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THE IMPACT OF THE DODD-FRANK ACT: 

WHAT IT MEANS TO BE A SYSTEMICALLY 

IMPORTANT FINANCIAL INSTITUTION 

HEARING 

BEFORE THE

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS 

AND CONSUMER CREDIT 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

MAY 16, 2012 

Printed for the use of the Committee on Financial Services 

Serial No. 112–125 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

JAMES H. CLINGER, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

SHELLEY MOORE CAPITO, West Virginia, Chairman 

JAMES B. RENACCI, Ohio, Vice Chairman 

EDWARD R. ROYCE, California 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JEB HENSARLING, Texas 

PATRICK T. MCHENRY, North Carolina 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

MICHAEL G. GRIMM, New York 

STEPHEN LEE FINCHER, Tennessee 

CAROLYN B. MALONEY, New York, 

Ranking Member 

LUIS V. GUTIERREZ, Illinois 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

RUBE ́ N HINOJOSA, Texas 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

GREGORY W. MEEKS, New York 

STEPHEN F. LYNCH, Massachusetts 

JOHN C. CARNEY, JR., Delaware 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

May 16, 2012 ..................................................................................................... 1 

Appendix: 

May 16, 2012 ..................................................................................................... 55 

WITNESSES 

WEDNESDAY, MAY 16, 2012 

Auer, Lance, Deputy Assistant Secretary for Financial Institutions, U.S. Department of the Treasury .................................................................................... 7 

Elliott, Douglas, Fellow, The Brookings Institution ............................................. 43 

Gibson, Michael S., Director, Division of Banking Supervision and Regulation, 

Board of Governors of the Federal Reserve System .......................................... 9 

Harrington, Scott E., Alan B. Miller Professor, The Wharton School, University of Pennsylvania ............................................................................................. 37 

Quaadman, Thomas, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce ....................................................................... 39 

Wheeler, William J., President, Americas, MetLife, Inc. ..................................... 40 

APPENDIX 

Prepared statements: 

Auer, Lance ....................................................................................................... 56 

Elliott, Douglas ................................................................................................. 62 

Gibson, Michael S. ............................................................................................ 66 

Harrington, Scott E. ......................................................................................... 72 

Quaadman, Thomas ......................................................................................... 78 

Wheeler, William J. .......................................................................................... 93 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Capito, Hon. Shelley Moore: 

Written statement of the Financial Services Roundtable ............................. 101 

Written statement of the National Association of Insurance Commissioners (NAIC) ............................................................................................... 109 

Written responses to questions submitted to Michael S. Gibson ................. 112 

Written responses to questions submitted to Lance Auer ............................ 115 

(1) 

THE IMPACT OF THE DODD-FRANK ACT: 

WHAT IT MEANS TO BE A SYSTEMICALLY 

IMPORTANT FINANCIAL INSTITUTION 

Wednesday, May 16, 2012 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

AND CONSUMER CREDIT, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:02 a.m., in room 

2128, Rayburn House Office Building, Hon. Shelley Moore Capito 

[chairwoman of the subcommittee] presiding. 

Members present: Representatives Capito, Renacci, Royce, Manzullo, Hensarling, McHenry, Luetkemeyer, Duffy, Canseco, Grimm; 

Maloney, Hinojosa, Baca, Miller of North Carolina, Scott, and Carney. 

Ex officio present: Representative Bachus. 

Also present: Representatives Garrett and Green. 

Chairwoman CAPITO. This hearing is called to order. I want to 

welcome everyone. 

This morning the Financial Institutions and Consumer Credit 

Subcommittee will examine the impact of being designated as a 

systemically important financial institution (SIFI) specifically for 

nonbank financial entities. But I couldn’t begin the hearing without 

talking about the most topical subject of the day or of the week. 

There is no doubt that this week’s news of JPMorgan’s trading 

losses has raised significant questions about the supervision of 

risks within an institution. The story is still unfolding, and although it appears that the firm had sufficient capital to absorb this 

significant loss, one of the questions I would ask is, would a less 

capitalized institution survive a similar loss? Are other financial 

firms that are determined systemically significant sufficiently capitalized? Where did the lapses in the internal risk controls within 

the firm occur? Were Federal financial regulators aware of the position that JPMorgan was taking? Transparency is a question, I 

think. Did they do an adequate job of supervising the firm’s risk? 

Are they able to supervise the complexity of the firm’s positions? 

The losses at JPMorgan emanated from their London office, 

which begs the question, how well are our Federal financial regulators coordinating with their counterparts across the globe? And 

how did the provisions in Dodd-Frank help or exacerbate the problem? 

2 

I think there are plenty of questions that we will be answering, 

certainly in the next several weeks. 

But this morning’s hearing focuses on the effect of designating 

nonbank financial firms as systemically important. The DoddFrank Act grants the Financial Stability Oversight Council, better 

known as FSOC, the authority to designate firms as systemically 

important. While the statute is clear which financial institutions 

will be designated, it is less clear about designating nonbank financial institutions. 

The FSOC was tasked with promulgating rules to determine the 

criteria for nonbank financial institutions to be designated as systemically important, and the Federal Reserve is in the process of 

finalizing rules to supervise the entities that are designated. 

There are many questions again about the effect the systemically 

significant designation will have on these nonbank firms. We have 

already seen with the largest banks that systemic significance 

equates to market participants viewing these institutions as being 

too-big-to-fail and expects the government to intervene in times of 

severe distress. The implied government guarantee also results in 

lower borrowing costs. 

It is less clear what effect this designation will have on nonbank 

entities. I know that many of our witnesses on the second panel 

have serious concerns about the standards used for not only designating the firm but also for the supervision of nonbank firms once 

it is designated. There are legitimate questions about how these 

standards will work with the various business models of nonbank 

firms. 

Does the Federal Reserve have the expertise to supervise 

nonbank firms from different industries? How well will the FSOC 

and the Federal Reserve coordinate to ensure the standards for 

designation supervision are in harmony? And are they working 

with their counterparts across the globe to harmonize standards for 

systemic significance in the United States with global systems significance? 

These are questions that deserve a robust discussion. I am hoping we get to that in this morning’s hearing. 

I would like to thank our witnesses for appearing before the subcommittee this morning. 

I now recognize the ranking member of the subcommittee, the 

gentlewoman from New York, Mrs. Maloney, for the purpose of 

making an opening statement. 

Mrs. MALONEY. First of all, I want to thank you, Madam Chairwoman, for calling this hearing, and I welcome our witnesses. 

This hearing today is about a very important set of issues around 

designation of nonbank companies as systemically significant. 

There are certainly a lot of perspectives and issues around it that 

have been raised already by the Chair, but I think these are important issues and that we should stay focused on them. 

If there was one area where we learned from the financial crisis 

in 2008, it was that the regulators did not have the tools to regulate complex, interconnected nonbank companies, like AIG, and did 

not have the ability to wind down these companies in the event of 

a failure without disrupting the system and without taxpayer funding. As a result, these highly-interconnected overleveraged firms 

3 

nearly brought this entire country and its financial system to its 

knees, and it was quickly recognized that key supervision for these 

nonbank areas was missing. 

We did two important things in Dodd-Frank to address this by 

eliminating the hiding places from regulation, and by ending toobig-to-fail. First, we gave the FSOC, the Financial Stability Oversight Council, the authority to require Federal supervision of 

nonbank financial companies that pose a systemic risk and required the Federal Reserve (Fed) to impose heightened regulatory 

requirements on these companies, as well as any bank holding 

company with at least $50 billion in assets. These changes also leveled the playing field between nonbanks and banks. 

Second, if a company does fail in spite of the heightened requirements and supervision, we also provided an Orderly Liquidation 

Authority (OLA) in Title II of Dodd-Frank so that regulators would 

not be faced with the horrible choice between either bailing a company out at taxpayer expense, which we did with AIG, or letting 

it fail, to the great detriment of the broader financial system. 

Designation of nonbank companies is a two-step process. The entities must first be identified as nonbank SIFIs, and then they 

must be subjected to heightened supervision. FSOC rule was not 

required by Dodd-Frank and really was done to provide clarity to 

the public and companies about how FSOC will designate 

nonbanks as SIFIs. 

I understand it has been estimated that about 50 entities will be 

considered for heightened regulation based on the size and scope 

of their financial activities. Once designated, these companies will 

be subject to stricter standards under rules that the Fed is currently developing and on which it has asked for detailed input. 

So, I look forward to hearing from the panels, and I also look forward to hearing from the firms. 

I also would like to ask unanimous consent for Mr. Green to have 

privileges as a subcommittee member today so he may question the 

witnesses. 

I welcome our panelists today, and I yield back. 

Chairwoman CAPITO. Without objection, it is so ordered. 

I would like to recognize the chairman of the full Financial Services Committee, Chairman Bachus, for 3 minutes for an opening 

statement. 

Chairman BACHUS. I thank the chairwoman. 

At today’s hearing, we will have an opportunity to examine one 

of Dodd-Frank’s most vague and potentially problematic mandates. 

We are here to better understand what it means to be systemically 

important, a euphemism for too-big-to-fail. Which institutions will 

be categorized is significantly important. What are the consequences of being deemed systemically important? What are the 

advantages and what are the disadvantages? How will these institutions be regulated? And how will counterparties and other market participants interact with them? 

We have been told by the FDIC that part of this interaction will 

be to indemnify certain creditors and counterparties, and that 

seems very similar to AIG. And Members on both sides pledged 

that we would not get into another bailout situation. 

4 

Many companies are asking themselves the same questions and 

whether the regulators think they are systemically important. The 

Financial Stability Oversight Council’s final rule is not at all clear. 

It is therefore my hope that the regulators testifying here today 

can help provide the committee and all affected parties with some 

much-needed clarity on these important issues. I look forward to 

this discussion and I thank the witnesses for being here. 

I do want to say, in conclusion, that because of the JPMorgan 

Chase situation, we are again hearing from some of our colleagues 

that we need a law which will essentially prevent a business from 

losing money or taking risk, and no law can do that, nor should a 

law attempt to prohibit a company from taking risk. In fact, that 

is just an impossibility. Now, when taxpayer funds are at risk, and 

a bailout situation would certainly be one of those, or deposits, 

then that is another question. 

Just to put it in perspective, JPMorgan Chase—and if you are 

concerned about deposits in that institution, let me put that trading loss in perspective. Their pre-tax profit last year was $25 billion, so a $2 billion loss would represent 1 month of earnings. If 

it had been last year, it would reduce their earnings to $23 billion. 

The loss is about 1/100th of the firm’s $189 billion net worth and 

roughly 1/1000th of the firm’s $2.3 trillion in assets. 

Even with this loss, I believe they are one of the most profitable 

financial institutions in the country, and unless the facts are diametrically different from what we have heard, there is no risk from 

this loss to depositors or to taxpayers. JPMorgan Chase remains a 

very profitable and viable institution. 

Thank you, Madam Chairwoman. 

Chairwoman CAPITO. Thank you. 

Mr. Baca for 2 minutes. 

Mr. BACA. Thank you, Madam Chairwoman. 

I want to thank you for calling this hearing, along with the ranking member. 

I also want to thank both of the panelists for being here with us 

today to offer their insight on this important topic. 

As we know on the Financial Services Committee, Federal Reserve Chairman Greenspan came to us many times and said to, 

‘‘trust them, they know what they are doing.’’ I guess we are still 

trying to figure out if we should trust them, and apparently, we 

should not have trusted them. But we did. 

One of the biggest developments during the economic crisis in 

2008 was the realization of how much of the impact could be felt 

from the collapse of the too-big-to-fail firms. Until the problem 

arose, it seemed that no one quite understood the level of interconnectedness that some of these firms had. As a result, our government took drastic action to limit the stress the collapse of these 

institutions could have caused. And obviously, no one wants to see 

the events of 2008 repeated. 

In writing and passing Dodd-Frank 2 years ago, I believe we created a sound framework. I state, I believe we created a sound 

framework that will allow us to stay ahead of the curve with these 

systemically important institutions, to make sure that we regulate 

them and also that we do a lot of the enforcement that needs to 

be done. It is not just regulating them, but how are we going to 

5 

enforce them, and what action will actually be taken to make sure 

we don’t develop additional crises and that we work to solve the 

problem? 

This framework will allow the regulators to work with market 

participants in creating an efficient and secure regulatory structure. At the same time, it will allow the market to continue to operate in a free manner that will not be dictated by the needs and demands of the regulators. 

Finally, if a firm does run into trouble, the market has the confidence that the mistakes of a few will not impact the actions of 

many, and that is only if the action is taken and it is brought before us to make sure that it doesn’t affect a lot of the consumers 

or individuals involved. 

At the end of the day, what everyone is looking for is certainty. 

Industries want to be certain that they can run their business in 

a manner where they don’t fear becoming too unsuccessful but at 

the same time doing what is right. Regulators want to be certain 

that they can step in and act in a timely manner to correct the bad 

behaviors, and that is going to be the key right there. And the 

American public wants to know that all parties involved are doing 

their best to ensure that the abusive behavior is not something 

that will be allowed to be repeated. 

Again, I want to thank the ranking member and the chairwoman 

for having this hearing. 

Chairwoman CAPITO. Thank you. 

Mr. Garrett for 11⁄2 minutes. 

Mr. GARRETT. I thank the Chair also for this important hearing 

with regard to the designation of firms that are systemically important financial institutions, or SIFIs. But instead of calling these 

firms systemically important financial institutions or SIFIs, I think 

what we should call them is what we all know they are and what 

the market calls them as well, and that is too-big-to-fail institutions. If you are honest about it, Dodd-Frank basically codified toobig-to-fail in the law and then just simply changed the name over 

to SIFIs or systemically important financial institutions. 

And when you change the name, you really haven’t changed anything about the characterization of them or the substance of them. 

You really haven’t solved the too-big-to-fail problem. 

The firms now that are on the list of firms were chosen by this 

Administration and FSOC that are formerly designated as too-bigto-fail, they basically still have funding advantages in the marketplace because of that designation and they are subject to a resolution process that still allows the government to use taxpayer money 

at the end of the day to decide which creditors are going to win and 

which creditors are going to lose. 

So if you really ended too-big-to-fail, then Members on the other 

side of the aisle over here would not state that one of their goals 

for the next Congress is, ‘‘Let’s end too-big-to-fail.’’ And if we really 

had ended too-big-to-fail, then there would be no reason whatsoever 

in the media or anyplace else for people to be all concerned about 

JPMorgan’s $2 billion loss, because the taxpayers would not be on 

the hook, and they would be protected from it. 

So, lets’s be honest here. The entire debate about SIFI designation is nothing more than a charade, and we should call it what 

6 

it is. It is a debate about which financial institutions are too-bigto-fail. And we should not be debating which companies to call toobig-to-fail. We should be debating, how do we end the taxpayer 

being on the hook for these institutions? 

I yield back. 

Chairwoman CAPITO. Thank you. 

Mr. Scott for 2 minutes. 

Mr. SCOTT. Thank you very much, Madam Chairwoman. 

I think we need to make sure that as we look at the situation 

we are in today, the results of our financial crisis from a few years 

ago, even the JPMorgan Chase situation, that we have to do everything we can to make sure it doesn’t happen again, that all of that 

is taken into consideration. 

But I caution on this point. I think we need what I refer to as 

a ‘‘delicate balance’’ here. We need to make sure we have the regulations to make sure this is done. Dodd-Frank is in place to do 

that. It is an excellent framework. It put the FSOC in there so that 

it could marshal our efforts for stability. There is no assignation for 

SIFIs within the Dodd-Frank bill. We are leaving those kinds of 

threats and identification up to the FSOC. 

And I agree that the crisis we had a few years ago, the 

JPMorgan situation, certainly has to be avoided, but we have to 

make sure that any additional regulation for our financial institutions, including both banks and nonbanks, will not stifle the 

growth of our economy and the creation of American jobs. That is 

the most important thing before us today. 

We have to create jobs. We have to get this economy better. We 

have to also make sure that the forces that generate the capital, 

that disburse the capital, that lend and keep this economy going, 

are not put in a straitjacket. I say that as a proud sponsor of DoddFrank and also one who understands we have to make sure that 

the abuses don’t happen. But all I am simply saying is that it has 

to pass that ‘‘delicate balance’’ test. First and foremost, economic 

growth must not be stifled. 

Now, we are making some great progress here. The jobless rate 

is coming down, all of this. So all I am saying is as we move forward, let’s move forward with a jaundiced eye on this and do it correctly. 

Thank you, Madam Chairwoman. 

Chairwoman CAPITO. Thank you. 

Mr. Royce for 1 minute. 

Mr. ROYCE. Thank you, Madam Chairwoman. 

More than any other, Section 165 of Dodd-Frank is emblematic 

of Washington taking its eye off of the ball, because instead of focusing on those institutions everyone knows are too-big-to-fail, instead of getting back to less leverage and higher capital requirements for those few firms, government instead will publicly stamp 

institutions, potentially dozens of institutions, as systemic. 

And the explicit statement to the market is that Washington believes these firms are special and the implicit statement to the 

market is also going to be that Washington will never allow these 

firms to fail. Given the precedent that has been set, given the propensity of government to err on the side of intervention, err on the 

side of bailouts to save systemically important firms, it is my hope 

7 

that we can cast the smallest possible net in this and designate 

only the firms that everyone agrees are too-big-to-fail. But, frankly, 

the approach was the wrong approach. 

I yield back. 

Chairwoman CAPITO. The gentleman yields back. 

Mr. Green for 2 minutes. 

Mr. GREEN. Thank you, Madam Chairwoman. 

And I thank the ranking member as well. 

One thing I am totally absolutely and completely convinced of is 

this: Regardless of how we feel, the public is of the opinion that 

too-big-to-fail is the right size to regulate. It is the right size to 

deal with such that it does not bring down the economy. 

AIG is a prime example of what we did not have the authority 

and the ability to properly deal with when it was going out of business, as it were. We cannot allow ourselves on our watch to simply 

say, we need to get back to business as usual. And I hear a lot of 

that in other words; let’s get back to business as usual. We cannot 

afford business as usual because it brings down the economy with 

these institutions when they become so large that they have an impact across not only the American economy but the economy of the 

world. 

So today, I think it is appropriate for us to examine the rules, 

but it is also appropriate to note that we cannot allow business as 

usual to become the order of the day. 

I yield back the balance of my time. 

Chairwoman CAPITO. The gentleman yields back. 

I believe that concludes our opening statements. I will now recognize the witnesses for the purpose of a 5-minute summation of your 

written statements. 

Our first panelist is Mr. Lance Auer, Deputy Assistant Secretary 

for Financial Institutions, U.S. Department of the Treasury. 

Welcome. 

STATEMENT OF LANCE AUER, DEPUTY ASSISTANT SECRETARY FOR FINANCIAL INSTITUTIONS, U.S. DEPARTMENT 

OF THE TREASURY 

Mr. AUER. Thank you. Chairwoman Capito, Ranking Member 

Maloney, and members of the subcommittee, thank you for the opportunity to discuss the Financial Stability Oversight Council’s rule 

and guidance for identifying nonbank financial companies that will 

be subject to standards and supervision by the Federal Reserve. 

In the 2008 financial crisis, financial distress at certain nonbank 

financial companies contributed to a broad seizing-up of the financial markets. To address potential risks posed to U.S. financial stability by these types of companies, the Dodd-Frank Wall Street Reform and Consumer Protection Act authorizes the Council to determine that certain nonbank financial companies could pose a threat 

to U.S. financial stability and will be subject to the supervision of 

the Federal Reserve and to enhanced prudential standards. 

Although the Dodd-Frank Act specifically outlined substantive 

considerations and procedural requirements for designating 

nonbank companies, the Council elected to engage in a rulemaking 

process in order to obtain input from all interested parties and to 

provide increased transparency to the public. To these ends, the 

8 

Council provided the public with three separate opportunities to 

comment on its proposal. 

After receiving significant input from market participants, nonprofits, academics, and other members of the public, the Council 

approved its final rule in April of this year. The final rule provides 

a robust process for evaluating whether a financial company should 

be subject to Federal Reserve supervision and enhanced prudential 

standards. The Council will approach each determination using a 

consistent framework, but ultimately each designation must be 

made on a company-specific basis, considering the unique risk to 

the U.S. financial stability that each nonbank company may pose. 

The Council’s rule and guidance explain the three-stage process 

that the Council intends to use in assessing nonbank financial companies. 

In stage one, the Council will apply uniform quantitative thresholds to identify those nonbank financial companies which will be 

subject to further evaluation. The use of clear thresholds in stage 

one enables the public to assess whether a particular company is 

likely to be subject to further evaluation by the Council. 

In stage two, the Council will analyze the nonbank financial companies identified in stage one using a broad range of information 

available to the Council, primarily through existing public and regulatory sources. This review will include both quantitative and 

qualitative information. 

In stage three, the Council will contact each nonbank financial 

company that the Council believes merits further review to collect 

information directly from the company which was not available in 

prior stages for an in-depth review. Each nonbank financial company that is reviewed in stage three will be notified that it is under 

consideration and will be provided an opportunity to submit written materials to the Council for the Council’s consideration. 

If the Council votes to approve a proposed determination, the 

nonbank financial company will receive a written explanation of 

the basis of the proposed determination. The company may also request a hearing to contest the proposed determination. After the 

hearing, a final determination requires a second vote of the Council. 

The authority under the Dodd-Frank Act for the Council to designate nonbank financial companies for enhanced prudential supervision standards and Federal Reserve supervision is an important 

part of the Council’s ability to carry out its statutory duties to identify risks to U.S. financial stability and respond to such threats in 

order to better protect the U.S. financial system. 

Thank you, and I would be happy to answer any of your questions. 

[The prepared statement of Mr. Auer can be found on page 56 

of the appendix.] 

Chairwoman CAPITO. Thank you. 

Our second witness is Mr. Michael Gibson, Director, Division of 

Banking Supervision and Regulation, Board of Governors of the 

Federal Reserve System. 

Welcome. 

9 

STATEMENT OF MICHAEL S. GIBSON, DIRECTOR, DIVISION OF 

BANKING SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. GIBSON. Chairwoman Capito, Ranking Member Maloney, and 

members of the subcommittee, thank you for the opportunity to testify today on implementation of the Dodd-Frank Act as it relates 

to the designation, supervision, and regulation of systemically important nonbank financial companies. 

The recent financial crisis showed that some financial companies, 

including nonbank financial companies not historically subjected to 

consolidated prudential supervision, had grown so large, so leveraged, and so interconnected that their failure could pose a threat 

to overall financial stability. The sudden collapses or near collapses 

of major financial companies were among the most destabilizing 

events of the crisis. 

The Dodd-Frank Act addresses key gaps in the framework for supervising and regulating systemically important nonbank financial 

institutions through a multi-pronged approach that includes: first, 

the establishment of the Financial Stability Oversight Council, 

which has the authority to designate nonbank financial companies 

that could pose a threat to financial stability; second, a new framework for consolidated supervision and regulation of nonbank financial companies designated by the Council; and third, improved tools 

for the resolution of failed nonbank financial companies. 

With respect to the first prong, the Financial Stability Oversight 

Council was created to coordinate efforts to identify and mitigate 

threats to U.S. financial stability across a range of institutions and 

markets, including by establishing a framework for designating 

nonbank financial companies whose failure could pose a threat to 

financial stability. 

On April 3rd, the Council issued a final rule and interpretive 

guidance setting forth the criteria and the process it will use to 

designate nonbank financial firms as systematically important. The 

Council’s issuance of this rule is an important step forward in ensuring that systemically important nonbank financial firms will be 

subject to strong consolidated supervision and regulation. 

With respect to the second prong, the enhanced prudential standards, Sections 165 and 166 of the Dodd-Frank Act require the Federal Reserve to establish enhanced prudential standards both for 

the largest bank holding companies and for nonbank financial companies designated by the Council. These enhanced prudential 

standards include requirements for enhanced risk-based capital 

and leverage requirements, liquidity, risk management, stress testing, and resolution planning, as well as single counterparty credit 

limits and an early remediation regime. 

In December, the Federal Reserve issued proposed rules which 

would apply the same set of enhanced prudential standards to covered companies that are bank holding companies and covered companies that are designated nonbank financial companies. The Federal Reserve may tailor the application of the enhanced standards 

to different companies on an individual basis or by category. 

Working out the exact details of how enhanced prudential standards will apply will certainly require a thoughtful and iterative 

analysis of each designated company over time. The Federal ReVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
10 

serve is committed to assessing the business model, capital structure, and risk profile of each designated company and tailoring the 

application of the enhanced standards to each company. 

With respect to the third prong, resolution, the Dodd-Frank Act 

provides two important new regulatory tools, both of which extend 

to systemically important nonbank financial companies. First, each 

of the largest bank holding companies and each nonbank financial 

company designated by the Council is required to prepare and provide to the FDIC and the Federal Reserve a resolution plan or a 

living will for its rapid and orderly resolution under the U.S. Bankruptcy Code. 

Second, Title II of the Dodd-Frank Act provides for an orderly 

resolution process to be administered by the FDIC. 

Thank you very much for your attention. I would be pleased to 

answer any questions you may have. 

[The prepared statement of Mr. Gibson can be found on page 66 

of the appendix.] 

Chairwoman CAPITO. Thank you. 

Thank you both. I will begin with the questions. 

As you are probably well aware, many different companies from 

various industries,—and both of you emphasized the tailoring of 

the designation procedure and the resolution procedure—some that 

have been mentioned as candidates for systemic designation, are 

concerned about a sort of one-size-fits-all, where let’s say you are 

assessing a large insurance company on the same sort of criteria 

that you would judge a bank institution, and a nonbank institution 

the same. 

You kind of mentioned this in your statement, but how will you 

deal with the differences in the industry business models? I will 

start with the Treasury. 

Mr. AUER. Thank you, Madam Chairwoman. 

The process that the Council developed in putting out its proposed rule for comment on three different occasions was to devise 

a three-stage framework. The first stage provides clarity and consistency by using uniform quantitative thresholds that are based 

on publicly available data, so that they could screen out the large 

number of firms that the Council is unlikely to consider for further 

evaluation. 

It is very explicit in stages two and three that the Council plans 

to take an individualized look at each particular nonbank financial 

company under consideration, to look at all of its activities, all of 

its businesses, the types of business it is in, the type of activities 

it engages in, so that it can take into account the specific factors 

of that firm and of that industry in coming up with a final proposal 

for the Council. 

Chairwoman CAPITO. Thank you. 

Mr. Gibson? 

Mr. GIBSON. We have made it clear in our proposal for enhanced 

financial standards that we do intend to tailor the standards to the 

characteristics of the companies that are designated by the Council. 

What we have proposed is a single set of standards that apply to 

both the bank holding companies and the nonbank companies, but 

we have said that once the firms are designated, we will consider 

11 

tailoring the standards, and the Dodd-Frank Act explicitly gives us 

the authority to do that. 

Now, we understand that there are some nonbank companies for 

which the bank-like standards that we proposed would likely be a 

bad fit and we have committed to looking at that when those companies are designated and doing what we can to tailor the standards. However, there are other companies that could be designated 

that are not that different from a bank, and for those companies, 

we would expect that the bank-like standards we have would require less tailoring. 

Chairwoman CAPITO. Would the Federal Reserve be doing that 

particular exercise in terms of trying to tailor, let’s say, if you are 

looking at enhanced capital or such, would that be done within the 

Federal Reserve or within the FSOC? 

Mr. GIBSON. That would be done by the Federal Reserve. 

Chairwoman CAPITO. Do you have the expertise to oversee all the 

different types of business models that you are probably looking at 

here, or am I making it more complicated than it is? 

Mr. GIBSON. We have a lot of expertise across a range of activities. 

Chairwoman CAPITO. Right. Financial activities, yes. 

Mr. GIBSON. Bank holding companies engage in a lot of the activities that the nonbank companies are engaging in, so in a lot of 

cases, we feel like we would have sufficient expertise. But if there 

are cases where we need to bring in more expertise for nonbank 

companies that are designated, we would certainly do that. 

Chairwoman CAPITO. I would assume that the designation just 

simply by the name obviously means that if one institution were 

to fail, that there would be systemic problems to other institutions, 

bank or nonbank. We obviously found that in 2008. Is that one of 

the main criteria to having the designation? 

Mr. AUER. Yes. The statutory standard is that the Council should 

designate firms that could pose a threat to the financial stability 

of the United States. The Council in its rule and guidance has stated that a threat to the financial stability is where an impairment 

to financial remediation or financial activity could have a real effect on the real economy. So that is the standard on which a designation would ultimately be based. 

Chairwoman CAPITO. Okay. One of the concerns I have is with 

the Orderly Liquidation Authority. You are probably aware that we 

tried to go with an enhanced bankruptcy look on this and failed 

and said the Orderly Liquidation Authority rests with the FDIC. 

Again, I will go back to my original question. When you are looking at a nonbank entity, the FDIC obviously is more accustomed 

to working with banking entities. I want some confidence, and I 

know you probably can’t make a judgment statement, but is the 

confidence there that the FDIC has the expertise, again, to make 

judgments when trying to unwind nonbank institutions? Is that a 

concern? 

Mr. AUER. Madam Chairwoman, we, the Treasury Department 

and other FSOC members that will be involved in any Orderly Liquidation Authority have been working with the FDIC to understand what their approach will be to designating—I am sorry, to 

putting a firm in liquidation authority and how they would handle 

12 

that. They have devoted significant resources to that process. But 

ultimately what resources and the details of their approach is a 

question you would have to pose to them. 

Chairwoman CAPITO. All right. My time is up so I am going to 

go to Mrs. Maloney. 

Thank you. 

Mrs. MALONEY. Thank you. 

I would like to ask Mr. Auer, I understand the criteria the Council has established by regulation and statute, but I would like more 

clarity on the exact metrics that will be used in designating 

nonbank financial companies as SIFIs. For example, how much 

interconnectedness makes a firm an SIFI? Could you elaborate in 

this area? 

Mr. AUER. Certainly. Again, in the multiple rounds of public 

comment that we received, there was a desire that led to the development of a three-stage process. The first stage is based on publicly 

available data and easily calculable metrics in order to provide 

greater clarity to the public about the types of entities the Council 

is likely to want to examine further in stages two and three. 

However, the Council is very clear that it wants to look in stages 

two and three on a firm-by-firm basis, and the rules and guidance 

layout a specific framework for it to do so. Interconnectedness is 

one of the elements that the Council will be looking at in stages 

two and stages three, but it is one of six broad categories of frameworks. The others are size, substitutability, leverage— 

Mrs. MALONEY. How do you define interconnectedness? 

Mr. AUER. After much analysis and work, the Council does not 

believe that there is a single metric or formula that can measure 

interconnectedness. The Council believes that rather than trying to 

have a one-size-fits-all measure of interconnectedness, interconnectedness is simply one of the measures that it must look at 

it when it looks at any particular firm, and different firms might 

be interconnected in different ways, which is why you can’t have 

a formula for calculating that factor. 

Again, the final determination of a firm for enhanced prudential 

standards for Federal Reserve supervision is if that firm can pose 

a threat to the financial stability of the United States, whether 

through interconnectedness, lack of substitutes or other factors. 

