```

[Senate Hearing 114-103]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 114-103

   THE ROLE OF THE FINANCIAL STABILITY BOARD IN THE U.S. REGULATORY 
                               FRAMEWORK

=======================================================================

                                HEARING

                               BEFORE THE

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED FOURTEENTH CONGRESS

                             FIRST SESSION

                                   ON

EXAMINING THE ROLE OF THE FINANCIAL STABILITY BOARD ON U.S. REGULATORS 
  INCLUDING WITH RESPECT TO ITS INFLUENCE ON THE FINANCIAL STABILITY 
                           OVERSIGHT COUNCIL

                               __________

                              JULY 8, 2015

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                 Available at: http: //www.fdsys.gov /
                 
                             _____________
                             
                             
                       U.S. GOVERNMENT PUBLISHING OFFICE
97-398 PDF                   WASHINGTON : 2016
________________________________________________________________________________________
For sale by the Superintendent of Documents, U.S. Government Publishing Office, 
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, 
U.S. Government Publishing Office. Phone 202-512-1800, or 866-512-1800 (toll-free).
E-mail, gpo@custhelp.com.  

            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

MIKE CRAPO, Idaho                    SHERROD BROWN, Ohio
BOB CORKER, Tennessee                JACK REED, Rhode Island
DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois                  JON TESTER, Montana
DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
JERRY MORAN, Kansas

           William D. Duhnke III, Staff Director and Counsel

                 Mark Powden, Democratic Staff Director

                    Jelena McWilliams, Chief Counsel

                      Elad Roisman, Senior Counsel

            Laura Swanson, Democratic Deputy Staff Director

                Graham Steele, Democratic Chief Counsel

                 Elisha Tuku, Democratic Senior Counsel

                       Dawn Ratliff, Chief Clerk

                      Troy Cornell, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)

                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, JULY 8, 2015

                                                                   Page

Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     2

                               WITNESSES

Dirk Kempthorne, President and CEO, American Council of Life 
  Insurers.......................................................     4
    Prepared statement...........................................    32
Peter J. Wallison, Arthur F. Burns Fellow in Financial Policy 
  Studies, American Enterprise Institute.........................     6
    Prepared statement...........................................    36
Paul Schott Stevens, President and CEO, Investment Company 
  Institute......................................................     7
    Prepared statement...........................................    47
Eugene Scalia, Partner, Gibson, Dunn & Crutcher LLP..............     9
    Prepared statement...........................................    72
Adam S. Posen, President, Peterson Institute for International 
  Economics......................................................    10
    Prepared statement...........................................    88

              Additional Material Supplied for the Record

Prepared Statement of Michael S. Barr, The Roy F. and Jean 
  Humphrey Proffitt Professor of Law, University of Michigan Law 
  School.........................................................    93
Prepared statement of Chris Brummer, J.D., Ph.D., Professor of 
  Law, Georgetown University Law Center..........................    95
Prepared statement of the National Association of Mutual 
  Insurance Companies............................................    98
Prepared statement of the Property Casualty Insurers Association 
  of America.....................................................   103

                                 (iii)

 
   THE ROLE OF THE FINANCIAL STABILITY BOARD IN THE U.S. REGULATORY 
                               FRAMEWORK

                              ----------                              

                        WEDNESDAY, JULY 8, 2015

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:01 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Richard Shelby, Chairman of the 
Committee, presiding.

        OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

    Chairman Shelby. The hearing will come to order.
    Today the Banking Committee will examine the role of the 
Financial Stability Board, or what we call the ``FSB,'' in our 
domestic regulatory framework.
    The FSB is an international body that monitors and makes 
recommendations about the global financial system. It was 
established in April 2009 by the G-20.
    Most of the members of the FSB are political appointees and 
banking regulators. The three U.S. regulators who are members 
of the FSB are the Treasury, the Federal Reserve, and the SEC.
    As I mentioned at a Banking Committee hearing on the FSOC 
in March, the FSB is not a U.S. regulator, and it is not 
accountable to Congress or the American people.
    At this same hearing, when asked about whether the FSB has 
the power to designate U.S. firms as ``systemically risky,'' 
Secretary Lew acknowledged, and I will quote him, that ``the 
FSB cannot designate a firm for us.'' And yet Secretary Lew 
could not recall any particular instance in which the FSOC had 
deviated from the FSB. Interesting.
    Furthermore, two out of the three insurance companies that 
the FSOC has designated were first designated by the FSB. The 
question that appears is whether FSB designations have become a 
substitute for the independent judgment of our regulators. And 
if they have, what do we know about the FSB's designation 
process?
    The U.S. regulatory process should be open and transparent 
and should encourage public participation in the rulemaking 
process. Because the FSB process is opaque and devoid of public 
participation, very little is known about the specifics of its 
deliberations.
    There remains much uncertainty regarding how a consensus is 
reached and the degree to which U.S. regulators are involved in 
FSB decisionmaking.
    Ultimately, the FSB process should not allow U.S. 
regulators to avoid our own rulemaking process or congressional 
oversight.
    In past hearings we have heard from the Treasury, the Fed, 
and insurance experts, among others, about the interplay 
between the FSB and the FSOC. Today the Committee here will 
receive testimony from those affected by the FSB process as 
well as experts who have studied and analyzed the FSB and its 
impact on U.S. companies.
    Senator Brown.

               STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman. Welcome to the five 
witnesses today. Thank you for joining us.
    This month, as we know, marks the fifth anniversary of the 
passage of Dodd-Frank and the Consumer Protection Act, over 7 
years since the worst crisis since the Great Depression began 
to spread through the global financial system.
    As the months and years pass, we cannot forget that damage 
that was done because we are still living with the after 
effects. This Committee can never forget that in its 
deliberations. We continue to see the damage done to Americans' 
finances and their lives. We must make sure that financial 
reform continues. That reform should not stop at the edge of 
our shores.
    The financial crisis showed us and showed the world how 
interconnected our financial system had become, how fragile and 
fragmented the regulatory system actually is.
    In 2009, the leaders of the G-20 nations outlined an 
agenda, agreed to an agenda to guide international financial 
reforms and ``too big to fail.'' Improved capital standards 
make markets more transparent and resilient.
    The Financial Stability Board was formed, and international 
reform initiatives were launched. We have heard over and over 
in this room the importance of international cooperation and 
the need for improved global standards.
    In September 2009, SEC Commissioner Casey testified before 
a Banking Subcommittee, ``International cooperation is critical 
for the effectiveness of financial regulatory reform efforts. 
The G-20 banking statement . . . '' she went on, `` . . . 
correctly recognizes that, due to the mobility of capital in 
today's world of interconnected financial markets, activities 
can easily shift from one market to another.'' She continued: 
``Only collective regulatory action can be effective in fully 
addressing cross-border activity in our global system.''
    In March 2012, Treasury Under Secretary Brainard appeared 
before this Committee and said, ``We have secured agreement 
internationally to strengthen liquidity standards and limit 
leverage. We have identified the globally systemically 
important banks. We have agreed to a capital surcharge for 
these banks. We have developed a comprehensive set of enhanced 
prudential measures to address risks from globally active 
financial institutions.''
    She continued: ``However, there is much work that needs to 
be done. We must remain vigilant against attempts to soften the 
national application of new capital and liquidity and leverage 
rules.''
    These statements, Mr. Chair, only begin to explain the need 
for international coordination and financial regulation, not a 
new concept. Basel dates back to the mid-1970s. The Financial 
Stability Forum, the predecessor to FSB, was formed 16 years 
ago. Cross-border cooperation is important because just in 
recent memory we have seen several domestic and international 
financial crises. From the savings and loan crisis in the 1980s 
and 1990s, the bailout of Mexico in the mid-1990s, the Asian 
financial crisis in 1997, which led to the failure and bailout 
of the hedge fund Long-Term Capital Management, through to the 
financial crisis, and the default and uncertainty facing Greece 
right now, we know that another financial crisis can happen and 
that it will happen. It will affect more than any single 
nation.
    It is the desire to prevent the next crisis that should 
drive us to broad global efforts and higher regulatory 
standards so that no market falls behind and allows unchecked 
risk to accumulate. The world cannot afford another AIG or 
Lehman. To make sure it does not have to, the United States has 
led global reforms, passing comprehensive Wall Street reform 
quickly in 2010, pushing for higher capital requirements, 
improving derivatives regulation, building out resolution 
mechanisms.
    We can and need to do more. Risks do not just build up 
overseas. They build up here in the shadows. Yesterday, IMF 
released its 5-year financial sector assessment of the United 
States. It identified several areas of so-called shadow banking 
where we still have work to do. We need to address gaps in 
regulation and oversight. We need to ensure that regulators 
communicate globally. We need to expose areas where excessive 
risk develops.
    Given that all the systemic risk questions have not been 
answered and regulations are still being considered and 
implemented, it is clear our work is not done. I hope today's 
witnesses will highlight the importance of international 
coordination to a stable financial system. It would be a shame 
if instead criticism of a nonbinding international coordinating 
body were used to weaken or stop the kinds of safeguards needed 
to prevent the next AIG.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you. Thank you, Senator Brown.
    Without objection, at this point I would like to enter into 
the record statements from the following organizations: 
Property Casualty Insurance Association of America and the 
National Association of Mutual Insurance Companies. Without 
objection, it is so ordered.
    Senator Brown. Mr. Chairman, excuse me a second. If I 
could, Mr. Chairman, I have two statements I would like entered 
into the record: one from Michael Barr, University of Michigan 
Law School, and one from Professor Christopher Brummer of 
Georgetown Law School.
    Chairman Shelby. Without objection, so ordered.
    Senator Brown. Thank you, Mr. Chairman.
    Chairman Shelby. They will be part of the record.
    Our witnesses today--I think we have a distinguished panel 
here--include the Honorable Dirk Kempthorne. He is no stranger 
to a lot of us. He is President and the CEO now of the American 
Council of Life Insurers. Governor Kempthorne has had a 
distinguished public service career and has previously served 
as Secretary of the Interior as well as mayor, U.S. Senator, 
and Governor of Idaho. Dirk, thank you.
    Peter Wallison is no stranger to this Committee either. He 
is well known and distinguished in his own right. He is the 
Arthur F. Burns Fellow in Financial Policy Studies at the 
American Enterprise Institute. Mr. Wallison has held a number 
of Government and private sector positions over his notable 
career, and the Committee welcomes him again.
    Mr. Paul Schott Stevens is President and CEO of the 
Investment Company Institute. Mr. Stevens is a well-known 
lawyer and previously served in senior Government positions at 
the White House and the Defense Department.
    Mr. Eugene Scalia is a Partner at Gibson, Dunn & Crutcher. 
Mr. Scalia is a renowned administrative law scholar and 
practitioner who previously served as U.S. Solicitor at Labor 
and as a Special Assistant to the Attorney General of the 
United States.
    Dr. Adam Posen, the President of the Peterson Institute for 
International Economics, will be our fifth witness. Dr. Posen 
is a member of the Council on Foreign Relations. He previously 
served as an external member of the Bank of England's rate-
setting Monetary Policy Committee.
    All of your full written testimonies will be made part of 
the hearing record, and, Dirk, we will start with you.

   STATEMENT OF DIRK KEMPTHORNE, PRESIDENT AND CEO, AMERICAN 
                    COUNCIL OF LIFE INSURERS

    Mr. Kempthorne. Mr. Chairman, thank you so much. Chairman 
Shelby, Ranking Member Brown, and all Members of the Committee, 
thank you for this opportunity.
    I would like to begin with a sincere thank you for 
shepherding through Congress last year important legislation 
that the Federal Reserve needed. Enactment of the Insurance 
Capital Standards Clarification Act, a fix to the Collins 
amendment, should enable the Federal Reserve to appropriately 
account for the fundamental differences in business models 
between banking and insurance. This was Congress at its best, 
bipartisan work to enact essential legislation.
    ACLI is the principal trade association for the U.S. life 
insurance industry. Life insurers offer real solutions to help 
millions of American families. We help people plan and save for 
retirement. We help people cope when a loved one dies. We help 
people who are disabled and need long-term care. Government 
will face more problems without the solutions offered by life 
insurers.
    I offer three observations:
    First, the Financial Stability Oversight Council should 
utilize an activities-based approach to identifying systemic 
risk rather than designate individual companies based merely on 
size.
    Second, the Federal Reserve should finalize their work on 
capital standards in a way consistent with congressional 
intent.
    Third, common sense and good policy certainly should 
require that the United States write its own insurance capital 
standards before agreeing to any international standards. 
Getting our standards completed at home and done right needs to 
happen first. This will require Congress to continue proper 
oversight of the work of Federal agencies who represent the 
United States on the Financial Stability Board, the 
International Association of Insurance Supervisors, and FSOC 
should also be subject to congressional oversight.
    I thank Chairman Shelby and Senators Heller and Tester for 
including language in pending legislation to increase 
opportunities for stakeholder input and congressional 
oversight.
    With respect to capital standards, ACLI is grateful that 
the Federal Reserve will proceed with a methodical process that 
will include a formal rulemaking and public comment period. 
ACLI also commends the FSB and FSOC for considering an 
activities-based approach for assessing the potential risks of 
asset managers before systemic designations.
    Yet with respect to insurers, I am troubled by the fact 
that these two organizations have made no similar effort. 
Instead, these organizations have chosen to designate 
individual companies as SIFIs without providing insight into 
the rationale for such designations or how the designations 
could have been avoided.
    The fact is that the FSB named institutions as ``globally 
systemic important insurers,'' or G-SIIs, and the FSOC followed 
suit. Designated companies were not accorded any ability to 
engage directly with the FSB over its review or to challenge a 
designation. The process is closed and opaque.
    In a similar lack of transparency, FSOC also pursued the 
designation of individual insurance companies and provided the 
public with little, if any, rationale. FSOC's only independent 
voting insurance expert, Roy Woodall, former commissioner in 
Kentucky, raised serious concerns over the intersection between 
the FSB's actions and FSOC's decisionmaking. To quote Mr. 
Woodall, ``Although not binding on the Council's decision, the 
declaration of Prudential as a G-SII by the FSB based on the 
assessment by the U.S. and global insurance regulators, 
supervisors, and others who are members of the IAIS has 
overtaken the Council's own determination process.''
    A relevant issue is how a company once designated a SIFI 
can exit being a SIFI. In other words, what is the off ramp to 
exit the SIFI highway? The answer to that question will help 
companies understand how they became SIFIs in the first place. 
Chairman Shelby, I thank you for working to provide the off-
ramp exit in pending legislation.
    It is important for the Federal Reserve's capital standards 
and the FSB's international capital standards to work in 
harmony, not in conflict. Quite frankly, there should be no 
rush in writing international capital standards for insurance 
companies in a very short period of time. After all, consider: 
It took 13 years to write Solvency II. It took 11 years to 
write Basel II. Life insurers want international standard 
setters to take the time to get it right, to avoid adverse or 
unintended consequences. This will help preserve the ability of 
insurers to provide financial and retirement security to 
millions of families.
    To quote Senator Tim Scott, ``the more successful the 
insurance company industry is, the less Government will have to 
do.'' We should embrace policies that enable Government to 
focus on those who are truly needy.
    Mr. Chairman, that is why the issues that you have 
presented here today with the Committee are so vitally 
important. Thank you for being vigilant in guarding against 
unintended consequences of regulatory action wherever and 
whenever they occur.
    Thank you, Mr. Chairman.
    Chairman Shelby. The Honorable Peter Wallison, welcome 
again.

   STATEMENT OF PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN 
    FINANCIAL POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE

    Mr. Wallison. Thank you, Chairman Shelby, Ranking Member 
Brown, and other Members of the Committee. Both the Financial 
Stability Board and the Fed have made clear in public 
statements that they want to impose prudential regulation on 
what they call the ``shadow banking system.'' Both defined 
``shadow banking'' as all financial intermediation outside the 
regulated banking system. This means broker-dealers, asset 
managers, mutual funds, insurance companies, hedge funds, and 
any other firm that is not a regulated bank.
    Prudential regulation is the regulation of risk taking. 
This is normally the prerogative of a firm's managers. So what 
the FSB and the Fed mean by placing shadow banking under 
prudential regulation is they want to control the risk taking 
of firms in the capital markets. This would be a major change 
in the capital markets where firms are generally regulated for 
conduct and not told by regulators what risks are permissible. 
The free capital markets in the United States are the source of 
our economic growth. Prudential regulation would end that 
freedom.
    The Treasury and the Fed are members of the FSB. Treasury 
Secretary Lew has repeatedly denied that the United States is 
bound by decisions made at the FSB. He told the House Financial 
Services Committee, ``We work in the FSB to try to get the 
kinds of standards that we think are appropriate in the United 
States to be adopted around the world.'' This tells us two 
things:
    First, FSB is important because it provides a forum for 
negotiating rules that will be globally effective. The Fed 
cannot control shadow banking from the United States alone.
    Second, Secretary Lew's statement makes sense only if the 
FSB's decisions can be implemented in the United States. No 
other country will abide by the FSB's decisions if the United 
States does not. This raises the question where the Treasury 
and the Fed think they have gotten the authority to implement 
the FSB's decisions in the United States.
    Unfortunately, it may be in the Dodd-Frank Act. Section 113 
of Dodd-Frank says that the FSOC can designate a firm of any 
size as a SIFI if its mix of activities could cause instability 
in the U.S. financial system.
    A year ago, Fed Governor Daniel Tarullo, who leads the 
FSB's efforts on shadow banks, said it was necessary ``to 
broaden the perimeter of prudential regulation both to certain 
nonbank financial institutions and to certain activities of all 
financial actors.'' The key word here is ``activities.''
    In 2013, in outlining how it would regulate shadow banks, 
the FSB stated that ``risk creation may take place at an entity 
level''--what they mean is in a SIFI, a single institution--
``but it can also form part of a complex chain of 
transactions''--still quoting here--``in which leverage and 
maturity transformation occur in stages.''
    This is a highly implausible idea, I think, but it is the 
foundation of the FSB's efforts to impose prudential regulation 
on the shadow banking system. The FSB would do it through 
controlling ``complex chains of transactions.'' But this is how 
business is done in the capital markets. Firms there buy, sell, 
securitize, finance, and trade risks and assets through complex 
chains of transactions.
    Recently the Fed's Vice Chair, Stanley Fischer, adopted the 
same idea, saying in a speech that, ``A complex chain of 
activity can increase the likelihood or severity of systemic 
stress.'' Thus, it appears that a global effort to control 
shadow banking will probably be based on an FSB agreement to 
regulate complex chains of transactions. But in the United 
States, because of the Dodd-Frank language quoted earlier, it 
will be based on regulating complex chains of activities.
    Thus, the FSOC could threaten to designate nonbank firms as 
SIFIs if they do not cease a certain class of activities--
unless the Fed approves the activity. That would, in effect, 
give the Fed the authority to approve activities only if done 
under the Fed's prudential rules.
    If this Committee does not want to see prudential 
regulation of the capital markets, it has to make clear to the 
FSOC and the Fed that the term ``activities'' in Dodd-Frank 
cannot be used for this purpose.
    Thank you very much for the opportunity to testify this 
morning.
    Chairman Shelby. Mr. Stevens.

STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT AND CEO, INVESTMENT 
                       COMPANY INSTITUTE

    Mr. Stevens. Thank you, Chairman Shelby, Ranking Member 
Brown, Members of the Committee. I am grateful for this 
opportunity to discuss the FSB and the role it plays 
internationally as well as here in the United States.
    The Investment Company Institute is an association whose 
members include mutual funds and other regulated funds in the 
United States and in jurisdictions worldwide. ICI understands 
the importance of sound, tailored regulation in maintaining 
strong and resilient financial activities in a financial 
system.
    In recent years, we have made numerous submissions to the 
FSB, including detailed responses to its successive 
consultations on asset management. Our experience with these 
consultations and with FSB more generally raises very serious 
concerns.
    FSB asserts a very broad mandate, no less than the 
stability of the entire global financial system; but most of 
its members and virtually all of its leadership consists of 
central bankers or finance ministry officials. The FSB 
describes its efforts in the asset management sector as a 
review of ``shadow banking.'' This disparaging term reflects 
the FSB's bias that all financial activity conducted outside of 
banks is inadequately regulated and, therefore, is ``risky'' 
because it is not subject to bank standards and bank regulatory 
supervision.
