Although Janet Yellen has her hands more than full at the moment, she has already called up an expanded version of the President’s Working Group on Financial Markets and will shortly use her powers as chair to do the same for the Financial Stability Oversight Council. As we have noted, Ms. Yellen is a fan of both firm-specific and activity-based systemic designations. She will thus commence a two-track process of rewriting the Trump Administration’s designation standards and, without waiting to finish that, also target a few firms and activities for near-term scrutiny. A wide net will be cast and the fish will be judged systemic not only by traditional criteria (e.g., size), but also under a criterion neglected by the Obama Administration that comes in handy right now: risks to equitable economic opportunity. Some systemic fish will be whales, some are seen as sharks, some will still have hooks in their mouths after escaping long-ago designation, and more than a few haven’t yet heard the sonar.
First to the whales. The head of the Bank for International Settlements recently called for entity-based designation for BigTech companies with increasing financial-system footprints. His immediate target is cloud-service providers. BIS managers do not make off-the-cuff suggestions – this idea was surely cleared by the U.S. given that all of the big cloud-service providers are U.S.-based. We thus expect immediate consideration of financial-market utility (FMU) designations.
Of course, cloud services aren’t the only thing tech-platform companies are big at. Their payment-system role is already evident and their ambitions seemingly boundless. No Treasury decision has been made about whether payment-system participants should be individually considered FMUs or if key activities should be subject to activity-and-practice regulation covering not just BigTech, but also fintechs, payment-card companies, and payment processors. The entity-versus-activity decision will be based on whether the Fed and Treasury think nonbank payment players can be reached via activity-and-practice rules. This is their preference given the challenges of entity-based standards for very diversified companies, but the only way to regulate these nonbanks may be to restrict the way banks work with them. This may or may not suffice, especially if nonbanks grow still more concentrated and payment-powerful.
Who might FSOC consider to be sharks? Large companies some call predatory or just unduly sharp-toothed are already within the ambit of a newly-ambitious CFPB and FSOC won’t step in where consumer-finance standards suffice unless – and it’s a big unless – FSOC thinks nonbank providers raise systemic risks along with consumer hazard. Nonbank mortgage servicers may be first on this hit list, but an array of digital-currency products could well be next.
Who’s got an ugly designation hook still dangling? MMFs are clearly on this systemic list. As we’ve noted, we expect the PWG and FSOC to work through the reforms outlined at the end of last year. If the SEC balks again, then SIFI designation is nigh; if it doesn’t – and under Gary Gensler it likely won’t – activity-and-practice rules implemented by the Commission and the banking agencies are to come.
Two other hook-danglers are Fannie Mae and Freddie Mac. Now that conservatorship is here for the foreseeable future, FSOC and the Fed will not allow FHFA alone to set the GSEs’ systemic course. Systemic designation gives the Fed powers FHFA lacks and, under Mark Calabria, generally wants. A partnership between the Fed and FHFA will forge a new framework for the GSEs that, costly though it will be, may finally allow them out of purgatory.
Ironically, the only major nonbanks out of harm’s way are those the Obama Administration designated that were subsequently de-designated by the Trump team: large insurance companies. Although the Fed is still frightened by large life insurers, capital rules for the insurers under its thumb are incomplete despite almost a decade of statements about their importance. Some – e.g., auto insurers – are headed for hard times on the racial-equity front and others – private mortgage insurers – will be swept up in the systemic assessment of Fannie Mae and Freddie Mac. However, the crisis last time – not the 2008 debacle quaintly called the great financial crisis – is the main focus of the White House, Treasury, the Fed, the PWG, and FSOC.
In March of 2020, the financial system again teetered over an abyss. This was clearly one carved by what regulators called shadow banks until, pressured by them, they adopted the less pejorative “nonbank financial intermediators” moniker. Whatever you call them, drag nets are about to be laid and more than a few will be caught this time around.