Mrs. MALONEY. Thank you. 

Mr. Gibson, will the Federal Reserve’s prudential standards proposal for SIFIs be modified to adopt to the unique and distinct profile of nonbank SIFIs? Different businesses with different business 

models will require different regulatory standards, do you agree? 

And specifically, insurance companies are very different from 

banks. Private businesses are very different. 

Mr. Gibson, could you elaborate on that? 

Mr. GIBSON. We understand that different types of nonbank financial companies will have different characteristics and different 

business models that may make it necessary or desirable for us to 

tailor the enhanced prudential standards, and we have committed 

that we will do that when the companies are designated. 

In terms of the proposed rule that we put out for comment in December, the comment period is still open. We have received many, 

many comments, including from many nonbank financial compaVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
13 

nies that were worried about the possibility of being designated, 

and we are currently in the process of weighing the comments. So 

I can’t predict where the final rule will come out on that. But we 

have committed that after the companies are designated, we will 

take a look at the need for tailoring the standards. 

Mrs. MALONEY. Okay. Mr. Auer, you said in your testimony you 

are going to be very transparent. So what are the plans to make 

the designation decisions transparent? 

Mr. AUER. First, I should note that the Council was not required 

to issue any sort of rule around its nonbank designations process. 

However, in a desire to provide greater transparency and gain 

greater input from the public, it wouldn’t actually— 

Mrs. MALONEY. And what is the timing? When do you expect to 

make this public? 

Mr. AUER. The rule and guidance were finalized in April and 

went into effect this month. The Council is now beginning its process for looking at calculating the stage one, which firms passed the 

stage one thresholds. It is collecting that data and making sure it 

is accurate. The Council will then move through stages two and 

three. As the Secretary has said publicly, at least he hopes that the 

Council will begin the first of its designations sometime this year. 

Mrs. MALONEY. My time is almost over, but Mr. Gibson, what is 

the timing for the development of prudential standards for 

nonbanks, and do you need to know who they are before you develop these standards? 

Mr. GIBSON. As to finishing our rulemaking on Sections 165 and 

166—we have put the proposed rule out for comment. We have received a lot of comments. We are in the process of reviewing those 

comments, and we are working towards a final rule. But we will 

still have the possibility even after the final rule is done and once 

a specific nonbank company is designated to tailor our standards 

to that particular company. 

Mrs. MALONEY. My time has expired. 

Thank you. 

Chairwoman CAPITO. I now recognize the chairman of the full Financial Services Committee, Chairman Bachus, for 5 minutes. 

Chairman BACHUS. Thank you. 

Mr. Gibson, I am reading Section 113—you have to read Section 

113, I guess, in connection with Section 165, is that correct, in determining what is an SIFI and what is not? 

Mr. AUER. Section 113 lays out the rules for designating firms, 

and Section 165 describes the standards that apply to the firms. 

Chairman BACHUS. The standards that apply, right. It appears 

the prudential standards that are in Section 165, once you designate, are bankcentric, are they not? 

Mr. GIBSON. Yes. The prudential standards in Sections 165 and 

166 are bankcentric, and they are some of the traditional standards 

that we have had, such as capital liquidity, and the requirement 

is to enhance those standards, make them higher standards for 

systemically important firms. 

Chairman BACHUS. I noticed when you read Section 113, which 

is really the section that determines whether something is designated, it says, ‘‘Nonfinancial activities of the companies shall not 

14 

be subject to the supervision of the Board of Governors and prudential standards of the Board.’’ 

Would insurance activities be considered nonfinancial? 

Mr. GIBSON. Insurance activities are considered financial. 

Chairman BACHUS. They are. Okay. But the standards don’t appear to apply to insurance. There is no discussion of reserves or 

policies. In fact, if you look at what you discuss in Section 113 and 

you talk about the extent and nature of—you talk about underserved low-income communities, their outreach there. Does there 

need to be a different set of standards developed for insurance companies? 

Mr. GIBSON. The Federal Reserve currently in its role as bank 

holding company supervisor and savings and loan holding company 

supervisor already supervises some companies that have insurance 

operations, so we are already doing supervision and regulation of 

holding companies with insurance activities. 

Chairman BACHUS. But would you agree that the standards are 

bankcentric, and these are not banks? 

Mr. GIBSON. That is right. What we have done is in the existing 

cases of insurance companies that are supervised by the Federal 

Reserve because they have chosen to be bank holding companies or 

savings and loan holding companies, we have taken an approach 

that has applied some capital, the capital and leverage requirements to the holding company, but we do rely on the State functional regulators of the insurance companies which have traditionally focused on the risks and the individual legal entities that are 

insurance companies. 

Chairman BACHUS. So you will consult with those State insurance regulators? 

Mr. GIBSON. Yes, we already do work closely with them in the 

existing— 

Chairman BACHUS. You will before a designation is made? For 

instance, you are trying to determine leverage or whether there is 

capital or enough cap reserves, and that would obviously—if you 

are talking about an insurance company, an important part of that 

would be their insurance policies. 

Mr. GIBSON. The FSOC includes members who have insurance 

expertise. 

Maybe I should let you respond, Mr. Auer? 

Mr. AUER. Yes, the FSOC contains at least three members who 

are primarily focused on insurance expertise. And as the Council 

gets into stages two and three of looking at any particular firm, we 

do expect to be working with State insurance commissioners to ensure that we have a good understanding of the unique nature of 

those firms. 

Chairman BACHUS. Is there any recognition by either of the two 

of you gentleman that these standards don’t really appear to fit, 

say, asset managers or money markets or captive finance companies or insurance companies? You can look at them as a bank and 

tell what you are going to do, but they need a lot of work in 

nonbank financial companies. 

Mr. GIBSON. Regarding some of the nonbank financial companies 

that you mentioned, such as asset management companies or captive finance companies, we would certainly have to look at the need 

15 

to tailor the standards that are in the proposed rule to the specific 

characteristics of those companies. And as you point out, an asset 

management company is very different from a bank because the assets it manages are not on its own balance sheet; they are held in 

custody for customers. That is an important difference. 

We have experience with asset management companies because 

there are large bank holding companies that are significant participants in asset management, but we don’t have the experience of 

writing capital and other prudential standards for a company that 

only engages in asset management, and that is what we would 

need to tailor—if and when those companies are designated, we 

would tailor the standards. 

Chairman BACHUS. But your original threshold is $50 billion, so 

that would capture—I know you said 50 or 60 companies, but 

wouldn’t it be closer to 100 companies that could possibly be designated? 

Mr. AUER. The stage one thresholds include a $50 billion consolidated assets test. As we say in the final rule and guidance, we expect that would capture less than 50 companies in total. 

Chairman BACHUS. Okay. 

Chairwoman CAPITO. The gentleman’s time has expired. 

Mr. Hinojosa for 5 minutes. 

Mr. HINOJOSA. Thank you, Madam Chairwoman. 

Most people agree that the lack of the regulation of the nonbank 

segments of the financial industry, such as the nonbank mortgage 

lenders and the derivatives market, was a very large contributor to 

the recent financial crisis. One of the cornerstones of the Wall 

Street Reform Act was to ensure that going forward, the regulators 

can reach any financial company whose failure or activities could 

threaten our whole system. 

My question to Mr. Auer is, do you agree that the Wall Street 

Reform Act mechanism for designating nonbank financial companies for Fed supervision as implemented by the FSOC’s recent final 

rule will help prevent future crises by ensuring that there is no 

place to hide from appropriate regulation? 

Mr. AUER. Thank you, Congressman. 

Yes, we view the authority to designate nonbank financial companies that could pose a threat to the financial stability of the 

United States as a key part of the Dodd-Frank reforms and an essential element to ensure that those types of firms that encounter 

distress and were at the heart of the last financial crisis can be 

better identified going forward and subject to heightened standards, better risk management, and capital and liquidity rules, so 

that they are less likely to get into distress in the future as well 

as being subject to an Orderly Liquidation Authority and a requirement to provide living wills that will describe how they can be 

wound down without government support in a bankruptcy without 

causing disruption to the rest of the financial system. We think 

this nonbank designation process is a key element of achieving 

those goals. 

Mr. HINOJOSA. There has been, of course, a lot of effort made to 

go back to the old regulations. Do you think that this new regime 

for regulating significant nonbank financial companies will level 

16 

the playing field between the banks and their nonbank competitors 

that provide comparable services? 

Mr. AUER. I think the key goal and objectives of designating 

nonbank financial companies is if they pose a threat to the financial stability of the United States, regardless of their legal structure or business line. If a firm does pose such a threat, regardless 

of its activities, it ought to be designated and subject to heightened 

standards so that all firms that could pose such a threat are treated equally. 

Mr. HINOJOSA. Mr. Gibson, I have heard repeated criticism from 

community banks I represent that Wall Street reform increased 

regulatory burdens on them, the community banks. Does anything 

in this regulation affect community banks directly? Do you think 

that the increased prudential standards on these larger, riskier 

companies could actually lead to an improved competitive atmosphere for our community banks? 

Mr. GIBSON. The majority of Sections 165 and 166 does not apply 

to community banks. What we are doing is raising standards for 

bank holding companies that are $50 billion and above, which is 

far above the level of a traditional community bank. So any bank 

holding company that is above $50 billion in size would be subject 

to these higher standards. 

You asked the question of whether that could give a competitive 

advantage to community banks. The potential is there for that to 

happen, because community banks will not be subject to the higher 

capital, liquidity, and the other standards to which the bank holding companies $50 billion and above or the nonbank companies will 

be subject. 

Mr. HINOJOSA. I have seen that we have a small group of banks, 

then the medium-sized banks, and then the very large banks, the 

too-big-to-fail banks, and it seems to me that the medium-sized, 

those in the $12 billion, $13 billion in assets or larger, are coming 

together with community banks to come visit me in my office and 

together point out that these regulations are overreaching and that 

we should just throw them all out. 

From listening to your answer, it seems to me that in most cases 

the Consumer Financial Protection Act exempts those community 

bankers, but that is not the perception that is out there. What can 

we do to clarify that? 

Mr. GIBSON. I have encountered the same perception when I 

have talked to community bankers, and I think it is a fear based 

in part on what has happened in the past, that requirements which 

are imposed on the large banks eventually roll down and affect 

community banks as well. What we are trying to do as we implement the Dodd-Frank provisions is to make it clear, in both our 

rules and when we put out guidance, which parts apply to community banks and which parts do not apply to community banks. We 

have started to put statements at the beginning of both to say either this does not apply to community banks at all, or only these 

particular sections apply to community banks to try to counteract 

that perception. 

Mr. HINOJOSA. Thank you for that explanation. 

I yield back. 

Chairwoman CAPITO. Thank you. 

17 

Mr. Renacci for 5 minutes. 

Mr. RENACCI. Thank you, Madam Chairwoman, and I thank both 

of the witnesses for being here today. 

As a business owner for the last 28 years before coming to Congress, one of the biggest challenges was not the regulation, but the 

certainty and predictability and timing of the regulation. And what 

I am hearing so far—I know when Ranking Member Maloney 

asked about timing, I really never thought I heard a good answer 

from either of you about timing, which is a problem for the business owner, but also the certainty and predictability. So those are 

things that concern me as we move down this path, not as much 

the regulations, but understanding where you are going. 

Mr. Gibson, Title I of Dodd-Frank defines a nonbank financial 

company as a company that is predominantly engaged in financial 

activities. However, there has been some confusion over what it 

means to be engaged in financial activity. Doesn’t this confusion 

need to be resolved before FSOC can start designating nonbank financial companies for supervision by the Federal Reserve? 

Mr. GIBSON. The Federal Reserve has a proposed rule out for 

comment that would define the phrase in the Dodd-Frank Act as 

activities that are financial in nature, which defines the set of 

nonbank financial companies that could be designated. 

We issued a proposed rule in February of 2011. We received a 

lot of comments on that proposed rule. In response to the comments, we issued a supplemental proposed rule in April of this year 

that clarifies certain aspects of that definition. But the FSOC has 

noted that they don’t believe they have to wait until the Federal 

Reserve’s rule is final to designate the companies. 

Mr. RENACCI. So how did the Fed determine which activities are 

financial? 

Mr. GIBSON. What we have defined as financial in nature are activities that are referenced in certain sections of the law that define 

what activities are permissible for a bank holding company. By referring to that section of the law, we are incorporating the existing 

definitions of what is a financial activity into this definition of 

nonbank financial company. 

Mr. RENACCI. Are there really any limits then to what the Fed 

can determine as financial activities? 

Mr. GIBSON. Yes. 

Mr. RENACCI. Financial activities are widespread. You can almost 

go into any company and say they have financial activities. 

Mr. GIBSON. Right. It is required that a certain percentage of 

your business has to be financial. Commercial companies that do 

a small amount of trade finance or the like would typically not be 

defined as financial if that is the only financial activity that they 

are doing. But the definition is designed to capture any company 

whose financial activity rises to a level that would put it into the 

category of posing a systemic risk. 

Mr. RENACCI. So the answer really is any company with that particular— 

Mr. GIBSON. There is a well-defined set of activities that are familiar to the legal community that deals with bank holding company regulation and what is permissible for a bank holding company, and they understand what these activities are. So, we are 

18 

just trying to use the existing body of knowledge to say what is financial in this case. We are not trying to invent a new definition 

of what is a financial activity. 

Mr. RENACCI. Are companies that are subject to a determination 

not entitled to an evidentiary hearing as part of the appeals hearing? And what recourse do they have if they are so designated? 

Mr. AUER. So in the final rule and guidance that the Council 

published, the Council went above the statutory requirements in 

providing for opportunities for firms to challenge or present information about why they should or should not be designated. 

Specifically, starting in stage three, a firm will be sent a notification that it is under consideration, and the firm would have the option to provide any material or arguments or information it wishes 

to the Council either in support or in opposition to its designation, 

and the Council will take those into account. 

If the Council, after completing stage three, decides to vote for 

a proposed determination, the firm has the right to request a hearing in front of the Council to contest its proposed designation. If, 

after that hearing, the Council decides to vote in the affirmative for 

a final determination, the firm then has recourse to an appeal to 

the Federal court system. 

Mr. RENACCI. Thank you. 

I am running out of time, so I yield back. 

Chairwoman CAPITO. Mr. Scott for 5 minutes. 

Mr. SCOTT. Yes, thank you very much, Mr. Gibson and Mr. Auer. 

Let me ask you this first question. Is the FSOC the only way to 

further regulate systemically important nonbanks, or have alternative methods been contemplated? 

Mr. AUER. Some nonbank companies are already subject to some 

degree of regulation. Many insurance legal entities are subject to 

State insurance supervision, even if their holding companies are 

not. Hedge funds have to have certain reporting requirements, as 

do asset managers. So there are bits and pieces, elements in which 

nonbank financial companies may in some cases already be subject 

to supervision. But the rule in the Dodd-Frank Act that provides 

for the Council to identify those firms which are a threat to the financial stability of the United States is designed to ensure that 

those firms that could pose such a threat are subject to consolidated supervision and enhanced prudential standards. 

Mr. SCOTT. Does it seem prudent to impose bank-like regulations 

on nonbanks? 

Mr. GIBSON. In our proposed rule to implement Sections 165 and 

166, it applies to both bank holding companies that are $50 billion 

and above and any nonbank companies that are designated by the 

Council. The standards that we have proposed are focused on the 

banks, but we have been given the authority in Dodd-Frank to tailor the standards to the characteristics of a nonbank company that 

is designated, and we have said that we will use that authorization 

to tailor the standards as appropriate. 

Mr. SCOTT. Has is the FSOC conducted a thorough cost-benefit 

analysis on the designation of nonbanks as systemically important, 

specifically in regards to asset managers? 

Mr. AUER. The FSOC member agencies are obviously very concerned about the costs and benefits of their actions. They want to 

19 

bear in mind that this rule was not required in statute. The rule 

was designed to provide greater clarity about the purpose of the 

process by which the Council would engage in designations. 

Mr. SCOTT. Let me just ask you also, have you all taken a look 

at or considered any adverse effects of the designation? 

Mr. AUER. The effects of a designation are— 

Mr. SCOTT. Adverse effects. 

Mr. AUER. Right, well, there are certain effects that—for instance 

requirements for greater supervision, heightened capital standards, 

liquidity requirements—I don’t think those are adverse effects. I 

think those are effects that are appropriate to a firm that could 

pose a threat to the financial stability of the United States. 

Mr. SCOTT. Okay. And involved in this in an intricate way are 

indeed the asset managers. Now, asset managers do not invest 

with their own balance sheets. They invest on behalf of their clients. So when a client changes asset managers, it does not result 

in an immediate portfolio liquidation? 

And the point that I am getting at is, where will this process 

end? If nonbank financials are designated systemic, will there be 

other nonbank industries that are systemic as well? 

Mr. AUER. The Council’s determination about whether a firm 

could pose a threat to financial stability and hence should be designated is going to be done, not on an industry-by-industry basis, 

but on a firm-by-firm basis. 

So, the degree that an asset management firm largely has its activities in custody and on behalf of customers and, as a result, does 

not pose a threat to financial stability, it is unlikely to be designated. To the degree it engages in activities that could pose a 

threat to financial stability, then the Council would likely make 

such a designation, but that assessment will be done on a firm-byfirm basis. 

Mr. SCOTT. And then, finally, will the FSOC evaluate business 

models, capital structures, and risk profiles as intended by Congress before pursuing designations? 

Mr. AUER. As part of its designations, the Council will look at all 

of those factors you mentioned for each individual firm to see 

whether or not in total that firm could pose a threat to the financial stability of the United States. 

Mr. SCOTT. Thank you very much, Madam Chairwoman. 

Chairwoman CAPITO. Mr. Royce for 5 minutes. 

Mr. ROYCE. Thank you, Madam Chairwoman. 

I would like to ask a question of Mr. Auer just to get his feedback on a problem I see here that I don’t think is going to go away, 

which is that the market is going to make a determination once 

these firms are designated systemically significant by you. And it 

is reflected in the credit rating agencies deciding already that the 

cost of borrowing, based upon their decision—they have shared 

with us that they believe that implicitly, there is a likelihood of 

government support. So the cost of borrowing is lower for these 

firms than their competitors. 

And the consequences when you are in a situation like that, you 

can often gobble up your competitors, your smaller competitors especially. You can outperform them. Frankly, you can overleverage. 

20 

But you acquire your competition, and the competition shrinks in 

the market as a consequence of this reality. 

Orderly liquidation authority was supposed to imply, I think at 

some point liquidation, but these firms will never fail. I just want 

to quote back to you the new head of the FDIC, Mr. Gruenberg’s, 

recent comments, and get your reflection on this. He said, ‘‘Three 

of the goals of the OLA are to ensure financial stability, accountability, and viability, which means converting the failed firm into 

a new, well-capitalized and viable private sector entity.’’ 

Now, when the market hears that, they don’t think that is a firm 

that he is going to fail. The implication here, and it may not be for 

the stockholders but certainly the creditors, is that if you loaned 

to that firm, there is a very good chance—that is, not to talk about 

death panels or what is going to happen to the firm. It sounds like 

the goal here is the same as it was in 2008, unfortunately. And although part of that goal is to stop the crisis from spreading, the 

other part is the nursing that insolvent firm back to health, essentially through either public dollars or new debt, which I think we 

can argue that it likely will be guaranteed by the government. 

So the assumption here again is that these firms will be punished by the market by being designated as an SIFI. That is what 

we would like to believe is going to happen. But that does not seem 

to hold water, given the reaction by the market, given the reaction 

when we talked to the credit rating agencies about this, because 

the presumption is they are going to receive very favorable treatment by the agency tasked with unwinding it, by the FDIC. 

Mr. Gruenberg’s comments certainly would imply that, and I just 

wanted to get your take on that. 

Mr. AUER. I can’t speak for Mr. Gruenberg’s comments, but I can 

say my understanding of the application of orderly liquidation authority is that when a firm is put into orderly liquidation, all of its 

equity holders would be wiped out, and its debt holders would be 

given haircuts or only paid back in part. The result is it will allow 

the new company that survives to be well-capitalized. 

Mr. ROYCE. I understand that. But understand that the market 

arguably looks at that and says, that haircut is not the equivalent 

of what a haircut would be if they went through bankruptcy, and 

because they have now this potential pathy, we are going to evaluate that as an advantage for creditors. And it is implied through 

the decisions by the credit rating agency. 

Last question: capital, capital, and more capital. Secretary 

Geithner said that, and it bears repeating. This is the only way to 

ensure that banks are going to be able to absorb unforeseen losses, 

and luckily, banks have been increasing the amount of cash on 

their books largely, I think, because of Basel III. And there were 

some that have been critical of the Fed and the international work 

being done by Basel as having the potential to harm economic 

growth. I hope that recent incidents put that argument at rest. I 

think that these requirements for more capital have been borne out 

here, and I would like your view on that. 

Mr. AUER. One of the requirements of any firm that is designated on the basis that it may pose a threat to financial stability 

is enhanced prudential standards, including increased capital tailored to the risk that that firm poses. 

21 

Mr. GIBSON. I would certainly agree that the reforms to raise 

capital standards for the largest bank holding companies are an 

appropriate response to the crisis and are necessary. 

Chairwoman CAPITO. Mr. Carney for 5 minutes. 

Mr. CARNEY. Thank you, Madam Chairwoman. 

Thank you for having this hearing today. 

And thank you to the panelists for coming. 

Mr. Auer, your written testimony provides I think a pretty clear 

walk-through for determination, but I would like to run through it 

and see if you could put a timetable and make sure that I understand. 

So the first—as you said in your remarks—to cut is the stage one 

and just these quantitative measures that are listed on page 3 of 

your written testimony, the $50 billion, then $30 billion in gross 

notional credit default swaps, $3.5 billion derivatives, so on and so 

forth. 

So you will look at all of these. When will that test—when will 

the process start? 

Mr. AUER. The process has started. The final rule was published 

in April. It went into effect this month. So the Council, member 

agencies, and the Office of Financial Research are collecting data 

to assess which firms pass the stage one thresholds. 

Mr. CARNEY. So you are in the stage one assessment process, determining which firms meet these criteria? 

Mr. AUER. That is correct. 

Mr. CARNEY. When you do that, will there be any notification to 

those firms? It is just not clear here. Will you just then go to stage 

two? 

Mr. AUER. Then we go to stage two. 

Mr. CARNEY. Explain that a little better, please. You mentioned 

quantitative—I guess additional quantitative measures and qualitative measures. What would they look like? 

Mr. AUER. Stage two is designed around a six-factor framework 

for analysis. That are several factors that relate to sort of probability that a firm might get into distress, things like leverage, liquidity, existing regulatory scrutiny. There are also factors that indicate whether a firm might transmit that distress, including lack 

of substitutes, interconnectedness, and size. 

The stage two process will look at all of those factors. It will take 

all publicly available data and any data already available to regulators and try to provide an in-depth and comprehensive analysis 

of how that firm might or might not pose a threat to financial stability. 

Mr. CARNEY. So leading up to this stage three question—on page 

5 of your written statement—which says whether the company’s 

material financial distress or whether the nature, scope, size, scale, 

so on and so forth, could pose a threat to the U.S. financial stability. That is a judgment that is both subjective and objective. 

How would you characterize that judgment? 

Mr. AUER. The Council used—in stage three, the firm will be notified that it is under consideration by the Council. The firm will 

have an opportunity to provide any arguments, information, or 

data that it feels would be useful to the Council in making its determination. The Council may also ask the firm— 

22 

Mr. CARNEY. Can I stop you there? So that after a two-thirds 

vote of the Council— 

Mr. AUER. No. 

Mr. CARNEY. So there is this process first, and then there is a 

two-thirds vote. And then there is an additional hearing and a 

process, and an additional vote if there is a hearing; correct? 

Mr. AUER. That is correct. 

Mr. CARNEY. It is a pretty involved kind of back-and-forth and 

certainly an adequate opportunity for the firm to question some of 

the conclusions that are made, but certainly a lot of opportunity for 

feedback. 

Mr. AUER. There are multiple points at which a firm can engage 

with the Council and its member agencies about its designation. 

Mr. CARNEY. So you get through this whole process, and you determine that here is a big firm which has a lot of this interconnectedness and meets all of these qualitative criteria and quantitative 

criteria and by a two-thirds vote is determined to pose a threat to 

the financial system. Do you expect that many of these nonbank 

firms will meet that type of criteria at the end of the day? 

Mr. AUER. As we say in the final rule and guidance, we expect 

that less than 50 firms will pass the stage one thresholds. Stage 

one thresholds however are not meant to be definitive in any way. 

They are more of a screening device to identify those firms where 

the Council will spend more of its time and effort. I think it would 

be premature and inappropriate to speculate how many firms are 

designated before we have analyzed them. 

Mr. CARNEY. Sure. Fair enough. 

Thank you. 

Chairwoman CAPITO. Mr. Hensarling for 5 minutes. 

Mr. HENSARLING. Thank you, Madam Chairwoman. 

Mr. Gibson, in your testimony you stated that the Dodd-Frank 

Act addresses the market perception that such firms are too-big-tofail. It seems to be fairly well-documented that the larger investment banks still enjoy funding advantages over their smaller competitors, and since the passage of Dodd-Frank, we know that the 

big have gotten bigger and the small have gotten fewer. So I am 

curious about your observation of market perception. 

Mr. GIBSON. It is certainly true that some market perceptions 

still exist, and as was mentioned previously by rating agencies and 

others, the market does not seem to be fully convinced that the 

tools given under Dodd-Frank will be used. I think we, the regulators, still have a ways to go to prove to the market that we will 

use those tools in a way— 

Mr. HENSARLING. So you posit that the Act addresses market 

perception, it is just the market doesn’t understand it? Is that what 

you are trying to tell me? 

Mr. GIBSON. I think the market is skeptical that the regulators 

will have the means and the will to use the tools, and they are 

waiting to see. 

Mr. HENSARLING. Count me as part of the market. 

The other question I have, and I think the gentleman from Ohio, 

Mr. Renacci, asked a somewhat similar question, but when we are 

looking at potentially designating nonbank SIFIs, and if we are 

looking at the first part test of the financial activities, a company 

23 

that the market may not perceive to be financial, if they, for example, import some type of raw material from overseas, they have to 

manage potentially currency risk, commodity risk, interest rate 

risk, operational and shipping risk, and I thank the Chamber for 

their upcoming testimony and helping to elucidate this question. 

But if these activities are found to be financial in nature, if this 

helps trigger the threshold test, isn’t it possible that some firms, 

nonbank financial firms or nonbank firms that wish to avoid an 

SIFI designation, may indeed decide not to hedge certain risk, in 

which case have we not perhaps concentrated more risk where we 

don’t want it and maybe they will go naked on these positions? 

Has that been considered? 

Mr. Gibson, I will go to your rule. 

Mr. GIBSON. The Federal Reserve has a proposed rule out for 

comment on the definition of what are financial activities that 

would make a firm potentially subject to designation. It has to be 

predominantly financial, a very high percentage financial. 

Mr. HENSARLING. Are the activities that I just described financial 

or does it depend upon the motives? Does it depend upon the underlying business entity? What does it depend on? 

Mr. GIBSON. It depends on the particular activities as they are 

defined in the current bank holding companies for what are permissible activities for bank holding companies. Some of those same 

definitions are being used for the definition of financial activities, 

but it is a very high threshold. So a commercial company that does 

a small amount of financial activities, hedging or financing, typically would not be deemed predominantly financial. But of course, 

it depends on the facts and circumstances of a particular company. 

Mr. HENSARLING. But also included in FSOC’s rules, once you 

outline the criteria by which one is adjudged in stage one to be a 

nonbank SIFI to go to stage two, isn’t your last criteria essentially, 

we can ignore all of our other criteria and still decide to send a potential firm to stage two? I am trying to figure out, if you are trying to add some clarity to the definition, you seemingly take— 

whatever you provide with one hand, you take away with another. 

Where is the clarity here? 

Mr. AUER. Let me make one point. In order for a firm to be designated and determined to be a nonbank financial company, at 

least 85 percent of its assets or 85 percent of its revenues in nature. So that should be very effective in limiting the types of firms 

that are merely engaging in some hedging activities of their commercial business. Such firms would be unlikely to trip the 85 percent threshold. 

The Council, in designing the stage one thresholds, want to provide clarity about the types of firms that it was likely to focus on 

and for further evaluation and to give some clarity about its thinking in that regard and to act as an initial screen. However, the 

Council is reluctant to put itself in a position where a very risky 

firm, that through whatever gaming techniques was able to avoid 

the stage one thresholds— 

Mr. HENSARLING. I see my time has expired. If I could, as I read 

the guidance provided from FSOC, it says, ‘‘FSOC may advance a 

nonbank company to stage two irrespective of whether such comVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
24 

pany makes the threshold in stage one.’’ Again, I see no clarity 

here. 

I yield back. 

Chairwoman CAPITO. Mr. Green for 5 minutes. 

Mr. GREEN. Thank you, Madam Chairwoman. 

I thank you and the ranking member again. 

Let’s start with SIFI. To a good many members of the public, 

SIFI is ‘‘SciFi.’’ It really is. And perhaps we can find a way to explain this in a much more intelligible fashion for persons who are 

not privy to much of the intelligence that you two fine witnesses 

are sharing with us. So let’s start with a very basic question: Was 

AIG a nonbank financial institution? 

Mr. Gibson? 

Mr. GIBSON. Yes. 

Mr. GREEN. Thank you. I tend to ask questions that you can answer yes or no. 

Was AIG into many different kinds of products, exotic products, 

if you will, credit default swaps, derivatives? Was AIG into what 

we now refer to as exotic products, Mr. Gibson. 

Mr. GIBSON. With the caveat that the Federal Reserve was not 

the supervisor of AIG, I am pretty sure the answer to your question is yes. 

Mr. GREEN. I understand the Federal Reserve was not, and I am 

not going there. But I am going here: Was AIG the type of institution that FSOC would be designed to have an impact on? 

Do you want to pass, Mr. Gibson? I am still with you. 

Mr. GIBSON. I would say that looking at the quantitative screens 

in stage one of the FSOC’s process, AIG would trip many or all of 

those. 

Mr. GREEN. Of course, it would. It was over $50 billion, wasn’t 

it? 

Mr. GIBSON. Yes. 

Mr. GREEN. Go on, elaborate. Tell us the reasons why AIG would 

come under the auspices of FSOC 

Mr. GIBSON. Under the FSOC’s rule, the characteristics that 

make up systemic importance, which have already been listed, 

some of the most important ones are the size of the company and 

the interconnectedness of the company. 

And what we learned about AIG after its near failure was that 

its size was of an extent that was seen to pose a systemic failure, 

and its interconnectedness with other large financial firms was also 

substantial. 

Mr. GREEN. Who knew that AIG was part of the glue that was 

holding the company together? 

Mr. Auer, it was discovered after the fact that AIG was part of 

the glue holding the economic order together, true? 

Mr. AUER. I think AIG was intimately involved in and highly 

interconnected with a great number of financial firms. 

Mr. GREEN. And that would be your way of saying yes? 

Mr. AUER. Thank you. 