    Compounding this predisposition are FSB's broad lack of 
expertise on funds and capital markets as well as its 
insufficient regard for empirical evidence on the regulated 
fund industry, including our historical experience, structure 
and practices, and existing form of regulation.
    As a result, FSB's proposed methodology for G-SIFI 
designation proceeds on the basis of flawed assumptions and 
mere conjecture. Indeed, they appear almost reverse engineered 
to result in possible designation of certain large U.S. asset 
managers and the largest U.S. mutual funds.
    Now, this is ironic. Unlike banks, the group of U.S. stock 
and bond funds that FSB would single out for possible 
designation demonstrated a high degree of stability during the 
financial crisis. Why? As we have repeatedly explained to FSB, 
mutual funds use little to no leverage. They do not ``fail'' 
like banks and do not require Government intervention. Their 
structure and regulation limit risk as well as the transmission 
of risk. And as history has repeatedly demonstrated, they do 
not experience ``runs'' or ``fire sales'' during times of 
stress.
    In our view, FSB is not conducting its work with the same 
degree of rigor required of regulators in this country, nor is 
it operating with the same kind of transparency. We do not know 
the positions that U.S. representatives have taken on the 
methodologies proposed by FSB for possible G-SIFI designation. 
We do know that the whole work stream in this area is being led 
by the Fed.
    It does seem plain that there are extensive links between 
FSB and FSOC. It seems certain that any final FSB methodology 
for possible G-SIFI designation of mutual funds and their 
managers, no matter how deeply flawed it may be, will influence 
FSOC's own review of asset management and financial stability.
    In our judgment, a sector-wide appraisal of activities and 
practices is the best way to evaluate any potential risks in 
asset management. The Board of the International Organization 
of Securities Commissions, a global group of securities 
regulators with long experience in overseeing funds and asset 
managers, has recommended that a review of asset management 
activities ``take precedence'' over consideration of individual 
funds or asset managers as systemically important.
    Clearly, FSB's work would be far better informed and far 
more effective if FSB were reconstituted to accord capital 
markets regulators an equal place and an equal voice at the 
table. It would appear that for both FSB and FSOC, however, 
designation of mutual funds or their managers remains a live 
policy option. Subjecting U.S. mutual funds or their managers 
to bank-like regulation will harm millions of Americans saving 
for long-term goals like retirement. The direct costs will be 
substantial while the overlay of enhanced prudential 
supervision will introduce a highly conflicted form of 
regulation, clearly not in the best interests of fund 
shareholders. So, in sum, ICI strongly commends this Committee 
for its oversight of the role of U.S. regulators in the FSB.
    Regarding FSOC's designation process, ICI believes that 
before designating a company, FSOC should be required to 
specifically identify any risks and communicate those risks to 
the company and its primary regulator. It should provide a more 
meaningful role for the primary regulator to address risks, and 
it should provide companies under consideration with the 
opportunity to ``de-risk'' prior to designation.
    We, therefore, strongly support Chairman Shelby's efforts 
to reform FSOC's designation process and are pleased that he 
has included these common-sense reforms in Title III of S. 
1484, the Financial Regulatory Improvement Act.
    Mr. Chairman, thank you for the opportunity to present our 
views. I look forward to your questions.
    Chairman Shelby. Thank you.
    Mr. Scalia.

 STATEMENT OF EUGENE SCALIA, PARTNER, GIBSON, DUNN & CRUTCHER 
                              LLP

    Mr. Scalia. Chairman Shelby, Ranking Member Brown, and 
Members of the Committee, thank you for the opportunity to 
appear before you today. It is an honor.
    I speak to you today not as an expert on financial 
institutions, but as a lawyer who practices administrative law 
and who has represented clients in connection with the 
Financial Stability Board and designation as a systemically 
important institution by FSOC. This includes representing 
MetLife in connection with its designation as a SIFI, but today 
I testify in my individual capacity and not on behalf of any 
clients. The views I will express are my own.
    I would like to touch on three legal points that I hope may 
frame the Committee's consideration of the FSB.
    First, it is a basic principle of administrative law that, 
in the words of one court, an agency should not ``adjudge the 
facts or law of a particular case in advance of hearing it.'' 
So in one case, the court found that there had not been due 
process of law when an agency decisionmaker had made a speech 
indicating that he had already reached a decision on a matter 
that was currently pending in a case before him. The person who 
had given the speeches was not the only decisionmaker involved 
in those proceedings, but the court in the case said, 
``Litigants are entitled to an impartial tribunal, whether it 
consists of one person or 20.'' And it added that there was no 
way of knowing what influence that one member had had.
    There is no record of the role the U.S. members played in 
the FSB's designation of the three U.S. insurance companies we 
have heard about as systemically important. But to the extent 
that one or all of the U.S. members joined in those 
designations by FSB, it becomes a legitimate subject of inquiry 
what effect that subsequently had in FSOC proceedings.
    Second, and related, the designation process before FSOC 
must not serve as a forum for implementing decisions 
essentially already made before the FSB. Dodd-Frank sets forth 
specific criteria for FSOC to apply. The FSB criteria are 
different to the extent that they can be discerned at all. Most 
important, Dodd-Frank establishes procedures for FSOC to reach 
its decisions. Under law, those procedures must present 
companies a real and genuine opportunity to make their case 
before open-minded decisionmakers.
    The statements you have heard by FSOC Member Woodall that 
FSB's designations have ``overtaken'' FSOC's designation 
process are troubling. By way of analogy, if the judge wrote in 
dissent that her colleagues had based their decision on 
considerations other than applicable law, the facts in the 
record, and the explanations set forth in their majority 
opinion, we would regard that as a matter warranting further 
inquiry.
    The third point I'll make is that weaknesses in FSOC's SIFI 
designation decisions to date give further reason to question 
whether the rationale in those decisions is a full account of 
what drove FSOC's decisionmaking. One such weakness is FSOC's 
insistence on a company-specific designation process for 
insurance companies even as it considers an activities-based 
approach for other entities.
    In explaining in its MetLife decision why it was not taking 
an activities-based approach, FSOC used circular reasoning. It 
said that Dodd-Frank required it to consider specific statutory 
criteria when making a company-based designation and ``an 
activities-based analysis is not one of the statutory 
considerations.''
    In other words, FSOC said that it was not considering an 
activities-based approach because it had not considered taking 
an activities-based approach. One is left to wonder again about 
the degree to which FSOC's designation of three specific 
companies designated by FSB resulted from that prior FSB 
action.
    Mr. Chairman, the legislation you have introduced would 
address some of the concerns that I have raised today. Section 
403 would provide visibility into FSB-type processes, including 
the positions taken by U.S. regulators on policies they may be 
called upon to address back home.
    Section 302 addresses the uncertainty companies face about 
how to avoid being considered systemic. Under the bill, a 
company could submit a plan to FSOC for changing its corporate 
structure and operations so the company would not be deemed 
systemically important. If FSOC believed that plan was 
insufficient, it would have to explain why and what actions the 
company could take to avoid SIFI regulation. That change, like 
Section 403, would increase transparency, fairness, and thereby 
the quality of Government decisionmaking.
    Thank you for this opportunity, and I look forward to any 
questions that you may have.
    Chairman Shelby. Thank you.
    Dr. Posen.

 STATEMENT OF ADAM S. POSEN, PRESIDENT, PETERSON INSTITUTE FOR 
                    INTERNATIONAL ECONOMICS

    Mr. Posen. Thank you, Mr. Chairman and Ranking Member 
Brown, for this opportunity.
    Let us begin sort of as Senator Brown did, to remember that 
international coordination and regulation remains in the U.S. 
interest. It remains in the U.S. interest because the rest of 
the world's banks and financial entities exist whether or not 
we want them to or not. And the spillovers of them screwing up 
are much bigger and much faster today than they have ever been. 
There is no simple defense against that. I realize no Members 
of the Committee are challenging that, but let us start there 
because that is where the FSB comes from.
    It is also worth remembering that the FSB, like every other 
international financial institution since the war, is largely 
the child of success of American administrations, Democrat and 
Republican. When we think of the Financial Stability Forum, 
that was founded 16 years ago through U.S. efforts. The 
graduation of it to the FSB was, again, through U.S. efforts, 
through the U.S. Government, and it remains the fact that the 
United States is the dominant voice in this effort.
    This is, in fact, because of our technological experience, 
our technical expertise, the depth of our markets, the fact 
that we still remain a model, and we have overweight influence 
in the FSB. Most of the complaints about the FSB abroad are 
because the United States is seen as having too much power, not 
too little. I think it is important to have that baseline as we 
go forward. We cannot simply live with the institutions and the 
misbehaviors of other countries' financial institutions.
    So, therefore, what is it we want and what is it we get out 
of international regulation? We want to raise minimum 
standards, we want to increase cross-border transparency, and, 
most importantly, we want to prevent regulatory arbitrage. We 
want to prevent, whether it is U.S.-based entities or foreign 
entities, getting around the legislated regulations from 
Congress and from Congress' appointees by going to other 
jurisdictions and inflicting damage on the United States. The 
FSB is actually making a major contribution to diminishing 
this--not getting rid of it, but certainly diminishing it.
    There are instances where the FSB is messing up, and I will 
indicate that I actually share some views with some of the 
other witnesses on the insurance industry where I think the FSB 
does have it wrong. But these are instances of where they are 
getting a specific decision wrong, not something inherent to 
the process or inherent to the relationship between the FSB and 
the FSOC or the U.S. Government.
    Now, why is the FSB useful? There has been a lot of talk 
about the fact that it is opaque, it is not accountable. 
However, I think it is important to recognize several 
attributes that are positive. The first is it involves all of 
the major countries that have major financial centers and all 
of the minor countries that have major financial centers, which 
is a body that we need if we are going to plug these holes.
    It also, for that matter, is small enough that it can make 
decisions, which is a key attribute. As we know from, say, the 
IMF or the WTO, when every member gets a vote, it deadlocks, 
you get nothing.
    It is cutting across regulatory and turf barriers, perhaps 
not always in a way the other witnesses would like, but it 
importantly gets us out of this cognitive capture that both 
United States and other regulators can get when they are only 
in their own silo.
    It is coordinated directly with the G-20 economic leaders' 
meetings and processes, which means there have to be 
transparent progress reports, there have to be public 
accountings, and things that reach the G-20 level can be 
brought to the public for buy-in.
    By including central banks and finance officials, you are 
not only getting the right experts in the room; you are getting 
it past the narrow bank supervisors, which is an important 
quality.
    And, finally, I would argue that, in addition to the 
bipartisan U.S. legacy, it has rightly a soft-law legacy. They 
are not legislating for us. They are setting standards that we 
and others might adhere to, and if they are good standards, 
there will be market and peer pressure and public pressure to 
adhere to them by others. All the FSB can do is name and shame. 
It cannot enforce anything.
    Now, I think we can get some specific areas where the FSB 
has done great work. People who believe in resolution as a key 
cause of the financial crisis can see huge progress there, 
certainly bank capital standards, certainly liquidity 
standards. These are important aspects.
    I do believe the FSB is wrong about insurance companies 
because of a general problem in the FSB, but also a general 
problem in the FSOC. We do not have a coherent U.S. 
representative of expertise on insurance companies at that 
level. Therefore, the European Commission, which has a pre-
made, pre-baked Solvency II, gets to shove that through, and 
their companies who are going to be stuck with it want to be 
sure that their competing foreign companies also get stuck with 
it. That is not a good reason for a law, and if the U.S. 
representatives of the insurance companies were better equipped 
and had better arguments at FSB, we could prevent Solvency II 
from causing harm. Solvency II harm is not because it engages 
in prudential risk regulations, as Mr. Wallison said; it is 
because they interfere with long-term capital in ways that are 
not efficient for insurance companies by making them act like 
banks. That is a mistake. But it is an intellectual mistake of 
the FSB that the FSOC and U.S. representatives have the power 
to correct. It is not an inherent problem of the FSB.
    Thank you for this opportunity.
    Chairman Shelby. Thank you, Dr. Posen.
    A lot of concerns have been raised in testimony today and 
at previous hearings we have held here about the role of the 
FSB and its regulatory influence in the United States. As I 
have mentioned, the FSB is neither a U.S. regulatory body nor 
is it accountable to Congress and the American people.
    Could each of you succinctly elaborate, if you can do that, 
on your top concerns with the work, the transparency, and 
accountability of the flexibility and what Congress can do to 
address some of these concerns? Governor, we will start with 
you.
    Mr. Kempthorne. Mr. Chairman, thank you very much. In 
visiting with different members of the FSB, in one instance 
where it was a central bank president of another country, but 
he made the point--he said one of the things that we should do 
is give much greater exposure to the insurance industry because 
we do not know much about it. We have had other members of FSB 
say it is interesting at times to see what the International 
Association of Insurance Supervisors say they must do in the 
name of FSB, and that somebody should press them on that. There 
are a variety of things.
    And then, Mr. Chairman, as mentioned earlier, the close 
connection between FSB actions and FSOC actions, where within 
days AIG is named as a G-SII, the three that are now designated 
as SIFIs were all named as G-SIIs first by the FSB. Why did 
they not coordinate? Why did they not say to those that have 
the expertise in this country, ``Where do you think there may 
be a problem?'' And that is why, again, Mr. Chairman, we ask 
that the activities-based approach should be taken. That has 
not occurred. There is no transparency. The FSB does not 
communicate to the companies why they made the decision they 
did. We would like greater transparency.
    Chairman Shelby. Mr. Wallison, succinctly.
    Mr. Wallison. I will try.
    Chairman Shelby. I know, I know. Thank you.
    Mr. Wallison. My concern, as I expressed in my oral 
testimony, is that the FSB is intending to regulate shadow 
banks and the shadow banking system. I think that would be a 
major mistake, and if that idea is brought into the United 
States, it would substantially weaken our financial system.
    I would like to see a lot more transparency and 
accountability at the FSB so that we understand why they are 
trying to regulate shadow banks, other than the fact that 
banking regulators in general are trying to get control of 
everything that is not a bank. But, of course, we are not 
getting that. To the extent we can, that would be helpful. But 
the most important thing I think we have to worry about is the 
idea that our capital markets will ultimately be put under 
prudential regulation by an organization like the Fed.
    Chairman Shelby. Mr. Stevens.
    Mr. Stevens. Mr. Chairman, there are any number of issues. 
One, for example, is that the full record of comments that the 
FSB receives is not made public, so you do not really have an 
idea of who or what may be influencing its decisions.
    Second, it does not appear that the FSB feels obliged as a 
U.S. regulatory agency would actually to take into 
consideration and respond to the commentary it receives. This 
pack of papers in front of me represents just what the ICI has 
put in front of the FSB. Much of it has been, frankly, 
disregarded. We have no idea what the positions are that the 
U.S. representatives are taking, but when recommendations 
emanate from the FSB, it is clear they have been front-run in 
terms of the FSOC process, and certain decisions have already 
been made, which are then revisited here in Washington. It is 
sort of like being both the pitcher and the umpire in a 
baseball game.
    Chairman Shelby. Mr. Scalia.
    Mr. Scalia. Transparency certainly, you have heard. 
Transparency also into the influence that might exist, FSB upon 
the FSOC, which has not been provided and should be avoided in 
the future.
    Second, a balance. Dr. Posen's point about insurance 
representation is a very important one, I think.
    And, third, FSB should hesitate and think long and hard 
before making company-specific decisions. That implicates 
principles of due process, the opportunity to be heard and the 
like, that really change the nature of what it is doing.
    Chairman Shelby. Dr. Posen.
    Mr. Posen. Thank you. I am much more concerned about the 
substance than the process. I think the substance has gotten 
too bank-captured, too bank-controlled, too much bank 
supervisor mind-set, as my colleagues and I have discussed. I 
think they remain a little too timid on surveillance, and they 
need to extend what needs to get the Chinese banks, which, of 
course, are in the news right now, which are becoming major 
systemic actors. We need to be willing to open up the 
governance enough because we need to get them in and get them 
observed.
    And I sort of echo Mr. Scalia's point. I think there has 
been too much time wasted and too much distraction on 
individual designations, and that is a fight we cannot have. 
But at the same time, if the FSOC and the FSB come up with 
completely different designations, that is a recipe for 
regulatory arbitrage because national champions will cheat 
around our rules.
    Chairman Shelby. Thank you.
    Governor Kempthorne, could you briefly describe the key 
differences between the U.S. and European regulation of 
insurance? And given those differences, is it appropriate for 
the FSB to influence insurance regulations in the United 
States?
    Mr. Kempthorne. Mr. Chairman, it is a totally different 
system that is used in the European Union than in the United 
States. I have stated in international forums that the idea of 
Solvency II, it may work for Europe. It will never, ever work 
here in the United States. We are State-regulated, and as 
Secretary Geithner said after the 2008 crisis, the insurance 
industry came through it ``quite well.'' So we have a program 
that has worked for decades.
    Chairman Shelby. Even AIG did not get in trouble on 
insurance. They got in trouble doing something that they 
probably wish they had never known about.
    Mr. Kempthorne. Mr. Chairman, you are absolutely correct. 
It had nothing to do with their insurance element within AIG.
    Chairman Shelby. Thank you.
    Dr. Posen, in your testimony you highlighted several 
troubling FSB outcomes. For example, you noted that calling all 
nonbank financial companies ``shadow banks'' and regulating 
them as banks endangers the very financial diversity that 
enabled the United States to recover from the financial crisis 
better and more quickly than our global counterparts.
    You also noted, and I will quote you, ``We do not want any 
global regulatory process to interfere with this diversity in 
U.S. finance.''
    What are your concerns with the FSB potentially interfering 
with the U.S. financial system's strength and diversity?
    Mr. Posen. My concerns are more theoretical, to be honest, 
than practical at the moment. I do not think the FSB is a 
direct threat. I do think that it is important that the U.S. 
regulators and your representatives make it clear that it is a 
good thing to have capital markets as well as banks. It is a 
good thing to have lively risk taking as well as lending. It is 
a good thing to have nonconcentrated banking systems. And it is 
entirely possible and consistent with part of the FSB process 
to make that the agenda.
    I do not think there is a need for absolute convergence. 
The example I chose to give of the insurance companies is the 
one place where I do feel there is a costly effort being under 
way from the FSB. I do not think this is motivated so much 
because the leadership of the FSB wants convergence, although 
some people do. I think it is motivated by an excessive--some 
people have mentioned rush to judgment. The FSB is trying very 
hard to wrap up what it considers its post-crisis duties very 
quickly, and I think it is trying to force everything with off-
the-shelf solutions because it is rushing too much.
    Chairman Shelby. The last question will be directed to Mr. 
Scalia. As an administrative law practitioner, among others, 
you are familiar with our domestic rulemaking process. For 
example, the Administrative Procedures Act governs the way, as 
I understand it, in which Federal and administrative agencies 
may propose and establish regulations in the United States. But 
none of those processes apply to the FSB. In fact, according to 
the FSB, ``The organization operates by moral suasion and peer 
pressure to set international standards.''
    Mr. Scalia, in your opinion, would FSB's reactions and 
decisions pass legal muster in the United States? And what are 
your main concerns with the role and impact of the FSB on our 
regulatory process?
    Mr. Scalia. Mr. Chairman, no, the FSB processes would not 
pass legal muster in the United States. One principle that is 
absent is that of notice, of providing notice to the public in 
advance of what might be coming down the pike.
    Now, that furthers interests of fairness, but I think more 
importantly it leads to better decisionmaking, because when the 
public has notice, it has an opportunity to weigh in, provide 
guidance, and regulators benefit from those insights. So I 
think that is one important difference.
    A second I will mention is the opportunity to be heard and 
appear and defend your rights and interests. And I think when 
FSB finds itself making company-specific designations, the 
absence of that is striking as a matter of the perspective of 
U.S. law, or really I think any perspective.
    A third difference that I will mention--and then I will 
stop in the interest of time, although I could go on--is an 
opportunity to appeal. You know, in the United States, when 
there is regulatory----
    Chairman Shelby. Basic due process.
    Mr. Scalia. Basic due process, being able to go to court 
and say, respectfully, we believe this was a mistake, you 
erred. And that also is absent from the FSB process.
    Chairman Shelby. Thank you.
    Senator Brown, you have been very patient. Thank you.
    Senator Brown. Thank you, Mr. Chairman, as you always are, 
so thank you for that.
