Dodd-Frank SIFI Power: A Real Frights to the Future of Nonbank Business

Dodd-Frank SIFI Power: A Real Fright to the Future of Nonbank

Businesses

Dodd-Frank SIFI Power: A Real Fright to the Future of Nonbank Businesses

One of the most voluminous and complex piec-es of legislation in our country’s history was passed by the Obama Administration in 2010. The Dodd- Frank Wall Street Reform and Consumer Protection Act came about to address the 2007-2012 global financial crisis.

With its numerous provisions, the Dodd-Frank Act (DFA), will undergo a phased rollout over the next sev-eral years. Its overriding mission is to decrease varied risk in the financial system of the United States. Sev-eral new government overseeing agencies have been established to enforce various components of the act.

DFA supporters believe it will prevent another crisis like the U.S. experienced in 2008. The real key is to protect consumers from the types of abuses seen during the economic crisis. Detractors contend that the act will have an adverse effect on our economic health.

Should their fears be realized, the act could mean higher unemployment, diminished wages, and slow-er wealth and living standard advances. Additionally, opponents to the bill warn that the competitiveness of U.S. companies abroad could be hampered enough to be of real concern to future jobs and economic expansion.

SIFI Institutions are anything but sci-fi The United States Federal Reserve defines a SIFI as any institution whose collapse would present a seri-ous risk to the economy. These financial institutions were targeted for regulatory reform and legislation by the Obama Administration. This action took shape in 2008, in response to issues concerning their consoli-dated supervision and regulation. The great recession brought the need for unprecedented measures to be

taken in preventing future failures of SIFIs, and the threat that failure presents to literally all of us.

The economic risk posed by SIFIs can arise from more the just the banking sector. Other financial organiza-tions (e.g. investment banks and insurance firms) also pose significant threats. The Dodd-Frank legislation’s regulations mandate that financial institutions—fitting SIFI qualifications—must meet ramped-up capital standards. They must develop executable contingen-cy plans for any potential failures in the future.

Oversight cannot be overstatedThe Financial Stability Oversight Council (FSOC) was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and is charged with three primary purposes:

• To identify risks to the U.S. financial stability that could arise from financial distress or failure of large, interconnected bank holding companies or Nonbank financial companies, or that could arise outside the financial services marketplace.

• To promote market discipline, by eliminating ex-pectations on the part of shareholders, creditors,

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and counter parties of such companies that the U.S. government will shield them from losses in the event of failure.

• To respond to emerging threats to the stability of the U.S. financial system.

With the authority to break up banks that are considered to be so large as to pose a systemic risk, the FSOC imposes sufficient force to move them to increase vital reserve requirements. Insurance companies also fall into this same set of actions.

All FSOC members are appointed by the Execu-tive Branch, and all current voting members are Democrats. Each was appointed by the Obama Administration, causing many on Wall Street and some in Washington real concern.

Representative Scott Garrett, a New Jersey Republi-can, had this to say during an American Nonbank In-stitute luncheon: “Any government organization made up of members supporting one ideology can become yes-men. With the Treasury as head of FSOC, the White House enjoys greater control over financial reg-ulators than ever, which is leading to an increasing po-liticization of the bodies,” he continued. “It is important to remember than the President comes and goes and someday there will be a Republican back in the White House. It would still be an inappropriate way for us to regulate our financial system. We need a system that reduces the pressure to make political decisions in this regulatory process,” Garrett concluded.

The ability to sustain stabilityLeaders of the G-20 directed the Financial Stability Board (FSB) to plan ways to prevent another financial crisis in 2009. The FSB is not a government agen-

cy, nor does it have any legal authority in the United States. Its functions were determined politically as a mandated direct order from leaders representing the world’s most powerful nations.

A leading issue is that the FSB can, and has, declared US companies as global SIFIs, before the FSOC even voted on their national systemic risk. It is reasonable to identify SIFIs as risks nationally, before identifying them as being so internationally. When the FSB deter-mines any company to be a global systemic risk, that company will certainly be identified as a national risk by FSOC. This is not the optimum way to apply busi-ness regulations. The FSB labeled AIG, MetLife and Prudential as global SIFIs. AIG and Prudential were both declared SIFIs by FSOC. Currently, the council is reviewing MetLife as a SIFI.