Now, given that we know that there are other AIG’s, not in the 

sense that they are right now about to go out of business, but there 

are other big businesses that may pose systemic risk. They may become SIFIs and because we know that they may become or maybe 

25 

they are SIFIs, is this not a means by which we can deal with them 

without making an attempt to prevent them from making bad business decisions? 

Here is what I am saying: We can’t stop businesses from making 

bad business decisions. My belief is that happens and that is a part 

of the ebb and flow of doing business. But we can deal with the 

consequences of bad decisions. Is that what we are attempting to 

do here, Mr. Gibson, to deal with the consequences of bad decisions 

by these mega businesses? 

Mr. GIBSON. Yes, and one of the enhanced prudential standards 

that nonbank companies which are designated by the Council will 

be subject to are enhanced capital requirements that will make 

sure that a buffer exists to cover unexpected losses such as the 

type you are describing. 

Mr. GREEN. And for edification purposes, those who would like 

to, go back to the stock market crash and read about how the resistance took place when we were trying to put the FDIC in place. 

And FDIC has proven to be very beneficial when we are looking for 

an orderly means by which we can liquidate banks. 

True, Mr. Gibson? 

Mr. GIBSON. Yes— 

Mr. GREEN. Are we trying to do the same thing now with 

nonbank institutions? 

Mr. GIBSON. The intention of the Title II Orderly Liquidation Authority is to extend what the FDIC currently has for banks to 

nonbanks. 

Mr. GREEN. I would simply close with this: We can do this and 

not overregulate. And I think that is what we are trying to accomplish today. 

Do you agree we can do this and not overregulate, Mr. Gibson? 

Mr. GIBSON. That is what we are trying to do. 

Mr. GREEN. Mr. Auer? 

Mr. AUER. I would agree. 

Mr. GREEN. Thank you very much. 

Thank you, Madam Chairwoman. 

Chairwoman CAPITO. Mr. Luetkemeyer? 

Mr. LUETKEMEYER. I have a question with regards to FSOC. 

Coming from the small bank, community bank perspective, some of 

the things that have come down obviously do not affect them. But 

there are a lot of rules in Dodd-Frank that do. Is FSOC going to 

go through and look at some of the rules? I believe that DoddFrank was sort of a shotgun approach. Are we going to go back and 

take some of the pellets out the bullets so we can go back to a rifle 

approach and make sure that the rules are specific to the larger 

institutions and take some of those back off the smaller institutions 

and nonbank-lending folks? 

Mr. AUER. The FSOC regularly discusses existing and upcoming 

regulations that are part of Dodd-Frank, and I expect it will continue to do so and try to encourage cooperation and consistency 

across the agencies as they develop the rulemaking process, and 

that helps ensure that any rules and regulations that are promulgated are handled appropriately. 

Mr. LUETKEMEYER. But they are not going to go back and take 

some of them back out or make them streamlined or more approVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
26 

priate to just the bigger folks, who are the problem areas here, and 

alleviate the smaller folks? 

Mr. AUER. The FSOC itself is not a regulatory agency— 

Mr. LUETKEMEYER. But they can surely provide some guidance, 

could they not? 

Mr. AUER. Many of its members are regulatory entities and you 

discussed their upcoming regulations with other Council members. 

I don’t know what those agencies’ plans are for their previously 

issued— 

Mr. LUETKEMEYER. With regard to the rules that are promulgated, is there a cost-benefit analysis done on any of those rules? 

Mr. AUER. On which rules? 

Mr. LUETKEMEYER. On the FSOC rules. 

Mr. AUER. The FSOC has issued at least two rules that I am 

aware of today. One is the rule we are discussing, which was published in April. That is a rule which does not directly impose any 

restrictions. 

Mr. LUETKEMEYER. My time is limited. Can you give me a yes 

or no? 

Mr. AUER. There is no need to do a cost-benefit analysis. 

Mr. LUETKEMEYER. What enforcement mechanisms are in place? 

Mr. AUER. To enforce what? 

Mr. LUETKEMEYER. The rules. 

Mr. AUER. This rule does not, as I said, put in place any restrictions or limitations on firms. What it does is it helps explain the 

Council’s process by which it will identify nonbank financial companies that can pose a threat to financial stability. 

Mr. LUETKEMEYER. We leave that to the regulators then to enforce? 

Mr. AUER. Yes, the regulators— 

Mr. LUETKEMEYER. As a regulator, what is your enforcement 

mechanism? 

Mr. GIBSON. We will have the same enforcement tools for enforcing the enhanced prudential standards on any nonbank companies 

that are designated that we currently have. 

Mr. LUETKEMEYER. Which are what? 

Mr. GIBSON. Which are our supervisory tools, examinations. 

Mr. LUETKEMEYER. Which are? What is your enforcement? If 

they are bad actors, and they do something wrong, what are you 

going to do? 

Mr. GIBSON. We can impose on them written agreements, memoranda of understandings, civil money penalties, the full range of 

tools we currently have with bank holding companies. 

Mr. LUETKEMEYER. Okay. Whenever you designate someone as 

an SIFI, is this going to be public knowledge, or is this going to 

be just something that is internal between your agencies and the 

individual company? 

Mr. AUER. The final designation of any particular firm is, for 

Federal Reserve supervision and enhanced prudential standards, 

would be a public event. 

Mr. LUETKEMEYER. One of the things that I, quite frankly, like 

about the Dodd-Frank Act is the living will that these agencies— 

not agencies but entities—are going to have to put together. Can 

you describe to me some of the tenants that would be in a living 

27 

will that would be important to you to see that were in there and 

how it would operate? 

Mr. AUER. The living will requires that the company describe 

how it could be resolved under the Bankruptcy Code. So for companies that are very complicated, the living will needs to have a description of how different legal entities within the company interact 

with one another, so that if different legal entities are subject to 

different bankruptcy procedures or different regulatory procedures, 

exposures of one entity aren’t so tied in with another that it just 

creates an intractable situation. 

By having that information in advance, and especially by requiring the companies to produce that information and understand 

what those impediments to resolution could be, we can then use 

our supervisory process to push the companies to reduce the impediments to resolution and make them more resolvable. 

Mr. LUETKEMEYER. What you are saying is a living will basically 

lays out the connectivity of all of the things that are going on within that company? 

Mr. AUER. That is one of the important aspects of it, yes. 

Mr. LUETKEMEYER. I see my time has expired. 

Thank you, Madam Chairwoman. 

Mr. Miller for 5 minutes. 

Mr. MILLER OF NORTH CAROLINA. My questions are about the 

losses in Chase’s synthetic credit portfolio, and I don’t claim to understand that entirely. The details have been sort of sketchy, but 

it also appears that nobody at Chase really understood it, either. 

So that makes me feel a little better. 

There has been some criticism by defenders of the banks that the 

critics of the banks are taking too much pleasure over the loss, are 

gloating over the loss. I don’t think I have been gloating. But it is 

also hard to see this as something to grieve over. Because it is not 

like a factory, a $2 billion factory burned down that was making 

something useful and giving jobs to people who want to make an 

honest living. It has just sort of shifted $2 billion. It was Chase’s 

$2 billion, around to probably some hedge funds. 

So it really appears that the only thing to worry in all of that 

is the effect that it might have on the soundness of any given 

banks engaged in these kinds of transactions, or especially to the 

system as a whole, whether it creates a systemic risk. 

I am wondering how on Earth we even have a fighting chance 

to figure that out. Ina Drew, the chief investment officer of Chase, 

who has now resigned, was making $14 million last year. And she 

apparently did not understand these transactions, and we are supposed to send in some examiners on government salaries, and they 

are supposed to figure out what kind of risks are involved in these 

transactions. 

It would be easier for an examiner to say or to think, this kind 

of looks like it creates a risk, but it is a $2.3 trillion bank. Even 

if they lose money on this, they are probably making it somewhere 

else. They will be okay, which is the exactly the kind of attitude 

or the kind of thinking that can lead to a great risk for an institution that size if every division is taking risks like that. 

What sense does it make to create banks this big, and they are 

actually even bigger now than they were before the crisis? Why do 

28 

need to combine what appear to be just entirely discrete business 

all within one huge $2.3 trillion bank that will be impossible to 

regulate, to examine, that will be impossible for the market to discipline? Why not have smaller banks so that if we can’t figure out 

what risks they have and a risk pulls them down, it won’t create 

quite the same effect on the entire economy, and even if—and it 

should be possible to figure out more what their business is if it 

is smaller. So why not have smaller banks? 

Mr. GIBSON. Under the Dodd-Frank Act, in particular Section 

165 on enhanced prudential standards that we have been talking 

about today, the Dodd-Frank Act asks the Federal Reserve to 

apply— 

Mr. MILLER OF NORTH CAROLINA. Part of my question is, does 

the Dodd-Frank Act go far enough? Or should we have done more 

to take apart the big banks? I know the Kanjorski amendment allows for breaking up banks based on a very high standard of risk, 

but should they just be smaller? 

Mr. GIBSON. What we will be doing as we implement Dodd-Frank 

is to impose higher capital and other standards on the largest 

banks, and we will be doing that in a graduated way that imposes 

the highest capital standards, for example, on the largest banks 

and less stringent capital standards on the smaller banks. So it 

will have the effect of tilting the incentives away from becoming 

large simply for the sake of becoming large because the largest 

banks will be subject to the capital surcharge eventually once the 

Basel surcharge is implemented in the United States. 

Whether that will work or not, I think, remains to be seen. We 

still have a lot of work to do to implement that, but for now, it is 

an approach that is going in the direction of putting higher requirements, stiffer requirements on the very largest companies and less 

stiff requirements on smaller companies. 

And that is what we are implementing now. 

Mr. MILLER OF NORTH CAROLINA. Why have apparently entirely 

discrete lines of business consolidated into one firm? There appear 

to be no economies of scale, no economies of scope. There appears 

to be no particular reason to do it, and it creates conflicts of interest. Why not have servicing units be—why do they have to be an 

affiliate of a bank that holds second mortgages on the same homes 

that they are servicing? 

Mr. GIBSON. The approach we are taking by having larger capital 

standards on the largest banks will naturally create an incentive 

if an activity can be done outside of a big mega bank, to be done 

with a lower capital requirement, presumably more cost-effectively. 

So we are providing an incentive where there is not a synergy that 

creates a benefit that would then be passed along to the customers, 

then with those activities, logically, there would be an incentive to 

move them out of the largest banks. 

Chairwoman CAPITO. Mr. McHenry? 

Mr. MCHENRY. Thank you, Madam Chairwoman. 

Mr. Auer, in designating nonbank SIFIs, how much weight will 

the FSOC give to companies that have existing regulators? Perhaps 

you have an international nonbank financial institution, and in 

their home country, they have supervisory authority that is very 

29 

clear. Would the Fed be—would it be likely that the Fed would be 

designated or less likely? 

Mr. AUER. Both in the 10 statutory or 11 statutory considerations as well as in the framework that the Council lays out in its 

rule and guidance for doing it in stages two and three, the Council 

does plan to take into account existing regulatory scrutiny, whether 

that scrutiny is domestic or foreign. Whether it is at the consolidated level or at a legal entity level, the quality and extent of that 

regulation will all be factors that would lead into the Council’s ultimate determination about whether or not that firm poses a threat 

to our ultimate responsibility. 

Mr. MCHENRY. Mr. Gibson, you said earlier that the Fed has the 

authority to ‘‘tailor standards as appropriate to nonfinancial companies.’’ Isn’t this uncharted territory for the Fed? 

Mr. GIBSON. We have the authority to tailor the standards for 

nonbank financial companies. Commercial companies would not be 

subject to the FSOC designation, but nonbank financial companies 

would. And we have experience with different types of nonbank activities in which bank holding companies and financial holding 

companies already engage. There are bank holding companies and 

financial holding companies that own insurance companies, that 

own asset management companies and a variety of other nonbank 

companies. We will use that experience that we have and, if necessary, bring in more experience so that we are able to do a good 

job of supervising nonbank companies that are designated. 

Mr. MCHENRY. Will you be consulting with the Federal Insurance Office? 

Mr. GIBSON. We are already consulting with the Federal Insurance Office on our existing supervision of bank holding companies 

and financial holding companies that have insurance operations, so 

yes. 

Mr. MCHENRY. Moving on to another issue, it is my understanding that the counterparty limits the Fed currently has put 

forward is a pretty significant shift in how financial institutions 

manage their risk. I appreciate the challenge of managing interconnectedness in the financial system. But what I am concerned 

about is whether the Fed is putting the cart before the horse in 

that there is not sufficient analysis that we have seen in the public 

sphere on the impact that this proposal would have on banks, on 

clearinghouses, on foreign sovereigns, and on the rest of the financial system. 

Is there significant data within the Federal Reserve on measuring that? 

Mr. GIBSON. We put out our proposal for Section 165 in December, and the comment period recently closed. One of the things we 

asked for comment on was exactly the question of what would the 

impact of the single counterparty credit level be, in terms of how 

constraining would it be for the banking organization’s $50 billion 

and above. We have received a lot of comments from the public on 

that aspect of the proposal, and those comments do include some 

information about the impact, and we have done our own analysis 

through our supervisory process as well. And we will be using all 

that data as we move forward toward that final rule. 

30 

Mr. MCHENRY. Have you done a cost-benefit analysis on the proposal? 

Mr. GIBSON. We look at the costs and benefits of every rule that 

we put out. On this particular proposal, we are still gathering information on the particular counterparty credit limits that were 

proposed, and the alternatives that were suggested by the commenters as well. 

Mr. MCHENRY. Okay. Have you done any analysis on the current 

levels of exposure? 

Mr. GIBSON. Yes. 

Mr. MCHENRY. Would you be willing to share that data with us? 

Mr. GIBSON. In the proper way that doesn’t require me to talk 

about confidential supervisory information, I would be happy to 

provide more information, including the information we have gathered and the information that companies have submitted to us 

through the public comment letters which are available to you. 

Companies have also submitted confidential information to us 

through the supervisory process, which they intend for us to use 

as we move forward towards a final rule and have the best information available. So, we have all of that information. 

Mr. MCHENRY. What information will be made public? That is 

sort of my question. 

Mr. GIBSON. I can’t predict how we are going to move forward toward the final rule, but when we do the final rule, we will certainly 

come out with a discussion of how we weighed the comments that 

we received and what judgments we made based on those comments to move from the proposed rule to the final rule 

Chairwoman CAPITO. Mr. Canseco? 

Mr. CANSECO. Thank you, Madam Chairwoman. 

Good morning, Mr. Auer. I noticed that at the first February 1st 

FSOC meeting, you updated the Council on comments that had 

been received regarding the second notice of proposed rulemaking. 

The meeting that day was gaveled in at 1 p.m., and was concluded 

at 3:13 p.m., and your presentation was one of 5 or 6 items on that 

day. 

I am not certain how long the Council discussed your presentation or what questions were asked, but I assume it couldn’t have 

been more than 20 or 30 seconds. Could you shed some light for 

us on what was discussed that day and some concerns that were 

raised by the Council members? 

Mr. AUER. The discussions at that particular Council meeting 

were not the first time that the nonbank designation rule had been 

discussed by the Council. The Council actually put out an advanced 

notice of proposed rulemaking, a first notice of rulemaking, and a 

second notice of proposed rulemaking. In all three cases, we received comments, and in all three cases, the Council discussed 

those comments, how the next iteration of the rule would incorporate and respond to those comments, so that there was a thorough conversation at each point in the process about how the final 

rule responded to the comments from the public. 

Mr. CANSECO. Did you discuss the comments that you received? 

Mr. AUER. Yes. 

Mr. CANSECO. And were those comments and those comment letters discussed at that time? 

31 

Mr. AUER. Yes. 

Mr. CANSECO. And what were some of the dissensions? 

Mr. AUER. I don’t know that there was any dissension. There was 

discussion among the principals about how—and questions about 

how the rule addressed the comments and what changes were necessary at various points to address the comments and how those 

were reflected in the final rule. 

Mr. CANSECO. So everybody was on the same page? 

Mr. AUER. All Council members asked a lot of questions, but the 

ultimate vote, I believe, if I recall correctly, was unanimous in supporting the publication of the rule and guidance. 

Mr. CANSECO. The final rule was approved 2 months later, so can 

you shed some light on specifically how comments were incorporated into the final rule, or were they not incorporated into the 

final rule? 

Mr. AUER. Many comments were not incorporated into the final 

rule throughout the process. The entire three-stage process that is 

enshrined in the rule is a result of comments received over the 

course of the rulemaking process, so that the very structure of the 

rule in fact is built around comments from industry. The comments 

drove other changes to the rule and amendments to the rule, for 

instance, the desire that many firms had that they be given some 

advanced notice that they were under consideration, which is what 

led to the stage three notification. I think that is an excellent example. There were other answers about ensuring the confidentiality of information that is provided to firms, information with regard to the Council, so we elaborated on that. So I think every serious comment that came in was addressed in one or another. 

Mr. CANSECO. Were they incorporated, or were they thrown out? 

Mr. AUER. Depending on the comment, I think the rules addressed every comment. Certainly, the preamble to the final rule 

described all significant comments and described whether that 

comment was adopted wholesale, adopted in a way that was adjusted, or deemed not relevant. 

Mr. CANSECO. Thank you. 

Mr. Gibson, in the final rule that was issued in April, it was 

noted that the Fed has authority to issue regulations for determining if a company is predominantly engaged in financial activities and has issued a proposed rule under this authority. So if I am 

interpreting it correctly, if I say that the FSOC has moved forward 

with a final rule on SIFI designations before the Fed has determined the definition of financial activities, who is engaging in that? 

Has it done that? 

Mr. GIBSON. We have a proposed rule which has not been made 

final yet on the definition of ‘‘financial’’ as it applies to the nonbank 

regulation. 

Mr. CANSECO. If that is the case, then when does the Fed expect 

to finalize this rule, and shouldn’t it have been done before the 

final SIFI designation? 

Mr. GIBSON. I don’t think there is any legal requirement that it 

be done before the final FSOC rule, and indeed, the FSOC had 

said— 

Mr. CANSECO. I am not asking about legal requirements. I am 

just specifically asking because it seems to me, it is putting the 

32 

cart before the horse. And that is a very common occurrence these 

days. 

Mr. GIBSON. I think the rule that defines what it means to be 

activities that are financial in nature will be relevant for companies where there is some uncertainty about whether they are financial enough. And I think, as we have mentioned, the cutoff is 85 

percent financial. So there are undoubtedly some companies out 

there that are kind of on the boundary and are not sure. But I 

think there are a lot of companies that are clearly financial and 

where exactly the boundary is drawn is not going to affect whether 

they are determined to be financial or not. 

Chairwoman CAPITO. Mr. Manzullo? 

Mr. MANZULLO. Thank you, Madam Chairwoman, for calling this 

hearing. 

I have problems with the fact that the proposed regulations 

sweep insurance companies into the same area as bank holding 

companies. What is unfortunate about the inability to have all of 

the witnesses on one panel is the fact that if you take a look at 

the testimony of MetLife—which will occur shortly when William 

Wheeler testifies—it discusses the fact that the asset and liability 

structures of banks are much different than insurance companies. 

Insurance companies are in for the long haul, very solid fixed-income, stable investments. Banks borrow money short term and 

then put it into long term, it could put them in a position where 

you would have a risk taking place. Would you agree with that? 

Mr. AUER. Yes. 

Mr. MANZULLO. That being the case, if MetLife failed, of all the 

questions to ask is this, if MetLife failed, would the failure of the 

company threaten the stability of the United States? We agree the 

answer is no, we cannot think of a single firm that would be 

brought down by its exposure to MetLife. Would you agree with 

that statement? 

Mr. GIBSON. MetLife has been supervised by the Federal Reserve 

because it is a bank holding company. 

Mr. MANZULLO. They are getting rid of their bank holding company. 

Mr. GIBSON. Once they get rid of the bank holding company, they 

will no longer be supervised under the Federal Reserve. 

Mr. MANZULLO. Would they come under the new regulations? 

Mr. AUER. MetLife is now a nonbank financial company. I am 

fairly certain that more than 85 percent of its assets or revenues 

are financial in nature. So it would be eligible to be designated by 

the Council, but that does not mean the Council would choose to 

do so. 

Mr. MANZULLO. I think it is the largest insurance company. If 

they are eligible, and then you say we are not going to regulate, 

then no insurance company would be regulated. Is that correct? 

Mr. AUER. I don’t think the Council has done an analysis—I 

know the Council has not done— 

Mr. MANZULLO. This is a pretty easy question. 

Mr. AUER. I don’t know whether the Council plans to designate 

MetLife or not— 

Mr. MANZULLO. Because that is not your decision. 

Mr. AUER. It is not our decision. 

33 

Mr. MANZULLO. The reason I bring that up is the fact that if you 

take a large company like MetLife and you treat them like a bank 

holding company, are you gaining anything? Is anybody safer? 

Mr. GIBSON. The difference in the regulation and supervision 

that the Federal Reserve has been engaged in with MetLife and 

other large insurance companies that chose to become bank holding 

companies is that we are a consolidated bank— 

Mr. MANZULLO. Remember, they are shedding their bank holding 

company. They will be just an insurance company. 

Mr. GIBSON. If you are talking about after they shed the bank 

holding company, then it will be completely up to the FSOC to decide if they should be regulated as a— 

Mr. MANZULLO. What do you think? They propose no systemic 

risk. 

Mr. GIBSON. Also, it is up to the FSOC to make the judgment— 

Mr. MANZULLO. I understand that, but the reason for this hearing is the dragnet that we see taking place here. You are imposing 

standards—no, you are creating standards, and yet you don’t know 

to whom they will apply. And then when we show—and I am not 

being critical—but when it is shown that a company like MetLife 

after it sheds its bank holding company would produce no systemic 

risk, then it follows they should not be regulated under this new 

regulation. 

Mr. AUER. If the Council does decide to assess MetLife and it 

comes to the conclusion that MetLife does not pose a threat financial stability— 

Mr. MANZULLO. But no insurance companies—three insurance 

companies got TARP funds. AIG—maybe two didn’t need it. AIG 

got it, but that is because, even the insurance—under Illinois rules, 

they were walled off. Those assets were walled off because of Illinois liquidity requirements—I am sorry, reserve requirements. 

So what I am just suggesting to you is that I don’t see the need 

to drag the insurance companies into this particular rule when in 

fact they did not present a systemic risk in the event that—in the 

terms of MetLife, we cannot think of a single firm that would be 

brought down because of its exposure to MetLife. 

You don’t have to answer that question. 

I yield back. 

Chairwoman CAPITO. Thank you. 

Mr. Grimm for 5 minutes. 

Mr. GRIMM. Thank you, Madam Chairwoman. 

And I thank the witnesses for being here today. 

It is interesting, I will tell you that. 

I think Mr. Manzullo’s questions hit to the heart of why everyone 

is so confused. The amount of uncertainty has risen to an all-time 

high, and it is getting worse. 

The gentleman from North Carolina asked before why we don’t 

have more small banks. That should be obvious to everyone in the 

room because smaller banks can’t compete—they can’t keep up 

with the administrative costs of all of the rules and regulations. 

And I would purport to you that as we continue to add on, in the 

hopes of getting rid of systemic risk, you are going to be left with 

only a few large institutions that can afford to keep up, therefore 

34 

making them systemically risky. But maybe I have it backwards. 

I don’t know. Maybe I am missing something. 

Let’s talk a little bit about asset managers for a second. With regard to asset managers, has the Council considered the possible adverse effects of a designation for asset managers? 

Mr. AUER. The Council, in its proposed rule and guidance, describes how it is going to go about assessing whether or not a firm 

poses a threat to the financial stability of the United States. The 

consequences of being designated are that a firm will be subject to 

enhanced capital requirements—I am sorry, the consequences of 

being designated will be the firm would be subject to enhanced prudential standards, including capital requirements, liquidity and requirement for living wills, among others. 

Mr. GRIMM. Is that a yes? 

Mr. AUER. The Council is aware of what the consequences of 

being designated an asset management firm are, yes. 

Mr. GRIMM. So you have considered the adverse effects? 

Mr. AUER. I am not sure what you mean by adverse effects. 

Mr. GRIMM. Let me ask you this: Have asset managers been involved in the OFR study to date? 

Mr. AUER. The OFR is engaging in an analysis of the extent to 

which there are potential threats to financial stability from asset 

management firms. The OFR has begun the process of talking with 

people in the asset management industry and will continue to do 

so. The OFR, the Council and its member agencies welcome any 

comments or— 

Mr. GRIMM. Is there a formal process for conducting the due diligence for asset managers? 

Mr. AUER. Any asset management firm or other entity that 

wants to meet with the Council staff or member agency staff about 

the designations process is welcome to contact any Council member 

agency or the OFR, and we will try to set up meetings for that 

firm. 

Mr. GRIMM. What I am concerned with is, is the FSOC evaluating the substitutability of asset managers? Asset managers, they 

don’t invest in their own balance sheets. They are investing on behalf of clients. So when a client changes an asset manager, that 

doesn’t mean that the portfolio is immediately liquidated. So I just 

hope that the FSOC is looking at that and that there certainly 

would be adverse effects, and I wish they would certainly consider 

that. 

Following up, before, we heard a little bit about the transparency. I have been hearing, and correct me if I am wrong, but 

I am hearing that it has not been a transparent process. I am hearing that the FSOC is almost working in a black box, so-to-speak. 

And I just want to know—let’s take an example to make it easy. 

When a nonbank entity is put into designated stage three, it seems 

that there is no explanation why. Can you elaborate on that? 

Mr. AUER. If any firm makes it, any particular firm makes it to 

stage three, that firm will be provided a notification that it is in 

stage three. That begins the process of having a discussion with the 

firm. The firm has the opportunity to provide comments, arguments, and data to the FSOC and its member agencies about why 

it should or should not be designated— 

35 

Mr. GRIMM. Let me just stop you there for a second, if I may. So 

a company may have to disclose this information, that they have 

been put in stage three, but all they have is a notification with no 

explanation. Do you see how that could be an untenable situation 

for these companies? 

Mr. AUER. I think that the desire to create a stage three was put 

specifically at the request of companies in the comments that we 

received on the various stages of developing the rule where they 

wanted an advance notice of whether or not they would be under 

consideration. While the exact composition of what will be in that 

notice is yet to be determined, the Council can’t, before finishing 

its analysis, provide a firm with all of the reasons that it thinks 

the firm may or may not be designated. That would prejudge the 

outcome. 

Mr. GRIMM. The cart before the horse seems to be the theme of 

the day. Thank you so much. 

I yield back. 

Mr. RENACCI [presiding]. Mr. Garrett for 5 minutes. 

Mr. GARRETT. I thank the Chair, and I thank the gentlemen on 

the panel. 

So the Fed, Mr. Gibson, as has already been discussed, has proposed a rule to define ‘‘financial activity’’ for the definitions purposes of Dodd-Frank, but it would appear that a few additional 

lists of financial activities that are different from what Dodd-Frank 

had intended and from those activities as it is defined under bank 

holding companies are now included. In other words, Dodd-Frank 

clearly says that the Fed has the authority to define the criteria 

for falling into this category, but it doesn’t give the Fed the option 

to redefine terms that are already set forth in Dodd-Frank. 

So I guess my opening question is, why do you think the Fed has 

this authority to go beyond what Dodd-Frank is explicitly setting 

forth as far as defining terms? 

Mr. GIBSON. I am not aware of any ways that the proposed rule 

is going beyond or trying to redefine terms. I think the proposed 

rule, which has been reproposed now for a second time, is responding to the comments we received in response to the first proposal 

with some suggested changes, and in order to incorporate those, we 

put out a second proposal. 

Mr. GARRETT. Let me just give you an example. And I know how 

this all came down with regard to Dodd-Frank. Normally, during 

a thoughtful and deliberative piece of legislation, I think the Fed 

would be responsive to what that legislation is. I am not sure 

whether we are talking about the same thing. We are not talking 

about Dodd-Frank as being thoughtful and deliberative. But I know 

there was concern by the various industries, when there was talk 

about the Fed being able to designate nonbank financial institutions, that it might be overly broad going forward, so a specific 

amendment was adopted into the law. And what it says was to define this area was, ‘‘predominantly engaged in financial activities’’ 

defined under existing law, Section 4(k) of the Bank Holding Act. 

But now, the Fed has gone beyond that, because here in DoddFrank it describes specifically, ‘‘predominately engaged in financial 

activities is described as Section 102(a)(6) to mean a company that 

derives 85 percent or more of its revenue or assets from activities 

36 

that are financial in nature as defined in Section 4(k) of the Bank 

Holding Act of 1956. Section 102(b) further provides the Board of 

Governors shall establish by regulation the requirements for determining if a company is predominantly engaged in those sections, 

again,’’ as defined in Section (a)(6). 

It seems as though it is laying out there pretty clearly in the 

statute that financial activities are already defined in (a)(6). So it 

makes sense that the list of activities for financial companies, bank 

holding companies and the like, would be the same for nonbank 

holding companies. And yet, that is not what is occurring here. So 

that is why I make the supposition that the Fed is going beyond 

what is clearly set forth was part of that deliberation of Congress 

in that amendment to try to make sure that it would be limited to 

this area. 

Mr. GIBSON. We have the reproposal out for comment. The comment period ends on May 25th. Part of the reproposal in April included a list of the activities that would be considered to be financial activities because we were requested, and to be responsive to 

that, to provide additional clarity on activities that are financial in 

nature for the purpose of determining whether a company is predominantly financial or not. So we are trying to be responsive to 

the request for more clarity, and we are open to the comments we 

receive and will use those comments as we go along. 

Mr. GARRETT. Is that list then potentially or actually beyond 

what would be those lists of financial activities under the Bank 

Holding Act as defined in the statute? 

Mr. GIBSON. I am not aware that it is, but I think that the comments that come in will help us determine whether we got it right 

or not in the proposal. 

Mr. GARRETT. I am watching my time here—I think it was Mr. 

Royce who ran down the list and the possibility as far as the fact 

that once a company, once a bank, a financial institution becomes 

designated, there may be certain benefits to the institution as far 

as lending and the like, and so there is an anticompetitive nature, 

if you will, with regard to those bank financial institutions vis-avis other nondesignated institutions. 

He didn’t go this far, but I will go this far, now you carry that 

potentially one step further, right? Because now if you designate 

nonbank firms such as insurance companies or finance companies 

as an SIFI, that same aspect of benefits for that designation will 

now inure to their benefit, and whereas before you were trying to 

alleviate the anticompetitive effect for banking institutions, now we 

have just spread it over to nonbank institutions as well. Is that 

something that we really want to do? 

Mr. GIBSON. The intent of what we are trying to do with the enhanced prudential standards that will be imposed on the nonbank 

companies that are designated is to impose tougher regulation, 

higher enhanced capital requirements, not easier. We meet with a 

lot of nonbank companies, and they are all more worried about 

being designated than desiring to be designated. 

Mr. GARRETT. I see my time is up. I yield back. Thank you. 

Mr. RENACCI. I recognize Mr. Duffy for 5 minutes. 

Mr. DUFFY. I pass. 

37 

Mr. RENACCI. Okay. I want to thank the gentlemen for their testimony this morning. 

