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Regulators in U.S. Propose Criteria for Risky Financial Firms

U.S. Secretary Treasury Timothy Geithner
Timothy Geithner, U.S. treasury secretary. Photographer: Chris Ratcliffe/Bloomberg

A team of U.S. regulators will scrutinize asset size, leverage and debt levels of non-bank financial firms to determine which ones need extra supervision because they pose a potential threat to the economy.

The Financial Stability Oversight Council voted yesterday to evaluate companies that have more than $50 billion in assets and meet any of five other criteria, including a 15-to-1 leverage ratio, $3.5 billion in derivatives liabilities or $20 billion of outstanding loans borrowed and bonds issued.

Firms such as insurance companies that meet the tests might be subject to additional supervision by the Federal Reserve. Bank holding companies with more than $50 billion in assets are automatically considered systemically risky under the terms of the Dodd-Frank act, passed last year in a bid to avoid a repeat of the financial crisis that was deepened by the collapse of Lehman Brothers Holdings Inc. in 2008.

“We’re going through a very careful process to make sure we define, provide guidance, on the types of risk that would justify putting in place the kind of safeguards we have over banks,” Treasury Secretary Timothy F. Geithner, who chairs the council, said in a Bloomberg Television interview last night.

The proposal is open to a 60-day public comment period and can be changed. Geithner declined to specify what types of non-bank financial firms, such as hedge funds or asset management companies, might be designated systemically risky.

‘Living Wills’

Firms deemed financially risky by the council could then be ordered by the Fed to raise capital and reduce risky practices. The companies also would have to file “living wills” that spell out how they could be unwound in an orderly way to avoid rocking the wider financial system.

The council also will look closely at firms with $50 billion or more in assets that also have $30 billion in gross notional credit-default swaps outstanding or a 10 percent ratio of short-term debt to assets.

“This is a step forward,” Fed Chairman Ben S. Bernanke, a council member, said at yesterday’s meeting. “It provides more clarity, more quantitative, and in fact, it’s based on data in the public domain. I just do want to note that this is a first-stage process.”

Under a three-step process, the council will use additional data, including on size, interconnectedness and liquidity risk, to identify non-bank financial companies that might qualify as systemically risky. The council will analyze the companies, and then regulators will contact the firm in question to collect more information.

Based on the review, the council may vote by a two-thirds majority to designate a company as risky. The firm may request a hearing to contest the designation.

Increased Transparency

“We appreciate the increased transparency in the process and the flexibility in the rule that recognizes the individual characteristics of market participants,” Scott Talbott, chief lobbyist for the Financial Services Roundtable, said in an interview yesterday. At the same time, he said, he’s “concerned the thresholds are over-inclusive.”

Ernest Patrikis, a partner at law firm White & Case LLC and a former general counsel at the Federal Reserve Bank of New York, said the initial $50 billion threshold for assets and the “specific thresholds make sense.”

“One issue will be to ensure that the specific thresholds will be consistently applied,” he said. “Another is whether a holding company will be able to shift business to ensure that no subsidiary trips over a threshold.”

The council said it would further analyze what information it can use to assess whether asset managers are systemically important.

‘Hugely Important’

“Asset managers are an area where qualitative and business measures are hugely important because just relying on quantitative doesn’t tell the whole story,” Ken Bentsen, executive vice president for public policy and advocacy at the Securities Industry and Financial Markets Association, said in an interview yesterday.

Among the bank-holding companies with more than $50 billion in assets that are automatically subject to heightened Fed supervision are JPMorgan Chase & Co., Citigroup Inc. and Goldman Sachs Group Inc.

Insurance companies have said they are fighting the legacy of American International Group Inc. as they try to avoid being subjected to Fed supervision.

Lobbyists representing Prudential Financial Inc., Allstate Corp. and Berkshire Hathaway Inc.’s Geico Corp. say the business model for insurers has little in common with the high-risk derivatives and securities-lending operations that might have destroyed AIG if it weren’t for a $182 billion taxpayer-funded bailout.

‘Enhanced Standards’

Insurer MetLife Inc., which is also a bank-holding company, has said “enhanced standards” will be applied to its risk-based capital, liquidity, leverage, wind-down plan and concentration limits.

The financial stability council, which also includes the chairmen of the Securities and Exchange Commission, Federal Deposit Insurance Corp. and Commodity Futures Trading Commission, was created by Dodd-Frank. The law, the most sweeping overhaul of financial regulations since the Great Depression, was named for former Connecticut Senator Christopher Dodd and Massachusetts Representative Barney Frank, both Democrats.

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