For any firm designated by the FSB as a global SIFI, that company’s home country’s national authority has veto power. Although the US national Authority is un-known, it can be suspected that it is either the Federal Reserve or the Treasury. This means that either the Treasury or The Federal Reserve approved the des-ignation of MetLife and other US companies as inter-national SIFIs without FSOC’s vote. FSB is currently reviewing 14 asset managers for SIFI designation.

How might SIFI alter your company’s future decisions?These FSOC regulations are being challenged by many business leaders, the main issue being whether they are appropriate for Nonbank financial compa-nies. These recent rules have yet to display real im-pact; companies should prepare for how a SIFI des-ignation might affect longer-term strategic decisions. This is particularly true in the cases of mergers, acqui-

sitions, and divestitures. Both regulators and industry will devote considerable effort and resources to meet the final rules’ standards.

SIFI Selection Process: Overview The Nonbank SIFI designation process gives regula-tors increased oversight of those companies that are not banks, but still play critical roles in our county’s financial system. Once a company is given this des-ignation, these companies can expect considerably more scrutiny. At least two-thirds of the FSOC’s voting members must feel that a company is “systemically important.” It will certainly be thoroughly reviewed and subjected to applicable rules and oversight. These decisions can be appealed. However, companies are given little time to do so within the FSOC SIFI process.

Once a selection is made and the company is notified, they have only 30 days to respond and request a re-view hearing. The FSOC has an additional 60 days to reach a final determination of SIFI status.

A rigid and monitored six-phase process 1. Screening & consideration 2. Notice of consideration 3. Written notice 4. Hearing 5. Final determination 6. Reevaluation & rescission

Potential Impact to a SIFI DesignationThe Federal Reserve becomes directly involved with regulation. This translates to increased prudential standards, in addition to the following:

• Federal Reserve supervision and extra regulatory scrutiny. Nonbank SIFIs will have to register with the Federal Reserve and designate the Federal Reserve as their primary regulator.

• Prudential standards: Section 165 of Dodd- Frank requires the Federal Reserve to establish stricter prudential standards for all systemically important Nonbank financial companies.

• Risk-based capital and leverage: Nonbank SIFIs must comply with the Board of Governors’ capital plan rule and develop annual capital plans, conduct capital adequacy stress tests, and maintain adequate capital, including a tier-1 common risk-based capital ratio greater than 5%, under expected and stressed conditions.

• Liquidity: Institutions will be subject to qualitative liquidity risk management standards and must conduct internal liquidity stress tests and set internal quantitative limits to manage liquidity risk.

• Credit limits: Credit exposure of a covered financial company to a single counterparty will be limited as a percentage of the company’s regulatory capital.

• Implement risk management practices: Companies will need to implement an nonbank-wide risk management program that



is overseen by a risk committee of the board and chief risk officer.

• Company Stress Tests: Company stress tests will be conducted annually by the Board of Governors’ using three economic and financial market scenarios which will be made public. Companies are required to conduct one or more company-run stress tests each year.

• Debt-to-equity limits: Institutions may need to comply with the 15-to-1 debt-to-equity ratio requirements.

• Early Remediation: Institutions may be posed with restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales.

• Living Wills: Designated companies will have to document their organizational structure and create a “living will” to make it much easier in the

event of failure. This will involve both a risk management framework outlining a set of actions to maintain sufficient capital and liquidity levels

The SIFI Designation’s Potential ImpactThe Congressional Budget Office has stated that even those companies not designated to be SIFIs could see potential repercussions throughout the process. Nonbank financial companies may face increased data reporting requirements.

A tip for the future: Be preparedBanking is already feeling the SIFI presence; insurance companies will soon feel it as well. For finance direc-tors or CFOs of a Nonbanking business, preparation for the Federal bureaucracy to be at your doorstep is a wise action. However, you most likely will not know exactly why or even when FSOC looks at your indus-try. Criteria are still in a state of flux.