At this time, this panel is dismissed. I will now recognize the second panel. The first witness is Mr. Scott Harrington, Alan B. Miller 

Professor at The Wharton School, University of Pennsylvania. You 

are recognized for 5 minutes for your testimony. 

STATEMENT OF SCOTT E. HARRINGTON, ALAN B. MILLER PROFESSOR, THE WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA 

Mr. HARRINGTON. Good afternoon, Acting Chairman Renacci, 

Ranking Member Maloney, and members of the subcommittee. 

I am the Alan B. Miller Professor at the University of Pennsylvania’s Wharton School. I have been studying insurance markets for 

the better part of 30 years. I have done quite a bit of work on solvency prediction, capital standards, systemic risk, and market discipline in insurance markets. I am pleased to be here today to testify in this hearing as an independent expert. 

Let me start by just saying the term ‘‘systemic risk’’ encompasses 

the risk of financial institutions with spillovers on the real economy 

from large macroeconomic shocks and/or extensive interconnectedness among firms. There is a distinction between losses from common shocks to financial firms and losses that arise from interconnectedness and contagion. 

I think it is very important to keep in mind that a primary driver of the financial crisis in general and the collapse of AIG in particular was the bursting of the housing price bubble and declines 

in the value of mortgage-related securities and instruments. 

It is also important to keep in mind that AIG’s failure was primarily attributable to noninsurance activities, some of which were 

federally supervised, and the risk that there would have been significant damage and contagion from an AIG failure is still being 

debated. 

Consistent with the generally favorable performance of core insurance activities during the crisis, however, the consensus is, and 

there is a lot of research being done on this, that systematic risk 

is minimal in insurance markets compared with banking. Banking 

crises have much greater potential to produce rapid and widespread harm to economic activity and employment, and this fundamental difference helps explain historical differences in regulation 

of insurance and banking. 

Significant systemic risk strengthens the case for relatively 

broad guarantees of bank obligations and stringent financial regulation to help deal with the moral hazard that inherently flows 

from government guarantees. Because insurance poses little or no 

systemic risk, there is no need for broad guarantees of insurers’ obligations to policyholders, and there is less moral hazard and less 

need for stringent capital requirements. 

State insurance guarantees have been appropriately narrower in 

scope than Federal guarantees in banking. Insurance market discipline for safety and soundness is reasonably strong. Insurers generally hold quite a bit more capital than required by regulation and 

have not faced strong incentives for regulatory arbitrage. 

38 

The FSOC’s final rule and accompanying guidance for determining systemically important nonbank financial companies under 

Section 213 are essentially the same as its second notice of proposed rulemaking issued in October 2011. Much of the detail remains in the interpretive guidance. 

As we have heard this morning, it retains the six category analytical framework first set forth in the January 2011 notice. The 

final rules guidance retains the three-stage determination process 

originally proposed in October 2011. 

As described by Mr. Auer, the first stage analysis would employ 

publicly available information and information from regulatory 

agencies and specific quantitative thresholds to identify nonbank financial companies for more detailed evaluation than stage two, 

with perhaps further evaluation in stage three prior to any designation. 

A nonbank company would advance to stage two if it has over $50 billion of global assets and meets at least one of five additional 

quantitative thresholds. The inclusion of the quantitative thresholds provides some guidance to companies, presumably reflecting 

the Council’s desire to provide them with some degree of guidance 

and certainty, but the metrics are inherently in part subjective and 

the thresholds are not binding. For example, the Council reserves 

the right at its discretion to evaluate further any nonbank financial 

company, irrespective of whether any such company meets the 

thresholds in stage one. The final rule and guidance thus provide 

the Council with very broad discretion for designating systemically 

important nonbank financial companies and companies will face 

considerable uncertainty about such designation. 

Specific application of the final rule, in my opinion, should not 

result in any insurance companies being designated as systemically 

significant. As we have heard, and I think this is very important, 

there is a benefit and a cost associated with the overall procedure. 

Short run, there will be increased costs for companies that are so 

designated. In the longer run, I don’t think there is any doubt they 

will be considered too-big-to-fail. 

In insurance markets, this can be very problematic. Not only 

would it give companies an advantage in borrowing and raising 

capital, but it would give them an advantage in attracting customers in these markets, which could be very destabilizing over 

time to competition and safety and soundness in the business. 

The enhanced prudential standards as currently proposed are 

certainly bankcentric. They would need to be tailored if they were 

to be applied, tailored significantly to any insurance company that 

would be designated as systemically significant if that in fact occurs. I would hope that those prudential standards, if an insurance 

company is designated, would piggyback to a great extent off existing capital requirements for insurance companies. 

Thank you. 

[The prepared statement of Professor Harrington can be found on 

page 72 of the appendix.] 

Mr. RENACCI. Thank you. 

Next, Mr. Thomas Quaadman, vice president, Center for Capital 

Market Competitiveness, U.S. Chamber of Commerce. You are recognized for 5 minutes. 

39 

STATEMENT OF THOMAS QUAADMAN, VICE PRESIDENT, CENTER FOR CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE 

Mr. QUAADMAN. Thank you, Chairman Renacci, Ranking Member 

Maloney, and members of the subcommittee. I appreciate the opportunity to testify today. 

Reasonable risk taking is at the core of the free enterprise system. Businesses must have the right to fail in order to take risks 

to grow and create jobs. 

Systemic risk, that is, the possibility of a firm imperiling the domestic and global financial system, is a matter that is much different. During the last financial crisis, it was very apparent that 

the government did not have the ability to identify, understand, 

and manage systemic risk. 

In November 2008, the Chamber, as part of a larger financial 

regulatory reform package, called for the regulation of systemic 

risk and that it be used sparingly and when appropriate. That 

being said, a balance must be struck to manage systemic risk, to 

flag issues, and to prevent calamitous harm, while not constraining 

reasonable risk taking, which if limited will hurt economic growth 

and job creation. 

In creating Title I of the Dodd-Frank Act, we think Congress for 

the most part got it right in striking that balance. So if you take 

a look at Title I, right off the bat, Congress immediately separated 

systemic risk for banks separately from systemic risk for nonbanks, 

and then Congress also created specific delineated tests to determine if a nonbank should be determined to be systemically important. 

If you take a look at that system, you take commercial companies, mutual funds, insurance companies and the like, they then go 

through the very defined tests to see if they are predominantly engaged in financial activities. If they are then determined to be 

nonbank financial companies, then FSOC looks through a much 

broader criteria to determine if they should be designated, and if 

they are designated as systemically important financial institutions, then the Federal Reserve and the prudential regulator of 

that company work together in order to create enhanced regulations to deal with systemic risk, yet at the same time not impacting 

the nonfinancial activities of that company. 

So if you take a look what Congress did, Congress understood 

that sometimes when you travel, you have to travel through a 

dense forest, and if you have to travel through a dense forest, you 

clear a path, you brightly mark it so that the travelers can know 

with safety how to get to where they are going. What the regulators are doing, however, is that they are taking the markings off 

of the path so the path is not illuminated and forcing more participants into the forest than what Congress had envisioned. 

So we have six problems with the way that the regulators are 

implementing Title I. 

Number one, and I think we heard a discussion of it this morning, is that the regulators are actually using discretion to go 

around the very specific tests that Congress put in place to determine if nonbanks should be designated or considered to be predominantly financially engaged. 

40 

We are seeing a one-size-fits-all bankcentric approach in order to 

regulate systemically important financial institutions that are 

nonbanks, but they do not take into account the different business 

models. We are seeing that there is not a consideration of conflicts 

between systemic risk and existing regulations. So, for instance, if 

you have a public company that goes into this process, at what 

point in time does this become a material issue that that public 

company is going to have to disclose this to investors? If you do it 

too soon, you could harm capital formation. If you do it too late, 

the company can actually put itself into legal jeopardy. 

We are seeing that the process issues, so that is when FSOC is 

acting as a regulator, that FSOC isn’t following the same transparency and accountability processes that other regulators engage 

in when they are writing rule makings. We agree if FSOC is engaged in discussions about a systemically important problem or 

Title II issue, that should be done in private. But when they are 

acting as a regulator writing rules, that is something that is much 

different. 

I think we have heard testimony this morning which buttresses 

our point about the lack of a cost-benefit analysis. During the April 

discussion of finalization of rules on designation, it was determined 

that to designate systemically important financial institutions was 

not economically significant, meaning that it would not have a cost 

to the economy of $100 million or more. Commenters cannot understand what the costs and the burdens are. 

Finally, rules are being considered out of order. We are going 

into designations, we have designation rules, but we are talking 

about predominantly financially engaged rules now, which is really 

the start of the process. So we started backwards and started to 

work forward so that people cannot understand how the process is 

going to work or how it meshes. 

Finally, if these issues are resolved, the balanced system that 

Congress put in place can move forward. If these issues are not resolved, systemic risk regulation will be impaired and normal everyday business practices constrained, harming economic growth and 

job creation. 

I am happy to answer any questions you may have. 

[The prepared statement of Mr. Quaadman can be found on page 

78 of the appendix.] 

Mr. RENACCI. Thank you, Mr. Quaadman. 

Next is Mr. William J. Wheeler, president, Americas, MetLife, 

Inc. 

STATEMENT OF WILLIAM J. WHEELER, PRESIDENT, 

AMERICAS, METLIFE, INC. 

Mr. WHEELER. Acting Chairman Renacci, Ranking Member 

Maloney, and members of the subcommittee, my name is Bill 

Wheeler and I am the president of the Americas Division of 

MetLife. Thank you for the opportunity to testify on behalf of 

MetLife. 

MetLife recognizes the importance of managing systemic risk 

and the need for sensible regulations to protect taxpayers from 

costly bailouts. Coming up with the appropriate regulatory formula 

will not be easy, either for the Financial Stability Oversight CounVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
41 

cil and designated nonbank firms that are systemically important, 

or for the Federal Reserve in determining the prudential standards 

to be applied to those firms. Nevertheless, we must get the prescription right. The stakes are too high to allow the costs or the 

benefits of regulation to be miscalculated. 

MetLife is the largest life insurer in the United States. We are 

the only one that is also a bank holding company. Our experience 

as an insurance company regulated by the Federal Reserve has 

provided us with unique insights into the pitfalls of applying 

bankcentric rules to nonbank financial companies. Indeed, it is because we do not believe our insurance business should be governed 

by regulations written for banks that we have decided to sell our 

depository business and join our peers in being regulated as an insurance company. 

I plan to discuss three topics in my testimony today: first, why 

regulated insurance activities generally do not pose systemic risk; 

second, why naming only a few companies as systemically important financial institutions, or SIFIs, would needlessly upset the 

competitive landscape in the insurance sector; and third, in the 

event that we are named as a nonbank SIFI, why the prudential 

regulations must be tailored to our unique asset and liability characteristics. 

Far from presenting systemic risk to the U.S. economy, traditional life insurance activities are a force for financial stability. Life 

insurance companies protect policyholders and their beneficiaries 

from the loss of income that occurs as a result of death, disability 

or retirement. 

In order to make good on these promises, we invest in primarily 

investment-grade fixed-income securities that provide us with reliable returns. Unlike banks, insurers generally have a stable portfolio of in-force insurance policies with regular premium payments 

and contractual features that prohibit or limit early calls by policyholders, such as surrender charges or tax penalties. 

Insurance company financial distress occurs far less frequently 

than bank distress. As of mid-2009, only three insurance companies 

had received taxpayer assistance through the Troubled Asset Relief 

Program (TARP), compared with 592 banks. Quite frankly, I do not 

believe TARP money needed to be provided to at least two of these 

insurers to prevent any sort of systemic event. 

Rather than designate a handful of insurance companies as SIFIs 

and design a whole new set of prudential standards for them, a 

more sensible approach would be to identify and regulate those activities that fueled the financial crisis in the first place. During the 

crisis, certain firms that expanded significantly into nontraditional 

and noninsurance activities suffered significant distress. Indeed, 

the main reason insurance companies are even part of the discussion about systemic risk is because of AIG. 

Yet, AIG’s troubles did not stem from traditional insurance activities operated within the regulated insurance company. As DoddFrank recognized, the Office of Thrift Supervision did not appropriately regulate the activities of AIG Financial Products. Insurance law and insurance regulators would not have permitted these 

activities to occur in the same manner within a regulated insurance company. 

42 

If FSOC names only certain insurance companies as SIFIs, it will 

inadvertently be picking winners and losers in the insurance industry. Some commentators believe that naming MetLife and other life 

insurance companies as SIFIs would give us a competitive advantage over our smaller rivals. An SIFI designation would be the Federal Government’s signal that we are indeed too-big-to-fail and that 

if we got into financial trouble, Federal funds would be used to rescue the firm. The implicit backing of the Federal Government could 

strengthen perceptions of our creditworthiness and may give us a 

significantly cheaper cost of funds than our peers. 

At the other end are those who believe that insurance companies 

deemed SIFIs would be placed at a competitive disadvantage. They 

would have to hold more capital and maintain higher liquidity levels, which would reduce returns on equity for shareholders and impose higher prices on customers. In addition, they would have to 

deal with two levels of regulation compared with one for the rest 

of the industry. I am in the second camp, having lived with the 

Federal Reserve regulation and been forced to stand on the sideline 

as nearly all of MetLife’s competitors, including those that took 

Federal bailouts, returned capital to shareholders while 

bankcentric rules prevented us from doing so. 

But whether an SIFI designation is a help or a hindrance, it 

seems certain that naming a handful of insurance companies as 

too-big-to-fail will needlessly distort the competitive landscape and 

misallocate capital in the insurance sector. 

In the event FSOC feels compelled to name MetLife and a few 

other life insurers, SIFIs, it would be essential to tailor the new 

prudential rules for insurance companies. Bankcentric regulations 

are wholly inappropriate for an insurance company. If the Nation’s 

largest life insurers are named SIFIs and subjected to unmodified 

bank style capital and liquidity rules, our ability to issue guarantees would be severely constrained at a time when governments are 

facing their own fiscal challenges. Faced with costly requirements, 

insurers would either have to raise the price of the product they 

offer, reduce the amount of capital or risk they take on, or stop offering certain products altogether. 

In closing, let me reiterate that I do not believe MetLife is or 

should be designated too-big-to-fail. Even in the event of insolvency, we would not threaten the stability of the financial system 

of the United States. Naming only a few large insurance companies 

as SIFIs would needlessly upset the competitive landscape in the 

insurance sector. If FSOC names the largest life insurers as SIFIs, 

I believe it will be imperative for regulators to get the prudential 

rules for nonbank SIFIs right. 

Thank you. 

[The prepared statement of Mr. Wheeler can be found on page 

93 of the appendix.] 

Mr. RENACCI. Thank you, Mr. Wheeler. 

Our final witness, Mr. Douglas Elliott, a Fellow at the Brookings 

Institute, is recognized for 5 minutes. 

43 

STATEMENT OF DOUGLAS J. ELLIOTT, FELLOW, THE 

BROOKINGS INSTITUTION 

Mr. ELLIOTT. Thank you. Thank you for the opportunity to testify 

here before you again today. 

Regulating SIFIs is crucial. They are the institutions most capable of triggering financial crises and therefore merit closer regulation than other firms and should be held to a somewhat higher 

standard of financial conservatism. 

The need for closer regulation is not erased by the steps taken 

to reduce the potential for government bailouts. Even if creditors 

and shareholders picked up all the losses, with no help from taxpayers, a serious financial crisis would still lead to a severe contraction of credit, sending the economy into a deep recession. As 

you know, the recent recession cost taxpayers far more than did 

the bailouts. 

In my brief time, let me just emphasize a few points made in my 

written testimony and in a comprehensive paper that Bob Litan 

and I wrote last year. 

First, no part of the financial industry should receive an automatic exclusion from SIFI designation because there is too much 

danger of regulatory arbitrage if we just go by legal category. 

Second, there are no absolutes in determining systemic importance. There are multiple ways of measuring the level of significance and no clear consensus on the exact methods, which is why 

the proposed rules allow for considerable judgment. Even within a 

single measurement approach, there are degrees of systemic importance with no bright line where an institution flips from unimportant to important. 

Third, we must strive for the right balance between the dangers 

of overdesignation and underdesignation. There will be an economic cost to designating firms as SIFIs. Therefore, we should do 

so whenever the safety benefits outweigh those costs, but only 

when they do. 

Your invitation letter and much of the discussion here has been 

around a question as to whether firms might benefit from being 

named as SIFIs. I would just emphasize a point, which is that if 

it is true that funding costs will be lower after designation, the primary beneficiaries of that will be the managements and the shareholders of these companies. I have been heavily lobbied by these 

companies to take the position they shouldn’t be SIFIs. I am sure 

you as actual Members of Congress have been lobbied much more 

heavily. So you may find yourself in an ironic position of someone 

making an argument to you that you shouldn’t do something to 

their advantage. I simply do not believe for that and other reasons 

that there would be a significant funding cost advantage. 

Fourth, the additional oversight applied to nonbank SIFIs must 

be appropriate to the systemic risk they represent and be coordinated as effectively as possible with their existing regulation. We 

need to avoid overlap, conflicting requirements, and gaps where no 

one regulates. 

Fifth, similar activities should be regulated in similar ways with 

similar safety margins to the extent possible, regardless of the 

legal form of the institution doing the activity. Otherwise it will be 

easy to fall prone to regulatory arbitrage as well as the inefficienVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
44 

cies that are produced by arbitrary differences and competitive advantage. 

So evaluating the proposed rules in light of these key points, the 

regulators appear to be generally on the right track, although there 

is a great deal that cannot be judged yet. The rules focus on the 

right sources of systemic risk, and they recognize the need to carefully review the specific facts and to apply considered judgment to 

questions that are inherently somewhat subjective. 

It makes sense that the regulators are casting a quite wide net 

in the initial phase in order to determine which institutions they 

will need more information about. As I have stressed, there are no 

straightforward quantitative methods to find the answers here so 

there is a need to gather information on a wide array of candidates 

for designation in order to assess each in a deeper way. 

The regulators have also said the appropriate things about recognizing the diversity of business models in different parts of the financial system. Although there remains cause for concern as to 

whether this will be reflected in actual practice, I do share that 

concern. 

From my point of view, I do not think there are currently many 

true SIFIs among the nonbank financial institutions. But I would 

stress, since this has been an area of much discussion today, it is 

possible that life insurers will fall within that. I would dispute the 

point made earlier that there is a clear consensus that life insurers 

do not present systemic risk. There are arguments coming from 

both sides, which is why I think it is premature to form a conclusion on that. 

So, in conclusion of my points, designating a nonbank SIFI is by 

its nature a complex endeavor that requires a careful balancing act 

and substantial human judgment. The rules proposed by the regulators generally reflect those considerations and I believe that the 

resulting uncertainty about the ultimate outcomes is unavoidable 

unless we either abandon the effort to designate such SIFIs or use 

cruder measurements that would almost certainly produce worse 

results. My larger concern, as I mentioned, is whether the rules 

might indeed be too bankcentric. 

Thank you. 

[The prepared statement of Mr. Elliott can be found on page 62 

of the appendix.] 

Mr. RENACCI. Thank you, Mr. Elliott. 

We will now recognize Members for 5 minutes. I recognize myself 

first. 

Mr. Quaadman, although the FSOC has finalized its rules on the 

SIFI designation process and the Federal Reserve has yet to finalize its rules on enhanced prudential standards, as a result no one 

can actually know what the effect of SIFI designation will have. 

Should the FSOC wait for the Fed to finalize its rule on enhanced 

prudential standards before it begins designating nonbank firms as 

SIFIs? 

Mr. QUAADMAN. I think what is interesting is that while there 

is a lot of discussion of the process, there is also discussion that 

they are looking at 50 different companies. A big problem that is 

posed here is that we have the bankcentric model that they are not 

willing to move off of, they are not looking at business models of 

45 

companies, and that if they have these 50 companies, they should 

start to look at whether or not there are unique characteristics that 

they should be looking at, as well as discussing that with prudential regulators as well. 

Mr. RENACCI. Thank you. 

Mr. Harrington, how optimistic are you that enhanced supervision of individual companies will reduce the likelihood of any future financial crisis? 

Mr. HARRINGTON. I am not optimistic about that given the historical record and the dynamism of the markets. I think it is very, 

very difficult to anticipate what is likely to happen and what the 

sources of risk may be. In the near term, I think it is likely that 

there will be heightened scrutiny and some reduction in the likelihood of excess risk-taking. But over time, as memories tend to fade, 

I think it is likely that we will be in an environment where the inherent risks will be very difficult to identify and control. 

Mr. RENACCI. Would you agree that the last crisis taught us that 

looking at individual companies in isolation is an ineffective way 

to monitor the systemic risk? 

Mr. HARRINGTON. I think it is preferable to try to look at activities, and you can look at companies that are then involved in those 

activities. Looking at individual companies is necessary as part of 

prudential regulation, but I do distinguish that from identifying 

specific companies as subject to heightened scrutiny and in, the 

case of the insurance industry, basically Federal regulation that 

could involve an implicit or explicit guarantee of their obligations. 

Mr. RENACCI. Thank you. 

Mr. Quaadman, you criticized the Fed in your testimony, stating 

that the Board appears to be creating a one-size-fits-all bankcentric 

approach that will not work well with nonbanks spanning diverse 

industries unrelated to banking. What should the Fed have done 

differently? 

Mr. QUAADMAN. I think they should be doing a number of things 

differently. One is, you also have to look at the Fed historically. 

They are a bank regulator. That is what they are used to. That is 

what they are involved with. If you take a look at a manufacturing 

company, right, if a manufacturing company uses derivatives to actually accept raw materials because they need to lock in prices and 

also prevent price volatility for consumers, as well as then have a 

financing arm to finance the purchase of their finished goods and 

services, that is a much different model than the bank model. 

So the question is when you go to the start of the process, and 

this is actually an FSOC issue, Congress specifically defined what 

should be looked at in order to determine what a company that is 

predominantly engaged in financial activities. The issue that I just 

raised about the use of derivatives to accept goods is specifically 

not in Reg 4(k), which Congress wrote into law in Title I through 

the Pryor-Vitter amendment. So then, from there, the Federal Reserve is now expanding out what the regulation should be at the 

end of the process. 

The problem here, and this is why we also raise the issue in 

terms of the rules being taken out of order, is if you start at the 

beginning of the process and start to have a flawed process of review that goes away from what Congress defined, then that also afVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
46 

fects how the regulation happens at the end, and then you overlay 

on top of that the historic nature of the Fed and you create a 

flawed system. 

Mr. RENACCI. Thank you. 

Mr. Wheeler, I know I am running out of time, but I do want to 

get your answer on this: How would naming only a few insurance 

companies as systemically important financial institutions upset 

the competitive landscape of the insurance sector? 

Mr. WHEELER. There are a couple of reasons why. One is it could 

be the halo effect, where customers or consumers or distributors 

would think because we have implicit Federal backing, we are 

therefore better to buy products from somebody like us if we were 

named. 

I don’t actually think that is what is likely to happen. I think the 

opposite is going to happen. We will be held to higher capital 

standards. We will be seen as an insurer that you don’t want to 

buy stock in, that frankly you should buy stock in insurance companies that don’t have these standards because frankly the capital 

levels won’t be quite as high. 

So we think at the end of the day, those few insurance companies, which, by the way, will be the largest in the industry probably, will be somewhat punished by the marketplace for the tighter 

regulation and higher capital standards. 

Mr. RENACCI. Thank you. 

I now recognize Mrs. Maloney, the ranking member, for 5 minutes. 

Mrs. MALONEY. First of all, I would like to welcome all of the 

panelists, especially Mr. Wheeler, whose company is headquartered 

in the great State of New York, and I want to compliment your 

many contributions to the economy in providing services to Americans. 

During the financial crisis, we really had only two ways to approach a troubled institution. We could either let it fail, which we 

did with Lehman, or we could bail it out, which we did with AIG. 

Neither alternative was a particularly good one. And what we tried 

to do in the Wall Street Reform Act was to try to have other tools 

to help regulators not only manage large institutions and hopefully 

make sure they don’t fail, but in the event that they did, that we 

would have a way to structure it, like we did with the FDIC, which 

I think did a brilliant job in structuring failing banks and putting 

them with stronger ones and really managing the economy in a 

way that was less disruptive. So that is what we did. 

During that time, we did have a lot of debate over insurance 

companies, and many insurance companies testified. I don’t know 

if you did, Mr. Wheeler, or not, but many, many CEOs and academics testified that insurance was not the problem, that in fact 

it had been a rock in our troubled economic times and had performed well, with the exception of AIG. And although many people 

agreed that most types of insurance activities conducted in isolation would not pose a systemic threat, AIG is an important and I 

would say tragic example of how insurance activities in combination with other financial risky activities could literally threaten 

and bring down a great company, a large organization, and really 

be a threat to the entire financial system. 

47 

The Wall Street Reform Act does not exclude any company for 

that matter or any area. They don’t exclude insurance or any type 

of company, because the whole thrust was to make sure there were 

not shadow areas of financial institutions that had risk-based factors that could do systemic risk to our entire economy. 

I would like to ask the panel, do you agree that a framework that 

applies broadly and evaluates a number of riskiness measures is 

preferable to a framework that categorically excludes some companies? Because under the definition that I am hearing before the 

panels today, AIG would have been excluded because it is primarily 

an insurance company. That excludes some companies and thereby 

creates hiding places or shadow places where risky activities could 

take place. 

So I would really like to ask, how is MetLife different from AIG, 

and how does your international expansion impact on MetLife’s 

risk profile? As we know, AIG was a very strong international company. 

So I throw that out to anyone who would like to answer. 

Mr. WHEELER. Maybe I will start, since you referenced MetLife, 

how is it different versus AIG. Of course, what got AIG in trouble 

was its noninsurance activities. The financial products division in 

London was not inside a regulated insurance activity. And I think 

the premise of your question makes perfect sense. I think we have 

to find these areas in the shadows. But I worry about—and, for instance, if MetLife were doing something outside of its regulated insurance activity which was deemed very risky and very interconnected, I think that activity should absolutely be regulated by 

the Fed. 

What I worry about is regulated insurance activity, which is not 

in our opinion systemically risky, and is already, by the way, highly regulated. 

So I think that is what I think the Fed, when they think about 

nonbank SIFIs and what kind of activities they should regulate, I 

think that is what they should be focused on. We worry about the 

Fed regulating—being yet another regulator to the insurance industry. 

Mrs. MALONEY. But could you comment on the fact that your 

firm acquired a good portion of AIG, as I understand it, in 2010, 

and what did MetLife pay for this acquisition, and did the Federal 

Reserve have to approve this transaction? Was there this a decision 

by your company, or was this part of the government trying to 

manage risk in the overall economy? 

Mr. WHEELER. During the financial crisis, MetLife performed 

well, and we had to—even though we were a bank holding company and eligible for TARP money, we did not take it. We were the 

only large bank holding company that did not. And I suppose that 

is a testimony to how we were managed and our capital solvency. 

But, frankly, I think it is also a testimony to the fact that we are 

not very interconnected with the banking system. So problems in 

the banking sector didn’t really spill over to Met. 

Coming out of the financial crisis, we were in a strong position. 

AIG, obviously, having been taken over by the government, needed 

to start selling assets to repay the government. We acquired a 

large international life insurance division of AIG called Alico for 

48 

$16 billion. And because we are a bank holding company, the Fed 

did have to approve that transaction, and they did, and obviously 

that money was then used to pay back—or a large portion of that 

money was used to pay back the Treasury. So that was good for 

the Treasury, ultimately good for helping AIG get back on its feet, 

and sort of showed kind of the stability of the insurance industry 

throughout this crisis. 

Mrs. MALONEY. My time has expired. 

Mr. RENACCI. Thank you. 

Mr. Luetkemeyer for 5 minutes. 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. 

Mr. Wheeler, you did a good job of explaining the lack of risk 

with the insurance portion of the financial services industry. I 

think it is fair to say that the insurance companies are not the 

problem; it is whenever they get into these other financial products, other financial services, that they get in trouble. Would that 

be a fair statement? 

Mr. WHEELER. Yes. 

Mr. LUETKEMEYER. Does your company engage in any other financial services products, other than life insurance? 

Mr. WHEELER. We own a small bank. 

Mr. LUETKEMEYER. You own a small bank. Okay. But your small 

bank apparently doesn’t deal in derivatives or default credit swaps, 

is that correct? 

Mr. WHEELER. It does not. 

Mr. LUETKEMEYER. Very good. In your judgment, where do you 

think—of course, I guess it is a hypothetical question here in trying 

to figure out what is going on in the minds of the Feds. That is 

always dangerous, isn’t it? But where do you think this should go, 

I guess is a better way to put it, from the standpoint of, as the 

ranking member indicated, at least putting some protections in 

place or transparency in place to be able to see those groups of 

folks who are in the business of dealing with those instruments 

and then how to separate that out from folks, like yourself, who are 

not involved in that? 

Mr. WHEELER. I am a little worried that the Federal Government 

is just focused on if you are big, ipso facto you must be systemically 

significant. Okay, MetLife is big. There is no doubt about it. But 

the insurance industry itself, especially life insurance, is probably 

not very interconnected, probably not systemically significant. If we 

were to engage—there may be the other nonbank SIFIs where that 

is not the case, who are not primarily insurance companies, and so, 

obviously, they should be scrutinized. 

I guess I would also say that if insurers get involved in something besides insurance, which could happen and obviously did 

under AIG, if they get involved in something else, and that is being 

a derivatives trader or a creator and seller of derivatives or anything else which really connects them to the banking sector, then, 

I think that is fair game. I think that should be scrutinized by the 

Fed and regulated. 

Mr. LUETKEMEYER. So you believe that there should be some sort 

of rules in place that describe the connectivity between your activity and the financial services markets, and if you go over the line, 

49 

then you fall into the category that you should be designated as an 

SIFI. Is that a fair statement? 

Mr. WHEELER. Yes, I do. 

Mr. LUETKEMEYER. Very good. 

Mr. Quaadman, I am just curious. I know the Chamber is very 

concerned about this one-size-fits-all—in your testimony, I think 

that is the way you put it—approach that the Fed is taking. What 

is your solution or what is your suggestion for them, for the FSOC 

people, to look at the regulations and come up with a tiered system 

or a system that allows certain folks to get out of it or to go back 

and review the existing rules to see how they are negatively impacting some of the small folks who don’t need to be in this. Insurance companies that are not in the financial services industry, they 

don’t need to be regulated. Community banks, other nonlending 

folks, nondeposit folks, they don’t need to be in this. They are not 

a systemic risk. Yet the rules that have been put out so far have 

had a dramatic impact on some, I am sure, of your members. 

Mr. QUAADMAN. Thank you for that question. I think number one 

is that they should follow the law. So if you take a look at the predominantly engaged test, which is the first stage to see if a company should even be considered, Congress sort of constructed that 

as a 1-inch pipe and now the Federal Reserve and FSOC, they are 

trying to make it a 12-inch pipe. They want to try and bring in as 

many companies as possible, whereas it really should be done sparingly. 

I think Mr. Wheeler also made an excellent point as well as we 

are also looking at size. And size isn’t necessarily determinative either. What is also important as well is that the marketplace investors and companies, they need to assess how the system works, 

how it is going to impact companies and the like. By taking rules 

out of order, by not following transparency in writing rules, it is 

impossible to decide that. 