    These hearings are especially important, and I am 
appreciative that we have them so that we do not forget the 
cost of the financial crisis. I live in a Zip code in 
Cleveland, Ohio, 44105, which had more foreclosures in 2007 
than any Zip code in America. I still see the cost in that 
neighborhood, and neighborhoods all over my State, as I think 
is true in so many places. I think these hearings force us to 
remember, and should, what Dodd-Frank and what the consumer 
protections did for our financial system and for consumers and 
for people that work and use the financial system. And I think 
it helps--these hearings help us recognize how much more we 
still have to do.
    Let me start with you, Dr. Posen. You mentioned cognitive 
capture today. I remember some maybe 3 years ago, I was on a 
panel with Governor Huntsman and at that point just former head 
of the FDIC, Sheila Bair, and I believe you were moderating it, 
and you used that term at the Peterson Institute 1 day of 
``cognitive capture,'' where regulators begin to hold the same 
world view as the companies which they oversee.
    It seems that one of the benefits of a single body with 
broad international membership and different agencies is that 
you can avoid a single nation or regulator protecting one of 
its companies or industries by avoiding regulation.
    My question is this: Dr. Posen, we know inconsistent 
regulatory standards create the potential for substantial risk. 
Would you discuss the importance of coordinating standards to 
address regulatory arbitrage and other systemic risks, please?
    Mr. Posen. Thank you very much, Senator Brown. You have 
already hit the issue in your question, so let me try to 
document the issues you raise.
    What I think has to be looked at when we look back at the 
financial crisis in the United States and the other major 
Western economies in recent years was that everyone was pulling 
in the same direction. Banks, their lobbyists, Congress people, 
Fed officials, Treasury officials, both parties--they were all 
largely on the same line that less regulation, infinitely less 
regulation was better, self-regulation was better. And as a 
result, when we look for a cause of the crisis, there is a 
clear failure of behavior, of regulation, of supervision, but 
it is so dispersed. It was not one person's decision, nor was 
it one person's bribe. It was, as I put it, cognitive capture, 
that everyone bought into this being the way of the world.
    And the FSB has been successful in breaking that down, not 
just because it has a mandate to look at regulations, a mandate 
to improve regulations, but because it is, as you say, cross-
border.
    We had a world in which AIG financial products, as 
mentioned, got away with doing something that an insurance 
company or, for that matter, no one ever should have done, 
because it took place in London instead of New York and because 
it took place in a subsidiary that was supposedly not part of 
the insurance, and so, therefore, it had a loophole to get to. 
And we all know the repercussions of that.
    We had bad lending on mortgages, be it in Spain, be it in 
the United Kingdom, and certainly here in the United States. 
And that was not because of Fannie and Freddie. As former Fed 
Governor Randall Kroszner has pointed out, it was because of 
bad standards in the banking system, bad enforcement of 
standards in the banking system. And that allowed other 
countries to get their mortgages paid for, distributed, and the 
standards to be lower throughout the world.
    So how do we stop this? We make our best efforts. We make 
our best efforts to come up with best practice; we make our 
best efforts to challenge assumptions; we make our best efforts 
particularly to assure that no one country, be it France, be it 
Japan, or even the United States, gets to say, ``The interests 
of my banking system, as companies not as a public interest, 
trump the need for decent regulation.'' And the FSB has been 
pursuing that goal at least.
    We have had various aspects where in the past, as created 
the euro crisis, French banks and German banks were bailed out 
at the public's expense, leaving Greece with the bill. This is 
the kind of thing that the FSB is meant to avoid by breaking 
down these barriers and subjecting these kinds of bad behaviors 
to global scrutiny and raising these bad behaviors. I agree, 
activity-based not so much institution-based, up to the G-20 
level where they can be properly addressed as well.
    I will finally say that the--this is where I differ on the 
due process point. I think it is important that international 
regulations be done by sovereign nations agreeing and creating 
standards that are soft power, that when countries or companies 
do not comply, it is up to the market and the public to punish 
them; it is not some supranational agency to do it. And I think 
the FSB is making huge strides and getting more plugging of 
holes of the AIG financial products kind because it involves 
this voluntary shaming and voluntary invoking of the market 
rather than legislating.
    Senator Brown. Dr. Posen, speak to the designation process 
in terms of interconnectedness related to securities lending 
and derivatives, the risk of runs, the potential for fire 
sales, if you will.
    Mr. Posen. Yes. Obviously, the question of how to handle 
the asset management industry is a crucial factor here, mutual 
funds and other asset managers. So much of our private savings, 
so much of our people's pensions and long-term savings are 
there, for understandable reasons.
    But as we saw with the money market mutual funds during the 
crisis, they were able to act as though they had an implicit 
Government guarantee and then eventually an explicit Government 
guarantee, because no one wanted to see them break the buck, 
and because it was so politically unpopular to see them not 
have deposit insurance like the banking system, even though 
inherently they are much more short term than the banking 
system.
    Paul Volcker, who is hardly a radical, has bemoaned this 
fact at great length before this Committee, I believe.
    This is just one example of how it is correct and right for 
the ICI and others to go out there and say you cannot treat 
mutual funds and asset managers like banks. They are not the 
same as banks. You have to judge the regulation appropriately. 
But it is not an argument that there should be no regulation or 
that we have sufficient regulation at this point.
    We have seen repeatedly that asset managers may not 
themselves cause leverage, which is a good thing and should get 
them some points. But we have also seen that fire sales can and 
do occur. We saw this with the European crisis in the past in 
which we have seen the sell-off of European bonds, which then 
led to losses in the U.S. system, which also exacerbated the 
European financial crisis in 2010-11.
    Fire sales, we may not have the right answer. Circuit 
breakers are not necessarily a perfect thing, as we have seen 
with the U.S. stock market. We have to think hard about how to 
do it, and we do not need to rush to regulate it in the next 5 
minutes. There clearly is a gap in regulation in this area.
    Mr. Stevens. Senator, since this is now touching on----
    Senator Brown. Thirty seconds, because my time has run out, 
and I want to ask Mr. Kempthorne--but, Mr. Stevens?
    Mr. Stevens. The ICI has insisted all along that there be 
an evidence-based analysis of things like fire sales. The 
documentation we have in front of the FSB is very clear. In the 
75-year history of U.S. stock and bond funds, there has never 
been the kind of fire sale or panicky sell-off that Dr. Posen 
is describing. It is hypothetical. It is a matter of 
conjecture. It is not a matter of historical experience or 
empirically demonstrated. And the money market fund example, 
which central bankers go back to all the time, has already been 
addressed in two successive rulemakings by the SEC. It is 
important to note the FSB's focus here is not money market 
funds; it is ordinary stock and bond funds. And so the issue 
is, I think, a false scent to raise the experience of money 
market funds in the crisis, because FSB's focus is elsewhere.
    Senator Brown. Governor Kempthorne, let me shift to 
something else. A number of my colleagues and I worked to pass 
and sign into law clarifications of insurance capital 
standards. You mentioned that a moment ago. Would you update us 
on your talks with the Fed to implement them?
    Mr. Kempthorne. Yes. Senator Brown, thanks very much. It 
was critical for the solution that Congress came up with. The 
Fed acknowledged that. They said, ``Absent that, we were not 
able to differentiate the business models between banks and 
insurance.''
    Since then, we have a group of companies that are under the 
banner of ACLI that leadership has met with Fed officials. They 
now have put in place what will be a series of just working 
sessions. We appreciate the fact that the Fed is saying while 
we have been for decades dealing with banks, this is a new area 
for us, and so they have asked the industry to please have the 
dialogue so that they can understand some of the nuances and 
some of the elements with regard to the insurance industry.
    We certainly as an industry cannot predict the outcome of 
what the Fed would recommend, but at least we appreciate this 
dialogue that is taking place.
    Senator Brown. Thank you.
    Thanks, Mr. Chairman.
    Chairman Shelby. Senator Heller.
    Senator Heller. Mr. Chairman, thank you, and thanks to the 
witnesses for being here today. It is a good group, and I 
appreciate your knowledge on these issues.
    I want to echo what has been said. It is no doubt that 
regulators are looking at risks associated with activities--
should be looking at risks associated with activities and not 
just the size of an institution. One of the frustrations is, 
instead of working to decrease systemic risk, it seems 
regulators just want to make more SIFI designations. I think 
most of the panel would agree with that.
    I think some of the best solutions, Mr. Chairman, is what 
you put together in your bill and what this Committee passed 
recently. I think the legislation does a great job in the 
nonbank SIFI designation process, and I would like to hear from 
the Governor and Mr. Stevens their thoughts on the Chairman's 
bill, specifically Title III and the reforms of FSOC's 
designation process.
    Mr. Kempthorne. Yes, Senator Heller, thank you very much, 
Mr. Chairman. We greatly appreciate the efforts of the Chairman 
and Members of the Committee. Specifically, one of the elements 
that we think is absolutely critical is the off ramp for a 
SIFI, because I do not think any of the companies can tell you 
what were the elements that put them into a SIFI designation. 
So perhaps by having an off ramp, it will give us those 
elements now so that a company knows how it can get off. It may 
help other companies from ever getting on.
    Also, I would just note that with regard to a lawsuit that 
has been referenced in this hearing, again, we think that will 
bring additional light to what were the elements that were 
utilized in actually putting a company in that situation.
    It can put an adverse competitive problem to those that may 
be designated SIFIs. One element may be additional capital 
requirements, different regulations that may put them at a 
disadvantage in a competitive marketplace. We need to have a 
highly competitive marketplace and not disadvantaged some of 
those elements.
    I would also say, Senator Heller, as I indicated in my 
opening comments, to you and Senator Tester, we greatly 
appreciate language, which you have included, that would help 
bring about much greater transparency, the idea that it would 
require that those entities in the United States, which have 
been termed ``Team USA,'' would on an annual basis have to 
submit a report to this Committee and would have to come to a 
hearing so that the Members of the Committee can ask them, 
``What is taking place at FSB, at FSOC?'' I think that is a 
tremendous benefit, and I compliment you.
    Senator Heller. Is this your view or ACLI's view?
    Mr. Kempthorne. I will tell you, Senator, that this is a 
view that I have heard repeatedly by industry. We need much 
greater transparency, and this would help accomplish that.
    Senator Heller. Mr. Stevens?
    Mr. Stevens. Senator, thank you for your question. The 
purpose of addressing potential systemic risk is not simply to 
identify it and admire it. Presumably it is to deal with it. 
And so common-sense provisions like those that are in the 
Chairman's bill that would, prior to designation, allow either 
a primary regulator or a firm to address and mitigate or 
eliminate the risks seems to me to be an improvement on the 
mechanisms in Dodd-Frank, and a sensible one as well.
    I think that it would require the FSOC to be specific about 
what risks it thinks exist, but if the FSOC cannot be specific 
and cannot articulate what they are, they probably should not 
be designating in the first place.
    So it seems to me that the provisions in Title III of the 
bill in that respect make eminently good sense and are 
consistent with the broad objectives of the statute.
    Senator Heller. Let me ask you a follow-up question. If 
some of these asset managers are labeled SIFI designations, who 
bears the cost of these increased regulations?
    Mr. Stevens. Well, you have to be mindful of what that 
entails under Dodd-Frank. There is a mandatory 8 percent 
capital requirement. There are various fees and assessments. 
There would be putting the fund into a bailout pool for large 
banks or other SIFIs that may fail in order to make sure the 
taxpayer is not on the hook. It is just another way of putting 
some of our taxpayers on the hook.
    And then, finally, it would subject them to enhanced 
prudential supervision, which essentially is the Fed coming in 
and telling the portfolio manager potentially how to run the 
fund. I think that a fund so designated is not going to be too 
big to fail. It is going to be too burdened to succeed because 
there are lots of alternative funds in the competitive 
marketplace for mutual funds in the United States, and many 
investors, being sensitive to costs, will simply say, ``Well, I 
will not invest in that fund. I will take my money somewhere 
else where I am not paying these kinds of penalties.''
    Senator Heller. So what you are saying is ultimately there 
will be cuts in their returns on their investments.
    Mr. Stevens. It will be paid by millions of Americans who 
are seeking to save for retirement.
    Senator Heller. OK. Mr. Chairman, thank you.
    Chairman Shelby. Senator Menendez.
    Senator Menendez. Well, thank you, Mr. Chairman.
    International coordination to address systemic risk is not 
easy, but as we learned during the financial crisis, I think it 
is critically important. As we saw with companies such as 
Lehman Brothers and AIG, systemic risk can easily cross 
national borders, and a company large enough to create systemic 
risk will most certainly have activities affecting or occurring 
in multiple countries.
    We also saw the need for harmonization; otherwise, risk can 
just flow to the darkest and least regulated corner of the 
system, where it can build unchecked beyond the reach of 
countries whose citizens could bear significant costs if things 
go wrong.
    Now, the Wall Street Reform Act made important reforms to 
address systemic risk here at home, and internationally, the 
United States and other countries have established forums such 
as the Financial Stability Board to improve coordination and 
close gaps across jurisdictional lines.
    Now, I understand that some companies have legitimate 
concerns about whether and how particular measures might be 
applied to them. And it is important that we distinguish these 
substantive concerns from procedural ones so that we are able 
to make appropriate improvements on both fronts. But if you are 
concerned about a SIFI designation, it would be overkill to 
destroy the entire process for designating anyone else as 
systemically important, too.
    So as always, from my perspective, in the 23 years that I 
have spent in the Congress, it is about getting the balance 
right at the end of the day.
    So I think individual cases may be able to illuminate ways 
that both the domestic and international processes can be 
improved, as we have already seen in some of the changes the 
Financial Stability Oversight Council has made to strengthen 
its review process. So with that focus in mind, I have a few 
questions for our witnesses.
    Dr. Posen, many have raised concerns about the sequencing 
of actions by U.S. authorities and international bodies such as 
the FSB, and this really gets at the heart of the challenges we 
face in terms of coordination with other major markets. So to 
me, it is important that concerns about sequencing be dealt 
with, but not be used as an excuse for inaction or obstruction. 
There are real questions about how to keep the domestic and 
international tracks moving together at the same pace.
    So why do you think international bodies such as the FSB 
have chosen to move ahead of individual countries' authorities 
in certain areas, whether SIFI designation or articulating a 
framework or principles for something like capital standards? 
What are the benefits of doing that?
    Mr. Posen. Thank you, Senator, and as you rightly said in 
your remarks, it is a question of balancing risks. The idea is 
that the United States has to be engaged with the international 
process not so much because of defending the United States from 
overregulation, but defending us from underregulation and poor 
performance abroad. And there has to be some willingness to 
tradeoff not the U.S. sovereignty and not the U.S. oversight, 
but occasionally officials want to be able to say I am much 
more at risk of something terrible going wrong, as you say, in 
the dark corner of some country that is eluding the safety net, 
eluding the regulators, than I am about the X pennies cost of 
slight overregulation in the United States. And that is a 
legitimate kind of tradeoff to make.
    And so in the real world, just as the case in Congress, as 
we saw with the TPA vote last week, the Senate and the House 
are not always perfectly sequenced. What matters is that in the 
end they come to an agreement. Nothing terrible is going to 
happen with them being out of sequence for a short while. What 
matters is the debate and the eventual convergence and 
compromise.
    Similarly, the FSB in part because it is more closed, in 
part, however, because, as I said to Senator Brown, they are 
also less subject to any individual country or interest group's 
lobbying, is able to make decisions faster. It does not mean 
they are right. It does not mean they should always do them at 
maximum speed. But in the case of the SIFI designations, for 
example, I think it was an important decision that was made 
about the balance of risks, that leaving the uncertainty about 
who was going to be a SIFI, at least as far as the FSB was 
concerned, had unfair costs to those private sector entities 
and had costs to the regulatory process. And so, therefore, it 
made sense for them to go forward, and if it turns out that the 
FSOC or other national regulators were to push back, those are, 
as you said, individual cases that could be corrected.
    The process, the fact that this appearance of timing is not 
the subject of a conspiracy or even of undue pressure on the 
FSOC, it is just we are iterating to the right goal.
    Senator Menendez. Thank you. One last question. I think the 
sequencing in the Congress would go better if the House of 
Representatives would understand the enlightened process of the 
Senate. But, Mr. Stevens, let me ask you, how do you feel the 
feedback you have given at the domestic level, in terms of how 
different metrics might apply differently in the asset 
management context than they would to other kinds of financial 
market participants, is carrying through the international 
level? And to the extent that you have the concerns you have 
expressed about whether actions at the international level 
might reduce opportunities for a full and well-informed process 
here in the United States, what are some of the top 
recommendations that you would make to improve the process 
without effectively killing it overall?
    Mr. Stevens. Thank you, Senator. As I elaborate in my 
written statement, I do think there is a cognitive capture at 
FSB, and it is because virtually all of its members and all of 
its leadership consists of central banks. If its mandate is to 
look at the financial system in its totality, it needs to be 
reconstituted, in our judgment. It should not simply be bankers 
with their point of view trying to impose bank-type regulatory 
models on everyone. The capital markets regulators and 
securities regulators ought to sit as co-equals at the table 
when you are talking about areas like asset management. 
Insurance regulators ought to be there as co-equals at the 
table when you are talking about insurance. That would be a 
meaningful form of international collaboration and 
international exchange, and I think it would solve many of the 
problems.
    We have an example now of IOSCO basically saying that it 
thinks that the FSB is headed in a completely wrong direction 
with respect to asset management, putting the cart before the 
horse, trying to find what the solution is before it has even 
identified the problem. And so IOSCO has said let us look at 
activities and products straight across the asset management 
sector instead of, as the FSB's process essentially is doing, 
picking a handful of large U.S. mutual funds and U.S. advisers 
and recommending them for designation as SIFIs.
    So I think the fundamental reform of the FSB is to 
reconstitute it in a significant way and break up the club of 
central bankers who have only one view of the world.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Kirk.
    Senator Kirk. For Mr. Scalia, I would ask you a question 
about--what would you think of applying notice and comment 
provisions of the U.S. Administrative Procedures Act to the FSB 
deliberative process so that U.S. insurers could have notice 
and time to comment on potential actions? I have been very 
worried over time that the process of providing insurance to 
millions of Americans is different than banking in 
international circles, that if we provide the wrong standards, 
we could make insurance products much more expensive and less 
available to Americans.
    Mr. Scalia. Thank you, Senator. I think it would be a 
valuable improvement for there to be advanced notice and 
opportunity for public comment, and also consultation, which 
are some features that I believe the Chairman's bill would 
achieve before the FSB takes action.
    As I mentioned, notice is in part simply about fairness, 
giving people a heads up and a chance to speak up, assert their 
rights and interests. But it is also about reaching better 
decisions through information, consultation and the like. So 
those benefits would certainly exist.
    Dr. Posen has drawn the analogy to the House and Senate, 
and I am sure all of us could identify respects in which we 
think the House and Senate could do their jobs even better than 
they do. But one very important thing they do have going for 
them is the openness of the debate that occurs and the like, 
and we do not have that in connection with the FSB.
    Dr. Posen also referred to the House and Senate coming to 
agreement, which is what they do. It is also what the FSB does. 
And, yes, it purports to act through moral suasion, but there 
certainly appears to have been an influence exerted on the FSOC 
process as a result of the FSB designations. At least it is 
something worth examining as the Committee is seeking to do 
today.
    Finally, with respect to your comments, Senator Kirk, about 
insurance and the FSB, there seems to be perhaps consensus 
among members of the panel that the FSB would benefit from 
representation of a broader set of expertises and that one area 
of expertise that is underrepresented currently is insurance, 
and it may well be that had that insurance expertise been 
present in 2013, the designation decisions that were made might 
have been approached differently.
    Senator Kirk. Thank you. Mr. Chairman, I will be 
considering legislation to provide notice and comment 
provisions with regard to insurance matters in the FSB. I think 
that would--as one commentator said, the FSB was as clear as 
mud. To provide the notice and comment provisions, to provide 
much more transparency, would calm people's irrational fears.
    Chairman Shelby. Thank you, Senator Kirk.
    Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. It is good to be 
sitting beside you.
    Because our financial institutions can transfer assets 
around the globe in the blink of an eye, they can effectively 
choose which country regulates many of their riskiest 
transactions. That means that regulators around the world must 
be vigilant and must coordinate their efforts in overseeing the 
world's largest financial institutions. The Financial Stability 
Board is the main forum for that kind of coordination, which 
makes its work critical in preventing another financial crisis.
    Now, while the FSB is not legally binding on the United 
States, its decisions are not, those decisions can certainly 
influence our domestic policies, and that is why it is 
important that the FSB have the same kind of transparent, data-
driven decisionmaking that we ask of our own regulators.
