Law 360: Nine Former SEC and CFTC Regulators Say FSOC Should Overhaul Approach To Examining Systemic Risk

By Richard Breeden, SEC Chairman, 1989-93; J. Christopher Giancarlo, CFTC Chairman, 2017-19; James E. Newsome, CFTC Chairman, 2001-04; Harvey L. Pitt, SEC Chairman, 2001-03; Paul S. Atkins, SEC Commissioner, 2002-08; Daniel M. Gallagher, SEC Commissioner, 2011-15; Frederick W. Hatfield, CFTC Commissioner, 2004-06; Richard Y. Roberts, SEC Commissioner, 1990-95; Jill E. Sommers, CFTC Commissioner, 2007-13.

This joint opinion originally appeared in Law360 on December 2, 2019. The authors write:

During the past year, the U.S. Department of the Treasury has spearheaded a proposal for common sense changes to the procedures of the Financial Stability Oversight Council, a powerful body created by the 2010 Dodd-Frank Act and made up of heads of the federal financial regulatory agencies that touch every facet of the American financial system.

We write as former capital markets regulators to express our support for the much-needed overhaul of FSOC rules, and to urge the adoption of the proposed guidance. FSOC is meeting on Dec. 4 and is expected to consider this issue.

The proposed changes to FSOC’s functioning will significantly improve the FSOC’s existing seven-year-old procedures. FSOC’s remit is to examine risks to the financial system. Thus, the proposal prioritizes a focus on activities of financial institutions, rather than designating individual nonbank businesses as systemically important financial institutions, or SIFIs.

An activities-based process would be more likely to identify emerging issues, versus a necessarily lengthy process of one-by-one, individual firm designations. Designation is inherently adversarial and resource intensive, risking losing the forest for the trees amid vehement and substantive objections from FSOC’s own subject matter experts.

FSOC’s initial bank-oriented approach was never appropriate for nonbank institutions. By their nature, asset managers, which the U.S. Securities and Exchange Commission regulates, have not created systemic risks simply because, unlike banks, asset managers use far less leverage. If they fail, they do not take down other institutions.

Asset managers do not risk their own capital in the market; their customers put assets at risk and share in any gains or losses. Those customers have a final say over their assets, including whether to keep them with the asset manager.

As a result, the primary remedy for a designated SIFI under the Dodd-Frank Act — enhanced capital requirements — would not work for asset managers. Since they do not risk capital, there is no logical basis for requiring more capital to make them safer.

As FSOC considers financial market activities, it must understand the unique aspects of the activities at issue and not reflexively apply bank-like regulation to dissimilar industries. As originally constituted, FSOC unfortunately functioned as a thin veil for the perspectives of banking regulators, allowing them to override subject matter regulators.

Accordingly, the proposed guidance correctly assigns a significant role to primary regulators, instead of FSOC.

We cannot overstate the practical importance of FSOC’s consultation with primary regulators. Consider the flawed study on asset management released by the Office of Financial Research in 2013. That study lacked any meaningful participation by knowledgeable capital markets regulators, resulting in fundamental misconceptions about securities markets. Effective oversight of America’s complex financial markets requires true depth of regulatory expertise, not guesswork.

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