NEW YORK (Reuters) - A federal judge’s ruling that MetLife Inc is not important enough to warrant special regulatory scrutiny has opened the door for other non-bank financial firms to try and unshackle themselves from the designation of “too big to fail.”
Those that stand to benefit from Wednesday’s decision include insurers Prudential Financial Inc and American International Group Inc, as well as General Electric Co’s GE Capital and asset managers like BlackRock Inc, Fidelity Investments and The Vanguard Group Inc.
Metlife, Prudential, AIG and GE Capital are the only four non-banks that have been deemed systemically important financial institutions, or SIFIs, by the Financial Stability Oversight Council. BlackRock, Fidelity and Vanguard have not been assigned systemic importance, but analysts and regulatory experts say they are large enough to merit consideration.
It is difficult to assess whether any of these firms can avoid a “too big to fail” classification forever because the criteria are fluid and SIFI assessments start fresh every year. As such, even MetLife’s victory may be short-lived.
The Financial Stability Oversight Council, known as FSOC, is comprised of members from 15 regulatory bodies, 10 of which have a vote on matters including SIFI designations. The council was created as part of the 2010 Dodd-Frank financial reform law. Its SIFI designations are meant to add an extra layer of oversight on firms that could cause a system-wide financial crisis if they get into trouble, because of how large and interconnected they are.
FSOC has been plagued by criticism about opaqueness nearly since its birth, even as it has taken steps to address complaints.
In 2014 the U.S. Government Accountability Office, a nonpartisan watchdog, criticized FSOC’s “lack of full transparency,” saying FSOC did not always disclose public documents or explain the rationale for SIFI designations. Republican lawmakers have also lashed out at FSOC for not sharing enough information.
The council has taken corrective measures, both in its public disclosures and in the way it interacts with companies. At an event last year, GE Capital Chief Executive Keith Sherin called GE Capital’s designation as a systemically important institution “very clear” and “very understandable.”
In a statement on Thursday, a spokesman for the Treasury Department, which chairs FSOC, said the council also has a “clear process” for removing SIFI designations. It includes discussions between FSOC staff and company officials, as well as independent analysis of changes within companies or across markets, he said.
Overall, the council aims to determine whether “a firm’s distress could destabilize the financial system,” he said.
Size is certainly one factor in determining which firms are “too big to fail,” but it is not the only one, regulatory experts say. For instance, AIG’s near failure in 2008 created a system-wide panic not because it was large, but because of its connections to dozens of other firms through derivatives trades.
But while complexity and interconnectivity may be even more important than size, defining precisely what those words mean is not an easy task. One big question posed by analysts and regulatory experts is whether FSOC would consider mutual fund firms systemically risky because investors could rush to redeem their shares at the same time.
U.S. District Judge Rosemary Collyer’s opinion in the MetLife case is currently sealed. But in her order, she pointed to arguments that FSOC’s assessment of MetLife was flawed, that some of its assumptions were “arbitrary and capricious” and that it did not give enough consideration to how the SIFI designation would affect MetLife financially.
It is not clear whether FSOC will appeal the decision, but regardless of how the litigation proceeds MetLife may not be out of the woods.
FSOC makes its determinations on an annual basis, and can simply designate MetLife as a SIFI again in its next iteration. That could set up a scenario where MetLife and the council are in an endless legal battle - which is partly why other firms declined to pursue litigation the way MetLife did.
AIG’s chief executive said in a television interview on Thursday that the insurer is considering whether to dispute its designation in light of the MetLife ruling.
Coincidentally, GE Capital asked FSOC on Thursday to de-designate it because it had taken steps to shrink and simplify. The company has been planning to do this for some time, after exiting businesses, selling assets and shrinking its balance sheet by more than half to get out from under the SIFI designation.
BlackRock, Vanguard and Fidelity representatives declined to comment on the MetLife decision.
Some analysts said GE’s strategy was a wiser one than MetLife‘s, because rather than fighting a powerful group of regulators in court, it adapted to become “not-too-big-to-fail” in response to FSOC’s analysis of its business model.
“GE Capital no longer poses a major threat to U.S. financial stability,” said RBC Capital Markets analyst Deane Dray, “and we believe the federal review is almost a formality at this point.”
Additional reporting by Lisa Lambert and Sarah N. Lynch in Washington, Sruthi Shankar in Bengaluru and Trevor Hunnicutt in New York