    For example, here in the United States, a company may be 
designated by FSOC as systemically important, but the 
designation can be reversed if the company restructures its 
operations so that it creates less risk. That means there are 
now two ways to manage risks posed by a big bank--the bank can 
change its business model to produce less risk or it can face 
the stricter regulations and greater oversight. The bank 
decides which is less costly, and the result we get is what we 
want, and that is, less risk.
    Now, Governor Kempthorne, as you have noted, many of your 
members have been designated systemically important by the 
international FSB. Are you aware of any process that the FSB 
has for allowing those companies to reverse their designation 
by changing their business activities?
    Mr. Kempthorne. Senator Warren, thanks for the question. I 
am not aware of any FSB off ramp to get the G-SIIs out of 
there. It would have been extremely helpful if they would have 
announced what were the elements that caused them to be name G-
SIIs in the first place, and also, was there an opportunity to 
correct that, as you are alluding to, before they were 
designated?
    Senator Warren. OK. So let me just break this down. So the 
answer to the question--Was there any process for reversing the 
designation?--you are not aware of any process for reversing 
it. I do want to talk about whether or not companies were 
informed about what the criteria would be. Does the FSB provide 
designated companies with the information they need to 
understand why they were designate and how they could 
potentially change their business activities to pose less risk?
    Mr. Kempthorne. Senator Warren, based on the input I have 
received from those companies, the answer is no.
    Senator Warren. All right. Would you support changing the 
FSB process so that designated companies would have a chance to 
change their operations and possibly reverse their designation?
    Mr. Kempthorne. Senator, yes, because we must have greater 
transparency; we must have greater communication. And, again, 
before a designation, why not identify what is the risk and 
then a company may determine it could take its own actions to 
remove the risk, or it could change its operation, or you could 
ask the primary regulators: Would you please deal with this 
issue?
    Senator Warren. Mr. Stevens, would you agree with that? 
Would you support such a proposal?
    Mr. Stevens. I am trying to puzzle out, Senator, how it 
would actually work in the methodologies that have been 
proposed with respect to mutual funds. The methodology 
basically is based solely on size. What the FSB has proposed is 
if you are a mutual fund with $100 billion in assets under 
management, you will be automatically within a materiality 
threshold recommended for consideration.
    So to change the business model, I suppose, you would 
either have to split the fund in half--and now the manager has 
got two $50 billion mutual funds. Maybe that makes it less 
risky. I think what it does is says that the original 
materiality threshold is nonsensical.
    Senator Warren. So I take it, though, Mr. Stevens, what you 
are concerned about is you believe--although I am not sure if 
it is posted, but you believe that in an area--there is an area 
where FSB says size is all that is ever going to matter to us, 
we do not care what your practices are? But I take it there are 
also many that are pulled into designation because of their 
specific business practices, some combination of the risks they 
present, because of size, and because of the activities they 
engage in. This is what I understand Governor Kempthorne to be 
talking about, that there is no information right now about 
what it is that causes this designation and no off ramp for the 
companies that are willing to adjust.
    So my question is: Does it make sense to at least ask the 
FSB for more clarity around what it is that causes someone to 
be so designated and to provide off ramps if there are multiple 
factors that are involved?
    Mr. Stevens. I certainly would never argue against more 
clarity. In fact----
    Senator Warren. Good.
    Mr. Stevens.----we have even asked for them to justify the 
materiality thresholds that they have put into their 
methodologies, and, Senator, they are nothing more than just 
numbers picked out of the air.
    Senator Warren. Mr. Scalia.
    Mr. Scalia. Thank you, Senator. I think it is a very 
important question you have asked. One other point that I would 
make is that if FSB were to make that change, it is not clear 
at this time what difference that would make for companies that 
have already been designated by FSOC, because it is FSOC that 
has designated them and the Fed that will regulate them.
    What we are told is that FSOC is not influenced by FSB 
decisions. But an FSB un-designation would only matter to an 
FSOC-designated company if, lo and behold, FSOC were influenced 
by FSB.
    So I think it is a very important question, but it is only 
getting at one part of the problem the companies face.
    Senator Warren. I appreciate that point, although at least 
we have within FSOC--we have had the testimony here that there 
are off ramps, there are possibilities for coming out from 
underneath an FSOC designation. And so what we are looking for 
is can we get the same kind of thing over at FSB. And I take it 
you would support that sort of change in the approach that FSB 
uses.
    Mr. Scalia. Yes. I think it would be a valuable step 
forward if FSB considered the sort of changes that the 
Chairman's bill would make in the FSOC process.
    Senator Warren. Well, so this is--Governor Kempthorne, I 
think you wanted--I am sorry, Mr. Chairman. I think we are 
running over.
    Mr. Kempthorne. Senator Warren, thanks very much for the 
line of questioning, and just a clarification. There currently 
is not an FSOC off ramp from designation. There is language 
that is proposed in Senator Shelby's bill that would provide 
that off ramp.
    Senator Warren. I think we have had testimony, though, from 
those on the FSOC saying that adjustment is possible so that if 
risk is reduced, then FSOC designation changes, which sounds to 
me an awful lot like an off ramp.
    Mr. Kempthorne. Again, Senator Warren, based on the input I 
have received from the member companies that have been so 
designated, I do not believe they know what would be elements 
necessary to be de-designated.
    Senator Warren. All right. Fair enough on the transparency 
point, and one we have certainly had this conversation, I think 
with those who have testified before us. But they have 
indicated there are ways to change FSOC designation and that it 
is important to review how much risk is posed.
    You know, I just want to make the point, as I see it--and 
we have heard the testimony repeatedly in front of this 
Committee that once a company is designated as systemically 
important here in the United States, the company should have a 
chance to reverse that designation if it can show that it no 
longer poses a systemic risk.
    The United States, according to those who have testified in 
front of us, say that we now permit this, and I believe the FSB 
should do so as well. It seems to me that is fully consistent 
with the FSB's important mission of making global financial 
markets safer.
    Thank you, Mr. Chairman. Sorry to run over.
    Chairman Shelby. Senator Warren, I believe Mr. Wallison has 
a comment.
    Senator Warren. Yes.
    Mr. Wallison. I just have a small point here, but the 
problem is that we do not understand the metrics that either 
the FSOC or the FSB uses to designate a company as a SIFI. And 
we could avoid a lot of problems, including the need for an off 
ramp, if it were clear to companies before they were designated 
what they could do to keep from being designated. That is not 
available to anyone, but it is in the Chairman's bill and makes 
a certain amount of sense. We reduce a lot of the legal costs 
and other problems that companies have if they are condemned to 
be SIFIs and regulated by the Fed.
    Senator Warren. Well, as I said earlier, I think it is 
important that there be transparency about what it is that 
causes an FSOC designation and that it is important that the 
company have the alternative of choosing to reduce its own risk 
so that it has an exit ramp from FSOC designation.
    Thank you very much, Mr. Chairman.
    Chairman Shelby. Thank you, Senator Warren. Thank you for 
raising the question.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chairman, and 
thank you all for your testimony.
    As a strong supporter of our State-based insurance 
regulatory system, I share the concern of many of my colleagues 
and some of the witnesses that an international body would set 
standards for U.S. financial institutions. During the trade 
debate that we just had, I supported Senator Warren's amendment 
to the Trade Promotion Authority Act that would limit the 
inclusion of financial services in future agreements. 
Unfortunately, we did not pass that amendment. I wish 
otherwise. But I am concerned about international organizations 
setting structures that might diminish our regulation of risk 
within our own American economy. So U.S. officials at the very 
least should have a say in efforts to change or influence our 
financial regulatory system.
    The conversation about the FSB, we are represented right 
now by the Federal Reserve Board, the Treasury Department, the 
Securities and Exchange Commission. Governor Kempthorne, as a 
representative of the life insurers, do you see this as 
sufficient or the appropriate representation or specific 
recommendations for how that might be changed?
    Mr. Kempthorne. Senator Merkley, thanks for the question. 
Without question, with regard to Treasury, they need to have 
developed the additional expertise on the insurance industry. 
There is a step forward in the designation by Dodd-Frank of the 
Federal Insurance Office. Director Mike McRaith is doing a 
commendable job in that position. But I think some of the 
reports that perhaps have not come out in the timeframe first 
suggested may suggest that the vetting of those reports is more 
difficult because there is not the insurance expertise at this 
point within Treasury, with
regard to the Federal Reserve; and, again, we appreciate 
Governor Tarullo's approach where he is now having 
opportunities of working groups to just discuss the elements of 
the industry. With regard to the Fed, they have added Tom 
Sullivan, a former State insurance commissioner, who is doing a 
fine job at the Fed.
    But I would add, Senator Merkley, when we had post crisis 
and the Fed decided to put in a low interest rate environment, 
we sent teams of two to four insurance industry CEOs to every 
regional Fed President, and I will tell you that the comments 
were such as: ``We did not even have anecdotal evidence about 
your industry.'' ``We did not realize that you were the number 
one U.S. investor in corporate bonds.'' ``We did not realize 
that, on average, you hold your investments for 17 years, quite 
different than banks.'' ``We did not realize what a capital 
source you could be for infrastructure.''
    So I think through those comments, Senator, you realize 
that those who are now given responsibility with regard to the 
well-being and the regulation of the industry have a learning 
curve. They are on the curve. We appreciate their efforts. But 
there is still a tremendous amount that needs to be done.
    I would add that is true of the FSB as well, which is 
populated in a great deal by banks.
    Senator Merkley. Well, your points are well taken. Thank 
you. And if I could just summarize it, it is not so much who is 
there as how they proceed to educate themselves on the issues, 
the huge range of issues that are important, and in your cases 
specifically the life insurance industry.
    I just would like to ask the parallel question, if anyone 
else wants to chip in, about ways that U.S. representation 
could be improved on the FSB. Mr. Stevens?
    Mr. Stevens. Senator, I think it is a substantive issue, 
not just a process issue. But you have to look closely at the 
FSB as an organization and ask yourself who its members are. By 
and large, the members are central bankers and finance ministry 
officials. They do have some capital markets regulators, like 
the Securities and Exchange Commission. Virtually the entire 
leadership--that is to say, the head of the FSB, the head of 
its important working committees, and things of that sort--are 
all central bankers. I think the IOSCO statement makes it very 
clear that having now experienced over a couple of years an 
effort collaboratively within the FSB to work, that they have 
said this is not going to be satisfactory, we have got to take 
a different approach.
    And so what we take from all of that is the need to 
reconstitute some international body and to give capital 
markets regulators, and insurance regulators for that matter, a 
co-equal place at the table. Because if the mandate is to look 
at the entire global financial system, that is much more than 
banking, and you need to bring the right expertise and 
background and experience to bear. The FSB simply cannot do 
that as it is currently constituted.
    Senator Merkley. Thank you. Yes?
    Mr. Posen. Senator Merkley, just very rapidly, as I said in 
my written testimony, like others here, I support filling the 
particular gap that we have in insurance knowledge where I 
think the European regulators are going amok. But that said, I 
think it is very important that we pick up on something Senator 
Brown and I
exchanged upon earlier, which is that the FSB by its 
international nature also provides a certain amount of 
insulation against industry lobby groups and against national 
champions of various companies. And I think it is important 
that we do not make this into a body that, for all our desire 
for admin law, not oppressing any individual company that does 
not--that gets captured in the way that various specific 
regulators got captured in the past. And we always have to be 
suspicious when you can say central bankers have limitations. I 
am one of that breed, and I certainly have mine. But the fact 
remains that we know that there are particular industry-
designated regulators who become captured either in corrupt 
terms or intellectual terms by those industries, and we do not 
want this to become that again.
    Senator Merkley. And so if I can capture your comment, 
while expertise is essential in order for the FSB to have 
insight on key industries in various countries, you are raising 
the concern that the regulators, the FSB, not be intellectually 
captured by those industries.
    Yes, Mr. Wallison?
    Mr. Wallison. I would like to add one thing here, and that 
is, we have to understand that the FSB as well as the FSOC, 
whatever decision they come to, is an agreement among 
regulators. Regulators have an interest in having more power 
and more opportunity to control the direction of their 
respective economies. So although it is a good idea to have 
regulators talk to one another, discuss ways that they can 
address things, I think we have to recognize that regulation 
can be imposed because regulators want it to be imposed, and 
from the standpoint of the United States, where we have very 
free capital markets which have kept us ahead of almost the 
rest--actually created the economy that we have in the United 
States today, which is the best in the world, we have to be 
concerned that someone is speaking from the standpoint of the 
United States. And when we look at what the Fed wants to do, 
which is to get control of shadow banks, which is basically our 
entire capital market system, we have to be worried about that 
and be sure that whatever the FSB does, or even the FSOC, it is 
consistent with what Congress wanted when it created the Dodd-
Frank Act. And I am afraid that we are not exactly clear on 
that right now.
    Senator Merkley. Thank you very much, and my time has 
expired. Thank you, Mr. Chairman.
    Chairman Shelby. Mr. Stevens, I would like to ask you a 
question about mutual funds and the model. It is totally 
different from banking, as we know. We know insurance is 
different. We know that you are dealing with financial products 
and so forth. And you brought it up earlier. If you are a $100 
billion mutual fund, you have that under management. Now, if 
you are 25, that does not change the risk, does it? If you are 
big, you might be so well run and so forth. But explain 
basically the difference in the model of a bank and a managed 
fund, just for the record.
    Mr. Stevens. Well, in the case of United States mutual 
funds, Mr. Chairman, irrespective of their size, there are 
still certain principles that apply.
    Chairman Shelby. Absolutely.
    Mr. Stevens. They use little to no leverage, which 
dramatically distinguishes them from banks. They act as agents, 
not principals, so that the adviser is not retaining risk at 
the adviser's level. Whatever the----
    Chairman Shelby. They are spreading the risk, aren't they?
    Mr. Stevens. That is correct, and----
    Chairman Shelby. They are spreading the risk. If I buy 
mutual funds, I am taking a risk in a sense. I am hoping it 
goes up, but it could go down. Right?
    Mr. Stevens. And it does both over a cycle.
    Chairman Shelby. Sure.
    Mr. Stevens. But all those investment risks are then 
experienced by the underlying shareholders in their millions. 
They are also highly transparent, Mr. Chairman. The amount of 
information you can get about how a mutual fund and its 
portfolio and the like are managed is really quite dramatic.
    There is also extensive regulation that is calculated to 
control risks, and, frankly, that is why even these largest 
funds exhibited a remarkable degree of stability in the 
financial crisis. Now, this is the second worst financial 
crisis since the early 19th century. Some of our stock and bond 
fund investors lost very substantial portions. Equity funds 
went down 40, 45 percent--even more. There was no panicky sell-
off----
    Chairman Shelby. The same thing with 401(k), our pension 
funds, everything up and down. That is the market.
    Mr. Stevens. That is exactly right.
    The other thing, Senator, is that our industry in the 
United States is largely a retail industry. Upwards of 90 
percent of our investors are individual investors who are 
saving for very long-term purposes. So they do not look at 
mutual funds as a short-term trading proposition. They look at 
it as something that they are going to stick with--and they did 
stick with them during the crisis--for the very longest term 
and most important financial goals that they may have.
    Chairman Shelby. Let me ask you this. Let us say I could 
buy through a mutual fund part of an index fund, right?
    Mr. Stevens. Yes.
    Chairman Shelby. How are you going to regulate the index 
fund which is based, say, on the S&P 500 or some other model 
like that? Basically you are tracking the market, aren't you?
    Mr. Stevens. That is exactly right, Senator, and in the 
FSB's methodologies, there are a number of very large index 
funds that would be captured, because they tend to grow above 
$100 billion as they are sponsored by some firms in the United 
States.
    So you ask yourself then, that recommendation comes to the 
FSOC, and were the FSOC to say, yes, you know, you are right, 
FSB, we need to designate that fund, how then would the 
provisions of Title I of Dodd-Frank apply in that case? They 
are actually nonsensical as you think of them in the context of 
a mutual fund, and to me that is the very best evidence that 
when Congress put Dodd-Frank together, it never intended the 
result that Title I of Dodd-Frank would be brought to bear 
against our largest mutual funds unless that title is looked at 
as a roving commission by the Federal Reserve simply to get 
more and more and more of the U.S. financial system under its 
jurisdiction. I think Congress did not intend that at all.
    Chairman Shelby. I agree. But, Mr. Wallison, let me ask you 
a question, and then any comment you want to follow up on that. 
The ramp in the legislation, some of it I proposed, if you are 
designated--and Senator Warren got into this, which I think was 
an excellent topic. If you are designated, that is not an easy 
thing. That is tough. Most people have a way through process to 
get un-designated or get off the hook, so to speak, probation 
or whatever you want to call it. I do not believe that they 
have, although they alluded to it here, that there is a way to 
get off, because it is not explicit, it is not transparent. 
There is no mechanism that I understand to do it. Once you are 
designated, you know, a lot of people say you are damned in a 
way. Do you want to comment on that?
    Mr. Wallison. Well, I think it is absolutely true, Mr. 
Chairman, that once you are designated, unless there is a clear 
way for you to exercise an off ramp in some way, you are 
damned. But look at it this way: If you do not know why you 
have been designated----
    Chairman Shelby. That is exactly right.
    Mr. Wallison. And that is where we are today.
    Chairman Shelby. Well, that is what Senator Warren got 
into----
    Mr. Wallison. Right, and she is completely right. If you do 
not know why you have been designated, there is no way that you 
can exercise the off ramp unless the regulating agency, like 
the FSOC, is willing to say to you, well, you were designated 
for this particular reason or these four particular reasons, 
and if you eliminate all of those things, well, then, we will 
un-designate you. But apparently we have no indication that the 
FSOC at least is willing to do that, and certainly not the FSB.
    If I may follow up, Mr. Chairman, on one issue----
    Chairman Shelby. Go ahead. Go ahead.
    Mr. Wallison.----you were talking about with Mr. Stevens, 
and that is, mutual funds, the key issue here is what is called 
``maturity transformation.'' Mutual funds and other investment 
organizations do not involve maturity transformation. That 
happens to be the riskiest thing that banks do. They borrow 
money short term and lend it out long term. That is maturity 
transformation, and it is very risky because the funds you lent 
out could be withdrawn by depositors when you are a bank. 
Mutual funds do not have that problem and should not----
    Chairman Shelby. And neither do insurance companies.
    Mr. Wallison. And insurance companies, too. Mutual funds 
and insurance companies and other capital markets operators 
generally do not have that problem at all. Yet the FSB says, as 
I said in my oral statement, the FSB says that complex chains 
of transactions can create maturity transformation 
collectively. That raises the question of whether all of these 
small firms operating in the capital markets, engaged in these 
complex chains of transactions, could be designated by the 
FSOC. Certainly that is what the FSB is after. And whether the 
FSOC has the power to do that is the problem.
    Chairman Shelby. Mr. Scalia, do you want--I know you want 
to answer that, too--to get into due process? It seems like 
there is lack of due process here, but go ahead.
    Mr. Scalia. Thank you, Mr. Chairman. In a sense, that is 
what I wanted to comment on. This exit ramp idea is a very 
important one. It would be a significant contribution of your 
bill, and it would be good if agencies, FSOC in this case, 
disclosed to companies what FSOC needed to be done in order for 
that company not to be systemic.
    But I think we would want to avoid a circumstance where a 
company's fate depended on FSOC's opinion or FSOC's whim, FSOC 
saying, ``We have decided you do this, that, or the other 
thing, and then you will be OK.''
    Obviously what we need as well is discernible, 
ascertainable legal and empirical standards that the public can 
look to and judge for themselves what they need to do, and if 
FSOC, for example, declines to de-designate, that those 
entities can have the confidence that they could go to court 
and say, ``Look at all we did, but FSOC is not letting us out 
of the pen.''
    Mr. Stevens mentioned the importance of evidence-based 
approaches, and that has been lacking as well in FSOC's 
decisionmaking. So I think in addition to providing the off 
ramp, it will be very important in the future for FSOC to base 
its decisions more on a closer empirical and evidentiary 
approach toward its task.
    Chairman Shelby. Governor?
    Mr. Kempthorne. Mr. Chairman and, again, Senator Warren, I 
think this answers a bit to what we were discussing and that is 
with regard to the off ramp that may exist. In the Dodd-Frank 
Act, it does call for an annual review of a designated company 
by FSOC. However, as Mr. Wallison pointed out, they do not know 
what was the criteria, the metrics that made them designated in 
the first place.