One example is, Vince Lombardi when he started training camp 

every year, he would say, ‘‘This is a football.’’ He didn’t start training camp by saying, ‘‘This is the last play we are going to play in 

the Super Bowl.’’ So FSOC and the Federal Reserve are starting at 

the very end trying to work forward, where you really should start 

at the beginning. 

Mr. LUETKEMEYER. With regards to the promulgation of the rules 

and the process they are going through, are you gentlemen, are 

your associations, are you at the table with the discussions that are 

going on? 

Mr. QUAADMAN. We have commented extensively. We have met 

with the regulators in different forums on these issues. 

Mr. LUETKEMEYER. Are they receptive to your ideas and your 

concerns? 

Mr. QUAADMAN. I can say in this and other areas where we have 

spoken to them, we have always brought forth how this impacts 

nonfinancial companies. And, there are times where we had very 

good discussions, but there are also times where it is very clear 

that they are coming at it from a bank approach and then are not 

willing to move off of that. 

Mr. LUETKEMEYER. Mr. Wheeler? 

50 

Mr. WHEELER. I think I would agree with that. We are obviously 

very engaged. This is very important to us in dealing with the regulators. Obviously, we are regulated by the Fed today, so we have 

conversations with them a lot. Whether we are having an impact, 

whether they are listening, I honestly don’t know. 

Mr. LUETKEMEYER. We won’t know until we get the rules, will 

we? 

Mr. WHEELER. Right. 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. 

Mr. RENACCI. Mr. Manzullo for 5 minutes. 

Mr. MANZULLO. Thank you. 

Is there anybody in the room here from the Department of the 

Treasury or the Federal Reserve? 

See? That is the problem. They testify first; then they leave, and 

they don’t listen to you. It is a chronic problem with the agencies. 

They refuse to be on the same panel as those who are regulated. 

These Departments and Agencies ought to be ashamed of themselves, because it deprives you of the ability to interact with the 

people who represent the Government. That is why, Mr. Wheeler, 

I asked the questions that you wanted to ask. And that is the problem with Washington. That is why this City is broken, because people who make the regulations don’t think they have to stick around 

in order to listen to the people impacted. 

Mr. Chairman, I would suggest that at the next hearing we have, 

we put the people impacted first. Force the government bureaucrats to listen to the testimony. There is no reason why they should 

have to go first. 

That brings me to another point. It wasn’t until October 1, 2009, 

that the Fed actually adopted a policy, are you ready for this, requiring written proof of a person’s earnings before that person 

could even fill out a mortgage application. Now, I would say that 

is pretty basic. They took an entire year to review everything, as 

Chairman Bernanke said, a bottom-up review as to what would be 

necessary. And if it took that long to figure out that you don’t condone the so-called ‘‘liar laws’’ that allowed people to do that, I just 

wonder how the Fed is going to start to be able to regulate insurance companies. 

I think all of you generally agree, with the exception of Mr. Elliott, who also agrees that insurance companies generally should 

not be regulated but may under certain circumstances. Can you 

guys tell me, what would the Fed do in messing up MetLife? Do 

you like that question? 

Mr. WHEELER. That is a great question. Look, as Mr. Quaadman 

said a bit ago, the Federal Reserve, at least part of their mandate 

is to regulate the banking industry. So the people who work at the 

Fed, that is their training, that is their experience. They regulate 

banking. So now MetLife is a bank holding company, and therefore 

regulated by the Fed, and I can tell you there was a very strong 

reluctance on the part of the Fed to look at us as anything other 

than a bank, even though, of course, 98 percent of our business is 

insurance. 

And we were very frustrated by that, and, of course, that is probably why I am here today is because of that experience. 

51 

So, I would also tell you that the Federal Reserve—I have met 

a lot of people at the Federal Reserve but I have yet to meet somebody who I thought had what I call a sophisticated understanding 

of the insurance industry. 

Mr. MANZULLO. It is a mismatch. 

Mr. WHEELER. Right. So it worries me. We are already highly 

regulated by the States. The New York Insurance Department in 

the State of New York is, I would argue, the most sophisticated 

State regulator which regulates us today, and they know what they 

are doing. 

Mr. MANZULLO. Can I ask you a question? AIG, I think, was in 

five pieces of the company. Did the insurance division—was that 

ever at risk, or were the Illinois requirements so profound that 

none of the policyholders were imperiled at any time? Professor? 

Mr. HARRINGTON. If you look at AIG’s total capital and surplus 

in its insurance subsidiaries, it was substantially positive throughout the crisis, and the laws were in place that overall if you aggregated across those subsidiaries, AIG had plenty of capital to meet 

its obligations to all policyholders. 

There has been some debate about the extent to which specific 

subsidiaries may have run into capital shortfalls, and that would 

raise the question of how fungible the capital held by different AIG 

subsidiaries would be so that heavily capitalized subsidiaries, the 

resources could somehow make up for any shortfall at a few of the 

entities that may have been underfunded. 

So that has been debated, and I have not seen a really clear coherent analysis that would document whether any of those specific 

subsidiaries would have actually had a crisis that would have required regulatory intervention. Overall, though there was plenty of 

money, and the overall system of insurance regulation, with the 

strong walls between the subsidiaries and the holding company— 

Mr. MANZULLO. So you don’t know if those walls could have been 

breached surrounding the insurance division? 

Mr. HARRINGTON. They wouldn’t have been breached by having 

money sucked out to support the noninsurance activities. 

Mr. RENACCI. Mr. Duffy for 5 minutes. 

Mr. DUFFY. Thank you. One of the boogymen of the financial crisis was AIG, which was a nonbank financial company. We have 

touched on this a little bit. But just maybe again, and I don’t mean 

to pick on Mr. Wheeler, who has been answering a lot of questions, 

but what is the difference between MetLife and AIG? 

Mr. WHEELER. I think for purposes of your question, if you look 

at all our subsidiaries that are the holding company, how many of 

them are engaged in insurance, and how many of them do something else? And MetLife is I would say, other than the small bank 

we own, which we are in the process of selling because we don’t 

want to be a bank holding company anymore, other than the fact 

of our bank, almost everything we own in the holding company is 

in the business of insurance, whether that is P&C insurance or life 

insurance, in this country and around the world. 

AIG was in all those insurance businesses as well in the United 

States and around the world, but they also engaged in a lot of 

other, what I would call noninsurance activity. And the one that 

got so much attention, of course, was something called the AIG FiVerDate Nov 24 2008 11:35 Feb 07, 2013 Jkt 075731 PO 00000 Frm 00057 Fmt 6633 Sfmt 6633 K:\DOCS\75731.TXT TERRI
52 

nancial Products, which was a business they ran in London, where 

they sold credit default swaps on all kinds of securities and sold 

them to banks and other financial institutions. And, when the crisis occurred, they weren’t able to pay, and therefore threatened the 

security of the bank system that was relying on that money. So 

that is the big difference between us. 

And, by the way, most of the insurance industry looks like 

MetLife, okay? They are pretty much pure play insurance companies. They aren’t involved in a lot of other activities. 

Mr. DUFFY. If you are looking at AIG, wasn’t the credit default 

swaps and the mortgage-backed securities, wasn’t that an investment strategy for AIG on the insurance side? 

Mr. WHEELER. That is a good question, and we use derivatives, 

too, in our insurance entities and I think there is something you 

have to understand here. So what Financial Products did was create and sell derivatives to others. 

We purchased derivatives from Wall Street, and I will talk 

maybe about why that is okay to do. We have to hold collateral 

against those derivative positions, and they get trued up every day. 

So Lehman Brothers, for instance, which was a big derivative 

counterparty of ours, when they failed, we didn’t lose any money 

because we held collateral against their derivative positions, and 

that is the way good derivative management practice works. 

We do use derivatives in our insurance company to manage risk, 

and most major financial institutions do. Just investing in derivatives to manage risk doesn’t in my mind make you systemically important. 

Mr. DUFFY. Switching gears a little bit, you guys are all aware 

of the three-stage process set up by FSOC for the SIFI designation. 

Do you guys as a group of four agree with that three-stage process. 

Do you think that is a good process to go through? Does anyone 

disagree with the three-stage process? Does anyone have a recommendation to change the three-stage process? 

You all like it? 

Mr. WHEELER. Look, it is good to have a process. I think it is 

more about the substance of the decision-making. What we have 

heard a lot about is, when somebody said, well, define interconnectedness,—I think that was on the last panel—measure interconnectedness. They can’t, of course, because it is judgmental. 

And if you think about the six criteria they are going to use to 

designate something systemically important, they talk about business being one, but almost everything else is very judgmental. And 

I guess, I am hoping the FSOC has I would say a robust discussion 

about those other more qualitative factors. 

Mr. DUFFY. Mr. Harrington or Mr. Quaadman? 

Mr. QUAADMAN. That is a great question. I think, number one, 

Congress had a process in place to do this system, and the regulators are trying to go around this that. 

I think one thing to also think about, and I think this also gets 

overshadowed by the general financial crisis, but if you actually 

look back a few years ago, there was a problem with monoline insurance companies that led to liquidity problems in State and municipal securities. That is a $3.6 trillion dollar market. I think the 

question you should all be asking the regulators is, could they find 

53 

the problem with monoline insurance companies with the processes 

they have set up, because if you are just looking at size, you are 

trying to use a searchlight when in fact you probably should be 

using a flashlight. 

Mr. DUFFY. Mr. Harrington? 

Mr. HARRINGTON. In general, a three-stage process where you do 

a broad screen and work down is sensible. Actually having a process where in the first stage, you get the right criteria and the right 

thresholds, that is very difficult, and I don’t think there is sufficient information to evaluate the specifics in the first stage. 

I am troubled by the overriding amount of discretion in the overall system, including the fact that if you don’t meet the first stage 

test, you can still be advanced through the screen. Unfortunately, 

I don’t have any sharp ideas of how you would fix this to optimally 

trade off the specificity that would be desirable versus some degree 

of discretion. 

Mr. DUFFY. I will ask one more question: Would everyone agree 

that nonbank financials should be considered an SIFI? Do you all 

think that is a reasonable area for us to look at? Or does anyone 

on the panel say, no, no, we just want to look at banks. 

Mr. WHEELER. No, no. I totally think that is necessary, that we 

catch these activities in the shadows. 

Mr. QUAADMAN. It should be done through exacting standards, so 

it is only used sparingly but when it is appropriate. 

Mr. HARRINGTON. I am very skeptical of identifying individual 

nonbanks as being systemically significant because of the disruptions it can create in competition and incentives for safety and 

soundness. I wish more attention would be paid to looking at how 

we might do this without identifying specific companies, but instead looking overall at areas that could create systemic risk and 

having some sort of supervisory regime that could deal with that 

without labeling companies as systemically significant, which ultimately will translate into ‘‘backed by the safety and soundness of 

the Federal Government.’’ 

Mr. DUFFY. I have to say, I don’t see a way to do what Scott just 

described. Ultimately, we need each of these institutions to be able 

to handle the claims on them. So in the end, we have to say these 

institutions have enough capital, enough liquidity, and enough 

safety margins in general. 

My time has expired. I will yield back. 

Mr. RENACCI. I want to thank all of the witnesses for their testimony this afternoon. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 30 days 

for Members to submit written questions to these witnesses and to 

place their responses in the record. 

This hearing is adjourned. 

[Whereupon, at 1:03 p.m., the hearing was adjourned.] 

(55) 

A P P E N D I X 

May 16, 2012 

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Testimony of Mr. Lance Auer, Deputy Assistant Secretary 

U.S. Department of the Treasury 

Before the House Financial Services Financial Institutions Subcommittee 

Hearing on "Implementing Title I of the Dodd-Frank Act: The New Regime for Regulating 

Systemically Important Nonbank Financial Institutions" 

May 16,2012 

Chainnan Capito, Ranking Member Maloney, and members of the Subcommittee, thank you for the 

opportunity to discuss the financial Stability Oversight Council's (the Council) rule and guidance for 

identifYing nonbank financial companies that will be subject to enhanced prudential standards and 

supervision by the Federal Reserve. I serve as the Deputy Assistant Secretary for Financial Institutions at 

the U.S. Treasury, where I helped coordinate the work of the Council's members in developing the rule 

and guidance setting out the Council's process and analysis for evaluating nonbank financial companies 

for supervision and regulation. 

In the 2007-2008 financial crisis, financial distress at certain nonbank financial companies contributcd to 

a broad seizing up of financial markets. These nonbank financial companies were not subject to the type 

of regulation and consolidated supervision applied to bank holding companies, nor were there 

mechanisms in place to resolve the largest and most interconnected of these nonbank financial companies 

without causing further instability. 

To address potential risks posed to U.S. financial stability by these companies, the Dodd-Frank Wall 

Street Refonn and Consumer Protection Act (the Dodd-Frank Act) authorizes the Council to detennine 

that certain nonbank financial companies will be subject to supervision by the Board of Governors of the 

Federal Reserve System (the Board of Governors) and to enhanced prudential standards. This authority is 

one of the Council's important tools to carry out its statutory duty to identifY risks to financial stability 

and respond to emerging threats. The Council acts as a collaborative body, chaired by the Secretary of 

the Treasury, that brings together the expertise of the federal financial regulators, an insurance expert 

appointed by the President, and state regulators. 

Although the Dodd-Frank Act specifically outlines the substantive considerations and procedural 

requirements for designating nonbank financial companies, the Council determined that a rulemaking 

would provide increased transparency and guidance that would be beneficial. The Council went to great 

lengths in its rulemaking to foster additional transparency and to obtain input from all interested parties. 

The Council issued an advance notice of proposed rulemaking in October 20 I 0 and a first notice of 

proposed rulemaking (the First NPR) in January 2011 providing guidance on the statutory criteria and 

specifYing the procedures that the Council will follow in assessing nonbank financial companies for 

designation. The Council elected to issue a second notice of proposed rulemaking (the Second NPR) in 

October 20 II to provide additional details regarding the framework for assessing nonbank financial 

companies and to offer further opportunity for public comment on the Council's proposed approach. 

After receiving significant input iTom market participants, non-profits, academics, and other members of 

the public, the Council's members worked in close collaboration to develop a final rule. The final rule, 

issued in April 2012, describes an analytic framework for designations that provides a consistent 

approach to detenninations that incorporates both quantitative analyses and qualitative judgments. 

Council members are also working closely with their international counterparts on the process for 

identifYing global systemically important financial institutions. Treasury and U.S. regulators are active 

participants in the G-20 and Financial Stability Board (FSB). G-20 Leaders, at the Seoul Summit in 

November 20 I 0, endorsed a policy framework developed by the FSB to address the moral hazard posed 

by systemically important financial institutions. Most recently, at the Cannes Summit in November 20 II, 

G-20 Leaders requested extension of this policy framework beyond global systemically important banks 
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to nonbanks of global systemic importance. Council members are continuing to cooperate with their 

international partners to ensure consistency across frameworks and the development of international 

standards of the highest quality. For example, the International Association ofinsurance Supervisors 

(lAIS) is working, in cooperation with the FSB, to extend the FSB's policy framework to the insurance 

sector, and is developing criteria and a methodology for identifying global systemically important insurers 

(G-SIIs). The Federal Insurance Office (flO) of the Treasury Department, whose director is also a 

member of the Council and a member ofthe IAIS and the IAIS Executive Committee, is pursuing an 

international consensus that aligns the IAIS criteria, methodology, and timing with the final rule issued by 

the Council. At the same time, the Council's designations under the Dodd-Frank Act are an important 

part orthe U.S. financial reform process, and the Council will continue to move forward in implementing 

its framework in a timely manner. 

Process for Determinations 

The Council has developed a robust process for evaluating whether a nonbank financial company should 

be subject to Board of Governors supervision and to enhanced prudential standards. The Council will 

approach each determination using a consistent framework, but ultimately each designation must be made 

on a company-specific basis, considering the unique risks to U.S. financial stability that each nonbank 

financial company may pose. 

The Dodd-Frank Act requires the Council to assess ten considerations when evaluating nonbank financial 

companies, as well as any other risk-related factors that the Council deems appropriate. The Council has 

grouped these ten statutory considerations into a six-category framework for its analysis. Three of these 

six categories seek to aSSesS the potential impact of a company's financial distress on the broader 

economy: size, interconnectedness, and substitutability. The remaining three categories seek to assess the 

vulnerability of a nonbank financial company to financial distress: leverage, liquidity risk and maturity 

mismatch, and existing regulatory scrutiny. An assessment of all six categories will encompass all ten of 

the statutory considerations. 

The Council's interpretive guidance issued with its final rule explains the three-stage process that the 

Council generally intends to use in assessing nonbank financial companies: 

Stage 1: First, the Council will apply unifonn quantitative thresholds to identify those nonbank 

financial companies that will be subject to further evaluation. 

Stage 2: The Council will analyze the nonbank financial companies identified in Stage I using a 

broad range of information available to the Council primarily through existing public and 

regulatory sources. 

Stage 3: The Council will contact each nonbank financial company that the Council believes 

merits further review to collect infonnation directly from the company that was not available in 

the prior stages. Each nonbank financial company that is reviewed in Stage 3 will be notified that 

it is under consideration and be provided an opportunity to submit written materials related to the 

Council's consideration of the company for a proposed determination. 

If the Council approves a proposed determination, the nonbank financial company will receive a written 

explanation of the basis of the proposed determination. The company may then request a hearing to 

contest the proposed determination. After any hearing, a final determination requires a second vote of the 

Council. 

Stage 1 Analysis 

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Much attention has been focused on the Stage 1 thresholds. Stage 1 is not intended to identify nonbank 

financial companies for a final determination. Instead, the Council developed the uniform quantitative 

thresholds in Stage I as a tool that the Council, nonbank financial companies, market participants, and 

other members of the public may use to assess whether a nonbank financial company will be subject to 

further evaluation by the Council. As noted in the final rulemaking, based on data currently available to 

the Council through existing public and regulatory sources, the Council has estimated that fewer than 50 

nonbank financial companies meet the Stage 1 thresholds. The Council recognizes, however, that the 

Stage I thresholds may not capture all types of nonbank financial companies and all of the potential ways 

in which a nonbank financial company could pose a threat to financial stability. Therefore, the Council 

reserves the right to subject any nonbank financial company to further review if the Council believes that 

further analysis of the company is warranted to determine if the company could pose a threat to U.S. 

financial stability, regardless of whether such company meets the thresholds in Stage I. 

A nonbank financial company will be subject to further evaluation beyond Stage 1 if it has at least $50 

billion in total consolidated assets and meets or exceeds anyone of the following Stage 1 thresholds: 

o $30 billion in gross notional credit default swaps outstanding for which the nonbank financial 

company is the reference entity; 

o $3.5 billion in derivative liabilities; 

o $20 billion of total debt outstanding; 

o 15 to I leverage ratio, as measured by total consolidated assets to total equity; or 

o 10 percent ratio of short-term debt (having a maturity of less than 12 months) to total 

consolidated assets. 

The Stage 1 thresholds and their levels reflect the collective judgment of the Council members, in light of 

the statutory standards and considerations and an extensive review of applicable data and various 

analyses. The Council selected the Stage I thresholds based on their applicability to nonbank financial 

companies that operate in diverse financial industries and because the data underlying these thresholds for 

a broad range of nonbank financial companies are generally available from existing public and regulatory 

sources. The Council reviewed distributions of various samples of nonbank financial companies and 

bank holding companies to inform its judgment regarding the appropriate thresholds and their quantitative 

levels. The Council also considered historical testing of the thresholds to assess whether they would have 

captured nonbank financial companies that encountered material financial distress during the financial 

crisis of 2007-2008. 

For U.S. nonbank financial companies, the Council intends to apply each of the Stage 1 thresholds based 

on the global assets, liabilities, and operations ofthe company and its subsidiaries. For foreign nonbank 

financial companies, the Council intends to calculate the Stage 1 thresholds based solely on the U.S. 

assets, liabilities, and operations of the foreign nonbank financial company and its subsidiaries. These 

thresholds add significant transparency to the designation process, beyond the statutory requirements, by 

helping nonbank financial companies assess whether they are likely to be subject to additional review by 

the Council. In addition, the Council may develop additional guidance regarding potential metrics or 

thresholds, as appropriate, as more data and information about firms and industries, such as asset 

managers, hedge funds, private equity firms, and swaps entities, become available. Any additional 

guidance will be released to the public, 

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While the Board of Govemors has not issued regulations under section 170 of the Dodd-Frank Act to 

cxempt certain types or classes of nonbank financial companies from designation, the Stage I thresholds 

provide a significant level of transparency and certainty for the public regarding the nonbank financial 

companies that are most likely to be subject to evaluation for designation. 

Stage 2 Analysis 

In the second stage of the process, the Council will conduct a comprehensive analysis of each nonbank 

financial company identified in Stage J. In contrast to the application of uniform quantitative thresholds 

to a broad group of nonbank financial companies in Stage I, the Council intends to evaluate the risk 

profile and characteristics of each individual nonbank financial company in Stage 2 based on a wide range 

of quantitative and qualitative industry-specific and company-specific factors. The analysis will use the 

six-category analytic framework described above - sizc, interconnectedness, substitutability, leverage, 

liquidity risk and maturity mismatch, and cxisting regulatory scrutiny. To the extent data are available, 

the Council also intends in Stage 2 to consider the impact that resolving a failing nonbank financial 

company could have on U.S. financial stability. 

In general, this analysis will be based on a broad range of information already available to the Council 

through existing public and regulatory sources, including information possessed by the company's 

primary financial regulatory agency or home country supervisor, as appropriate, and any information 

voluntarily submitted by the company. The Council also intends to fulfill its statutory obligation to rely 

whenever possible on information available through the Office of Financial Research (the "OfR"), 

member agencies, or the nonbank financial company's primary financial regulatory agencies before 

requesting the submission of information from any nonbank financial company in Stage 3. 

Based on the Stage 2 analysis, the Council intends to contact those nonbank financial companies that the 

Council believes merit further evaluation in Stage 3. 

Stage 3 Analysis 

The Council will conduct a review of each nonbank financial company in Stage 3 using information 

collected directly from the nonbank financial company, as well as the infonnation used in the first two 

stages. At the beginning of Stage 3, the Council will send a notice of consideration to each nonbank 

financial company that will be reviewed in Stage 3. Notified companies will be provided an opportunity 

to submit materials to the Council. This opportunity for the company to submit materials to contest the 

Council's consideration of the company for a proposed determination is an additional protection, not 

statutorily required, that the Council provided in its final rule. 

The notice of consideration likely will also include a request that the nonbank financial company provide 

information that the Council deems relevant to its evaluation. This information will generally be 

collected by the OFR. Before requiring the submission of reports from any nonbank financial company 

that is regulated by a Council member agency or any other primary financial regulatory agency, the 

Council will coordinate with such agencies and will, whenever possible, rely on information available 

from the OFR or from such agencies. The Council will also consult with appropriate foreign regulatory 

authorities, to the extent appropriate. Council members and their agencies and staffs will maintain the 

confidentiality of such information in accordance with applicable law. 

In its analysis under the six-category framework, the Council will consider both quantitative and 

qualitative information. The Council expects that the information necessary to conduct an in-depth 

analysis of a particular nonbank financial company may vary significantly based on the nonbank financial 

company's business and activities and the information already available to the Council trom existing 

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public sources and domestic or foreign regulatory authorities. Information relevant to the Council's 

analysis may include confidential business information such as internal assessments, internal risk 

management procedures, funding details, counterparty exposure or position data, strategic plans, 

resolvability, potential acquisitions or dispositions, and other anticipated changes to the nonbank financial 

company's business or structure that could affect the threat to U.S. financial stability posed by the 

nonbank financial company. The Council will also consider qualitative factors that include considerations 

that could mitigate or aggravate the potential ofthe nonbank financial company to pose a threat to U.S. 

financial stability, such as the nonbank financial company's resolvability, the opacity of its operations, its 

complexity, and the extent and nature of its existing regulatory scrutiny. 

The objective of the Stage 3 analysis is to assess whether a nonbank financial company meets one of the 

statutory standards for a determination: that is, whether the company's material financial distress, or the 

nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company, 

could pose a threat to U.S. financial stability. 

At the end of Stage 3, based on the results of the analyses conducted during each stage of review, the 

Council may, by a vote of at least two-thirds of the Council's voting members then serving, including an 

affirmative vote by the Chairperson of the Council, make a proposed determination regarding the 

company. If a proposed determination is made, the Council will provide the nonbank financial company 

with a written explanation of the basis of the proposed determination. The company may request a 

hearing to contest the proposed determination. After any hearing, in order to make a final determination, 

the Council must again vote by a two-thirds majority of the Council's voting members then serving, 

including an atlirnlative vote by the Chairperson. The Council will publicly announce all of its final 

determinations, as required by the Dodd-Frank Act. The Council is also required, by statute, annually to 

reevaluate currently effective determinations and rescind any determination if the Council determines that 

the nonbank financial company no longer meets the standards for determination. 

Revisions to the Rule and Interpretive Guidance Based on Public Comment 

In response to comments on the First NPR, the Council incorporated numerous additions and changes in 

the Second NPR. Most notably, the Council added extensive interpretive guidance that outlined the threestage process described above, including the addition of the uniform, quantitative Stage I thresholds and 

sample metrics for each item in the six-category analytic framework. In response to requests from 

commenters, the Council also added definitions of the terms "threat to the financial stability of the United 

States" and "material financial distress" with respect to the statutory determination standards to the 

interpretive guidance, and added a confidentiality provision to the mle. [n addition, the Second NPR 

included greater safeguards for nonbank financial companies under evaluation, including a requirement 

for a notice from the Council to companies upon completion of the Council's evidentiary record in Stage 

3, and a 180-day deadline for a proposed determination after that notice is sent; and greater clarity on the 

process for emergency waivers or modifications of the otherwise applicable procedural requirements. 

In developing the final rule and guidance, the Council made a number of additional changes in response 

to comments on the Second NPR. The final rule provides greater clarity on the confidentiality provisions 

that will apply to information submitted voluntarily by nonbank financial companies and information that 

is collected from regulators that are not Council members. The final rule and guidance also include 

additional procedural steps to benefit nonbank financial companies and aid the Council's analysis, 

including an intention to consult with primary financial regulatory agencies ofa company's significant 

subsidiaries in Stage 2, when appropriate; an intention to provide at least one business day's notice to a 

firm before publicly announcing its designation following a final determination; and additional notice and 

opportunity for firms to submit information in annual reevaluations of designated companies. The final 

rule also provides greater clarity on a number of issues, including the definition of "company"; how the 

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Council may consider managed funds and fund advisors; and several clarifications to the definitions, 

calculations, and processes for applying the Stage 1 thresholds. 

Determinations 

The Council will exercise its judgment as it considers both quantifiable metrics and the unique risks that a 

particular nonbank financial company may present to the financial system. This flexibility will allow the 

Council to address the diverse range of business models among nonbank financial companies. Moreover, 

given the dynamic nature of financial markets and the evolution of financial products and services, the 

Council will need the ability to take such changes into account in its determinations. Ultimately, in 

accordance with the Dodd-Frank Act, all designations will be based on a determination tbat a company's 

material financial distress - or the nature, scope, size, scale, concentration, interconnectedness, or mix of 

the activities of the company could pose a threat to U.S. financial stability. 

Every designation decision will be firm-specific, and every firm will receive robust due process 

protections, including the opportunity for judicial review of any final designation. Even before the 

Council votes on a proposed designation, a company under consideration will have the opportunity to 

submit written materials to the Council addressing whether, in the company's view, it meets the standard 

for designation. Only after Council members have reviewed that information will they vote on a 

proposed designation, which requires the support of two-thirds of the Council (including the affirmative 

vote of the Chairperson) and after which the Council will provide the company with a written explanation 

of the basis of the proposed designation. If challenged, the proposed designation is subject to review 

through a formal hearing process and another two-thirds Council vote. The Council must report to 

Congress annually on all final designations and the basis for such designations. 

In the wake of the 2007-2008 financial crisis, Congress included in the Dodd-Frank Act the authority for 

the Council to designate nonbank financial companies that could pose a threat to U.S. financial stability. 

The designations process described in the Council's rule and guidance is the result of over a year of 

dialogue with market participants, non-profits, academics, and members of the public. The resulting rule 

and guidance fonn an important part of the Council's ability to carry out its statutory duties to identify 

risks to financial stability and respond to such threats in order to better protect the U.S. financial system. 

Thank you. I would be happy to answer your questions. 

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Douglas J. Elliott 

Thank you for the opportunity to testify again today, this time on systemically important non-bank 

financial institutions. I should note that while I am a Fellow at the Brookings Institution, my testimony 

today is solely on my own behalf. Brookings does not normally take policy positions as an institution. 

In Dodd-Frank, Congress Wisely gave regulators a wider mandate to oversee systemically important 

financial institutions (SIFls). These institutions are the ones most capable of triggering financial crises 

through mistakes or bad luck, due to their importance as financial intermediaries and their 

interconnections with the rest of the financial system. As such, they merit more attention from 

regulators, more tools should be available for regulatory intervention, and they should be held to a 

somewhat higher standard of financial conservatism. 

The need for closer supervision is not erased by the steps that have been taken to reduce the potential 

for government bailouts of failing institutions. First, because it is impossible to totally eliminate the 

potential for a financial crisis to be severe enough to merit further taxpayer-financed rescues. Second, 

because even if this goal were achieved, so that creditors and shareholders picked up all the losses with 

no help from taxpayers, a serious financial crisis would still lead to a severe contraction of credit, 

sending the economy into a deep recession, such as we just experienced. You will recall that the recent 

recession cost taxpayers far more than did the bailouts. 

Banks are among the most likely institutions to be systemically significant, but other types of financial 

institutions can certainly be SIFls and it is good that Dodd-Frank recognized this. Prior to this legislation, 

it was very difficult for the regulators to track the systemic risk of non-bank financial institutions, much 

less affect the level of that risk. 

Robert litan and I wrote an extensive paper on non-bank SIFls, to which I refer the members for a fuller 

explanation of my views. 

(http://www.brookings.edu/papers/2011/0116 regulating sifis elliott litan.aspx). Today's testimony 

will focus on a few key beliefs about how to identify and regulate non-bank SIFls and some thoughts on 

the proposed regulations. 

First, no part of the financial industry should receive an automatic exclusion from SIFI designation. There 

is too much danger of a firm taking advantage of its legal form to acquire the importance of a SIFI 

without the appropriate oversight. Regulatory arbitrage is a fact of life against which we must guard. 

Second, there are no absolutes in determining systemic importance. There are multiple ways of 

measuring the level of significance and no clear consensus on the exact methods, which is why the 

proposed rules allow for considerable judgment. Even within a single measurement approach, there are 

degrees of systemic importance, with no bright line where an institution flips from unimportant to 

important. In essence, the entire SIFI concept, like much of regulation, is about costs and benefits. The 
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benefits of the improved information, more careful supervision, and higher capital and other safety 

margins must outweigh the costs of imposing the extra regulation. 

