The Financial Stability Oversight Council (FSOC) on September 29, 2017 issued a determination rescinding its prior designation of American International Group, Inc. (AIG) as a systemically important financial institution (SIFI). The rescission came on a 6-3 vote – the Treasury Secretary, the Chairs of the Federal Reserve Board (FRB), the Commodity Futures Trading Commission and the National Credit Union Administration, the Acting Comptroller of the Currency and the independent insurance representative voted in favor of the rescission; the Chair of the Federal Deposit Insurance Corporation, and the Directors of the Consumer Financial Protection Bureau and the Federal Housing Finance Agency voted against the rescission. The FSOC’s action came under a requirement that FSOC reevaluate its SIFI designations at least annually.
FSOC’s 68-page document is striking, as it is more analytically probative and detailed than the original order designating AIG on July 13, 2013. While the FSOC rescission determination found AIG had taken steps that had reduced the potential effects of its financial distress on its counterparties and markets, FSOC also painstakingly analyzed the nexus between the statutory requirements of Title 1 of the Dodd-Frank Act and the actual financial characteristics of AIG that tied to those facts. FSOC also cited significant changes that had occurred in the company (which had not previously earned it a de-designation from FSOC). These included reductions in AIG’s total outstanding debt, short-term debt, derivatives, repurchase agreements and total assets. FSOC noted that AIG had sold certain businesses in which it held dominant market shares, thus leaving the company less interconnected with other financial institutions and smaller in size and scope.
In a development of considerable significance for possible future SIFI evaluations, FSOC conducted a further evaluation of the incentives and disincentives for policyholders to surrender their life insurance policies and annuities. This was a critical basis in FSOC’s prior SIFI designations of AIG, Prudential and MetLife. Taking this additional analysis into account, FSOC determined that there was not a significant risk that a forced asset liquidation by AIG would disrupt market functioning and thereby pose a threat to U.S. financial stability.
When FSOC was established in 2010, a great deal of attention was focused on its authority to make SIFI designations for nonbank financial companies, which would subject the designated company to supervision by the FRB and enhanced prudential standards. There had been significant controversy regarding the process FSOC would use in considering whether to designate a nonbank financial company as a SIFI, as well as much interest regarding the number and type of companies that would be designated. FSOC ultimately made four SIFI designations.
FSOC SIFI Designations
July 8, 2013: AIG General Electric Capital Corporation (GECC)
September 19, 2013: Prudential Financial, Inc. (Prudential)
December 18, 2014: MetLife, Inc.
Now, three of the four designated companies are no longer deemed to be SIFIs. First, in March 2016, a U.S. District Court for the District of Columbia invalidated the FSOC designation of MetLife on several grounds. For further information, please refer to Dechert OnPoint, MetLife Opinion Turns the Tables on FSOC: Back to the Drawing Board.
The MetLife decision is currently on appeal to the U.S. Court of Appeals for the District of Columbia Circuit. In April 2017, President Trump directed the Treasury Secretary to review the process under which nonbank financial companies are designated as SIFIs, and to make recommendations for improvements to the process or for legislative changes. The Secretary was directed not to vote in favor of any new designations (which would prevent such a designation), except in an emergency situation, while the report was in process. The Secretary’s report is due by mid-October. The Court of Appeals has placed the MetLife appeal in abeyance pending the issuance of the Secretary’s report.
In June 2016, prior to the election, FSOC rescinded GECC’s designation. FSOC based its action on significant changes that GECC had made since its designation, including substantial divestitures of financial activities, a transformed funding model and a corporate reorganization.
Under these circumstances, the Treasury Secretary in issuing his report will have broad practical flexibility to either make future designations of SIFIs more unlikely or to seek to strengthen the FSOC’s legal position in making and upholding such designations. The Secretary’s decision will come with the backdrop of the House of Representatives having passed the Financial CHOICE Act of 2017, which would simply repeal FSOC’s authority to designate nonbank financial companies as SIFIs. The Secretary will also likely consider the impact of his recommendations on the U.S. ability to respond to any G-SIFI designations that might be made by the Financial Stability Board in the future. For further information, please refer to Dechert OnPoint, Financial Stability Board Issues Activities-Based Recommendations for Global Asset Management Industry.
The Secretary did not tip his hand with regard to the future of FSOC in Treasury’s June 2017 Report entitled, A Financial System That Creates Economic Opportunities. In that regard, however, it is fair to ask what the future agenda of FSOC will be. The last seven years suggest that it may be a more productive use of FSOC’s time for FSOC to focus less on designation of individual companies, and more on global red flags that can act as an early warning system to provide regulators with information to prevent or mitigate future global crises.