    If there was an existing off ramp, I think a major company 
would not have felt that they needed to go through a legal 
process. Currently there is no appeal process with regard to 
designation of a SIFI, and that is why we do commend and 
support the concept of an off ramp of a designation so you can 
de-designate knowing what it was that put you there in the 
first place.
    Chairman Shelby. Thank you.
    Senator Warren, do you have any comments?
    Senator Warren. No. I am good. Thank you, Mr. Chairman.
    Chairman Shelby. I thank all of you for the hearing. This 
is very important, and we appreciate your contributions here 
today. Thank you very much.
    Mr. Kempthorne. Thank you.
    [Whereupon, at 11:40 a.m., the hearing was adjourned.]
    [Prepared statements and additional material supplied for 
the record follow:]
                 PREPARED STATEMENT OF DIRK KEMPTHORNE
          President and CEO, American Council of Life Insurers
                              July 8, 2015
    Chairman Shelby, Ranking Member Brown, and Members of the 
Committee, I am Dirk Kempthorne, President and CEO of the American 
Council of Life Insurers (ACLI). ACLI is the principal trade 
association for U.S. life insurance companies with approximately 300 
member companies operating in the United States and abroad. ACLI 
advocates in Federal, State, and international forums for public policy 
that supports the insurance marketplace and the 75 million American 
families that rely on life insurers' products for financial and 
retirement security. ACLI member companies offer life insurance, 
annuities, reinsurance, long-term care and disability income insurance, 
and represent more than 90 percent of industry assets and premiums.
    ACLI appreciates the opportunity to address the impact of the 
Financial Stability Board (FSB) on the U.S. regulatory framework. ACLI 
recognizes the important role of the FSB in enhancing international 
cooperation and coordination among financial supervisory organizations. 
The FSB was formed in 2009 by the G20 to promote financial stability 
through reform of the international financial regulatory structure. Its 
membership includes financial regulators from 25 major nations, 
including the European Union; international financial institutions, 
such as the IMF and World Bank; and standard-setting bodies, including 
the International Association of Insurance Supervisors (IAIS) and the 
International Organization of Securities Commissions (IOSCO). The U.S. 
representatives to the FSB are the Department of the Treasury, the 
Federal Reserve, and the Securities and Exchange Commission.
    My testimony focuses on two standard-setting actions by the FSB and 
its member organizations that intersect with the powers and authorities 
of the Financial Stability Oversight Council (FSOC) and the Federal 
Reserve Board. Those standard-setting actions are the designation of 
``globally systemically significant'' insurers and the establishment of 
an international capital standard for insurers. More specifically, ACLI 
is concerned that----

    FSB's designations of G-SIIs have prejudged FSOC's 
        designations and placed designated insurers at a competitive 
        disadvantage in the marketplace;

    The FSB and FSOC have not applied consistent standards to 
        the designation of nonbank financial companies; and

    There is a potential for conflict between insurer capital 
        standards being developed by the Federal Reserve Board and 
        those under development by the IAIS. These new standards may 
        also unnecessarily deviate from the existing, proven insurance 
        risk-based capital regime U.S. State insurance regulators use 
        today.

To address these concerns, ACLI is recommending that----

    The designation process for insurers should be replaced 
        with ``activities-based'' regulation that avoids the negative 
        consequences of designating individual companies merely because 
        of size.

    The Federal Reserve Board should finalize the capital 
        standards mandated by Congress last year in a manner that is 
        consistent with the Insurance Capital Standards Clarification 
        Act before agreeing to capital standards developed by the IAIS; 
        and

    This Committee should exercise vigorous oversight of the 
        capital standard-setting process by the Federal Reserve Board 
        and the IAIS to ensure that the intent of Congress and the 
        competitiveness of the U.S. insurance industry is preserved.

    Before I address those issues, however, I would like to commend 
Chairman Shelby and the Committee for The Financial Regulatory 
Improvement Act of 2015.
Financial Regulatory Improvement Act
    The Financial Regulatory Improvement Act reflects many of the 
principles of transparency, accountability, and due process that are 
supported by ACLI and its member companies. In particular the bill:

  (1)  Proposes important, meaningful reforms that would strengthen 
        Financial Stability Oversight Council procedures and ultimately 
        facilitate a reduction in systemic risk;

  (2)  Increases opportunities for stakeholder input and Congressional 
        oversight of the International Association of Insurance 
        Supervisors regarding the development of international capital 
        standards. ACLI commends Senators Dean Heller (R-Nev.) and Jon 
        Tester (D-Mont.) for their strong leadership on this issue;

  (3)  Requires the Federal Reserve Board to plan for the different 
        kinds of nonbank financial companies, including insurance 
        companies that it supervises; and

  (4)  Includes language from the Policyholder Protection Act of 2015, 
        which would afford insurance policyholders in the context of a 
        savings and loan holding company structure the same protections 
        as those currently provided under the Bank Holding Company Act.

ACLI urges the Committee to move this important legislation to the full 
Senate for consideration.
FSB's Designations of Globally Systemically Important Insurers (GSIIs) 
        Seems to Have Prejudiced FSOC's Designations and Placed 
        Designated Companies at a Competitive Disadvantage
    Both FSB and FSOC have designated three U.S. insurers as 
``systemically important.'' In July 2013, the FSB, in consultation with 
the IAIS, designated nine insurers as G-SIIs, including three U.S. 
insurers: AIG, Prudential and MetLife.\1\ These designations were based 
upon a methodology developed by the IAIS.\2\ The FSB envisioned that 
designated companies would be subject to certain policy measures, which 
would be developed by the FSB and IAIS and implemented by member 
countries. Those policy measures include recovery and resolution 
planning requirements, enhanced group supervision, and higher loss 
absorbency requirements for nontraditional activities.
---------------------------------------------------------------------------
    \1\ Global Systemically Important Insurers (G-SIIs) and the Policy 
Measures That Will Apply to Them, Financial Stability Board, July 18, 
2013.
    \2\ Global Systemically Important Insurers: Initial Assessment 
Methodology, International Association of Insurance Supervisors, July 
2013.
---------------------------------------------------------------------------
    FSOC also has designated AIG, Prudential and MetLife as 
systemically important, subjecting them to supervision and regulation 
by the Federal Reserve Board. FSOC's designation of AIG occurred on 
July 8, 2013, just days before the FSB initial designations.\3\ 
Prudential was designated by FSOC in September 2013,\4\ and MetLife was 
designated in December 2014.\5\ The regulation of these companies by 
the Federal Reserve Board includes heightened capital standards, 
resolution planning requirements, liquidity requirements, and risk 
management standards.
---------------------------------------------------------------------------
    \3\ Basis of the Financial Stability Oversight Council's Final 
Determination Regarding American International Group, Inc., Financial 
Stability Oversight Council, July 8, 2013.
    \4\ Basis for the Financial Stability Oversight Council's Final 
Determination Regarding Prudential Financial, Inc., Financial Stability 
Oversight Council, September 19, 2013.
    \5\ Basis for the Financial Stability Oversight Council's Final 
Determination Regarding MetLife, Inc., Financial Stability Oversight 
Council, December 18, 2014.
---------------------------------------------------------------------------
    FSOC's independent member having insurance expertise, Roy Woodall, 
has raised serious concerns about the timing of these designations. In 
his dissents to both the Prudential and MetLife designations, Mr. 
Woodall noted that the FSB's designations were taken in consultation 
with members of FSOC, and that these discussions appear to have pre-
judged FSOC's independent designation process:

        Although not binding on the Council's decision, the declaration 
        of Prudential as a G-SII by the FSB based on the assessment by 
        the United States and global insurance regulators, supervisors, 
        and others who are members of the IAIS has overtaken the 
        Council's own determination process.\6\
---------------------------------------------------------------------------
    \6\ http://www.treasury.gov/initiatives/fsoc/council-meetings/
Documents/September%2019%
202013%20Notational%20Vote.pdf.

        It is clear to me that the consent and agreement by some of the 
        Council's members at the FSB to identify MetLife a G-SIFI, 
        along with their commitment to use their best efforts to 
        regulate said companies accordingly, sent a strong signal early 
        on of a predisposition as to the status of MetLife in the 
        United States--ahead of the Council's own decision by all of 
        its members.\7\
---------------------------------------------------------------------------
    \7\ http://www.treasury.gov/initiatives/fsoc/designations/
Documents/Dissenting%20and%20
Minority%20Views.pdf.

    ACLI shares Mr. Woodall's concern. FSOC has a mandate to designate 
nonbank financial companies for supervision by the Federal Reserve 
Board based upon criteria established by Congress, and FSOC's 
designation decisions should not be pre-determined by the actions of 
the FSB.
    A lack of transparency and due process compounds this concern. 
While the FSB has stated that it follows a designation methodology 
developed by the IAIS, the FSB designations are not accompanied by any 
explanation or rationale. Nor are designated companies accorded any 
ability to engage directly with the FSB or challenge a designation. 
Moreover, there is no transparency surrounding the FSB's actual
directions to the IAIS, other than what the IAIS or FSB chooses to 
announce after the fact.
    The immediate and potential negative consequences of designation 
are significant. The insurance industry is highly competitive, and the 
additional regulation imposed upon a designated company can place that 
company at a significant competitive disadvantage relative to its 
nondesignated competitors. Capital standards are the most obvious 
example. If capital requirements on designated insurers are materially 
different from those imposed by the states, designated insurers may 
find it difficult to compete against nondesignated competitors, 
resulting in a loss of business or an altered product mix. Less 
competition or less product availability is not in keeping with a 
healthy market that best serves insurance consumers. Even before any 
additional regulation is implemented, the prospect of such regulation 
has an immediate impact as it forces designated companies to manage 
their operations taking into account looming but unspecified regulatory 
requirements.
FSB and FSOC Should Pursue ``Activities-Based'' Regulation of Insurers 
        Rather than Designating Individual Companies
    FSB and FSOC have taken markedly different approaches in their 
treatment of different categories of nonbank financial companies. While 
FSB and FSOC have designated three U.S. insurers for heightened 
supervision and regulation, they are pursuing an ``activities-based'' 
approach for asset managers rather than the imposition of heightened 
regulation on individual companies merely because of size.
    Recent public statements by Federal Reserve Board Governor Daniel 
Tarullo and by Greg Medcraft, the Chairman of IOSCO, have acknowledged 
this different treatment accorded asset managers over insurers.\8\
---------------------------------------------------------------------------
    \8\ See, Conversation with Governor Tarullo, Institute for 
International Finance, North American Summit, June 4, 2015; https://
www.youtube.com/watch?v=dV1tJMX-z2c&feature=
player_embedded; and Remarks of Greg Medcraft, Chairman, International 
Organization of Securities Commissions, to the National Press Club, 
Washington, DC, on ``IOCSO and the International Reform Agenda for 
Financial Markets,'' June 22, 2015.
---------------------------------------------------------------------------
    The difference in treatment also is evident in the manner in which 
FSOC has approached the evaluation of insurers and asset managers. 
Instead of designating asset managers, FSOC has directed its staff to 
``undertake a more focused analysis of industry-wide products and 
activities to assess potential risks associated with the asset 
management industry.''\9\ This request followed the release of a study 
by the Office of Financial Research on asset management and financial 
stability, which FSOC had requested ``to better inform its analysis of 
whether--and how--to consider such firms for enhanced prudential 
standards and supervision.''\10\ This request also followed a 
conference on the asset management industry by FSOC ``to hear directly 
from the [asset management] industry and other stakeholders, including 
academics and public interest groups, on [the asset management industry 
and its activities].''\11\ At that conference, FSOC members heard from 
representatives of the Securities and Exchange Commission, the Bank of 
England, New York University, Columbia Business School, and the Wharton 
School, as well as several asset management companies. No such public 
hearing was conducted to engage insurers and other stakeholders about 
the insurance industry.
---------------------------------------------------------------------------
    \9\ Press Release, U.S. Treasury Department, Financial Stability 
Oversight Council Meeting, July 31, 2014.
    \10\ Office of Financial Research, Asset Management and Financial 
Stability, Sept. 2013. 11 Press Release, U.S. Treasury Department, 
Financial Stability Oversight Council (FSOC) to Host Public Asset 
Management Conference, March 28, 2014.
    \11\ Press Release, U.S. Treasury Department, Financial Stability 
Oversight Council (FSOC) to Host Public Asset Management Conference, 
March 28, 2014.
---------------------------------------------------------------------------
    In sum, the FSOC's actions with regard to the asset management 
industry stand in sharp contrast to FSOC's treatment of the insurers. 
FSOC has pursued the designation of individual insurance companies and 
provided the public with little, if any, insight into the rationale for 
those designations or how designations could have been avoided.
    Moreover, FSOC has pursued this approach despite the fact that one 
of the principal authors of the Dodd-Frank Act has stated publicly that 
he sees no difference between the asset management industry and the 
insurance industry when it comes to systemic risk. In a hearing before 
the House Financial Services Committee last year, former Congressman 
Barney Frank told the Committee that ``I don't think asset managers or 
insurance companies that just sell insurance as it's traditionally 
defined are systemically defined . . . Their failure isn't going to 
have that systemic reverbatory [sic] effect.''\12\
---------------------------------------------------------------------------
    \12\ Assessing the Impact of the Dodd-Frank Act Four Years Later 
Before the H. Comm. On Fin. Serv., 113th Cong., Statement of the 
Honorable Barney Frank during question and answer session, unofficial 
transcript.
---------------------------------------------------------------------------
    ACLI finds this disparate treatment of insurers inexplicable and 
distressing. Why has FSOC undertaken a thoughtful analysis of one 
category of nonbank companies, but not another? Why has FSOC concluded 
that an ``activities-based'' approach to regulation is appropriate to 
asset managers, but not insurers?
    The Dodd-Frank Act gives FSOC two principal powers to address 
systemic risk. One power is the authority to designate nonbank 
financial companies for supervision by the Federal Reserve Board. The 
other power is an ``activities-based'' authority to recommend more 
stringent regulation of specific financial activities and practices 
that could pose systemic risks.
    FSOC's power to recommend more stringent regulation of specific 
activities and practices has distinct public policy advantages over its 
power to designate individual companies for supervision by the Federal 
Reserve Board. FSOC's power to recommend primary regulator action 
brings real focus to the specific activities that may involve potential 
systemic risk and avoids the competitive harm that an individual 
company may face following designation. As I have noted above, in 
certain markets designated companies can be placed at a competitive 
disadvantage to nondesignated companies because of different regulatory 
requirements. Finally, the power to recommend avoids the ``too-big-to-
fail'' stigma that some have associated with the designation of 
individual companies.
    FSOC's recommendations for more stringent regulation of certain 
activities and practices must be made to ``primary financial regulatory 
agencies.'' These agencies are defined in the Dodd-Frank Act to include 
the SEC for securities firms, the CFTC for commodity firms, and State 
insurance commissioners for insurance companies. A recommendation made 
by FSOC is not binding on such agencies, but the Dodd-Frank Act 
includes a ``name and shame'' provision that encourages the adoption of 
a recommendation. That provision requires an agency to notify FSOC 
within 90 days if it does not intend to follow the recommendation, and 
FSOC is required to report to Congress on the status of each 
recommendation.
    ACLI believes that FSOC and FSB should both pursue an ``activities-
based'' approach to insurers through their processes and not rely on 
designations, in the same manner that they are pursuing such an 
approach to asset managers. Failure to do so raises a fundamental 
question of fairness and casts doubt on the legitimacy of the policies 
and practices of FSOC and the FSB.
The Federal Reserve Board Should Finalize the Capital Standards 
        Mandated by the International Capital Standards Clarification 
        Act Before Agreeing to IAIS Standards
    Both the Federal Reserve Board and the IAIS are developing 
insurance capital standards that are likely to have significant impacts 
on life insurance companies. Considered together, these two initiatives 
directly affect approximately 60 percent of the direct premiums of ACLI 
member companies. If these standards are bank-centric or inconsistent 
with capital standards developed by State insurance supervisors, they 
will disrupt the marketplace and undermine the ability of life insurers 
to provide long-term, guaranteed retirement products to savers and 
retirees.
    To ensure the best possible outcome for policyholders, the Federal 
Reserve Board should adhere to the intent of Congress as reflected in 
the Insurance Capital Standards Clarification Act, which was 
unanimously approved by Congress last year, and develop an insurance 
capital standard that is appropriate for U.S. insurers and the 
insurance business model. We are encouraged by the fact that the Board 
has indicated its intent to undertake a methodical, thoughtful approach 
to the development of these standards. Moreover, the Federal Reserve 
Board should partner with the other U.S. representatives to the IAIS 
(FIO and State insurance supervisors) to ensure that any international 
insurance standards reflect the unique strengths of the U.S. system of 
insurance supervision.
    It is essential that policymakers correctly address insurance 
capital standards here in the United States first, so that our 
representatives to the IAIS, ``Team U.S.A.,'' have a stronger, unified 
position in any international discussions. Common sense suggests that 
the United States should conduct its own process for the development of 
an insurance capital standard before agreeing to any international 
standards. The ACLI believes that it is in the best interests of the 
United States to focus on domestic rulemaking first and ensure that the 
domestic process is as thoughtful, informed, and transparent as 
possible.
    The Federal Reserve Board's capital setting process should include 
formal rulemaking with notice and public comment, and ACLI is grateful 
that the Federal Reserve Board has indicated it will proceed in this 
way. Any insurance capital standard must reflect the long-term nature 
of life insurers' investments and the need to match investments with 
the long-term duration of insurance liabilities. Bank standards that 
favor short-term assets simply do not work for the insurance company 
business model, in which commitments to provide benefits to insurance 
policyholders and annuity contract holders often last many decades.
    The ACLI has been actively engaged with the Federal Reserve Board 
on a proposed capital regime for insurance companies. The IAIS timeline 
must accommodate the Federal Reserve Board's implementation of the 
Insurance Capital Standards Clarification Act. These processes should 
not be abbreviated or confused by a rushed IAIS timeline. Just last 
month, the IAIS released a proposal for higher loss absorbency capital 
standards and reiterated plans to finalize these standards by the end 
of this year. The Federal Reserve Board's rulemaking process should 
proceed normally and allow ample time for notice and public comment. 
The three U.S. representatives to the IAIS should not agree to anything 
at the IAIS that would interfere with a robust and thoughtful 
rulemaking process here in the United States. In fact, the IAIS process 
would benefit from the work being conducted by the Federal Reserve 
Board and should adjust its timeline accordingly.
    ACLI is encouraged by the recent IAIS announcement to develop 
international insurance capital standards, particularly the ICS, 
through a staged and incremental process that will be more respectful 
of and informed by jurisdictional developments.\13\ This is a clear 
example of Team U.S.A. working on all cylinders to achieve a positive 
outcome for U.S. insurers and insurance markets. However, much work 
remains to be done, including further and deeper consideration and 
analysis of what types of activities actually create systemic risk in 
the insurance model. Getting our standards completed at home needs to 
happen first.
---------------------------------------------------------------------------
    \13\ ``The IAIS Risk based Global Insurance Capital Standard (ICS): 
Ultimate and Interim Goals, Principles for Development and Delivery 
Process'' June 25, 2015.
---------------------------------------------------------------------------
    ACLI commends the three U.S. representatives to the IAIS for the 
important partnership that they have established in the Team U.S.A. 
approach. Only by working together, meeting regularly, coordinating 
their efforts, and agreeing to common objectives, the Federal Reserve 
Board, FIO, and State insurance supervisors are best positioned to 
represent the United States and secure the best outcome for U.S. 
consumers and insurers. The Team U.S.A. concept constitutes an effort 
to speak with a strong, unified voice as part of any IAIS discussions 
and ACLI fully agrees with the wisdom of this approach.
    ACLI urges this Committee to exercise vigorous oversight of the 
capital standard-setting process by the Federal Reserve Board and the 
IAIS to ensure that the intent of Congress and the competitiveness of 
the U.S. insurance industry are preserved. Congressional oversight of 
the development of a workable domestic capital standard for U.S. 
insurers will help support the goal of a well-capitalized and 
competitive insurance industry that continues to serve the needs of 
U.S. consumers.
                                 ______
                                 
               PREPARED STATEMENT OF PETER J. WALLISON *
---------------------------------------------------------------------------
     * The views expressed in this testimony are those of the author 
alone and do not necessarily represent those of the American Enterprise 
Institute.