Third, as a result, we must strive for the right balance between the dangers of over-designation and 

under-designation. Clearly, as many as possible of the true SIFls should be captured in the formal 

designation process, since oversight of the financial system as a whole will be stronger with the right 

information and with the regulatory tools to ensure safe operations of the key institutions. However, 

there are also costs to naming a firm as a SIFI when it does not really merit that designation. The 

additional level of regulation, and the higher required safety margins, will make credit and other 

financial products more expensive, which is only worthwhile if there is an increase in systemic safety 

that more than offsets the costs. 

The subcommittee's invitation letter asked specifically about one part of this trade-off, which is whether 

there will be a market advantage for those firms that are designated as SIFls. Some have raised the 

possibility that a firm which is named as a SIFI will have an implicit government guarantee, or at least 

seal of approval, which will give them a competitive advantage on their funding costs and their ability to 

sell products. I do not believe this to be a significant issue. Those firms likely to be designated as SIFls 

are already viewed by the markets as being safer because of their larger size and importance. This 

perception sometimes includes a residual belief in the possibility of a government rescue, despite the 

steps Congress and the regulators have taken to counter this belief. My experience in the financial 

markets, where I was an investment banker for almost twenty years, convinces me that the marginal 

effect of a formal designation would be small. Regardless of my own views, both the managements and 

investors of firms potentially designated as SIFls are sending very strong signals that they see such a 

designation as a negative. I can assure you that a number of those firms are working very hard to avoid 

designation, as you have doubtless noticed yourselves. It seems very unlikely that this would be the case 

were there a significant financial advantage to the designation. 

Fourth, the additional oversight applied to non-bank SIFls must be appropriate to the systemic risk they 

represent and be coordinated as effectively as possible with their existing regulation. Ideally, the 

regulatory framework for non-bank SIFls would be designed in parallel with the designation process, to 

facilitate the cost/benefit analysis inherent in choosing whether to subject a firm to the rigors of 

designation. Unfortunately, the deadlines in Dodd-Frank push the regulators towards deSignating the 

SIFls prior to deciding exactly how to regulate them. This creates uncertainty as to whether the 

regulation in practice will inadvertently harm desirable activities by those firms. 

Fifth, similar activities should be regulated in similar ways with similar safety margins, to the extent 

possible, regardless of the legal form of the institution doing the activity. Otherwise, it will be easy to fall 

prone to regulatory arbitrage as well as the inefficiencies that are produced by arbitrary differences in 

competitive advantage. 

Evaluating the proposed rules in light of these key points, the regulators appear to be generally on the 

right track, although there is a great deal that cannot be judged yet. The rules focus on the right set of 
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sources of systemic risk and they recognize the need to carefully consider the specific facts and to apply 

considered judgment to questions that are inherently somewhat subjective. It makes sense that the 

regulators are casting a wide net in the initial phase, to determine which institutions they will need 

more information about. As I have stressed, there are no straightforward quantitative methods to find 

the answers here, so there is a need to gather information on a wide range of candidates for 

designation, in order to assess each in a deeper way. I am sure that everyone would prefer that there 

existed a straightforward numerical test that could be used for the final determination, but the situation 

is much too complex to avoid the application of substantial amounts of human judgment. 

The regulators have also said the appropriate things about recognizing the diversity of business models 

in different parts of the financial system, although there remains cause for concern as to whether this 

will be reflected fully in actual practice. For example, the stress tests applied to banking groups appear, 

at least from what I can glean from news reports, not to have taken sufficient account of the differences 

between MetLife's insurance operations and the banking businesses that were the core of all the other 

groups subject to the full test. Hopefully, this was a byproduct of the specific circumstances and not an 

indicator of the broader approach regulators will take. 

In my view, there are currently no true SIFls in most of the financial sectors, including: private equity, 

venture capital, hedge funds, property-casualty insurance, and mutual funds management, with the 

possible exception of money market funds. This is not a matter of principle, but rather due to the fact 

that these are sectors which tend to generate quite low systemic risk per dollar of assets and none of 

them have enough assets for their absolute risk to come close to systemically important levels. It is 

possible that one or more of these sectors could develop SIFls over time, particularly in the hedge fund 

sector where there is a wide range of business models. Therefore, as noted earlier, a blanket exception 

by class of institution is inappropriate. 

It is possible that SIFls might exist among money market funds, since they can be of large size and their 

activities are somewhat analogous to deposit-taking, potentially giving them a great economic 

importance in a crisis. I have not studied money market funds sufficiently to reach a conclusion as to 

whether there is presently a SIFI among them. Regardless of the status of individual funds or funds 

managers, though, money market funds in aggregate clearly have systemic significance and it is good 

that their structure and regulation is being carefully considered through other processes at the moment. 

I do believe that there are probably several SIFls among the largest life insurers. These firms, like banks, 

are financial intermediaries that take funds from the public and operate with quite substantial leverage 

compared to a non-financial firm, and therefore are prone to some of the same risks as banks. At the 

same time, their business models tend to generate less systemic risk, particularly because they have 

much longer liabilities than banks do, giving them considerably more time to react to problems without 

being forced into a fire sale of assets. Thus, life insurers do generate systemic risk, but substantially less 

risk per dollar of assets than is true for banks. Some insurers are so large, however, that their size more 

than makes up for their low risk generation per dollar of assets. As a separate matter, political and 
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bureaucratic pressures are quite likely to result in SIFI designation in order to underline that the FSOC 

has taken its responsibility seriously to designate non-bank SIFls. 

It is very important, however, that any life insurers designated as SIFls should be regulated in a manner 

consistent with the major differences between insurance and banking. The regulators appear sincere in 

wanting to do this, but it remains a question as to whether ingrained ways of viewing the world may 

make it difficult to make the full transition in viewpoint in time for the initial SIFI regulations for nonbanks. It may become a cumbersome iterative process of starting with regulations that are far from a 

perfect fit and working out improvements over time, which would be a shame. 

The finance company business model is one that can generate even more systemic risk per dollar of 

assets than banking does. There is a similar maturity mismatch between short-term borrowings and 

medium- to longer-term loans, but the wholesale nature of the finance company's funding model makes 

them even more vulnerable to runs than banks are. In fact, this vulnerability largely eliminated the big 

finance companies in the crisis or forced them to adopt a banking-type business model that brings them 

into effective SIFI status already. There is one well-known exception among the large finance companies 

which I strongly assume will be designated as a non-bank SIFt. 

In sum, designating non-bank SIFls is by its nature a complex endeavor that requires a careful balancing 

act and substantial human judgment. The rules proposed by the regulators generally reflect those 

considerations and I believe that the resulting uncertainty about the ultimate outcomes is unavoidable, 

unless we either abandon the effort to designate such SIFls or use cruder measurements that would 

almost certainly produce worse results. I am more concerned about whether those non-banks that are 

designated as SIFls will be regulated in a way that fully reflects their differences with banks, but I am 

hopeful that this can eventually be worked out. 

Thank you again for the opportunity to testify today. I look forward to your questions. 
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For release on delivery 

10 a.m. EST 

May 16,2012 

Statement of 

Michael S. Gibson 

Director 

Division of Banking Supervision and Regulation 

Board of Govemors of the Federal Reserve System 

before the 

Subcommittee on Financial Institutions and Consumer Credit 

of the 

Committee on Financial Services 

U.S. House of Representatives 

May 16,2012 
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75731.012

Chainnan Capito, Ranking Member Maloney, and other members of the Subcommittee, 

thank you for the opportunity to testify on implementation of the Dodd-Frank Wall Street 

Refonn and Consumer Protection Act of2010 (Dodd-Frank Act) as it relates to the designation, 

supervision, and regulation of systemically important nonbank financial companies. 

Systemically Important Nonbank Financial Companies and the Problem of "Too Big to 

Fail" 

The recent financial crisis showed that some financial companies, including nonbank 

financial companies not historically subject to consolidated prudential supervision, had grown so 

large, leveraged, and interconnected that their failure could pose a threat to overall financial 

stability. The sudden collapses or near-collapses of major financial companies, and in particular 

major nonbank financial companies, were among the most destabilizing events of the crisis. The 

crisis also demonstrated weaknesses in the existing framework for supervising, regulating, and 

otherwise constraining the risks of major financial companies, as well as deficiencies in the 

government's toolkit for managing their failure. 

As a result of the imprudent risk-taking of major financial companies and the perceived 

severe consequences to the financial system and the economy associated with their disorderly 

failure, the U.S. government (and many foreign governments) intervened to reduce the impact of: 

or prevent, the failure of these companies. Before the crisis, market participants had assumed 

that major financial companies likely would receive government assistance if they became 

troubled. The actions taken by governments in response to the crisis, although necessary, helped 

to solidify the market view that such financial firms were too big to fail. 

The Dodd-Frank Act addresses key gaps in the framework for supervising and 

regulating systemically important financial institutions and the market perception that such firms 
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- 2 -

are too big to fail. Specifically, the Dodd-Frank Act seeks to mitigate the threat to financial 

stability posed by systemically important nonbank financial companies that were historically 

outsidc the existing regulatory framework for bank holding companies. The Dodd-Frank Act 

takes a multi-pronged approach to do so, including: (i) the establishment of the Financial 

Stability Oversight Council (the Council), which has the authority to designate nonbank financial 

companies that could pose a threat to financial stability; (ii) a new framework for consolidated 

supervision and regulation by the Federal Reserve of nonbank financial companies designated by 

the Council; and (iii) improved tools for the resolution of failed nonbank financial companies. 

I will briefly discuss the Federal Reserve's work to date in each of these key areas. 

Designation of Nonbank Financial Companies by the Financial Stability Oversight Council 

As you know, the Dodd-Frank Act created a council of regulators, the Financial Stability 

Oversight Council, to coordinate efforts to identify and mitigatc threats to U.S. financial stability 

across a range of institutions and markets. Among the Council's most important responsibilities 

are establishing a framework for designating nonbank financial companies whose failure could 

pose a threat to financial stability, and applying that framework to designate and reassess 

individual firms over time. Once designated, these firms would be subject to consolidated 

supervision by the Federal Reserve and would be required to satisfy enhanced prudential 

standards established by the Federal Reserve under title I of the Dodd-Frank Act. 

The Federal Reserve has been working closely with the other member agencies of the 

Council to put this designation framework in place. On April 3, the Council issued a final rule 

and interpretive guidance setting forth the criteria and process it will use to designate nonbank 

financial firms as systemically important. The Council's rule provides detail on the framework 

that it intends to use to assess a particular firm's potential to threaten U.S. financial stability. 
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- 3 -

The analysis would take into account the firm's size, interconnectedness, provision of critical 

products or services, leverage, and reliance on short-term funding, as well as its existing 

regulatory oversight. 

The Council's issuance of this rule is an important step forward in ensuring that 

systemically critical nonbank financial firms will be subject to strong consolidated supervision 

and regulation. The Council and its member ageneies' staffs currently are using these criteria to 

analyze the potential systemic importance of individual nonbank financial companies in different 

industries. As the Council gains experience ",ith the designation process, we expect it will make 

adjustments to its rule and procedures as appropriate. 

Regulation and Supervision of Systemically Important Nonbank Financial Companies 

Of course, the identification and designation of systemically important nonbank financial 

companies is only an initial step. Just as important is the establishment of a strong, effective 

regulatory framework for constraining the systemic risk posed by such firms. In this regard, 

sections 165 and 166 of the Dodd-Frank Act require the Federal Reserve to establish enhanced 

prudential standards both for bank holding companies with total consolidated assets of$50 

billion or more and for nonbank financial companies designated by the Council. These standards 

include enhanced risk-based capital and leverage requirements, liquidity requirements, singlecounterparty credit limits, stress testing, risk-management requirements, an early remediation 

regime, and resolution-planning requirements. Sections 165 and 166 also require that these 

prudential standards become more stringent as the systemic footprint of the firm increases. 

In December, the Federal Reserve issued a package of proposed rules to implement 

sections 165 and 166 of the Dodd-Frank Act. The Federal Reserve's proposed rules would apply 

the same set of enhanced prudential standards to covered companies that are bank holding 
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-4-

companies and covered companies that are nonbank financial companies designated by the 

Council. As we made clear in the proposal, however, the Federal Reserve may tailor the 

application of the enhanced standards to different companies on an individual basis or by 

category, taking into consideration each company's capital structure, riskiness, complexity, 

financial activities, size, and any other risk-related factors that the Federal Reserve deems 

appropriate. Working out the exact details of how enhanced prudential standards will apply to 

nonbank financial companies will certainly require a thoughtful and iterative analysis of each 

designated company over time. Once the Council designates one or more nonbank financial 

companies, the Federal Reserve is committed to thoroughly assessing the business model, capital 

structure, and risk profile of each designated company and tailoring the application of the 

enhanced standards to eaeh company on an individual basis or by category, as appropriate. The 

Federal Reserve will also give careful consideration to the appropriate transition period required 

for newly designated nonbank financial companies to comply with the enhanced prudential 

standards and other regulatory requirements. 

The comment period for the Federal Reserve's enhanced prudential standards proposal 

closed on April 30, 2012. Nearly 100 comments letters were received. The Federal Reserve is 

currently reviewing those comments carefully as we work to develop final rules to implement 

sections 165 and 166. 

Living Wills and Orderly Resolution 

Ending "too big to fail" also requires that a systemically important financial institution be 

allowed to fail if it cannot meet its obligations--and to fail without inflicting serious damage on 

the broader financial system. Thus, the Dodd-Frank Act empowers the Federal Reserve and the 

Federal Deposit Insurance Corporation (FDIC) to reduce the impact on the system in the event of 
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5 -

the failure of a systemically important nonbank financial company through two impOltant new 

regulatory tools. First, section J65(d) of the Dodd-Frank Act requires each bank holding 

company with total consolidated assets of$50 billion or more and each nonbank financial 

company designated by the Council to prepare and provide to the FDIC and the Federal Reserve 

a resolution plan, or "living will," for its rapid and orderly resolution under the U.S. bankruptcy 

code. Second, title II of the Dodd-Frank Aet provides for an orderly resolution process to be 

administered by the FDIC. Importantly, both of these new tools extend to systemically important 

nonbank finaneial companies, in addition to bank holding companies with total consolidated 

assets of $50 billion or more. 

Thank you very much for your attention. I would be pleased to answer any questions you 

might have. 
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75731.017

Statement of Scott E. Harrington 

Alan B. Miller Professor 

The Wharton School 

University of Pennsylvania 

On "Implementing Title I of the Dodd-Frank Act: The New Regime for Regulating 

Systemically Important Nonbank Financial Institutions" 

Before the 

Subcommittee on Financial Institutions and Consumer Credit 

Committee on Financial Services 

United States House of Representatives 

May 16,2012 

Chairman Capito, Ranking Member Maloney, and members of the Subcommittee: 

I am the Alan B. Miller Professor at the University of Pennsylvania's Wharton 

School, where I also serve as director of the WhartonlPenn Risk and Insurance Program 

and executive director of the S.S. Huebner Foundation for Insurance Education. I have 

spent much of my career conducting research and teaching on insurance markets and 

regulation, including solvency regulation and capital requirements. 1 

I am pleased to have this opportunity to testify as an independent expert on the 

Financial Stability Oversight Council's (FSOC's) final rule on the Authority to Require 

Supervision and Regulation of Certain Nonbank Financial Companies and the Federal 

Reserve's proposed rule for supervising such firms. My testimony first contrasts systemic 

risk between insurance and banking. I then provide specific comments on the FSOC's 

final rule and the Federal Reserve's proposed rule. 

SystemiC Risk in Insurance vs. Banking 

The term "systemic risk" encompasses the risk to financial institutions with 

spillovers on the real economy from large, macroeconomic shocks andlor extensive 

interconnectedness among financial firms. There is a distinction, however, between the 

11 am a member of the Federal Advisory Committee on Insurance, which was created in November, 2011 to 

advise the Federallnsurance Office established by the Dodd-Frank Act. 
73 


75731.018

risk of common shocks to financial firms and risk that arises from interconnectedness and 

attendant contagion. Rather than interconnectedness and contagion, the principal driver of 

the financial crisis in general and the collapse of American International Group, Inc. (AIG) 

in particular was direct exposure to the housing bubble and declines in values of mortgage 

related securities and instruments. The extent to which noninsurance activities at AIG 

presented significant risk of contagion is uncertain. 

Consistent with the generally favorable performance of core insurance activities 

during the crisis, the consensus is that systemic risk is minimal in insurance markets 

compared with banking. Banking crises have much greater potential to produce rapid and 

widespread harm to economic activity and employment. This fundamental difference 

helps explain historical differences in regulation across the insurance and banking sectors. 

Significant systemic risk strengthens the case for relativcly broad government 

guarantees of bank obligations and relatively stringent financial regulation, including 

capital requirements. Because insurance poses little systemic risk, there is less need for 

relatively broad guarantees ofinsurers' obligations to policyholders and stringent capital 

requirements. State insurance guarantees have been narrower in scope than federal 

guarantees in banking, and market discipline for safety and soundness is reasonably strong 

in insurance markets. Insurers commonly have held much more capital than required by 

regulation and have not faced strong incentives for regulatory arbitrage to evade capital 

requirements. 

The FSOC's Final Rule 

Section 113 of the Dodd-Frank Act gives the FSOC the authority by a two thirds vote 

to designate a nonbank financial company as systemically important (by imposing a threat to 

the financial stability of the United States) and subject to enhanced regulation and 

supervision by the Federal Reserve. The Federal Reserve is required to establish, with input 

from the FSOC, enhanced risk-based capital requirements, leverage rules, resolution 

standards, and other requirements for systemically important nonbank financial companies. 

Section 113 specifies factors the FSOC must consider in determining whether a company 

will be subject to enhanced supervision including its leverage; off-balance sheet exposure; 

importance as a source of credit and liquidity for households, businesses, state and local 

2 
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75731.019

governments, and low-income communities; the nature, scope, size, and interconnectedness 

of its activities; the amounts and nature of its assets and liabilities; the degree to which it is 

already regulated by one or more primary regulators; and "any other risk-related factors that 

the Council deems appropriate." 

The FSOC issued an advanced notice of rule making for Section 113 in October, 2010, 

a notice of proposed rulemaking in January, 201 I, a second notice of proposed rulemaking in 

October, 201 I, and a final rule in April, 2012. Apart from a number of clarifications, the 

final rule and accompanying guidance are essentially the same as the notice of proposed 

rulemaking issued in October, 2011. Much of the detail concerning implementation remains 

in the interpretive guidance, which retains the six-category analytical framework first set 

forth in the January, 2011 notice. The categories include firm size, substitutability of its 

products/services, interconnectedness, leverage, liquidity risk and maturity mismatch, and 

existing regulatory scrutiny. The final rule's interpretative guidance retains the three stage 

determination process proposed in October, 2011, including specific quantitative thresholds 

to be used in the first stage. 

Stage 1 of the analysis would employ publicly available information and information 

from member regulatory agencies to identify nonbank financial companies for more 

detailed evaluation in Stage 2. A nonbank financial company would be evaluated further 

in Stage 2 if global consolidated assets are $50 billion or greater and it meets at least one 

of the following thresholds: 

• $30 billion in gross notional credit default swaps 

• $3.5 billion of derivative liabilities 

• $20 billion of total debt outstanding 

• 15 to 1 leverage ratio (total consolidated assets to total equity, excluding separate 

accounts) 

• 10 percent ratio of short-term debt (maturity less than 12 months) to total 

consolidated assets (excluding separate accounts) 

While the guidance refers to analysis of historical data as the basis for the thresholds, it 

provides little detail, and it is not clear why dollar amounts are used for credit default 

swaps, derivative liabilities, and outstanding debt, as opposed to thresholds that arc scaled 

3 
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75731.020

by relevant measures of firm size. 

The inclusion of the quantitative thresholds provides guidance to companies 

regarding their potential for designation. The thrcsholds prcsumably reflect the FSOC's 

attempt to balance the desire of companies for some degree of certainty versus maintaining 

flexibility to designate nonbank financial companies that may not be readily identified by 

more precise quantitative standards. Indeed, the interpretive guidance indicates that "the 

Council may initially evaluatc any nonbank financial company based on other finnspecific qualitative or quantitative factors, irrespective of whether such company meets the 

thresholds in Stage 1." Thus, the $50 billion size threshold and requirement that a 

company meet at least one of the other thresholds are sufficient but not necessary for 

inclusion of a company in the "Stage 2 Pool" for further analysis. 

Stage 2 would entail a review and prioritization of Stage 2 Pool entities based on 

analysis of each company using infonnation available to the FSOC through existing public 

and regulatory agencies and information obtained from the company voluntarily. The 

analysis would use a wide range of quantitative and qualitative industry-specific and 

company-specific factors. The FSOC also would evaluate whether resolution of the 

company could pose a threat to U.S. financial stability and the extent to which the 

company is subject to regulation. Based on this analysis, thc FSOC would notify 

companies it believes merit further evaluation in Stage 3 (the Stage 3 Pool). 

In Stage 3, the FSOC (with assistance from the Offiee of Financial Rescarch) would 

review each company identified for further analysis in Stage 2, including analysis of 

additional information collected directly from the company. The evaluation would 

consider the company's resolvability, and the FSOC would consult with the company's 

primary regulator. Following such analysis, a Proposed Detennination would require a 

two-thirds vote of the FSOC, followed by a hearing if requested by the company, and, if 

so, a final vote by the FSOC. 

Overall, the final rule and interpretive guidance provide the FSOC with broad 

discretion for designating systemically important nonbank financial companies. Some 

nonbank companies will likely face considerable uncertainty about possible designation and 

actions they might take to rednce risk and avoid that result. The specific application of the 

4 
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final rule by the FSOC will determine whether the net is cast broadly or narrowly. In my 

opinion (and excluding AIG), appropriate application by the FSOC of the statutory criteria 

and the final rule should not result in designation of any companies that predominantly 

write property/casualty insurance as systemically important and vcry few, if any, life 

insurers. Given the uncertainty associated with the designation process and possible 

unintended consequences, consideration could be given to establishing some form of safe 

harbor that would reduce uncertainty and increase the likelihood of that result. 

l:-1fects of Designation on Competitive Dynamics 

The designation of individual insurance entities and other nonbank financial 

companies as systemically significant, as opposed to a system of heightened scrutiny and 

supervision of specific types of activities that pose systemic risk, has significant 

drawbacks. There is little cause for optimism concerning the ability of enhanced 

supervision of individual companies designated as systemically important to reduce 

significantly the likelihood of any future crisis. Greater capital requirements and tighter 

regulation for individual companies designated as systemically important raise the risk that 

they could face excessive burdens and costs that would disrupt competition and harm 

customers, at least in the near term when memories of the financial crisis are fresh. On the 

other hand, sooner or later a "systemically important" designation of a nonbank financial 

company would likely translate as "too big to fail," regardless of assertions that creditors 

and shareholders of companies will not be bailed out in the event of financial distrcss. 

That result would provide designees with a competitive advantage in attracting customers 

and capital and significantly undermine market discipline and incentives for safety and 

soundness. 

These drawbacks favor narrow application of the FSOC's statutory charge to identifY 

systemically important companies. In the specific case of insurance, the potential benefits 

from designating some companies as systemically important are small, and the potential 

costs are large. 

The Federal Reserve's Proposed Rule for Enhanced Prudential Standards 

The Fedcral Reserve's January, 2012 proposed rule for enhanced prudential 

standards and early remediation requirements for large bank holding companies and 

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nonbank financial companics designated by the FSOC, including capital requirements, 

liquidity standards, and strcss testing, is bank centric. Unless modificd significantly for 

nonbank financial institutions, the proposed rule would apply standards developed for 

large banks to nonbanks without regard to fundamental differences in operations and risk 

profiles, with the potential for significant market disruptions and unintended consequences. 

This result obviously should be avoided. 

Enhanced prudential standards for nonbank financial companies identified by the 

FSOC as systemically important should be tailored to the distinct nature of the operations 

and risks of specific nonbank financial services. In the case of insurance, careful 

consideration should be given to linking enhanced prudential standards to existing riskbased capital requirements for insurers and related state regulation. 

6 
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Statement 

of the 

U.S. Chamber 

of Commerce 

ON: "Implementing Tide I of the Dodd-Frank Act: The New Regime for 

Regulating Systemically Important Nonbank Financial 

Institutions" 

TO: The Subcommittee on Financial Institutions and Consumer Credit 

DATE: May 16, 2012 

The Chamber's mission is to advance human progress through an economic. 

political and social system based on individual freedom, 

incentive. initiative. opportunity and responsibility. 
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The U.S. Chamber of Commerce is the world's largest business federation, 

representing the interests of more than 3 million businesses of all sizes, sectors, and 

regions, as well as state and local chambers and industry associations. 

More than 96 percent of the Chamber's members are small businesses with 

100 or fewer employees, 70 percent of which have 10 or fewer employees. Yet, 

virtually all of the nation's largest companies arc also active members. We are 

particularly cognizant of the problems of smaller businesses, as well as issues facing 

the business community at large. 

Besides representing a cross-section of the American business community in 

terms of number of employees, the Chamber represents a wide management spectrum 

by type of business and location. Each major classification of American business 

manufacturing, retailing, services, construction, wholesaling, and finance is 

represented. Also, the Chamber has substantial membership in all 50 states. 

The Chamber's international reach is substantial as well. It believes that global 

interdependence provides an opportunity, not a threat. In addition to the 

U.S. Chamber of Commerce's 115 American Chambers of Commerce abroad, an 

increasing number of members are engaged in the export and import of both goods 

and services and have ongoing investment activities. The Chamber favors 

strengthened international competitiveness and opposes artificial U.S. and foreign 

barriers to international business. 

Positions on national issues are developed by a cross-section of Chamber 

members serving on committees, subcommittees, and task forces. More than 1,000 

business people participate in this process. 

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Chainnan Capito, Ranking Member Maloney and members of the Financial 

Institutions and Consumer Credit Subcommittee, my name is Tom Quaadman. I am 

vice president for the Center for Capital Markets Competitiveness at the U.S. 

Chamber of Commerce. I appreciate the opportunity to testify before the 

Subcommittee today on behalf of the businesses that the Chamber represents. 

To compete, grow, and create jobs, America's businesses need efficient capital 

markets. Efficient capital markets allow businesses to have the access to the resources 

needed to operate on a daily basis and strategically plan for long-tenn success. 

Effective regulators who understand these markets create a regulatory regime that 

promotes balance and allows good actors to play on an even playing field while 

identifying and acting against bad actors through vigorous oversight and enforcement. 

Monitoring and regulating systemic risk, whereby the collapse of a finn could 

imperil the entire domestic and/or global financial system, is an important part of a 

regulatory structure needed for America's businesses to compete in a 21 st century 

economy. While systemic risk is a very broad subject, I will confine my remarks to 

the issues related to the subject of today's hearing-identifying and regulating 

nonbank companies that are engaged in financial activities to such a degree and on 

such a scale that they pose a systemic risk to U.S. and global financial markets .. 

1. Overview 

In 2007, the Chamber created the Center for Capital Markets Competitiveness. 

The Center was established to advocate for financial regulatory refonns needed to 

ensure that American businesses had access to efficient flows of capital necessary to 

compete in a 21 st century global economy. 

It became apparent during the 2007-2008 financial crisis that the Federal 

Government did not have the regulatory apparatus necessary to identify, assess and, 

when appropriate, manage systemic risk. In November, 2008, the Chamber called for 

the establishment of a systemic risk regulator as part of a larger financial regulatory 

refonn effort. Congress included systemic risk regulation in Title I and II of the 

Dodd-Frank Wall Street Refonn and Consumer Protection Act ("Dodd-Frank Act"). 

While the Chamber opposed the final passage of the Dodd-Frank Act, the Chamber 

supported legislative efforts to properly address systemic risk. In particular we 

supported the efforts that resulted in the Pryor-Vitter amendment which creates the 

"predominantly engaged in financial activities" test for nonbank companies. We 

continue to believe that this amendment provided needed clarity to the process of 

identifying nonbank financial institutions that may be subject to desiguation for 

additional regulatory scrutiny as systemically important institutions. 

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In looking at means of managing systemic risk, Congress recognized that with 

respect to nonbank companies, it was crucial to provide a clear delineation between 

nonbank financial institutions, and those companies whose financial activities are 

incidental to a primary commercial focus. 

We believe that Congress did a good job in striking that balance. However, we 

are very concerned that the implementation of Title I of the Dodd-Frank Act by 

regulators is being done in a manner that is manifestly contrary to the clear and 

unambiguous language Congress used to strike this important balance. 

Congress clearly recognized that care must be exercised in distinguishing 

nonbank companies that may be systemically important from nonbank companies 

whose financial activities are ancillary to other commercial activities and have not 

posed such a threat. Thus, Congress established a two-part test for determining if 

nonbank companies should be considered to be financial companies, and potentially 

designated as systemically important. This process can be thought of as two inverted 

funnels sitting on top of each other. 

Under Title I of the Dodd-Frank Act nonbank companies first have to pass 

through a narrow stem of exacting criteria established by the Pryor-Vitter amendment 

to determine if a company is a financial company-that is, a company that is 

predominantly engaged in financial activities. A company is considered to be 

predominantly engaged if 85% of its consolidated revenues or assets are derived from 

financial activities as defined in section 4k of the Bank Holding Company Act. 

Section 4k defines specific activities, that when conducted subject to specific 

conditions, are considered "financial in nature" such that a regulated bank may engage 

in them. 

Those companies that meet this high threshold for being U.S. Of foreign 

"nonbank financial companies" then pass through to the "second funnel." In part 

two, Of the wide part of the second funnel, Financial Stability Oversight Council 

("PSOC") determines if a U.S. or Foreign nonbank financial company should be 

designated as a systemically important financial institution ("SIP!") by using a broad 

set of criteria including leverage and off balance sheet exposures. Going through the 

narrow stem of the second funnel, once a company is designated, it is subject to 

enhanced prudential regulation and oversight by the Board of Governors of the 

Federal Reserve ("the Board"), though the SIPI's prudential regulator is given the lead 

role in shaping regulations to meet the unique needs of the company. 

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We believe that Congress struck the right equilibrium with this system. It 

ensures that only nonbank companies engaging on a considerable scale in financial 

activities permissible for a regulated bank to undertake are even candidates to be 

assessed for designation by the PSOc. Once this initial sifting has been completed, 

Congress further required that banks and nonbank financial companies labeled as 

SIFIs by the FSOC should be treated differently from one and other. This is why the 

Dodd-Prank Act acknowledges the need for nonbank SIFIs to have enhanced 

regulations that meet the parameters of their business model and are different from 

the enhanced regulations mandated for systemically import,ltlt banks. 

In short, Congress determined that the power to designate and regulate 

nonbank SIns should be used only sparingly and, if used, it must result in regulations 

that take into account the unique circumstances of each company and the markets in 

which it competes. This system allows for the assessment and regulation of threats to 

the system, without causing undue stress or hann to the economy. 

Unfortunately, the Board and FSOC are disregarding the carefully balanced 

structure Congress passed into law. In doing so regulators are creating exactly the 

uncertainty and potential for regulatory overreach that prompted the Pryor-Vitter 

Amendment. If they are allowed to obtain by regulatory fiat a scope of power and 

discretion Congress denied them, regulators may create economic imbalances hanning 

businesses and consequently economic growth and job creation. 

