the tools available to FSOC will remain on equal footing,” Federal Reserve Chair Jerome Powell said.

Yellen reiterated her message that the banking system remains sound, with strong capital and liquidity positions. She cautioned that the recent turmoil in the sector shows that the authority for emergency interventions is critical and made a nod to the new proposals.

“Equally as important is a supervisory and regulatory regime that can help prevent financial disruptions from starting and spreading in the first place,” she said.

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