---------------------------------------------------------------------------
      Arthur F. Burns Fellow in Financial Policy Studies, American
                          Enterprise Institute
                              July 8, 2015
    Chairman Shelby, Ranking Member Brown and Members of the Senate 
Banking Committee:

    Thank you for the opportunity to testify in this important hearing.
    My name is Peter J. Wallison. I am the Arthur F. Burns Fellow in 
Financial Policy Studies at the American Enterprise Institute. The 
opinions expressed below are mine alone and not necessarily those of 
the American Enterprise Institute.
    This testimony will discuss the relationship among the Federal 
Reserve, the Financial Stability Oversight Council (FSOC) established 
by the Dodd-Frank Act, and the Financial Stability Board (FSB). As this 
Committee is aware, the FSB is a largely European group of financial 
regulators and central banks which was deputized by the G-20 leaders in 
2009--after the financial crisis--to reform the international financial 
system.\1\ The Treasury, the Federal Reserve and the SEC are members of 
the FSB.
---------------------------------------------------------------------------
    \1\ Financial Stability Board, ``Overview of Progress in 
Implementation of the G20 Recommendations for Strengthening Financial 
Stability'' Report of the Financial Stability Board to G20 Leaders, 
September 5, 2013, p3.
---------------------------------------------------------------------------
Summary of this testimony
    This testimony makes the following points:

    Both the FSB and the Fed have determined to impose 
        prudential regulation--i.e., regulation of risk-taking--on what 
        they call the ``shadow banking system.'' They define the shadow 
        banking system as all financial intermediation outside the 
        regulated banking system.

    Shadow banks, then, are essentially all the nonbank firms 
        that operate in in today's U.S. capital markets-broker dealers, 
        asset managers, hedge funds, mutual funds, insurance companies 
        and many others.

    The FSB and the Fed believe that ``complex chains of 
        transactions'' among these firms can create risks to financial 
        stability that are similar to the failure of a large financial 
        firm.

    On this basis, the FSB could decide that all member 
        countries should impose prudential regulation on firms active 
        in the capital markets-that is, shadow banks.

    The question is whether an agreement at the FSB to impose 
        prudential regulation on complex chains of transactions can be 
        enforced in the United States under the Dodd-Frank Act.

    Section 113 of the Dodd-Frank Act provides the FSOC (and 
        thus the Fed) with authority to designate firms as SIFIs 
        because of their ``mix of activities.'' These activities could 
        be deemed to include participating in ``complex chains of 
        transactions.''

    Although this would be a major extension of the language in 
        the Dodd-Frank Act, it is possible that the courts would defer 
        to the FSOC's interpretation.

    If the Committee does not want prudential regulation 
        imposed on the capital markets, it must act to prevent this 
        outcome, through amending Dodd-Frank or through aggressive 
        oversight of the Fed, FSOC and Treasury.
Introduction
    In recent years, both the FSB and the Fed have both expressed a 
determination to impose ``prudential regulation'' on what they call the 
``shadow banking system.'' Prudential regulation generally refers to a 
regulator's ability to supervise or control the risk-taking of 
regulated firms, and the shadow banking system--as defined by the FSB--
includes all financial intermediation that is not subject to bank-like 
prudential regulation.\2\ The Fed also accepts this definition. Stanley 
Fischer, vice chair of the Fed, refers to ``nonbank financial 
intermediation'' as including ``insurance companies, finance companies, 
Government-sponsored enterprises, hedge funds, security brokers and 
dealers, issuers of asset-backed securities, mutual funds and money 
market funds.''\3\ These are most of the major participants in the U.S. 
capital markets, and thus the prudential regulation of shadow banks is 
the same thing as prudential regulation of the U.S. capital markets.
---------------------------------------------------------------------------
    \2\ See, for example, FSB, ``Consultative Document/Strengthening 
Oversight and Regulation of Shadow Banking/An Integrated Overview of 
Policy Recommendations,'' November 18, 2012, p1.
    \3\ Stanley Fischer, speech at a Bundesbank conference on March 27, 
2015, p2.
---------------------------------------------------------------------------
    In general, although capital market firms like broker-dealers, 
finance companies, hedge funds and other types of funds and fund 
managers are subject to regulations of various kinds, these are mainly 
conduct regulations. Some, such as insurers and broker dealers, have 
capital requirements, but they are all generally free to take the risks 
that their managements consider prudent. Under prudential regulation, 
as bank supervisors see it, they are entitled to examine and criticize 
management risk-taking decisions. For example, the Fed has recently 
been telling banks that it does not want them to make leveraged loans, 
which the Fed considers excessively risky.
    The Fed has clearly decided that bringing ``shadow banking'' under 
prudential regulation should be a priority of the agency, and in this 
effort the Fed and the FSB are working together. The Fed's position was 
made clear by Governor Daniel Tarullo a year ago:

        The turmoil that attended the collapse of several large nonbank 
        financial institutions, and the extraordinary Government 
        measures necessary to contain the turmoil, had quickly changed 
        into a consensus--previously a 
        minority view--that prudential regulation should be broadened 
        to better safeguard the financial system as a whole.\4\
---------------------------------------------------------------------------
    \4\ Daniel Tarullo, Speech at the Federal Reserve Bank of Chicago, 
May 8, 2104, p2, http://www.federalreserve.gov/newsevents/speech/
tarullo20140508a.htm.

    The Fed is devoting a great deal of attention to this FSB project--
and for good reason. Governor Tarullo, is leading the FSB's work in 
this area. The close collaboration between the Federal Reserve and the 
FSB is happening because controlling ``shadow banking'' is not 
something the Fed can do alone; it is too easy for financial activities 
to be conducted outside the Fed's U.S. jurisdiction. The Fed cannot 
control shadow banking if they focus solely on the United States; 
pressure on the shadow banking system in the United States will only 
stimulate the development of shadow banking activity in other developed 
markets. The FSB, therefore, is the ideal venue for an international 
agreement to impose coordinated prudential regulation on shadow 
banking, which in effect means prudential regulation of the 
international capital markets. In one of its first statements on the 
need to regulate shadow banking, the FSB pointed this out: ``It is also 
important to note that different parts of the [shadow banking] chain 
are frequently located in different jurisdictions, underscoring the 
need for a global approach to monitoring and policy responses.''\5\
---------------------------------------------------------------------------
    \5\ FSB, Shadow Banking: ``Scoping the Issues: A Background Note of 
the Financial Stability Board,'' April 12, 2011, p5.
---------------------------------------------------------------------------
    The FSB is the successor to something called the Financial 
Stability Forum, an organization of the same developed countries that 
was formed in 1999 as a discussion group to promote financial 
stability. In April 2008, the group delivered a series of 
recommendations to the G-7 for increased prudential regulation. After 
the financial crisis, in 2009, the group was deputized by the G-20 
leaders to reform the international financial system, and changed its 
name to the Financial Stability Board. Since then, it used its mandate 
to broaden its reach and elevate its profile. Its statements regularly 
refer to the fact that the G-20 leaders have approved or authorized its 
activities. In 2011, according to the FSB, the G-20 leaders agreed to 
``strengthen the oversight and regulation of the shadow banking 
system,''\6\ and remarkably they did this before the FSB had actually 
defined what shadow banking was. Nevertheless, the FSB has no 
enforcement powers and--at least in the United States--no authority by 
virtue its G-20 mandate. The FSB says that it is relying on its members 
to enforce its decisions within their own jurisdictions, if they have 
the authority to do so.
---------------------------------------------------------------------------
    \6\ FSB, ``Strengthening the Oversight and Regulation of Shadow 
Banking,'' April 16, 2012, p 1.
---------------------------------------------------------------------------
    An apt analogy might be the agreements that are reached among bank 
regulators from many nations under the auspices of the Basel Committee 
on Bank Supervision. The decisions reached there are applied in each of 
the countries that are participants. This might even be seen by the 
U.S. regulators as a precedent for the enforceability of any agreement 
reached at the FSB, but this would be incorrect. The U.S. bank 
regulators already have the statutory authority to impose the capital 
requirements that are agreed in Basel. Congress has not (to my 
knowledge) ever questioned that authority.
    This raises the question whether the Dodd-Frank Act or any other 
U.S. law has given U.S. regulators the authority to impose on U.S. 
firms the decisions that originate in an agreement at the FSB. It is 
not true, as some may believe, that Dodd-Frank does not provide 
authority that can be used for this purpose. Unfortunately, as I will 
discuss below, the excessively broad language of the Dodd-Frank Act may 
permit the FSOC and the Fed to impose substantially the same 
regulations in the United States as the FSB will prescribe for its 
other members. Moreover, U.S. officials seem to believe that if the FSB 
adopts prudential regulation for the capital markets--that is, the 
shadow banking system--U.S. regulators will be able to impose it in the 
United States. If this effort succeeds, it will be a disaster for 
robust economic growth in the United States. Accordingly, this 
testimony will also explore the authorities that the FSOC and Fed might 
use, at the behest of the FSB, to control shadow banking in the United 
States.
    In March, 2015, the FSB issued what it called its Second 
Consultative Document on Methodologies for Identifying NonBank Non-
Insurer Global Systemically Important Financial Institutions (the 
Second Consultative Document).\7\ This is similar to a U.S. regulatory 
agency taking a second set of comments on a proposed regulation under 
the Administrative Procedure Act. The Second Consultative Document is 
basically a roadmap for FSB members to follow if they wish to subject 
nonbank firms within their jurisdictions to prudential regulation. 
There is little question that under the Dodd-Frank Act the FSOC could 
designate any financial firm as a systemically important financial 
institution (SIFI), and in fact after the FSB designated three U.S. 
insurers as global SIFIs, the FSOC did the same.
---------------------------------------------------------------------------
    \7\ FSB, ``Consultative Document (2nd)/Assessment Methodologies for 
Identifying Non-Bank Non-Insurer Global Systemically Important 
Financial Institutions/Proposed High-Level Framework and Specific 
Methodologies,'' March 4, 2015.
---------------------------------------------------------------------------
    Many of the comments submitted by U.S. firms on the Second 
Consultative Document reflected concern that the FSB will designate 
large U.S. firms--especially large investment funds and asset 
managers--as global SIFIs. That concern arose, presumably, because of 
fear that an FSB designation would provide a foundation for the FSOC to 
do the same. To forestall this possibility, the FSB was urged instead 
to consider regulating ``activities'' rather than designating SIFIs. 
This approach, as discussed below, is not without risk. Limiting the 
FSB and the FSOC to regulating activities, instead of designating 
SIFIs, may not prevent the FSOC and the Fed from imposing prudential 
regulation on virtually all firms that operate in the capital markets, 
including asset managers, regardless of size.
    In a recent speech, Governor Tarullo said that he favors 
``activities-based regulation'' for asset managers,\8\ and with 
Tarullo's support it is likely that the FSB will oblige. But as I will 
show several provisions of Dodd-Frank, if interpreted broadly by the 
FSOC and the Fed, could enable the Fed to place many transactions that 
are routine activities in the U.S. capital markets under what is 
essentially prudential control.
---------------------------------------------------------------------------
    \8\ John Heltman, ``Fed's Tarullo Favors Activities-Based 
Regulation for Asset Managers,'' American Banker, June 4, 2015.
---------------------------------------------------------------------------
    The need to cover these activities was outlined by Governor Tarullo 
a year ago: ``Prudential regulation,'' he said, ``must deal with 
threats to financial stability whether or not those threats emanate 
from traditional banking organizations. Hence the need to broaden the 
perimeter of prudential regulation, both to certain nonbank financial 
institutions and to certain activities by all financial actors.''\9\ 
[emphasis supplied] This is a statement of determination; if the Dodd-
Frank Act provides the necessary authority, we may see an effort by the 
FSOC and the Fed to impose prudential regulation on activities--that 
is, what they see as excessive risk-taking--in the capital markets.
---------------------------------------------------------------------------
    \9\ Daniel Tarullo, Speech at the Federal Reserve Bank of Chicago, 
note 4 above, p1.
---------------------------------------------------------------------------
    If this is not acceptable to this Committee it should act to modify 
these provisions before the FSB, the FSOC and the Fed act to impose 
prudential restrictions on the entire U.S. financial system.
Efforts by the FSB and the Fed To regulate shadow banking
    The widespread concern among bank regulators about ``shadow 
banking'' is best understood in the context of the competitive 
challenges facing the heavily regulated banking business. Since the 
mid-1980s, the capital markets have outcompeted banking in the 
financing of corporate and business borrowers. The chart below shows 
the growing gap between banks and capital markets financing. The 
existence of this gap was recently confirmed by Stanley Fischer, the 
vice chair of the Fed, when he told a banking audience: ``In recent 
years, about two-thirds of nonfinancial credit market debt has been 
held by nonbanks, which includes market-based funding by securitization 
vehicles and mutual funds as well as by institutions such as insurance 
companies and finance companies.''\10\
---------------------------------------------------------------------------
    \10\ Stanley Fischer, ``Nonbank Financial Intermediation, Financial 
Stability, and the Road Forward,'' March 30, 2015, p.1. http://
www.federalreserve.gov/newsevents/speech/fischer20150330a.htm.

Source: Federal Reserve Flow of Funds
    To a significant degree, this gap is the result of the relative 
efficiency of obtaining credit through the capital markets rather than 
banking, and left to itself this gap is probably irreversible. However, 
nonbank competition for banks restricts bank regulators' freedom in 
regulating banks. Tightening bank regulation simply makes banks even 
less competitive with the capital markets. A partial solution, then, is 
to gain some kind of regulatory control over the capital markets--the 
shadow banking system--so that some regulatory burden can also be on 
shadow banking. The financial crisis was a disaster for the American 
people, but it has provided a unique opportunity for bank regulators to 
seek greater authority over the whole financial system, despite their 
failure to prevent the failure or near-failure of the largest banks 
(and hundreds of smaller banks) in the financial crisis.
    Whatever the motive, the FSB's analysis of the dangers of shadow 
banking rests heavily on the risks associated with ``maturity 
transformation,'' an inherent risk of traditional banking. When banks 
take deposits withdrawable on demand and use those funds to make long-
term loans they are engaged in what is called maturity transformation. 
By its nature, this is a risky activity because the supporting deposits 
can be withdrawn while the loan is still outstanding, threatening the 
bank's liquidity position. Banks are subject to prudential regulation 
and have access to the Fed's discount window in part because of this 
inherent risk.
    The FSB has argued that the shadow banking system is also subject 
to this risk. For example, in a paper outlining its effort to gain some 
control of shadow banking, the FSB stated:

        [E]xperience from the crisis demonstrates the capacity for some 
        nonbank entities and transactions to operate on a large scale 
        in ways that create bank-like risks to financial stability 
        (longer-term credit extension based on short-term funding and 
        leverage). Such risk creation may take place at an entity level 
        but it can also form part of a complex chain of transactions, 
        in which leverage and maturity transformation occur in stages, 
        and in ways that create multiple forms of feedback into the 
        regulated banking system.\11\ [emphasis added]
---------------------------------------------------------------------------
    \11\ FSB, ``Strengthening Oversight and Regulation of Shadow 
Banking,'' August 23, 2013, pii.

    As the FSB sees it, then, many entities in the shadow banking world 
work together to produce the maturity transformation that is the risky 
element of traditional banking. This might seem somewhat dubious as an 
idea, but former Fed chair Ben Bernanke--a strong and persistent backer 
of regulating shadow banks--tried to provide an example of a ``complex 
---------------------------------------------------------------------------
chain of transactions'' in a 2012 speech:

        As an illustration of shadow banking at work, consider how an 
        automobile loan can be made and funded outside of the banking 
        system. The loan could be originated by a finance company that 
        pools it with other loans in a securitization vehicle. An 
        investment bank might sell tranches of the securitization to 
        investors. The lower-risk tranches could be purchased by an 
        asset-backed commercial paper (ABCP) conduit that, in turn, 
        funds itself by issuing commercial paper that is purchased by 
        money market funds.\12\
---------------------------------------------------------------------------
    \12\ Ben Bernanke, ``Fostering Financial Stability,'' Speech at 
2012 Federal Bank of Atlanta Financial Markets Conference, p2.

    The problem with this, Bernanke went on, is that ``Although the 
shadow banking system taken as a whole performs traditional banking 
functions, including credit intermediation and maturity transformation, 
unlike banks, it cannot rely on the protections afforded by deposit 
insurance and access to the Federal Reserve's discount window to help 
insure its stability.''
    Thus, to the extent that Bernanke's views reflect the underlying 
ideas circulating in the FSB--a good bet given the importance of the 
Fed in the world's financial system--the effort to control shadow 
banking is based on the idea that while it can create risky maturity 
transformation it does not have the necessary access to either deposit 
insurance or the Fed's discount window, both of which supposedly would 
protect shadow banks against runs or other instability. It follows that 
the risks taken by unregulated participants in the capital markets can 
only be mitigated by access to a bank-like Government safety net--and 
absent these protections must be modulated by strict prudential 
regulation. Of course, access to a bank-like safety net, as the 
President of the New York Federal Reserve Bank has noted, ``would 
entail substantial prudential regulation of entities--such as broker-
dealers--that might gain access . . . [since this would be] required to 
mitigate moral hazard problems.''\13\ Thus, more regulation begets more 
risks for the taxpayers, and more regulation after that to protect the 
taxpayers from the risks the regulators failed to foresee the first 
time.
---------------------------------------------------------------------------
    \13\ William C. Dudley, ``Fixing Wholesale Funding to Build a More 
Stable Financial System,'' February 1, 2013.
---------------------------------------------------------------------------
    Pursuing this idea, the FSB is developing a theory that would allow 
regulators in member countries to impose prudential regulations on 
capital markets firms. The basis for this regulation is the claim that 
``complex chains of transactions'' can create risks to market stability 
that are similar to the risks created by maturity transformation.
The Fed's pursuit of shadow banking
    There is no doubt that the Fed is an active partner of the FSB, 
maybe even the driving force in the effort to gain some control of 
shadow banking.
    In remarks at a meeting in New York on December 2, 2014, Stanley 
Fischer, the Fed's vice chair who also heads an internal systemic risk 
committee at the agency, described the Fed's then-current effort to 
control shadow banking. To the extent that the Fed itself does not have 
the authority to exert this control, he said that the Fed intends to 
use the authorities of the FSOC for this purpose.
    At the meeting, Fischer was interviewed by Larry Fink, chairman of 
BlackRock, one of the largest asset-management firms in the world. 
According to a transcript of the interview, Fischer was asked by a 
member of the audience: ``Stan, can you talk a little bit more about 
the shadow banking system and what, if anything, you think should be 
done at a policy level to ensure that there is the financial stability 
over this 80 percent that you don't--you have less control over?''

Fischer responded:

        FISCHER: Well, the--you know, there are real institutions--in 
        the shadow banking system. There are hedge funds. There are 
        insurance funds.

        FINK: Even asset managers.

        (LAUGHTER)

        FISCHER: Even asset managers, I've been reliably informed.

        (LAUGHTER)

        And other financial institutions, some of those have 
        regulators. The insurance companies, for instance, have 
        regulation. Others do not have--have regulation. And what is 
        being done right now is mapping out this system. One of the 
        most complicated maps you've ever seen was produced in the New 
        York Fed showing the shadow banking system and the interactions 
        between it and, you know, everybody is talking to everybody 
        else, doing business with everybody else, it's to understand 
        that [sic] that system is as a system, how it interacts with 
        the banking system, and who has any authority that will enable 
        them to take action--undertake actions to deal with a firm, 
        which is if it's large enough or interconnected enough, would 
        create a big problem if it failed.

        That's what we're doing now. And then, if it's--if we the Fed 
        have the authority to regulate it. Then on the basis of that 
        analysis, we would then go ahead, if we have the authority--for 
        instance, we have control over margin requirements--and if we 
        don't, then it goes to the FSOC and is discussed there.\14\
---------------------------------------------------------------------------
    \14\ Bloomberg transcript.