When Prudential Financial was dubbed a SIFI by the FSOC in 2013, its reasons were superficial and lacked data. This action implied that they do not feel obligated to justify its designations. If this is true, your business could be deemed as being too big to fail, whether that is true or false.

Even if this does not happen, the old adage “an ounce of prevention is worth a pound of cure,” certainly seems to apply here. Firms and organizations who are laying out a plan of action displays a state of readiness that makes perfect business sense. Preparation for fu-ture “what ifs” will be an asset when a large investor is looking at you. Your preparedness in the wake of a SIFI designation could spell the difference between yes or no designations on their part.


SIFI: It might be a science, but it’s sure not fictionSIFI is not a foray into a time and place in the distant future. SIFI is real, right now, and coming to your in-dustry, possibly sooner than you want to believe. The designation has financial implications, as well as im-pact from a positioning posture going forward.

While the foundation for SIFI remains a bit unsettled, your foundation to deal with it should be as rock solid as possible. Having the ability and agility to react can bolster your brand, or tarnish it. It’s not worth the risk of doing nothing. Create a plan proactively and with proficiency to gain a reputation as a forward-think-ing, progressive company. In conclusion, those com-panies approaching SIFI as the future, will be most prepared since the future is now.

A smart plan of action SIFI-ready strategies call for tactics, proactive proce-dures, and an overall sense of readiness. The ability to react to anything that could adversely impact your business can spell the difference between disaster and resilience. A SIFI-ready plan shows the FSOC that you have proactively chosen to meet their lofty stan-dards. Your contingency plans provide a real sense in their minds that your company is prepared to react to economic climate threats with potential threats to your viability and overall corporate strength. Of equal im-portance, is the trust of your investors and the public.

Why take a chance on being hand cuffed with more risk-based capital requirements, leverage limits, liquidity requirements, resolution planning and credit exposure report requirements, concentration limits, and short-term debt limits. Be proactive and start working on your SIFI-Ready Strategy Plan today. Smart Devine can guide you on best practices to take to make sure you are SIFI ready.


REFERENCESGarrett, S. (2014, May 7). The FSOC’s regulation of SIFIs. YouTube. Retrieved July 11, 2014, from: http://www.youtube.com/watch?v=q5sML-6sf4U

Wallison, P. (2014, June 30). American Enterprise Institute. FSOC lacks credibility in designating SIFIs. Retrieved July 11, 2014, from http://www.aei.org/article/economics/financial-services/banking/fsoc-lacks-credibili-ty-in-designating-sifis/

Eisenbeis, R. (2014, May 19). Limiting Systemic Risk and Too-Big-to-Fail. . Retrieved July 11, 2014, from http://www.aei.org/files/2014/05/19/-shadowfinancecommitteestate-ment051914_170335628458.pdf

Financial Stability Oversight Council. (n.d.). About FSOC. Retrieved July 11, 2014, from http://www.treasury.gov/initiatives/fsoc/about/Pages/de-fault.aspx

FEDERAL ADVISORY COMMITTEE ACT. (1972, January 1). . Retrieved July 12, 2014, from http://www.gsa.gov/graphics/ogp/without_annota-tions_R2G-b4T_0Z5RDZ-i34K-pR.pdf

Wallison, P. (2014, March 31). What the FSOC’s Prudential decision tells us about SIFI designation. What the FSOC’s Prudential decision tells us about SIFI designation. Retrieved July 12, 2014, from http://www.aei.org/outlook/economics/financial-services/banking/what-the-fsocs-prudential-decision-tells-us-about-sifi-designation/

Bandel, C., & Tracer, Z. (2013, July 13). Allianz Joins AIG on List of Too-Big-to-Fail Insurers. Bloomberg.com. Retrieved July 14, 2014, from http://www.bloomberg.com/news/2013-07-18/allianz-joins-aig-on-fsb-s-list-of-too-big-to-fail-insurers-1-.html



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Dodd-Frank SIFI Power: A Real Frights to the Future of Nonbank Business

Business

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