I nstead of the narrow "stem" of the first inverted funnel that limits inclusion to 

those nonbank businesses that meet the exacting "predominantly engaged" standard, 

the regulators are broadening the criteria to create a high-capacity pipeline. This flies 

in the face of both the intent and specific language of the Pryor-Vitter amendment. 

This may ensnare companies into the systemic risk web who should not be there. By 

broadening the range of activities counted towards whether non banks are threatened 

with being placed in the pot of entities that may be considered for nonbank SIF1 

designation by the FSOC, regulators are overreaching into commercial activities that 

had nothing to do with the recent financial crisis. In doing so, they do not lessen 

systemic risk. They simply compel responses that have adverse consequences 

throughout the economy. 

The fear and uncertainty that this regulatory overreach imposes is further 

enhanced by the fact that, as will be discussed further, the Federal Reserve has not 

given prudential regulators the lead role in shaping specific regulations for specific 

nonbank businesses that are ultimately designated. Instead, the Board appears to be 

creating a one-size-fits-all, bank-centric approach that will not work well with 

nonbanks, spanning diverse industries unrelated to banking. 

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2. Nature of Risk and Adverse Consequences of Circumventing the 

"Predominantly Engaged" Standard 

Risk, like energy, can neither be created nor destroyed, but only transferred. So 

when discussing systemic risk we cannot be tricked into thinking that risk disappears. 

It simply moves elsewhere. Our system relies on the presence of actors who view the 

potential rewards of accepting this risk as sufficient to prompt them to do so. If they 

should come to view the costs and risks as outweighing any potential reward, the flow 

of capital will come to a standstill. 

To truly minimize the probability of future financial crises, we must understand 

how this risk moves and where it will show up next. Risk is managed most efficiently 

when it is transparent and properly understood, and the market responds with robust, 

efficient and liquid hedging solutions. 

By creating a balanced system of clear criteria for nonbank financial companies 

to be subjected to systemic risk regulation, Congress went down the path of 

transparency to provide understandable guideposts. For instance, a corporate 

treasurer whose company imports a raw material from overseas, must manage 

currency risk, commodity price risk, interest rate risk, and operational shipping risks. 

By defining activities that are "financial in nature" to be different than the activities 

banks may undertake pursuant to section 4(k), regulators defY the clear and 

unambiguous command of Congress. If the above described activities were to be 

considered in the scope of activities that are financial in nature under a predominantly 

engaged test broadened by regulators, companies may conclude that some risk 

management techniques and heretofore efficient transactions will no longer be 

available, or, if they are available, they will no longer be cost effective. They will 

decide to "go naked" and retain more risk internally, ultimately shifting risk back to 

shareholders. The upshot of this is that they will hold even more precautionary cash 

on their balance sheets as a buffer. This will take money out of the real economy, stall 

economic growth, stunt the creation of new jobs, and destroy existing jobs. 

3. Process Concerns 

a. Lack of Transparency 

We fully understand and agree that FSOC discussions regarding SIFI designations, the 

affairs of a designated company, and, if need be deliberations regarding the use of 

Title II Orderly Liquidation Authority should be kept in camera. The very nature of 

those discussions could have damaging impacts upon the markets, the company and 

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its investors. However, when the FSOC is acting in its quasi-legislative capacity to 

establish the framework for its designation work, its actions should be subject to the 

same procedural safeguards that typically attach to such rulemaking efforts. This 

ensures that ret:,'Ulatory deliberations are happening with the same level of 

transparency and care as the deliberation of prudential regulators. 

By not following basic procedural standards and safeguards generally applicable 

to federal regulators, the FSOC has created needless uncertainty and concern as to the 

logic and motivations behind the regulations it promulgates. It reduces the ability of 

the regulated community to understand and comply with FSOC's rules. Although the 

FSOC has provided an opportunity to comment, in many instances there is no 

evidence that the comments are considered and, if so, to what extent. There is often 

no reasoned explanation in final rules responding to the comments of the regulated 

community. This discourages stakeholders from providing the FSOC with informed 

commentary that may improve a proposed regulation. It also decreases the regulated 

community's acuity as to what regulators may decree next, which increases uncertainty 

in the business community. 

The Chamber believes that Congress needs to ensure that when the FSOC 

issues regulations bearing on a matter as important as the security of the financial 

markets of America and the world, it abides by the same legal and procedural 

requirements that other administrative agencies must when promulgating rules on 

much less significant matters. 

b. Lack of Cost Benefit Analysis 

Additionally, in the rulemaking process, FSOC did not provide a cost-benefit 

analysis to allow stakeholders to determine the potential impacts of proposed 

regulations. In finalizing the rules on designating companies, the FSOC went so far as 

to state that the designation of systemically important companies was not 

economically significant as the Office of Management and Budget did not deem this 

rule a significant regulatory action. This is logically inconsistent reasoning that either 

implies that systemic risk regulation is meaningless or unnecessary, or that the 

statement is factually incorrect in stating that the regulations will not have a cost to 

companies and the economy. 

The Chamber believes that the FSOC should have to provide an economic 

analysis in promulgating a rule. The FSOC should also conduct an economic analysis 

during Phase 3 of the SIFI designation process to ensure that designation is the most 

appropriate path for a company rather than enhanced regulation by its prudential 

regulator. Furthermore, the Chamber believes that Congress should study the 

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possibility of streamlining the FSOC rulemaking along the lines of Executive Order 

13563 which places upon agencies the requirement, when promulgating rules to: 

1) Propose or adopt a regulation only upon a reasoned determination that its 

benefits justify its costs (recognizing that some benefits and costs are 

difficult to justify); 

2) Tailor its regulations to impose the least burden on society, consistent with 

obtaining regulatory objectives, taking into account, among other things, 

and to the extent practicable, the costs of cumulative regulations; 

3) Select, in choosing among alternative regulatory approaches, those 

approaches that maximize net benefits (including potential economic, 

environmental, public health and safety and other advantages; distributive 

impacts; and equity); 

4) To the extent feasible, specify performance objectives, rather than 

specifying the behavior or manner of compliance that regulated entities 

must adopt; and 

5) Identify and assess available alternatives to direct regulation, including 

providing economic incentives to encourage the desired behavior, such as 

user fees or marketable permits, or providing information upon which 

choices can be made to the public. 1 

Additionally, Executive Order 13563 states that "[i]n applying these principles, 

each agency is directed to use the best available techniques to quantify anticipated 

present and future benefits and costs as accurately as possible." 

This provides a valuable guidepost to strengthen the FSOC rulemaking 

process. 

c. Rules Considered Out of Order and Not Completed 

The consideration and promulgation of rules needed to implement Title I have 

been taken out of sequence and much has yet to be completed. The logical sequence 

of rules under Title I should be as follows: 1) the Board's definition of 

"predominantly engaged in financial activities"; 2) the Board's criteria for exempting 

certain types or classes of O.S. nonbank financial companies or foreign nonbank 

1 Executive Order 13563 

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financial companies from supervision under section 170 of the Dodd-Frank Act; 3) 

the FSOC's authority to require supervision and regulation of certain nonbank 

financial companies; and 4) the Federal Reserve's enhanced prudential standards and 

early remediation for covered companies. Promulgation of these rules in the proper 

sequence would allow interested parties, including those companies that could 

potentially be caught in any of the earlier rules in the logical sequence, to determine 

whether they will be subject to a subsequent rule and have certainty as to how any 

proposed subsequent rule will impact them, so that they can provide comment 

accordingly. 

Unfortunately, financial regulators have taken a different and illogical approach. 

The following outlines the actual sequence of the systemic risk rulemaking process: 

• October 2010 - FSOC issues advanced notice of proposed rulemaking 

regarding authority to require supervision and regulation of certain 

nonbank financial companies. 

• January 2011 - FSOC issues notice of proposed ruIemaking regarding 

authority to require supervision and regulation of certain nonbank 

financial companies. 

• February 2011 - Federal Reserve issues notice of proposed rulemaking 

regarding the definitions of "predominantly engaged in financial 

activities" and "significant nonbank financial company." 

• October 2011 - FSOC issues second notice of proposed rulemaking 

regarding authority to require supervision and regulation of certain 

nonbank financial companies. 

• December 2011 Federal Reserve issues notice of proposed rulemaking 

regarding enhanced prudential standards and early remediation 

requirements for covered companies. 

• Apri12012 - FSOC issues final rule regarding authority to require 

supervision and regulation of certain nonbank financial companies. 

• Apri12012 Federal Reserve issues supplemental notice of proposed 

rulemaking regarding the definitions of "predominantly engaged in 

financial activities" and "significant nonbank financial company." 

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• Yet to be issued are proposed rules regarding criteria for exempting 

certain types or classes of U.S. nonbank financial companies or foreign 

nonbank financial companies from supervision under section 170 of the 

Dodd-Frank Act. 

This haphazard approach to incomplete rulemakings has made it impossible for 

stakeholders to understand how the systemic risk regulatory system will work and 

whether it will be subject to further rules under this regime. The Federal Reserve's 

rules regarding the definition of "predominandy engaged in financial activities" and 

the criteria for exempting certain types or classes of U.S. nonbank financial companies 

or foreign nonbank financial companies from supervision should have been 

completed before the FSOC issued its proposal on authority to require supervision 

and regulation of nonbank financial companies. Instead, companies have been 

subject to an unfair and inappropriate rulemaking process that has not provided 

clarity in terms of whether they will be subject to such rules. This handicaps their 

ability to provide meauingful comments on the rules that should logically have come 

at a different point in the implementation process. 

It is important also to note that although the FSOC has indeed finalized rules 

and guidance on the SIFI designation process, the Board has yet to finalize its rules on 

enhanced prudential standards. Until the Board completes this rulemaking, the FSOC 

cannot know what the consequences of SIFI designation are, and therefore cannot 

meaningfully assess whether a nonbank financial company should be designated. 

Accordingly, the Chamber recommends that the designation process not commence 

until the entire systemic risk rulemaking process is completed. 

d. Regulatory Coordination and Investor Uncertainty 

Obviously, the FSOC rulemakings will conflict or overlap with other preexisting rules that may have been in place for some time. For instance, the Exchange 

Acts requires that companies disclose to the Securities and Exchange Commission 

("SEC") and investors any conditions that are material to the company. Clearly, at 

some point in time, the consideration of a nonbank financial company as systemically 

important qualifies as a material condition that should be disclosed to investors. 

However, neither the FSOC nor the SEC has provided guidance on when, how, or if 

this consideration should be disclosed. 

The Chamber recommends that the FSOC and prudential regulators examine 

existing regulations and coordinate an approach to give stakeholders clarity and legal 

certainty as to their duties and actions. 

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4. Other Substantive Concerns 

a. One Size Does Not Fit All 

The systemic risk designation process and regulation of nonbank financial 

companies will implicate varied companies with different business models spread over 

many industries. Congress recognized that the prudential regulators should take the 

lead in molding the appropriate regulatory structures to meet the unique needs of 

nonbank financial companies. This has not occurred, to date, and there is a great 

concern that a one-size-fits-all bank-centric approach will be imposed because of the 

Federal Reserve's experience as a bank regulator. 

Taking a one-size-fits-all approach goes against Congressional intent as 

reflected in the Dodd-Frank Act. It will increase potential risk rather than reduce it. 

Congress clearly delineated between the treatment of systemically important nonbank 

financial companies and systemically important banks by setting up a detailed 

designation process for nonbank companies while instituting automatic designation 

for bank holding companies with total consolidated assets of $50 billion or more. 

A one-size-fits-all approach will not produce more effective oversight. 

Shoehorning nonbank financial companies into a banking regulatory framework will 

disrupt how these companies compete within their industry and in our global 

economy. Each financial company fulfills the need for a specific product or service in 

the marketplace. In the long run, imposing bank-like regulations on a diverse group 

of nonbank financial companies will force these companies to alter their business 

model such that the financial services industry becomes homogenized. In some 

instances, bank-like capital requirements might make certain business lines no longer 

economically feasible, even though these businesses are not inherently risky. Instead 

of mitigating systemic risk, such regulation would concentrate it and increase it 

exponentially, while reducing competition, customer choice and economic efficiency. 

Furthermore, this would accelerate the flight to less regulated products and 

jurisdictions, expanding moral hazard. 

Accordingly, the Chamber recommends that Congress work with FSOC to 

ensure that the prudential regulators have an enhanced role and develop nonbank 

financial systemic risk regulatory structures that more appropriately suit the different 

business models throughout the financial services industry. 

b. Federal Reserve Discretion 

In its notice of proposed rulemaking for enhanced prudential standards and 

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early remediation under section 165 of the Dodd-Frank Act, the Board acknowledges 

that the proposal is not designed or structured to address the special circumstances of 

nonbank financial companies. The proposal states: 

"Willie this proposal was largely developed with large, complex bank holding 

companies in mind, some of the standards nonetheless provide sufficient flexibility to 

be readily implemented by covered companies that are not bank holding companies. 

In prescribing prudential standards under section 165(b) (1), the Board would [sic] to 

take into account the differences among bank holding companies and nonbank 

financial companies supervised by the Board. Following designation of a nonbank 

financial company by the Council, the Board would thoroughly assess the business 

model, capital structure, and risk profile of the designated company to determine how 

the proposed enhanced prudential standards and early remediation requirements 

should apply. The Board may, by order or regulation, tailor the application of the 

enhanced standards to designated nonbank companies on an individual basis or by 

category, as appropriate. [Footnotes omitted}" 

This paragraph raises a series of important issues regarding the validity of this 

rulemaking proceeding with respect to SIFIs: 

• Why is the Board seeking to apply the Enhanced Standards to a class of entities 

-nonbank financial companies-that it apparently did not have in mind when it 

drafted the proposal? 

• What is the Board's rationale for not carefully considering the circumstances 

presented by nonbank financial companies that might be designated as SIFIs 

and to draft Enhanced Standards to address and accommodate the differences 

between these nonbank SIFIs and Large Bank Holding Companies ("large 

BHe's")? 

• Has the Board considered and quantified the costs to potential SlFIs, the 

financial system and the economy of imposing Enhanced Standards designed 

for Large BHCs on nonbank SIFIs, and of SIFIs revising their business models 

and investment strategies to comply with Large BHCcentric metrics that may 

be inappropriate, ineffective and even counter-productive for achieving 

increased systemic financial stability? 

• Why has the Board not advised the public as to which specific standards it 

believes can be readily implemented by non-BHe SIFTs and which it believes 

cannot? 

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• The Board appears to indicate that only after a SIFI is designated will it 

consider how the rules should apply to it and that, depending on that review, 

the Board may amend the rules or issue an order to tailor the application of the 

rules to a particular SIFI or a category of SIFT s. Under this approach, how can 

anyone, including the FSOC, a potential SIFl's functional regulators, the 

markets, or a potential SIFI itself, understand how the rules would apply to it if 

it were to be designated? The Board's indicated approach would appear to 

ignore the assessment made of each SIFI by the FSOC in order to make its 

designation. Indeed, it would put the FSOC in the position of designating a 

SIF! without being able properly to consider how effectively or efficiently the 

rules would operate to mitigate the perceived threat to financial stability posed 

by the company. The Board's attempt to maximize its reservation of discretion 

to deal with SIFIs is, therefore, not only fundamentally unfair to SIFls but also 

destructive of the intended gate keeping function of the FSOC. 

The proposal would apply the rules to Large BHCs and SIFIs. As a result, it is 

incumbent on the Board to consider how the rules would apply to both categories of 

institutions. Without providing commenters with a reasonable description of how the 

rules would apply to the wide variety of unidentified companies that may be 

designated as SIHs, the Board's approach does not the public to provide input that 

the promulgating agency is required to evaluate and incorporate into its final 

rulemaking, including in a statement of basis and purpose. Here, the Board 

acknowledges that it has not made any effort to craft the Rules with SIHs in mind. 

As a result, a potential nonbank SIFI is subject to the risk that the Board will adopt 

Rules that may not appropriately apply to the company, but that nevertheless on their 

face would be applicable to critical aspects of the company's operations. The Rules 

provide no indication of whether or how they would be tailored to the actual situation 

and circumstances of a newly designated SIFI. 

To take just one example, a potential SIFT may operate under a capital structure 

and regulatory capital requirements that do not meaningfully correlate with the capital 

standards to which Large BHCs have long been subject. In such a situation, the 

potential SIFT might not have sufficient capital to meet the capital requirements 

imposed under the rules because of its organizational form, statutory or regulatory 

restrictions or long-standing business or operating considerations. If the company 

were to be designated as a nonbank SIFI and had inadequate capital under Large 

BHC-centric regulatory capital requirements, it could be subject to severe regulatory 

restrictions on its business under the early remediation structure established by the 

rules. 

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If the Board proceeds on this course, it would place potential nonbank SlFIs in 

the very difficult position of being forced to speculate both on 0) whether it would 

ultimately be designated as a SlF1 and (ii) how the Board might seek to tailor the 

application of the Large BHC-centric rules to it. 

During what could be an extended period of uncertainty, a potential SIFl 

would have to decide whether to proactively restructure its business operations, 

capital structure and strategic plan to seek to respond to a potentially inappropriate 

and inapplicable regulatory structure. To the extent that this situation holds the 

potential of significant hann to the company, including the prospect of adverse 

market valuation movements in response to public disclosures regarding the potential 

adverse impact of the rules if applied to the company following its designation, it 

underscores the defective nature of the current rulemaking proceeding and presents a 

presumably unintended and wholly avoidable threat to financial stability and the 

economy_ Moreover, restructuring or other actions taken by potential SIFls to 

address the possible application of the rules to them may have an adverse impact on 

financial markets and a destabilizing impact on U.S. financial stability. 

A fundamental element of a rulemaking proceeding is the promulgating 

agency's obligation to support the policy and legal choices that it has made in light of 

the comments received. The statement of basis and purpose should layout the 

agency's thought processes and evaluation of the arguments in the comments it 

received. If the Board continues on the path that it has outlined in the proposal, it 

will not be able to meet this requirement and will not provide fair or transparent 

treatment to companies that are ultimately designated as SIFTs. Therefore, we 

recommend that the Board tenninate this rulemaking proceeding with respect to 

SIFls and expressly limit it to companies that qualify as Large BHCs under section 

252.12(d)(2) of the Proposal. In addition, in order to satisfy the statutory 

requirements of section 165 of the Dodd Frank Act and the requirements regarding 

notice and comment and the statement of basis and purpose, the Board should 

undertake a separate S1F1 nilemaking that meets the principles enumerated above. 

The current proposed rules give the Board wide ranging discretion to change 

rules and practices, seemingly on a whim. This fails to give designated companies, or 

potentially designated companies any legal certainty and hanns the ability of investors 

to appropriatey evaluate their options. This will create economic harm. 

5. Conclusion 

In crafting Title I, Congress wisely went to great pains to create a balanced 

approach to address systemic risk while minimizing the impact upon non-financial 

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companies. The regulators are, contrary to Congressional directive, creating an openended hunting license that will bag companies, which if the law was followed, would 

have been considered off limits. By disregarding the bounds established by Congress, 

the regulators are possibly creating the unintended consequences Congress hoped to 

avoid creating adverse impacts within the nonbank sectors of the economy. In 

recognizing that we must observe and manage systemic risk, we must at the same time 

acknowledge that reasonable risk taking is a necessary component for growth 

conducive for prosperity. 

This is a difficult balance to achieve, but one that must be struck in order to 

have the efficient and effective capital markets needed for businesses and a growing 

economy that creates jobs. 

I will be happy to take any questions that you may have. 

15 
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75731.038

Testimony of William J. Wheeler 

President, Americas 

MetLife, Inc. 

United States House of Representatives 

Financial Institutions and Consumer Credit Subcommittee 

Hearing Date: May 16, 2012 
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Introduction 

Chairwoman Capito, Ranking Member Maloney, members of the 

Committee, my name is Bill Wheeler and I am the President of the Americas 

Division at MetLife. Thank you for the opportunity to testify on behalf of MetLife. 

MetLife recognizes the importance of managing systemic risk and the 

need for sensible regulations to protect taxpayers from costly bailouts. Coming 

up with the appropriate regulatory formula will not be easy - either for the 

Financial Stability Oversight Council in designating nonbanking firms as 

systemically important, or for the Federal Reserve in determining the prudential 

standards to be applied to those firms. Nevertheless, we must get the 

prescription right: The stakes are too high to allow the costs or the benefits of 

regulation to be miscalculated. Striking the right balance is a large part of the 

challenge to ensure that we capture the benefits of regulation without imposing 

unnecessarily burdensome costs. 

By way of background, I was named President of the Americas for MetLife 

late last year, after serving for roughly eight years as the company's Chief 

Financial Officer. 

As you may know, MetLife is the largest life insurance company in the 

United States. We are the only one that is also a bank holding company. Our 

experience as an insurance company regulated by the Federal Reserve has 

provided us with unique insight into the pitfalls of applying bank-centric rules to 

non-bank financial companies. Indeed, it is because we do not believe our 

insurance business should be governed by regulations written for banks that we 

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have decided to sell our depository business. Through this sale, MetLife will 

cease being a bank holding company and join its peers in being regulated as an 

insurance company. 

I plan to discuss three topics in my testimony today. 

• First, why regulated insurance activities generally do not pose systemic 

risk. 

• Second, why naming only a few insurance companies as Systemically 

Important Financial Institutions ("SIFls") would needlessly upset the 

competitive landscape in the insurance sector. 

• Third, in the event that we are named a non-bank SIFI, why the 

prudential regulations must be tailored to our unique asset and liability 

characteristics. 

True Systemic Risk 

One of the principal purposes of the Dodd-Frank Act is, quote, "to protect 

the American taxpayer by ending bailouts." The failure of a financial firm, by 

itself, is not sufficient grounds for heightened regulation for systemic risk. Only 

when such a failure would "threaten the stability of the financial system of the 

United States" is additional regulation warranted. 

Far from presenting systemic risk to the U.S. economy, traditional life 

insurance activities are a force for financial stability. Life insurance companies 

protect policyholders and their beneficiaries from the loss of income that occurs 

as a result of death, disability or retirement. In order to make good on these 

promises, we invest hundreds of billions of dollars in primarily investment grade 

3 
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fixed-income securities that provide us with reliable returns. At a time of 

increasing budgetary strain on governmental social insurance and transfer 

programs, it is becoming more important than ever that insurers be able to offer 

financial protection that is attractively priced. 

Insurance company financial distress occurs far less frequently than bank 

distress. As of mid-2009, only three insurance companies had received taxpayer 

assistance through the Troubled Asset Relief Program, compared with 592 

banks.1 Quite frankly, I do not believe TARP money needed to be provided to at 

least two of these insurers to prevent any sort of systemic event. The asset and 

liability structures of insurance companies and banks are dramatically different. 

Banks generally borrow funds short term and invest long term, creating maturity 

mismatches than can lead to liquidity crises and runs on the bank. Insurance 

companies tend to make long-term promises to policyholders and invest in longterm fixed-income securities, better matching assets and liabilities and posing 

less liquidity risk. Unlike banks, insurers generally have a stable portfolio of inforce insurance pOlicies with regular premium payments and contractual features 

that prohibit or limit early calls by policyholders, such as surrender charges or tax 

penalties. 

"From that essential difference flows the reason why integrated regulators 

tend in a crisis to sleep easier at night about their insurance company charges 

than about their banks," according to Adair Turner, chairman of the United 

Kingdom's Financial Services Authority, which oversees both insurers and 

I "Systemic Risk in Insurance: An Analysis ofInsurance and Financial Stability," The Geneva Association, 

March 2010 

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banks.2 Similarly, in a detailed analysis of insurance and financial stability, the 

International Association of Insurance Supervisors concluded that "for most lines 

of business, there is little evidence of traditional insurance either generating or 

amplifying systemic risk within the financial system or in the real economy." 3 

Rather than designate a handful of insurance companies as SIFls and 

design a whole new set of prudential standards for them, a more sensible 

approach would be to identify and regulate those activities that fueled the 

financial crisis in the first place. In fact, Senator Dodd expressed a similar view 

in an exchange with Senator Collins prior to the Senate vote in favor of the DoddFrank Act. 4 

During the crisis, certain firms that expanded significantly into nontraditional and non-insurance activities suffered significant distress. Indeed, the 

main reason insurance companies are even part of the discussion about 

systemic risk is because of AIG. Yet AIG's troubles did not stem from traditional 

insurance activities operated within a regulated insurance company. As DoddFrank recognized, the Office of Thrift Supervision did not appropriately regulate 

the activities of AIG Financial Products. AIG experienced significant losses due 

to credit default swaps on securities backed by sub-prime mortgages, as well as 

from securities lending activities where proceeds were invested in risky real 

estate securities. With the fall in the housing market and overall credit crisis, 

counterparties required additional collateral to be posted, straining AIG's capital 

2 Speech by Adair Turner before the International Association of Insurance Supervisors, October 20 10 

3 "Insurance and Financial Stability," International Association of Insurance Supervisors, November 20 I I 

4 Discussion of Section 113 .. - Designation ofInsurance Companies as Nonbank Financial Companies, 

Congressional Record 156:105 (July 15,2010), p. S5902. 

5 
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and liquidity positions. Insurance law and insurance regulators would not have 

permitted these activities to occur in the same manner within a regulated 

insurance company. 

The relevant question to ask of Metlife is: Would the failure of our 

company "threaten the financial stability of the United States"? We believe the 

answer is no. We cannot think of a single firm that would be brought down by its 

exposure to Metlife. 

Picking Winners and Losers 

If FSOC names only certain insurance companies as SIFls, it will 

inadvertently be picking winners and losers in the insurance sector. The 

marketplace is very competitive today. Innovation and growth in market share 

can and does come from companies both big and small. 

Some commentators believe that naming MetLife and other large life 

insurance companies as SIFls would give us a competitive advantage over our 

smaller rivals. A SIFI deSignation would be the federal government's signal that 

we are indeed "too big too fail," and that if we got into financial trouble, federal 

funds would be used to rescue the firm. The implicit backing of the federal 

government could strengthen perceptions of our creditworthiness and may give 

us a significantly cheaper cost of funds than our peers. 

Similarly, these commentators believe the Federal Reserve would have a 

powerful incentive to ensure the financial success of those insurance companies 

under its supervision. 

6 
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At the other end are those who believe that insurance companies deemed 

SIFls would be placed at a competitive disadvantage. They would have to hold 

more capital and maintain higher liquidity levels, which would reduce retums on 

equity for shareholders and impose higher prices on customers. In addition, they 

would have to deal with two levels of regulation compared with one for the rest of 

the industry. 

I am in the second camp, having lived with Federal Reserve regulation 

and been forced to stand on the sideline as nearly all of MetLife's competitors -

including those that took federal bailouts - returned capital to shareholders while 

bank-centric rules prevented us from doing so. But whether a SIFI designation is 

a help or a hindrance, it seems certain that naming a handful of insurance 

companies as "too big to fail" will needlessly distort the competitive landscape 

and misallocate capital in the insurance sector. 

Getting the Rules Right 

In the event FSOC feels compelled to name MetLife and a few other large 

insurers as SIFls, it will be essential to tailor the new prudential rules for 

insurance companies. Bank-centric regulations are wholly inappropriate for an 

insurance company. 

I would prefer that federal regulators simply adopt the risk-based capital 

rules that state insurance regulators have been using successfully for decades, 

but this may not happen based on the proposed prudential standards rule issued 

by the Federal Reserve in December of last year. As a second-best option, I 

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hope any bank-centric rules used will be modified to take into account the unique 

asset and liability characteristics of life insurers. 

Conclusion 

If the nation's largest life insurers are named SIFls and subjected to 

unmodified bank-style capital and liquidity rules, our ability to issue guarantees 

would be severely constrained at a time when governments are facing their own 

fiscal challenges. Faced with costly requirements, insurers would either have to 

raise the price of the products they offer, reduce the amount of risk they take on, 

or stop offering certain products altogether. 

In closing, let me reiterate that I do not believe Met Life is or should be 

designated "too big to fail." Even in the event of insolvency, we would not 

"threaten the stability of the financial system of the United States." Naming only 

a few large insurance companies as SIFls is an unsettling thought - it would 

needlessly upset the competitive landscape in the insurance sector and possibly 

discourage these large insurance companies from offering the insurance 

products average Americans rely upon as part of their financial planning. 

cannot tell from reading the FSOC's SIFI criteria regulation the exact metrics that 

will be used in designating nonbank financial companies as SIFls, so it is hard to 

predict outcomes. If FSOC names the largest life insurers as SIFls, I believe it 

will be imperative for regulators to get the prudential rules for non-bank SIFls 

right. At the very least, they should regulate insurance companies as insurers, 

not as banks. 

Thank you. 

### 

8 
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DRAFT 

Statement 

of the 

Financial Services Roundtable 

Submitted to the 

Subcommittee on Financial Institutions and Consumer Credit 

of the 

Committee on Financial Services 

U.S. House of Representatives 

on 

The Impact of the Dodd-Frank Act: 

What it Means to be a Systemically Important Financial Institution 

May 16, 2012 

The Financial Services Roundtable (the "Roundtable") appreciates the opportunity 

to submit this statement for inclusion in the record of the Subcommittee's hearing entitled 

"The Impact of the Dodd-Frank Act: What it Means to be a Systemically Important Financial 

Institution." 

The Roundtable is a trade association for 100 of the nation's largest financial 

services firms. Our members provide banking, securities, and insurance products and 

services to millions of consumers and businesses in the United States and other countries. 

The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank 

Act" or "Act") establishes a new supervisory regime for nonbank financial companies that 

are "systemically important." Section 113 of the Act authorizes the Financial Stability 

Oversight Council (the "Council") to designate a nonbank financial company for supervision 

by the Federal Reserve Board (the "Board") if two-thirds of the members of the Council, 

including its Chairman, conclude that the company could pose a threat to the financial 

stability of the United States based upon either material financial distress within the 

company or the nature, scope, size, scale, concentration, interconnectedness, or mix of 

activities of the company. Companies subject to such a determination are then subject to a 

set of enhanced prudential standards, which are set forth in section 165 of the Act. In April, 

the Council finalized its rules on the procedures for designation nonbank financial 

companies as "systemically important" ("Final Rule"). 

The Roundtable believes that the deSignation of nonbank financial companies should be 

integrated with other prOVisions of the Dodd-Frank Act. 

The Roundtable has urged the Council to integrate this designation process with the 

other related provisions in the Dodd-Frank Act. We believe that linking the 

implementation of the designation process with other related regulations would enhance 

the transparency and consistency of the designation process. It would enable all 
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stakeholders, including the Council, to better understand the implications and impact of 

designation. It also would ensure that the process is sufficiently integrated with other 

related provisions in the Dodd-Frank Act. The provisions of the Dodd-Frank Act that should 

be integrated with the designation process are as follows: 

The Board's Regulation on the Meaning o/the Phrase "Predominantly Engaged In 

Financial Activities" 

The phrase "predominantly engaged in financial activities" is integral to the 

designation of nonbank financial companies. Under the terms of the Dodd-Frank Act, a 

nonbank financial company may not be subject to supervision by the Board unless the 

company is "predominantly engaged in financial activities." The Dodd-Frank Act includes a 

definition of this phrase, but directs the Board to issue a regulation establishing the criteria 

for determining whether a company meets this definition. The Board proposed a 

regulation in February of 2011, but has yet to finalize that regulation. This regulation 

should be finalized before the Council begins the designation process. 