        The identity between the work of the FSB and the work of the 
        Fed on shadow banking is nowhere better exemplified than in a 
        statement by Mr. Fischer to a banking audience at a conference 
---------------------------------------------------------------------------
        sponsored by the Federal Reserve Bank of Atlanta in March 2015:

        [N]onbank intermediation often involves complex chains of 
        activity encompassing many entities and markets. Such chains 
        tend to increase the web of interconnections in the financial 
        system that, in some circumstances, can increase the likelihood 
        or severity of systemic stress . . . It is often said that 
        stronger regulation of the banking sector will cause activity 
        to move outside the perimeter of regulation. The evolution also 
        could lead to greater complexity, such as longer chains of 
        interconnection, which make it more difficult for market 
        participants to understand the risks arising from their 
        exposures. Examples of migration that have already occurred 
        include the movement of many loans made to large corporations 
        from banks to collateralized loan obligations, the 
        securitization of many credit card receivables, and the 
        securitization of mortgages.\15\ [emphasis supplied]
---------------------------------------------------------------------------
    \15\ Stanley Fischer, ``Nonbank Financial Intermediation, Financial 
Stability, and the Road Forward,'' Remarks at Central Banking in the 
Shadows: Monetary Policy and Financial Stability Postcrisis, Federal 
Reserve Bank of Atlanta, March 30, 2015. [emphasis supplied]

    Although the FSB's ``complex chains of transactions''--a way of 
describing the shadow banking system--became ``complex chains of 
activity'' in Mr. Fischer's telling, the concept is the same. The use 
of the term ``activity,'' as we will see, ties it more closely to the 
relevant Dodd-Frank language. In both cases, these unregulated complex 
chains are seen as increasing risks in the markets, and the migration 
of lending from banks to nonbank financial intermediation--``regulatory 
arbitrage'' to bank regulators, but in fact the inevitable outcome of 
greater efficiency--is an example of the problem the Fed and the other 
bank regulators are facing.
The FSB's influence on SIFI designations
    The way the FSOC has exercised its designation authority suggests 
that it is also cooperating with, if not leading, the FSB's efforts. In 
any event, the FSOC has been implementing the FSB's decisions in the 
United States. When Congress authorized the FSOC to designate large 
nonbank financial firms as SIFIs, it assumed that the FSOC would follow 
a fair, objective, and fact-based process in exercising that authority. 
Although officials have asserted that the FSOC's designation decisions 
have been the result of such a process, that is not supported by the 
facts.
    The Treasury and the Federal Reserve Board are unquestionably the 
most important and influential members of the FSOC--the Treasury 
because the secretary of the Treasury is the chair of the FSOC and the 
Fed because it is by far the most powerful and well-resourced U.S. 
financial regulator, especially after the extraordinary authorities it 
received in Dodd-Frank. Both the Treasury and the Fed are also members 
of the FSB, and it is reasonable to assume, given the importance of the 
U.S. financial system, that the Treasury and the Fed are the most 
important and influential members of the FSB.
    After receiving this mandate from the G-20 in 2009, the FSB 
determined to proceed by designating certain firms as ``global SIFIs,'' 
and on July 18, 2013, it designated nine large international insurers--
including three large U.S. insurers, AIG, Prudential and MetLife--as 
global systemically important insurers, or G-SIIs.\16\ The FSOC had 
designated AIG as a SIFI before the FSB had made its designations, but 
Prudential was not designated as a SIFI until September 2013 and 
MetLife not until December 2014.\17\
---------------------------------------------------------------------------
    \16\ FSB, ``Global systemically important insurers (G-SIIs) and the 
policy measures that will apply to them'' July 18, 2013, http://
www.financialstabilityboard.org/wp-content/uploads/
r_130718.pdf?page_moved=1.
    \17\ FSOC, U.S. Department of the Treasury, Designations, Feb. 4, 
2015, http://www.treasury.gov/initiatives/fsoc/designations/Pages/
default.aspx.
---------------------------------------------------------------------------
    The designation of SIFIs by the FSOC is what is called a quasi-
judicial proceeding, where evidence is weighed against a statutory 
standard of some kind, and an administrative agency applies the 
standard to a single party, as a court--based on evidence--would apply 
the law to a single defendant. Quasi-judicial proceedings are usually 
expected to meet certain standards of fairness and objectivity. This 
fairness and objectivity was missing in the FSOC's treatment of at 
least two of the U.S. insurers designated as G-SIIs by the FSB.
    In March testimony before the House Financial Services Committee, 
Treasury Secretary Lew stated that the FSB ``acts by consensus.''\18\ A 
consensus literally means an agreement; synonyms of consensus in most 
dictionaries are concurrence, harmony, accord, unity and unanimity. So 
when these three firms were designated by the FSB as G-SIIs the 
Treasury and the Fed necessarily concurred in the decision.
---------------------------------------------------------------------------
    \18\ See transcript of Hensarling/Lew exchange, March 25, 2015. 
http://www.aei.org/publication/exchange-between-rep-jeb-hensarling-and-
treasury-secretary-jacob-lew/?utm_source=para
mount&utm_medium=email&utm_campaign=wallison-kupiec-newsletter.
---------------------------------------------------------------------------
    This means that months before the FSOC designated Prudential or 
MetLife as SIFIs the Treasury, the Fed and the chair of the SEC--the 
three most important members of the FSOC and perhaps the FSB as well--
had already determined as members of the FSB to designate Prudential 
and MetLife as G-SIIs. Obviously, if a firm is a G-SII on a global 
scale, it is going to be a SIFI in its home country. Thus, whatever 
process the FSOC might have followed in the designation of Prudential 
and MetLife, it could not be considered fair, objective and evidence-
based if the chairman of the FSOC, the Fed and the SEC--as members of 
the FSB--had already decided the issue months before.
    Moreover, the FSB has not explained the basis for its designations 
of Prudential and MetLife, except to say that they were made in 
conformity with a methodology of the International Association of 
Insurance Supervisors. Although the methodology was made public, the 
FSB has never explained how the methodology applied to any of the 
insurers, including the three U.S. insurers. So the need for an 
objective evidence-based decisionmaking process could not be cured in 
any way by whatever process the FSB may have followed in making its 
designations.
    Clearly, then, the FSOC's tainted designations of Prudential and 
MetLife cannot be considered the kind of deliberative process that was 
sanctioned by Congress when it authorized the FSOC to make SIFI 
designations.
    Finally, there is now reason to believe that the FSOC's designation 
of MetLife was not the result of an objective study of evidence. In 
2015, as part of its legal challenge to the FSOC's designation, MetLife 
filed a brief that, for the first time, made publicly available the 
evidence that FSOC had produced to support its position. The brief 
showed that FSOC does not have any significant evidence that MetLife's 
financial distress or failure would cause financial instability in the 
United States.
    In the regulations it adopted to implement the designation process, 
the FSOC outlined two principal ways that the distress or failure of a 
firm could cause instability in the financial system as a whole: by 
causing losses to others financially exposed to the failing firm 
(called the Exposure Channel) or through a ``fire sale'' liquidation of 
assets that drives down asset prices and thus weakens other firms 
holding the same assets (the Liquidation Channel).
    MetLife's brief demolishes the factual underpinnings of both ideas.
    In addressing Exposure Channel, MetLife submitted evidence that 
showed other major firms had very small exposures to MetLife. For 
example, in the unlikely event that the largest U.S. banks were to lose 
100 percent of their exposure to MetLife, that loss would not exceed 2 
percent of their capital. In a point that would be funny if weren't so 
serious, MetLife showed that the fines recently levied on the largest 
U.S. banks by the Justice Department were four times larger than the 
biggest loss that any large bank would suffer in a total MetLife 
collapse, yet these fines had no observable effect on the health of the 
banks involved.\19\
---------------------------------------------------------------------------
    \19\ MetLife Brief, p46-7; https://www.metlife.com/sifiupdate/
important-updates/index.html
?WT.ac=GN_sifiupdate_important-updates.
---------------------------------------------------------------------------
    With respect to the Liquidation Channel, a study done for MetLife 
by Oliver Wyman showed that even in the implausible event that all 
policyholders were to surrender their policies and ask for return of 
their cash values--and all other MetLife liabilities that could 
accelerate would immediately become due--the firm could still liquidate 
enough assets to cover its liabilities ``without causing price impacts 
that would substantially disrupt financial markets.''\20\ According to 
the brief, the FSOC produced no data to contradict this evidence, but 
summarily asserted that these assets sales ``could'' have an adverse 
effect on the broader economy.
---------------------------------------------------------------------------
    \20\ MetLife Brief, p52.
---------------------------------------------------------------------------
    These facts raise the question of why FSOC chose to designate 
MetLife. Although the actions of the FSOC have consistently mirrored 
the decisions of the FSB, including the designation of the same three 
insurers, the FSOC has always denied that these decisions were in any 
way related to or compelled by similar decisions of the FSB. However, 
the designation of MetLife with so little evidence of its systemic 
importance adds weight to the idea that the FSOC is simply following 
the directives of the FSB.
    There is also evidence that the FSB, as well as the Treasury and 
the Fed, believe they, as members of the FSB, are bound by FSB 
decisions. In early February, 2015, Mark Carney, the chairman of the 
FSB, sent a memorandum to FSB members, notifying them that the FSB 
considered them to be bound by its decisions. Because of the importance 
of the United States as a member of the FSB, it is highly unlikely that 
the FSB chairman would have sent this memorandum without the prior 
agreement of the Treasury and the Fed.
    The memorandum noted peremptorily that the FSB expects ``full, 
consistent and prompt implementation of [its] agreed reforms.''\21\ 
This sounds like the FSB's decisions are binding, but when questioned 
about this by Chairman Jeb Hensarling at the HFSC's March hearing, 
Treasury Secretary Lew denied that the United States was bound by these 
``agreed reforms.'' Hensarling pointed out that the FSB had recently 
``exempted'' three Chinese banks from the reforms and asked ``if these 
are preliminary suggestions and not rules [by the FSB] why is it that 
the FSB found it necessary to grant exemptions, specifically to the 
Chinese?'' Secretary Lew had no answer to this question at the 
hearing.\22\
---------------------------------------------------------------------------
    \21\ Mark Carney, Memorandum to G20 Finance Ministers and Central 
Bank Governors, February 4, 2015, http://
www.financialstabilityboard.org/wp-content/uploads/FSB-Chair-letter-to-
G20-February-2015.pdf.
    \22\ See transcript, note 15 above. See also, Peter J. Wallison and 
Daniel M. Gallagher, ``How Foreigners Became America's Financial 
Regulators,'' The Wall Street Journal, March 19, 2015.
---------------------------------------------------------------------------
    If in fact the FSOC, the Treasury and the Fed are committed to the 
idea that FSB members are bound by FSB decisions, there is a further 
reason for seeing the FSOC's designation of Prudential and MetLife as 
illegitimate. The designation decision was in effect made by the FSB 
and not the FSOC.
    In a June 2014 letter to Congressman Scott Garrett, chair of a HFSC 
subcommittee, the Treasury secretary and the chairs of the Fed and the 
SEC denied that FSB designation decisions are binding on the United 
States: ``The identification of a firm as a G-SIFI does not have legal 
effect in the United States or any other country; rather, any action to 
implement heightened supervision of an identified G-SIFI within a 
particular country would need to be taken by that country pursuant to 
its own laws.''\23\
---------------------------------------------------------------------------
    \23\ Letter dated June 20, 2014, to Scott Garrett, chair of the 
HFSC subcommittee on Capital Markets and Government-Sponsored 
Enterprises, p2.
---------------------------------------------------------------------------
    However, the notion that United States is not obliged to follow FSB 
decisions is questionable in light of Treasury Secretary Lew's 
description--in the same March 25 HFSC hearing--of the purpose of the 
United States involvement in the work of the FSB. When asked by 
Chairman Hensarling whether FSB decisions were binding on the United 
States, the secretary replied: ``We work in the FSB to try to get the 
kinds of standards that we think are appropriate in the United States 
to be adopted around the world so that the whole world will have high 
standards.'' Clearly, if that is the Obama administration's purpose, it 
must itself accept and be bound by the FSB's decisions; if the United 
States isn't bound, the effort to get others to comply will never be 
successful. So Secretary Lew, at least, seems to be operating under the 
assumption that the FSB's decisions will eventually be imported into 
and adopted by the United States.
    In this connection, it is important to recall that the FSB's 
authority ultimately derives from the G-20 leaders. As S. Roy Woodall, 
the Independent Member Having Insurance Expertise on the FSOC noted in 
testimony before this Committee in April 2015: ``[I]nternational 
agreements and commitments made by the U.S. members of the FSB . . . 
are commitments made under the auspices of the G-20. As such, they 
carry considerable weight. Although it is true that they are not 
legally binding, such commitments are expected to be implemented as 
part of the G-20's regulatory reform agenda.''\24\ President Obama was 
a member of the G-20 when it directed the FSB to regulate shadow banks, 
and all the voting members of the FSOC are political appointees of 
President Obama. It is a small step in logic for the members of the 
FSOC--all of whom are appointees of President Obama--to believe that in 
following the directions of the FSB they believe they are carrying out 
the President's own policies.
---------------------------------------------------------------------------
    \24\ S. Roy Woodall, Testimony Before the Senate Banking Committee, 
April 28, 2015, p5.
---------------------------------------------------------------------------
    Thus, while the FSB's decisions have no direct legal effect in the 
United States, it seems that the U.S. members of the FSB believe that 
they have sufficient authority to agree to the FSB's decisions and 
impose them in the United States. Whether they actually have that 
authority is covered in the next section.
Do the FSOC and other U.S. agencies have authority to implement FSB 
        directives?
    If, as Secretary Lew avers, the Obama administration is using the 
FSB as a mechanism for raising ``global standards'' to a level that 
``we think are appropriate in the United States,'' this must mean that 
the Treasury and the Fed believe they have the authority to do in the 
United States what they are attempting to get the FSB to prescribe for 
all other FSB members.
Where is this authority?
    Although the Dodd-Frank Act clearly provides authority for 
regulating entities that are deemed to be systemically important, the 
authority for regulating ``complex chains of transactions'' is not as 
clear. Yet, by concurring with--if not actually sponsoring--the FSB's 
idea that ``complex chains of transactions'' should be regulated in 
order to control the dangers of shadow banking, it is apparent that the 
Treasury and the Fed believe that they would have the power to regulate 
those transactions when the directive from the FSB instructs them to do 
so.
    Indeed, a concept similar to ``complex chains of transactions'' has 
already been articulated by the FSOC, while using a slightly different 
form of words. In its December 18, 2014, Notice on Asset Management 
Products and Activities, the FSOC stated: ``risks to financial 
stability might not flow from the actions of any one entity, but could 
arise collectively across market participants.''\25\ [emphasis 
supplied]
---------------------------------------------------------------------------
    \25\ FSOC, ``Notice on Asset Management Products and Activities,'' 
December 18, 2014, p4.
---------------------------------------------------------------------------
    Most of the attention to the FSOC's designation of SIFIs has 
focused on the agency's efforts to designate large financial 
institutions which, if they become financially distressed, could cause 
instability in the U.S. financial system. The underlying idea here is 
that, because of its interconnections with other firms, the financial 
distress or failure of a nonbank firm could drag down others, causing 
the financial instability that the Act is intended to prevent.\26\
---------------------------------------------------------------------------
    \26\ The historical record does not support these claims. When 
Lehman Brothers failed--from the market's perspective suddenly and 
without a Government rescue in September 2008--it did not drag down any 
other significant financial firm, even though Lehman was one of the 
largest nonbank financial institutions in the United States. There was 
certainly chaos after Lehman's bankruptcy, but that was because the 
Government suddenly reversed the policy of rescuing large financial 
firms that it appeared to have established 6 month earlier with the 
rescue of Bear Stearns. This reversal completely upended the 
expectations of market participants, creating a panic in which 
institutions and investors sought and hoarded cash. The draining of 
liquidity from the financial system after the Lehman bankruptcy is what 
we now know as the financial crisis.
---------------------------------------------------------------------------
    However, the FSOC's authority is not limited to designating SIFIs 
because their financial distress could cause instability in the U.S. 
financial system. It also has authority to designate as SIFIs--and 
consign to regulation by the Fed--many firms that are not large and 
whose failure alone would not cause financial instability. For example, 
Sec 113(a) of Dodd-Frank states:

        The Council . . . may determine that a U.S. nonbank financial 
        company shall be supervised by the Board of Governors and shall 
        be subject to prudential standards . . . if the Council 
        determines that material financial distress at the U.S. nonbank 
        financial company, or the nature, scope, size, scale, 
        concentration, interconnectedness, or mix of activities of the 
        U.S. nonbank financial company, could pose a threat to the 
        financial stability of the United States. [emphasis supplied]

In addition, Sec. 112(a)(2)(H) describes the duties of the FSOC as 
follows:

        [R]equire supervision by the Board of Governors for nonbank 
        financial companies that may pose risks to the financial 
        stability of the United States in the event of their material 
        financial distress or failure, or because of their activities 
        pursuant to section 113; [emphasis supplied]

Finally, Sec. 120 provides that

        The Council may provide for more stringent regulation of a 
        financial activity by issuing recommendations to the primary 
        financial regulatory agencies to apply new or heightened 
        standards and safeguards, including standards enumerated in 
        section 115, for a financial activity or practice conducted by 
        bank holding companies or nonbank financial companies under 
        their respective jurisdictions, if the Council determines that 
        the conduct, scope, nature, size, scale, concentration, or 
        interconnectedness of such activity or practice could create or 
        increase the risk of significant liquidity, credit, or other 
        problems spreading among bank holding companies and nonbank 
        financial companies, financial markets of the United States, or 
        low-income, minority, or underserved communities.

    Finally, under Title VIII of Dodd-Frank, the Fed, with the approval 
of the FSOC, has authority to impose ``risk management standards''--
these are undefined--on any financial firm engaged in payment, 
clearance and settlement (PCS) activities. These provisions are 
sometimes seen as applicable only to clearinghouses and other financial 
market utilities, but in fact they are also applicable for financial 
firms that engage in payment, clearing and settlement activities. PCS 
are very broadly defined in Title VIII and could provide another avenue 
through which the FSOC and the Fed could gain prudential controls over 
the firms that make up the capital markets.\27\
---------------------------------------------------------------------------
    \27\ Peter J. Wallison, ``The Regulators' War on Shadow Banking,'' 
AEI Research, January 22, 2015. http://www.aei.org/publication/
regulators-war-shadow-banking/.
---------------------------------------------------------------------------
    All of these provisions are important because the FSB and the Fed 
are both focusing on a ``complex chain of transactions''--or as the Fed 
describes it, a ``complex chains of activity''--as a way to describe 
how the shadow banking system operates. The term ``activities'' could 
be interpreted to refer to a ``complex chain of transactions'' and thus 
provide the Fed and the FSOC with the authority to impose prudential 
standards on ordinary transactions in the capital markets.
    Thus, there is a plausible argument based on this language that the 
FSOC could designate as SIFIs all firms that engage in certain defined 
transactions--say, buying the commercial paper of asset-backed trusts--
or participate in those transactions to an extent that exceeds some 
dollar amount. The danger of being designated for these suspect 
transactions would be enough to give the Fed the ability to approve or 
disapprove transactions of that kind on a case-by-case basis--a 
plausible substitute for prudential regulation.
    The FSOC and the Fed would defend their position by arguing that it 
was transactions like those they are banning that caused the financial 
crisis. In addition, if the FSOC determines that a firm's activities 
should be regulated by the Fed under Section 112 or 113, the Fed is 
arguably then the firm's primary financial regulator for purposes of 
Section 120.
    We don't know, of course, how the courts will respond to 
interpretations like these. It is a distortion of the statutory 
language, but the courts often accord deference to agencies' 
interpretation of the scope of their statutory authority, especially if 
they believe that the agency is attempting to address a serious problem 
that is within the ``spirit'' of the legislation. The FSOC and the Fed, 
in carrying out a mandate of the FSB, could claim that they have 
authority to take these steps because they are attempting to prevent 
another financial crisis, and no one might be willing--or have the 
standing--to challenge them. Cases like this suggest the Supreme 
Court--as suggested recently by Justice Thomas, should revisit 
Chevron.\28\
---------------------------------------------------------------------------
    \28\ Michigan v. EPA, 576 U.S._(2015) (slip op., at 4-5) (Thomas, 
J., concurring).
---------------------------------------------------------------------------
    If the FSOC and the Fed are successful in controlling what the FSB 
has now defined as shadow banking--that is asset managers, securities 
firms, investment funds, finance companies and hedge funds, among 
others--they will succeed in stifling the continued growth of the 
securities and capital markets in the United States, which have been 
far and away the main sources of financing for U.S. business.
What to Do
    If this Committee believes that applying prudential regulation to 
capital markets activities should be unacceptable, it should act to 
prevent this from happening. The FSB is not the problem; as noted 
earlier, it has no legal authority in the United States; nor would a G-
20 statement or an agreement by U.S. regulators at the FSB by itself 
confer this authority.