In the preamble to its proposed rule, the Board clearly assumed that the regulation 

governing the meaning of the phrase "predominantly engaged in financial activities" would 

be finalized before the Council began the designation process. The Board noted that such a 

sequence not only would aid in the public's ability to comment on the designation process 

designed by the Council, but also would permit the Council to act promptly on designations 

after its procedural rule was final. 

The Board's Section 165 Regulation 

The section 165 regulation should be finalized before the Council begins the 

designation process. As noted above, section 165 ofthe Dodd-Frank Act directs the Board 

to establish enhanced prudential standards for nonbank financial companies that have 

been designated by the Council under the terms of section 113 of the Act. Those standards 

must include risk-based capital requirements and leverage limits, liquidity requirements, 

risk management requirements, resolution planning requirements, and concentration 

limits. They also may include contingent capital requirements, enhanced public disclosure 

requirements, short-term debt limits, and other prudential standards deemed appropriate 

by the Board. 

The Board has issued a proposed rule for comment, and the comment period on that 

proposal has just closed. We believe that no designations should occur until that rule is 

finalized. Issuance of the final regulation would reduce much of the uncertainty 

surrounding the impact of designations on the operations and activities of nonbanking 

financial companies. Until the section 165 regulation is final, neither the Council nor 

industry can fully appreciate the Significance and impact of a designation. 

2 
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The Board's Safe Harbor Regulation 

In recognition of the fact that not all nonbank financial companies pose systemic 

risks, section 170 of the Dodd-Frank Act directs the Board to issue regulations setting forth 

the criteria for exempting certain types or classes of nonbank financial companies from 

supervision by the Board. While the Final Rule only notes that the Board is authorized to 

promulgate such rules on behalf of, and in consultation with, the Council, we would like to 

reiterate that the Dodd-Frank Act mandates that the Board issue these rules. This safe 

harbor regulation should be finalized before the Council begins the designation process 

since the two rulemakings are intrinsically linked because of the implications with respect 

to the application of enhanced prudential standards and early remediation requirements. 

Publication of this regulation would further clarify the scope and impact ofthe designation 

process for the Council and industry. 

Intermediate Holding Companies Under Title I and Title VI 

In the Dodd-Frank Act, Congress recognized that some companies have both 

financial activities, including ownership of banks and thrifts, and nonfinancial activities, 

including manufacturing and retailing. It created a legal framework for such companies 

providing that the financial activities of such companies would be regulated, but that their 

nonfinancial activities would not be subject to regulation. To that end, section 167(b) of the 

Act provides for establishment of an intermediate holding company ("!HC") by a designated 

nonbank financial company when "necessary to (i) appropriately supervise activities that 

are determined to be financial activities, or (ii) to ensure that supervision by the Board 

does not extend to commercial activities." 

Section 626 provides a parallel structure for unitary savings and loan holding 

companies permitted to have nonfinancial activities ("Unitary SLHCs") and uses the same 

language as section 167(b). Title VI further provides that when an!HC is established by a 

Unitary SLHC, the nonfinancial parent will cease to be regulated as a SLHC. The statute thus 

contemplates the establishment of an IHC by a Unitary SLHC to ensure that the parent's 

nonfinancial activities will not be regulated. 

The corollary under the Dodd-Frank framework is that an !HC established under 

Title VI is the obvious and appropriate entity in that corporate structure to consider for 

possible designation under section 113. This is precisely the harmonization called for in a 

colloquy between Rep. Himes and then Chairman Frank on the House floor at the final 

passage of Dodd-Frank. Accordingly, we urge that the Council not begin its consideration of 

a Unitary SLHC or su bsidiary thereof for possible designation under section 113 until the 

Board has made its !HC determination under Title VI for that SLHC. 

The Guidance Issued by the Council Should be Incorporated into the Regulation 

As an appendix to the Final Rule, the Council has issued an extensive "guidance" that 

it will follow in making designations. We believe that this guidance should be issued as a 

regulation. The guidance includes many key details regarding the designation process. For 

3 
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example, it defines the terms "threat to the financial stability of the United States" and 

"material financial distress," which are central to the statutory designation standards; it 

includes the six-category analytical framework that groups the statutory factors the 

Council must consider in making designations; and it includes the three-stage 

determination process the Council proposes to use in making designations. These and 

other matters addressed in the guidance should be part of the regulation. 

Incorporating the guidance into the regulation also ensures that any changes to the 

process will be subject to formal notice and public comment. The Council has 

acknowledged that changes in the guidance are likely - especially changes in the metrics 

used in Stage 1. In its current form, however, any changes to the guidance would not be 

subject to public notice or comment, even though those changes could have a significant, 

and material, impact upon which companies mayor may not be subject to designation. 

Incorporating the guidance into the regulation would ensure that any changes to the 

designation process would be made in an open and transparent manner, following public 

notice and comment. Should the Council not incorporate the guidance into the regulation, 

we recommend the Council otherwise provide for public notice and comment on any 

changes to the guidance. 

The Council Should Clarify that the Threat to Financial Stability is a High Bar 

Under the terms of the Dodd-Frank Act, a nonbanking company cannot be 

designated unless the company poses a "threat to the financial stability of the United 

States" as a result of the activities of the company or material financial distress at the 

company. The guidance accompanying the Council's regulation provides some insight into 

the meaning of this phrase. It states that such a threat exists if "there would be an 

impairment of financial intermediation or of financial market functioning that would be 

sufficiently severe to inflict significant damage on the broader economy." Additional detail 

on the meaning of this phrase would enhance public understanding of, and appreciation 

for, the designation process. 

Specifically, we recommend that the Council clarify that this is a high bar; that 

"significant" damage to the broader economy means a widespread disruption to the 

economy over a period of time; and that short-term market disruptions do not constitute a 

threat to the financial stability of the U.S. Furthermore, we recommend that the Council 

define what constitutes "financial stability." 

The Council Should Define What Constitutes Material Financial Distress 

Again, the guidance accompanying the Final Rule provides some insight into the 

meaning of the term "material financial distress." However, we recommend that the 

Council revises its Final Rule and place some time frame on the period of distress and 

provide additional detail on the macroeconomic environment applicable to a determination 

of material financial distress. 

4 
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The Council Should Revise its Interpretation of "Company" 

The Council states its intention to interpret the term "company" broadly to include 

any corporation, limited liability company, partnership, business trust, association 

(incorporated or unincorporated), or similar organization. The Council also states that it 

may consider "the aggregate risks posed by separate [investment] funds that are managed 

by the same adviser, particularly if the funds' investments are identical or highly similar." 

Such an interpretation is not supported by the statute. Therefore, the Council cannot act as 

if a company exists if one has not been formed; nor can it act as if separate companies are 

one and the same or assume that they share the same types of relationships that make 

consolidated analysis and supervision possible in the bank holding company context if, as is 

the case with investment funds, they do not. 

We also believe that even if such an interpretation were authorized by the statute, it 

is too expansive from a practical perspective for purposes of the designation process and 

for the regulatory regime that is required to be applied to any designated company. It 

suggests that the Council would disregard the legal separation between entities that might 

have different governance, ownership and regulatory structures. To aggregate such 

entities during the deSignation process would be to adopt a distorted view of their actual 

structures and thereby increase the risk of erroneous analysis and ill-advised 

determinations. 

Furthermore, even if the Dodd-Frank Act permitted the Council to disregard 

companies' distinct legal identities during the designation process, it does not empower the 

Federal Reserve Board to do so when regulating designated companies and applying the 

enhanced prudential standards contemplated by Section 165. The consolidated 

supervisory regime and enhanced prudential standards that are required to be applied to 

designated companies are based on the bank holding company regulatory model. The 

Federal Reserve Board could not ignore the legal, regulatory and operational separations 

among companies that would prevent, or render inappropriate, the application of that 

model to separate companies as a group. We believe the Council should adopt a narrower 

definition of this term. 

We Support the Use of Metrics. but Have Several General Recommendations Regarding 

Their Design 

We support the establishment of quantitative metrics to serve as a screening 

mechanism by the Council. However, we have some concerns with the metrics established 

by the Council. 

The CDS Metric 

We have serious reservations with the CDS metric. Unlike the other metrics, this 

metric is outside the control of a nonbank financial company because it is based on the 

nonbank financial company's status as a reference entity. Moreover, it is subject to 

5 
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manipulation by competitors and other parties. For these reasons, we recommend that the 

Council reconsider the use of this metric. 

If the Council decides to keep a CDS metric, we recommend that it be based on 

ownership of a CDS rather than being a reference entity for a CDS. Also, we recommend 

that the tripwire be linked to a net amount of exposure to the holder of the CDS rather than 

a gross amount since companies typically hedge or offset credit default swap exposures. 

Netting exposure for this metric would be consistent with the manner in which the Council 

plans to measure a company's exposure to derivative liabilities. 

The Tripwire for Derivatives Liabilities Should be Revised Upward and Embedded 

Derivatives Liabilities Should Be Excluded 

We believe that the $3.5 billion tripwire for derivatives liabilities is too low for 

larger companies. For larger companies, losses from $3.5 billion derivatives portfolio are 

not sufficient to endanger the company or to meet the definitions of "threat to the financial 

stability of the United States" or "material financial distress." As an alternative to a fixed 

$3.5 billion tripwire, we recommend that the Council adopt a tripwire based upon a 

percentage of the size of the company. For example, if the percentage is set at 7 percent, 

the tripwire would be $3.5 billion for a company with $50 billion in consolidated assets, 

and $7 billion for a company with $100 billion in consolidated assets. Presumably, some 

ceiling on the tripwire may be appropriate under this alternative. 

We applaud the fact that the guidance appropriately defines the derivatives liability 

standard after adjusting for the existence of bilateral netting and offsetting 

collateral. Taking into account the effects of master netting agreements and cash collateral 

held with the same counterparty accurately depicts a nonbank financial company's 

exposure to its counterparties and interconnectedness to the financial markets. The Final 

Rule includes in the definition of a derivative liability derivatives embedded in contracts 

where there is no derivative counterparty (i.e., guarantees embedded in life insurance 

products such as variable annuities). We disagree that these derivatives should be included 

in this definition, as these embedded derivatives have no counterparty risk and do not 

expose the institution to the financial markets. We recommend the language in the Final 

Rule regarding the derivative liability threshold be revised to exclude these types of 

embedded derivatives. 

The Metric for Total Debt Outstanding Should Be Revised Upward 

The $20 billion tripwire for total debt outstanding is too low for larger companies. 

It is not unusual for well-managed companies with $50 billion or more in assets to have 

more than $20 billion in total debt outstanding. We recommend some greater threshold 

amount or an amount that scales up or down depending on the size of the company (see 

recommendation above related to derivatives liabilities). 

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The Metric for Short-Term Debt Should Be Adjusted 

The tripwire for short-term debt is 10% of a company's total debt outstanding. We 

do not believe that this metric is particularly indicative of risk. During the recent financial 

crisis it was not short-term debt per se that contributed to the financial distress at some 

companies, but a mismatch between short-term debt and long-term assets. Further, we 

believe that this tripwire is far too low for large financial companies. We recommend that it 

be adjusted to exclude cash and other liquid assets that pose little, if any risk, to a company. 

Liquid assets would include loans and other receivables due in less than one year. 

The Council Should Clearly Develop the "Other" Oualitative and Quantitative Factors 

that Could Result in a Company Moving to the Stage 2 Pool. 

The interpretive guidance attached to the Final Rule states that the Council may 

initially evaluate any nonbank financial company based on "other firm-specific qualitative 

or quantitative factors, irrespective of whether such company meets the Stage 1 

thresholds." The introduction of the foregoing language is overly broad and operates to 

undo the certainty that the Stage 1 thresholds were intended to create. We recommend 

that the Council clearly develop what these other "firm-specific qualitative or quantitative 

factors" are intended to cover in order to provide nonbank financial companies with a 

greater degree of certainty as to whether they will face further review under Stage 2. 

Stage 3 Should Include a "Targeted" Cost-Benefit Analysis 

Stage 3 of the designation process is undoubtedly the most important stage for any 

company. It is during Stage 3 that the Council will actively engage with a company and 

collect information about the company's activities and systemic risk profile. Moreover, the 

conclusions drawn by the Council at the end of this stage will affect whether or not a 

company receives a Determination Notice from the Council. 

Given the significance of the Stage 3 review, we believe the Council should conduct a 

"targeted" cost-benefit analysis of the impact of designating a company as part of the Stage 

3 review. This analysis would require the Council to consider whether designation is the 

best means for mitigating the systemic risk posed by the company or whether some other 

forms of regulation, such as industry-wide standards, would mitigate the identified risk 

more effectively or efficiently. 

Federal Reserve Board Governor Daniel Tarullo spoke to this issue in a speech 

earlier this year when he noted that" ... prudential standards designed for regulation of 

bank-affiliated firms may not be as useful in mitigating risk posed by different forms of 

financial institutions." 1 In those cases, he suggested sound regulation for the particular 

industry as a whole or the particular instrument may be more appropriate than 

designation under the section 113 process. 

I Speech by Federal Reserve Board Governor Daniel K. Tarullo at the 20 II Credit Markets Symposium, Charlotte, 

North Carolina, March 31, 2011, page 3. 

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On-Going Consultation with Other Regulators 

In each stage of the designation process, the Council indicates that it will consult 

with other regulators. We recommend that the Council exercise this authority early and on 

an on-going basis with U.S. and foreign regulators. A company's primary U.S. regulator or 

its home country regulator will have a current and in-depth understanding of the company. 

The Council should take full advantage of this knowledge base. 

Registration Process 

Section 114 of the Dodd-Frank Act provides for a nonbank financial company to 

register with the Board within 180 days of a final determination. We recommend that the 

Board provide necessary details on the mechanics of registration. 

Additionally, we recommend that this regulation, or the section 165 regulation, 

address the time frames for compliance with the section 165 prudential standards after a 

company has registered with the Board. Specifically, we recommend that a nonbank 

financial company be given 24 to 36 months following registration to comply with 

applicable section 165 standards. This will enable the company to make the changes in 

systems, policies and procedures necessary to comply with such standards. Such a phase-in 

period also is consistent with other provisions in the Dodd-Frank Act that require 

significant operational adjustments by financial companies, such as the conformance 

period associated with the Volcker Rule. 2 

Conclusion 

The authority of the Council to determine whether a nonbank financial company 

should be subject to Board supervision and enhanced prudential standards is one of the 

Council's most important powers. Such a determination will have a material impact on the 

company, its customers and the markets in which it operates. The recommendations made 

in this statement are intended to ensure that the Council exercises this power in a 

transparent, effective and consistent manner. 

2 See 75 FR 72741, November 26, 2010. 

8 
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75731.054

Jennifer J. Johnson 

Secretary 

Board of Governors of the Federal Reserve System 

20th Street and Constitution Avenue, NW 

Washington, DC 20551 

April 20, 2012 

Re: Docket No. 1438, RIN 71 00-AD86: Enhanced Prudential Standards and Early 

Remediation Requirements for Covered Companies 

Dear Ms. Johnson: 

We write on behalf of the National Association of Insurance Commissioners (NAIC) regarding the 

Federal Reserve's notice and proposed rulemaking on "Enhanced Prudential Standards and Early 

Remediation Requirements for covered Companies." Founded in 1871, the NAIC is the U.S. standardsetting and regulatory support organization created and governed by the chief insurance regulators from 

the 50 states, the District of Columbia and the five U.S. territories. Through the NAIC, state insurance 

regulators establish standards and best practices, conduct peer review, and coordinate their regulatory 

oversight. NATC members, together with the central resources of the NAIC, fonn the national system of 

state-based insurance regulation in the U.S. The NAIC respectfully submits the following comment to 

the Notice of Proposed Rulemaking and Request for Comment published in the January 5, 2012 issue of 

the Federal Register.' 

As noted in the proposed rule, the market perception associated with "too big to fail" can pose a 

significant threat to the financial system. 2 It reduces market discipline, encourages competitive 

distortions through funding advantages, and artificially encourages further consolidation and 

concentration in the financial system. We, therefore, think it is appropriate for the Federal Reserve to 

implement strong prudential standards to offset the advantages that may accrue to finns perceived as 

"too big to fail" as well as mitigate the other negative externalities associated with Financial Stability 

Oversight Council (Council) designation. 

The measures selected should seek to ensure critical protections to the financial system, while at the 

same time minimizing the harmful consequences that can result from such a designation. As it relates to 

any non-bank financial company the Council detennines poses a grave threat to financial stabilitl and 

is designated for oversight by the Federal Reserve, we believe that the enhanced prudential standards 

1 Enhanced Prudential Standards and Early Remediation Requirements for Covered Companies, 77 Fed. Reg. 594 (proposed 

January 5, 2012) (to be codified at 12 C.P.R. pI. 252). 

'Id at 595. 

lId 
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75731.055

applied should be tailored to the specific business model and structure of the financial institution, the 

characteristics of the markcts in which the firm operates, and the activities that make the institution 

systemically risky. With respect to insurance companies, systemically risky activities are antithetical to 

the interests of policyholders. Insurance consumers should not be materially exposed to such activities 

and we are actively working to ensure that is the case. 

Standards should minimize negative market implications 

Our interest in the proposed rule is the impact of federal policy on insurance markets and companies, 

and ultimately insurance consumers. Consumers value the financial strength of their insurer: They are 

often purchasing promises extending decades into the future, for payment upon the occurrence of an 

insured event. Although state insurance guaranty funds serve as a backstop for some coverages up to 

specified limits, an insurer's obligations to a consumer may exceed those limits. Thus, the value of 

those promises depends fundamentally on the ability of the insurer to survive into the future. 

Given the value placed on financial strength by insurance consumers, state insurance regulators are 

concerued that the creation of a two-tiered system of supervision, where some insurance companies are 

perceived as safer than others, could create competitive distortions, artificially advantage some 

companies, and encourage undesirable consolidation and concentration in the insurance sector. Our 

priority is to avoid such unintended and undesirable consequences in our sector. 

To prevent these consequences, we encourage the Federal Reserve to impose policies that will strongly 

discourage non-bank systemically important financial institution (SIF!'s) from engaging in activities that 

resulted in their designation as a SIFT. In particular, enhanced prudential standards applied to insurance 

groups that have been identified as SIFTs should be aimed at returning them to non-SIFT status, thus 

avoiding a market perception that some insurance companies are safer than others. 

Recommendations 

As supervisors of the insurance sector, we are keenly aware of the need to have a strong and competitive 

market to serve our policyholders. The inherent nature of most traditional insurance activities is such 

that government support is not essentiaL Traditional insurance activities typically do not add systemic 

risk to the financial system-they generally do not involve the transformation of short term liabilities 

into long term assets and do not lend themselves to run risk. 

To the extent that any insurance company is designated a SIFT, the rules for implementing enhanced 

prudential standards will have critically important, and potentially detrimental implications for the 

industry that we regulate and ultimately for the policyholders we serve to protect. Even the perception 

of implicit support could interfere with competitive insurance markets. We do not believe insurance 

companies should engage in systemically risky activities that would lead to designation by the Council, 

nor be materially exposed to companies that are engaging in such activities. 

4 It is not surprising that scholars have found evidence that consumers place considerable value on the solvency of their 

insurer, Among other evidence, researchers have found an inverse relationship between insurance premium and firm risk, an 

inverse relationship between default risk and policyholder willingness to purchase insurance, and a direct relationship 

between rating downgrades and an increase in life insurer lapses and a decrease in premium revenue. These findings are 

consistent with consumer preference for insurers that arc perceived to have a stronger financial condition. See, e.g. Sommer, 

D.W., The Impact afFirm Risk on Property-Liability Insurance Prices, Journal of Risk and Insurance 63(3): 501-514 (1996). 
111 


75731.056

To that end, state insurance regulators have already taken measures to improve their ability to identify 

systemically risky activity within an insurance group. We have recently enhanced the solvency 

framework to provide more "windows" into group activities and developed assessment tools to better 

identifY. quantify, and account for risk in various stress scenarios. In addition, holding companies will 

be required to identify activities of affiliates that could pose contagion or reputational risks to the 

insurer. These tools will allow state insurance regulators to work with insurers in a timely manner to 

limit the impact of systemically risky activities. We intend to continue to develop these tools and work 

with our fellow regulators toward the goals of protecting policyholders and the financial system from 

systemically risky activity by insurers. 

It is with these efforts in mind that we recommend the standards adopted by the Federal Reserve reflect 

these important features: 

To the extent that the systemically risky activities reside at an affiliate of an insurance company 

(as was the case with AIG), the affiliate should be walled-off from the insurance legal entities. 

That is, the affiliated company should not be able to leverage off the assets of the insurance 

company to support its risk taking activities. Among other measures, the affiliate should be 

required to hold sufficient capital to provide a strong disincentive for excessive risk taking. 

Cross subsidies, loans and guarantees of the affiliate's balance sheet by the insurance legal 

entities should be prohibited. Dividends provided by the insurance company to the holding 

company should be limited to those provided in the normal course of business. Any 

diversification benefits recognized in the capital framework should be eliminated. The measures 

to wall-off the systemic activities should be made fully transparent to the market so that financial 

strength ratings do not reflect implicit support from affiliate insurance companies. These 

measures will ensure that the risky activities of the affiliate are constrained and policyholder 

interests are not threatened by such activities. 

To the extent that an insurer engages in activities that result in its designation by the Council, 

state regulators have committed to curtailing snch activities that could result in designation in the 

first place. State regulators have improved mechanisms to identifY and address potential threats. 

In this regard, we strongly encourage the Federal Reserve to work closely and collaboratively 

with us. Any measures applied should be mindful of the interests of policyholders in addition to 

being consistent with desired outeomes from a macro perspective. 

Conclusion 

We appreciate the opportunity to comment. Should you wish to discuss this comment or any other 

matter relating to the NAIC's views on this proposed rule, please do not hesitate to contact Ethan 

Sonnichsen, Director of Goverrunent Relations, at (202) 471-3980 or Mark Sagat, Counsel and Manager 

ofGoverrunent Relations, at (202) 471-3987. 

Kevin M. McCarty 

Florida Commissioner ofInsurance and 

NAIC President 

Sincerely, 

Therese M. Vaughan, Ph.D. 

NAIC Chief Executive Officer 
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75731.057

Questions for Dr. Michael S. Gibson, Director, Division of Research and Statistics, Board 

of Governors of the Federal Reserve System, from Chairman Capito: 

1. Is it the Board's intention to significantly narrow the value ofthe thrift charter by 

sUbjecting SLHCs to BHC rules-and if not, can you describe the factors that are important 

in distinguishing the regulatory treatment of SLHCs and BHCs? 

Congress transferred authority for the supervision of SLHCs from the Office of Thrift 

Supervision to the Federal Reserve effective on July 21,2011. In preparing for that 

responsibility, the Board conducted extensive outreach with SLHCs to learn about their structure 

activities and practices. The Board also carried over existing Office of Thrift Supervision rules 

with respect to the activities of SLHCs and made no changes to the scope of permissible real 

estate activities for SLHCs.1 

In addition, the Board has sought to tailor its supervisory approach to the characteristics of 

SLHCs. Federal Reserve supervision of SLHCs has, as an initial matter, focused on risk 

management practices,2 and, as required under the Home Owners' Loan Act ("HOLA"), involves 

regular consultations with state insurance commissioners, the SEC, and other functional 

regulators.3 

The Board's supervision ofSLHCs also recognizes that different supervisory programs applied 

to SLHCs and BHCs prior to July 2011. During the current first round of inspections ofSLHCs, 

Federal Reserve examiners are becoming acquainted with each SLHC's management and are 

seeking to fully understand the organization's operations and business model. Examiners are 

discussing the Board's supervisory expectations and rating system with SLHC management, but 

are not issuing fmal Federal Reserve ratings.4 

Because regulatory capital requirements (including specific minimums) were not applied to 

SLHCs at the holding company level prior to July 2011, the Board currently is using both a 

qualitative and quantitative approach to evaluating capital at SLHCs. To be clear, the Board 

currently is not using the regulatory ratios used for BHCs to evaluate capital of SLHCs. Section 

171 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Act") provides that 

depository institution holding companies must meet consolidated minimum capital requirements 

that are at least as stringent as those applied to insured depository institutions. Consistent with 

section 171, the Board recently sought comment on a proposed rule implementing such 

consolidated minimum capital requirements for SLHCs (available at 

http://www .federalreserve. gov Inewsevents/press ). 

1 12 CFR 238.52(a)(i) and 238.53(b)(4) - (8). 

2 This approach is described in Attachment B to SR letter 11-11. For your reference, SR letter II-II and its 

attachments are appended to this response. 

3 12 U.S.C. § 1467a(b)(4)(C). 

4 The Board's approach to the first round ofSLHC inspections is discussed more fully in SR letter 11-11. 
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-2-

2. Regarding insurance companies, it is well-established that the risk-based capital 

standards utilized to regulate insurance companies and banks are starkly different-and is 

like comparing apples to oranges. Can you detail the benefits, if any, of applying 

incongruent bank-based capital standards (e.g., Basel) to insurance-based SLHCs, how this 

would work in practice, and how the benefits outweigh the costs? 

It has long been the Board's general practice to apply consistent consolidated minimum capital 

requirements to all bank holding companies with $500 million or more in total consolidated 

assets, including bank holding companies that control functionally regulated subsidiary insurance 

companies. This approach helps to ensure the safety and soundness of each bank holding 

company and a level playing field across bank holding companies. The Board does not, 

however, apply its capital standards to an insurance company subsidiary of a bank holding 

company. Instead, the Board relies for the insurance company subsidiary on the capital 

requirements established by the appropriate state insurance regulator. 

The Board is required under section 171 of the Act to apply to all bank holding companies and 

savings and loan holding companies minimum risk-based and leverage capital requirements that 

are not less than the minimum capital requirements applicable to insured depository institutions. 

However, the Board has recognized that some insurance company assets and activities are not 

permissible for banks and so has proposed tailored capital requirements that take account of 

these differences consistent with section 171 of the Act. 

For example, the Board recently sought public comment on proposed revisions to its regulatory 

capital requirements that included a specific capital treatment for certain lower-risk assets, such 

as non-guaranteed separate accounts, that are commonly held by insurance companies but not by 

depository institutions. In contrast, the Board proposed identical treatment under its capital rules 

with respect to assets that are commonly held by both insurance companies and banks, such as 

bonds and other extensions of credit. 

3. Do yon support and advocate establishing distinct regulatory standards governing 

insurance-based SLHCs that more accurately reflect the insurance business model over the 

BHCmodel? 

Please see response to question 4. 

4. Although all of us are familiar with AIG, how many insurers today are engaged in the 

types off'mancial engineering activities that caused AIG's collapse? Is the AIG-experience 

justification for imposing bank-centric holding company requirements upon companies 

engaged only in traditional insurance activities? 

Approximately 27 SLHCs primarily engage in insurance activities ("ISLHCs"). As explained in 

SR letter II-II (July 21,2011), the Board is using the first cycle ofSLHC inspections to learn 

more about the particular operations of each ISLHC. Supervisory assessments are currently 
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- 3-

being conducted at each ISLHC and its subsidiaries to more fully understand the activity make 

up of each ISLHC and determine if any activities pose safety and soundness concerns. 

In April 2011, the Board stated its intention, to the greatest extent possible taking into account 

any unique characteristics of SLHCs and the requirements of HOLA, to assess the condition, 

performance, and activities of SLHCs on a consolidated basis in a manner that is consistent with 

the Board's risk-based approach regarding bank holding company supervision. State insurance 

regulators currently supervise insurance companies only on an individual entity basis. The 

Board's consolidated supervisory program is applied in a risk-focused manner and supervisory 

activities (such as, continuous monitoring, discovery reviews, and testing) vary across portfolios 

of institutions based on size, complexity, and risk. Board and Reserve Bank staffs are working 

to create supervisory plans that specifically address the risks associated with the activities of 

ISLHCs. 

In its recent proposal that would revise regulatory capital requirements, the Board emphasized 

the importance of using a uniform approach to capital requirements for all depository institution 

holding companies in order to mitigate potential competitive equity issues, limit opportunities for 

regulatory arbitrage, and facilitate comparable treatment of similar risks. 

S. Regarding the Collins Amendment, do you believe it makes sense to apply bankoriented Basel risk-based capital (RBC) and leverage requirements to insurance 

companies? Does the Fed believe it has the discretion to use insurance-based measures of 

RBC and leverage-so long as the Fed determines these insurance measures satisfy the 

minimum floor requirements of the CoIlins Amendment? 

As indicated in the response to question 2, the Board is required under section 171 of the Act to 

apply minimum risk-based and leverage capital requirements, on a consolidated basis, to bank 

holding companies and savings and loan holding companies that are not less than the minimum 

capital requirements applicable to insured depository institutions. The Board expects also to 

consider insurance-based measures of an insurance company's capital to evaluate capital as a 

supplemental measure of capital adequacy and to assess the risk of the insurance company 

subsidiary as it relates to the consolidated structure. 

o 
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75731.060

Questions for the Record from Chairman Shelley Moore Capito 

May 16, 2012 

Subcommittee on Financial Institutions 

and Consumer Credit 

Hearing entitled "The Impact of the Dodd-Frank Act: What It Means 

to be a Systemically Important Financial Institution" 

Question for Treasury 

Federal financial regulators have repeatedly stressed the benefits of working with other regulatory 

agencies in developing rules for affecting different types of financial companies. We have been told 

that this cooperation helps avoid establishing standards or requirements that might make sense for 

some companies, but not for others. Unfortunately, since the States remain the primary regulator for 

insurance, it does not appear that insurance expertise is available in federal rulemaking affecting 

insurance companies. 

Recognizing that Treasury might not have final regulatory jurisdiction, can you tell us to what extent, 

if any, the Federal Insurance Office Director has participated or been consulted with in rulemakings 

such as setting enhanced prudential standards for SIFs, the Volcker Rule, or the regulation of 

insurance-based StHCs? 

The Department of the Treasury's Federal Insurance Office (FlO) provides insurance expertise to the 

Financial Stability Oversight Council (Council) and participates in Council committees, studies, 

rulemakings and other activities of the Council. FlO participated in the development of the Council's 

final rule and interpretive guidance regarding determinations under section 113 of the Dodd-Frank Act, 

and also provided insurance expertise in the Volcker rulemaking process. Additionally, FlO consulted 

with the Federal Reserve on the development of enhanced prudential standards for nonbank financial 

companies, and large bank holding companies under section 165 ofthe Dodd-Frank Act. FlO will 

continue to be consulted on any potential recommendations by the Council to the Federal Reserve 

concerning the refinement of such standards, including with respect to the regulation of insurancebased savings and loan holding companies. The Council also includes an independent member with 

insurance expertise and a state insurance commissioner, in addition to the Director of FlO, who have 

significant insurance expertise and who also participate in Council activities.