    The problem is that there is language in the Dodd-Frank Act that 
could be interpreted to confer the authority on the FSOC and the Fed to 
control the so-called shadow banking system by imposing prudential 
regulation on ordinary activities in the capital markets. Section 113 
of Dodd-Frank refers to ``mix of activities'' as a basis for 
designation of a SIFI, but it does not refer to the control of chains 
of transactions or an entity's participation in chains of transactions 
or chains of activities. In any event, the list of items in Section 113 
for which firms can be designated (``nature, scope, size, scale, 
concentration, interconnectedness, or mix of activities'') is far too 
broad and contains no inherent limit. Did Congress really intend to 
give the FSOC authority to designate a firm as a SIFI because of its 
``nature?'' If the doctrine of unconstitutional delegation of 
legislative authority were still alive, this would be a perfect 
candidate. Congress should repeal this list. Alternatively, Congress 
could make clear that the term ``activities'' was not intended to 
include specific chains of transactions, but the best solution would be 
to remove the term ``activities'' from the Act.
Conclusion
    Complacency about what the FSB, the FSOC and the Fed are doing to 
control shadow banking is not only unwarranted, it is a grave danger to 
U.S. economic growth. ``Shadow banks,'' as these agencies conceive it, 
are the firms active in the capital markets in the United States. The 
freedom of these firms to take the risks their managements find 
acceptable is the foundation of the innovative and efficient financial 
system that has made the U.S. economy the world's unquestioned leader. 
The financial crisis may have given bank regulators new powers that 
they can use to impose prudential controls on capital market firms. 
Indeed, several provisions of the Dodd-Frank Act could be creatively 
interpreted to provide the legal authority to do so. If this Committee 
agrees that bank--like prudential controls over the capital markets 
would be harmful to economic growth, it should take steps today to 
cutoff the legal authorities on which these agencies are likely to 
rely.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

                  PREPARED STATEMENT OF ADAM S. POSEN
      President, Peterson Institute for International Economics\1\
---------------------------------------------------------------------------
    \1\ I am grateful to the Alfred P. Sloan Foundation for its support 
of my research on global financial stability, and to my colleagues 
Morris Goldstein, Simon Johnson, Avinash Persaud, Edwin Truman, and 
Nicolas Veron for their suggestions for this specific submission of 
testimony. I remain solely responsible for the views and any errors in 
this statement, and thus it does not necessarily represent the views of 
the Peterson Institute, the Sloan Foundation, or any member of their 
staff or boards. Disclosure of the Institute's funders and transparency 
policy are available at http://www.piie.com/content/?ID=138.
---------------------------------------------------------------------------
                              July 8, 2015
    1. The rationale for international financial regulatory 
coordination at this time--Generally, the U.S. Government has the lead 
in international economic negotiations--as the largest and most 
developed economy, as the incumbent creator of the rules and 
institutions started after World War II, often as having the most 
technical expertise on a given subject, and usually as having the model 
of a property-rights respecting rule of law in its commercial affairs 
that other economies wish to emulate or import. But even where the U.S. 
Government is not entirely dominant in international policy agenda 
setting, there is room for the U.S. economy and citizens to benefit 
from international coordination. The rest of the world economy exists, 
whether or not the U.S. Government chooses to engage with other 
governments in discussion of the rules by which it is partially 
governed. Economic activities abroad can have significant negative 
spillovers on U.S. well-being, as well as present opportunities for 
(mutual) gain to be unlocked. Mostly, though not always, international 
economic coordination ends up raising standards abroad while 
constraining harmful behaviors in the United States that we would wish 
to limit anyway--and in fact, our own Government's legislated intent is 
often more effectively applied by making it harder for U.S. entities to 
skirt domestic regulations by moving abroad.
    The benefits to the U.S. economy and public from international 
financial regulatory cooperation are particularly high for a simple 
reason: unnecessary financial volatility and misbehavior abroad is 
transmitted to the U.S. economy directly, rapidly, and strongly. As 
other economies inevitably grow in size and financial depth relative to 
the U.S. economy, the impacts of their problems on the United States 
grow. We can see this in the comparison between the real but limited 
impact of the Latin and Asian financial crises of the 1990s on the 
United States and the far greater harms felt from the European crisis 
of recent years and the swings in capital flows and commodity prices 
driven by Chinese financial instability. This can do us great harm, 
despite the size, depth, diversity, and general robustness of U.S. 
financial markets and lending activities making us less vulnerable than 
other economies to any given shock.
    We cannot simply live with the misbehaviors and even unintended 
weaknesses of other economies' financial systems. We need changes in 
those other countries to defend ourselves, as well as to help them. 
Furthermore, the usual concern in international economic governance 
about a race to the bottom of low standards winning out takes on a 
particular form in the financial sector: cross-border regulatory 
arbitrage. Given the mobility of capital and the availability of 
information technology and connectivity, jurisdictions where 
regulations are much weaker can become places where activities 
prohibited in the United States and elsewhere thrive. These activities 
can produce globally dangerous buildups of financial risk very quickly 
and easily. While international regulatory coordination cannot rule 
these out completely, it can make it both much more difficult for such 
legal loopholes to arise, to be defended, to grow in size and 
riskiness, and to hide from at least supervisory awareness.
    International regulatory coordination, in the manner in which it is 
currently led by U.S. Government and Federal Reserve representatives, 
is reducing these risks to U.S. economic and financial stability. 
Please note that I said reducing, not removing, these risks--please 
note, also though, that I said reducing not raising. This reduction of 
foreign financial risks to the United States (including from U.S. 
entities moving dangerous activities abroad to elude supervision) is 
happening along four channels at present:

    Raising minimum standards for the soundness of major banks 
        and banking systems, including by setting minimums for bank 
        capital, improving risk assessment (e.g., stress testing), 
        creating liquidity/leverage limits, identifying systemically 
        important institutions, making cross-border resolution more 
        feasible, and so on.

    Increasing cross-border transparency of financial systems' 
        organization, institutions, financial flows, and buildups of 
        risk.

    Reducing the possibilities of regulatory arbitrage across 
        major financial centers, both in terms of getting agreement on 
        activities to be restricted and monitored, and of providing a 
        means for `naming and shaming' noncompliant regimes.

    Promoting largely U.S.-based versions of best practice for 
        regulators, supervisors, bankers, and nonbank financial 
        institutions in other countries.

    I would be remiss in my duty to this Committee, however, if I did 
not point out that other countries can legitimately expect better U.S. 
behavior and practice to emerge from international regulatory 
coordination as well. Our regulators, supervisors, banks, and other 
financial institutions did not cover themselves in glory with their 
practices in the run-up to the financial crisis of 2008-10. At a 
minimum, having the U.S. financial regulators and supervisors be 
confronted with international questions and standards should reduce the 
cognitive capture of that community by a set of blinders, as I have 
argued played a critical role in causing the U.S. financial crisis.
    There are other views which will claim that the current 
international financial regulatory process is either eroding desirable 
U.S. regulations by having other countries force compromise on the 
United States through the process, or is imposing unnecessary 
additional regulations upon the United States to erode our competitive 
advantages, or both. I readily acknowledge that there are a few 
instances of this sort--I believe that the attempt by European Union 
[EU] regulators to impose Solvency II, their set of insurance 
requirements, on insurers in the United States and elsewhere is a 
particularly costly example, as I will explain--but I view that as 
indeed instances of bad regulation, not the overall international 
process being inherently harmful. Any regulatory process, domestic or 
foreign, will have debates and make some mistakes. Arguably, the 
domestic Financial Stability Oversight Council [FSOC] within the United 
States is if anything primed to be more biased toward lowest common 
denominator or group think leaving gaps in the U.S. financial 
regulatory framework than the international Financial Stability Board 
[FSB]. So, the FSB is a useful check and occasional corrective to the 
U.S. FSOC process.
    Whether it is discussions of Trade Promotion Authority (which I 
commend the Senate for recently passing), of responses to climate 
change, of efforts to balance healthy global tax competition with the 
prevention of tax avoidance by multinational corporations and wealthy 
individuals, or of the need to prevent cross-border regulatory 
arbitrage by financial institutions, the U.S. Government has to 
confront the fact that behaviors and policies abroad affect us here at 
home. There is sometimes a paranoid tendency by some American 
politicians and pundits to assume that all international economic deals 
are about putting one over on the United States, eroding our high 
standards through subversion of domestic regulation, or eroding our 
market-based competitiveness by imposing undue additional regulation. 
This is a profound misunderstanding on both the right and the left of 
our public debate. The United States advances the economic welfare of 
its people through constructive international engagement, usually gets 
its way in such efforts and extends the rules it wants to others, and 
sometimes even benefits from having constraints imposed from outside 
pressure that domestic special interests would be able to prevent 
absent that. Yes, sometimes other governments do pursue narrow 
interests of their national champions, whether State-owned or simply 
influential private businesses, through these processes. But American 
economic negotiators are grown-ups, they can handle it, just as they 
would when having business negotiations in the private sector. The fact 
that somebody tries something self-interested does not mean you cannot 
work with them, you simply call them on that attempt.

    2. The demonstrated utility of the Financial Stability Board--
Turning from the general issue of international coordination on 
financial regulation to the current process for pursuing it, what about 
the FSB? Does it serve U.S. and global interests as currently 
constituted and operating? I believe that it clearly does, though with 
some inherent limitations, as well as some areas for improvement that 
can be fixed. I resolutely dispute any claims that the FSB is run amok, 
is undermining U.S. domestic financial regulation, or is trying to, let 
alone succeeding in, forcing our diverse and unique private-sector 
financial system to converge on others' models. This is not because I 
am part of some technocratic self-appointed elite, or more crassly 
simply buddies with the people involved in the FSB process--I have been 
rather critical on the record of some of the FSB's decisions for lack 
of ambition and for too much clubbiness in its agenda setting.\2\ But I 
do believe that the FSB as an organization for international 
coordination is a reasonably good institutional response to the need 
for effective, legitimate, and well-motivated global financial 
regulation.\3\ Among the positive attributes of the FSB are:
---------------------------------------------------------------------------
    \2\ See, among others, Adam S. Posen, ``Confronting the Reality of 
Structurally Unprofitable Safe Banking,'' in Too Big to Fail III: 
Structural Reform Proposals: Should We Break Up the Banks?, Andreas 
Dombret and Patrick Kenadjian, eds., Boston/Munich: De Gruyter, 2015. 
http://tinyurl.com/oxc7wk2.
    \3\ For an earlier assessment of the FSB, many of whose 
recommendations have largely since been adopted, see Edwin M. Truman 
and Gary Schinasi, ``Reform of the Global Financial Architecture,'' 
PIIE Working Paper 10-14, October 2010, http://www.piie.com/
publications/interstitial.cfm?ResearchID=1674.

    Its national membership covers all of the world's major 
        financial centers but is still limited enough in number to be 
---------------------------------------------------------------------------
        able to make decisions.

    It usefully cuts across national and regulatory turf 
        barriers in a way that is needed to confront regulatory 
        arbitrage and address globally connected financial networks.

    It is coordinated with the G20 economic leaders' meetings 
        and processes, which means major agenda items from the FSB get 
        on to the G20 agenda for buy-in.\4\
---------------------------------------------------------------------------
    \4\ I am grateful to Morris Goldstein for this insight regarding 
the G20 link.

      This also creates scrutiny and oversight for the G20 
        decisions, and a structure for issuing public progress reports 
---------------------------------------------------------------------------
        for assessment.

    By including central bankers and financial officials, as 
        well as bank supervisors narrowly defined, it avoids some of 
        the narrow thinking and silo mentality that caused cognitive 
        capture in the earlier Basel banking processes and in U.S. 
        supervisory decisions pre-crisis.

    It is a soft-law organization, meaning that agreements it 
        reaches are only binding on member governments to the degree 
        that not complying involves naming and shaming

      When a regulation issued becomes recognized as worthy, 
        popular and market pressure to adopt a good standard are the 
        main source of compliance, with the FSB simply providing public 
        benchmarks and monitoring.

      This to me is a virtue in a world of sovereign nation 
        states and the need to change regulations over time.

    It has grown out of leadership efforts by both Democratic 
        and Republican administrations, including the creation of its 
        direct predecessor the Financial Stability Forum, and as such 
        is at its core a U.S.-instigated nonpartisan institution.

    The proof is in the pudding, even though it has had little time to 
cook. The FSB process has produced some useful achievements that are 
being applied globally as a result of these structural attributes. 
Banking transparency, standards, and particularly capital requirements 
have been raised in the major financial institutions of a wide range of 
countries, including in some critical emerging markets and some 
financial centers outside of the United States and European Union. 
Agreement on a set of G-SIFIs, globally systemically important 
financial institutions, and on capital surcharges for them as partial 
insurance for the public, has been mutual including all FSB member 
countries, and done on largely sound replicable criteria. Progress has 
been made on procedures and compelling conditional funding for safer 
expedited resolution of such important institutions when they run into 
trouble.\5\
---------------------------------------------------------------------------
    \5\ Which matters if you believe that resolution threats are 
credible to large/important institutions, and that inability to resolve 
Lehman Brothers and others was a cause of the financial crisis. I have 
my doubts this is going to help much in preventing the next crisis. For 
this hearing, however, the point is that the majority of U.S. officials 
do believe this is important, and the FSB has delivered in response to 
their belief some global adoption of measures desired in this regard.
---------------------------------------------------------------------------
    Having widespread divergence on what different governments believe 
is adequate bank capital or what banks are systemically important would 
be a recipe for precisely the kind of race to the bottom that would 
imperil U.S. financial stability--every country would get looser 
regulations for its preferred client banks, and some would compete to 
be the place the world's banks could engage in activities that should 
not be allowed. This will become increasingly important with large 
Chinese financial institutions, as we are seeing in today's news. Given 
China's membership in the FSB and G20, we have a means to bring those 
potential dangers into the regulatory system beyond Chinese government 
bailouts and own soft-touch regulation (following the United States and 
United Kingdom mistakes of the 2000s, sadly).

    3. Where and why bad regulation is emerging from the FSB process 
regarding nonbanks--As I mentioned earlier, the FSB can be a good 
process, producing some good international standards as a result, thus 
serving U.S. economic interests, and still get some things wrong. This 
is inevitable, as getting things right is difficult, both because there 
are governments pushing compromises and proposals for the wrong reasons 
on any given issue, and because some issues are more difficult to 
tackle than others. Where the FSB at present is getting things wrong, 
in my opinion, largely has to do with its approaches to coordinating 
regulation of the nonbank parts of the financial system. Regulating 
nonbanks is more difficult because some well-organized interest groups 
that were less weakened or tainted by the financial crisis have some 
sway, because intellectually the manner and extent of nonbank 
regulation is less obvious and certainly less well precedented, and 
because the kinds of national regulators and supervisors involved are 
much more diverse. I also believe that the FSB has demonstrated a 
tendency to treat nonbanks as banks because it is something its 
technocratic members are more familiar with, it allows claims of 
neutrality across the financial sector, it utilizes off-the-shelf 
remedies, and it speeds the conclusion of the post-crisis agenda. In 
other words, treating banks and nonbanks largely the same is the easy 
way out.
    Diversity in financial systems is, however, a virtue. As I have 
argued for some time, a major reason that the United States and Germany 
recovered from the financial crisis more rapidly and strongly than 
other advanced economies was that they had more diversified financial 
systems, and thus were more robust in continuing to provide financing 
to nonfinancial business and households.\6\ This financial diversity so 
helpful to the United States comes along at least two dimensions: 
first, that we have a relatively unconcentrated banking system, despite 
the existence of megabanks, which includes community banks and various 
regional lenders; second, that we have a variety of nonbank means of 
providing finance for investment, including corporate and junk bonds 
and commercial paper, venture capital and private equity, pension funds 
and insurance firms, as well as newly emerging forms of direct lending. 
This makes the U.S. economy far more resilient to financial shocks, 
even the worst ones we have seen. We do not want any global regulatory 
process to interfere with this diversity in U.S. finance.
---------------------------------------------------------------------------
    \6\ See Adam S. Posen, ``Why is Their Recovery Better than Ours?,'' 
speech at the National Institute for Economic and Social Research, 
London, 27 March 2012, available at http://www.bankofengland.co.uk/
publications/Documents/speeches/2012/speech560.pdf.
---------------------------------------------------------------------------
    That is not the same, though, as saying any international 
regulation of nonbanks is a bad thing. If one remembers all the 
different kinds of financial firms engaged in bad lending and 
investment decisions, fraudulent behavior, speculation with other 
people's money, and reliance on implicit government bailout guarantees, 
during the 2000s in the United States, there is a prima facie case 
which I support for more entities coming under regulation than fewer. 
What the FSB needs to do, and the U.S. representatives there need to 
encourage, is serious discussion of which parts of the nonbank 
financial sector need further regulation, and which do not, and what 
form that regulation should take. Simply amping up capital 
requirements, for holding ``safe assets,'' and calling everything a 
``shadow bank'' that provides funding and is not a bank, misses the 
point and potentially does harm.
    Right now, the biggest mistake the FSB is making in this regard is 
in the attempt to extend Solvency II, the European Commission's 
regulation for insurance firms, to global application. This is a bad 
idea for European insurers on its own lack of merits--as argued by my 
colleague Avinash Persaud, long-term investors like life insurers with 
clear payout obligations need a very different approach to their 
portfolios than do asset managers or banks, and what constitutes safe 
investment for them is different than for banks.\7\ Insurers certainly 
need regulation and supervision, including clear capitalization to meet 
their policyholders' expected payouts. But almost every jurisdiction, 
and certainly the U.S. states, already provides such pure protective 
supervision. Solvency II tries to add on capital holding requirements 
of Government bonds and short-term assets akin to what is (rightly) 
required for banks. This is not only ill-suited for insurers, it is 
likely to result in a short-fall of private funds for long-term 
investment like infrastructure in the jurisdictions that adopt this set 
of requirements--where those investment funds for the long-term are 
desperately needed.
---------------------------------------------------------------------------
    \7\ Avinash D. Persaud, How Not to Regulate Insurance Markets: The 
Risks and Dangers of Solvency II, PIIE Policy Brief 15-5, April 2015, 
http://www.piie.com/publications/interstitial.cfm?ResearchID=2777.
---------------------------------------------------------------------------
    This bad outcome from the FSB illustrates what happens when the 
United States goes into international processes with its own house not 
in order. We have 54 State and other local insurance commissioners, and 
despite the addition of a Federal oversight, no real one representative 
to strongly present in the FSB. Meanwhile, the
European Union has a coherent Commission point of view on this, which 
has huge bureaucratic momentum after years of preparation centrally. 
The insurers in Europe for the most part rightly hate it, but since it 
seems inevitable to be imposed on them, they have given up fighting 
Solvency II, and instead back using the FSB to impose it on the United 
States, Japanese, and other competing insurers. They figure if they 
will be limited, they want to be sure their global competitors are as 
well. The United States needs to stand up against this in the FSB. This 
is the exception that proves the general rule that the FSB process 
serves U.S. interests, but it reflects an instance of bad regulation, 
not an overall assault on U.S. financial
diversity. And it should be responded to as such within the FSB 
process.

              Additional Material Supplied for the Record

                 PREPARED STATEMENT OF MICHAEL S. BARR
         The Roy F. and Jean Humphrey Proffitt Professor of Law
                   University of Michigan Law School
                              July 8, 2015
    In 2008, the United States plunged into a severe financial crisis 
that shuttered American businesses, and cost millions of households 
their jobs, their homes and their livelihoods. The crisis was rooted in 
years of unconstrained excesses and prolonged complacency in major 
financial capitals around the globe. The crisis demanded a strong 
regulatory response in the United States and globally as well as 
fundamental changes in financial institution management and oversight 
worldwide. The United States has led these reforms, both domestically 
and internationally.
    In the United States, the Dodd-Frank Act created the authority to 
regulate Wall Street firms that pose a threat to financial stability, 
without regard to their corporate form, and to bring shadow banking 
into the daylight; to wind down major firms in the event of a crisis, 
without feeding a panic or putting taxpayers on the hook; to attack 
regulatory arbitrage, restrict risky activities through the Volcker 
Rule and other measures, regulate repo and other short-term funding 
markets, and beef up banking supervision and increase capital; to 
require central clearing and exchange trading of standardized 
derivatives, and capital, margin and transparency throughout the 
derivatives market; to regulate payments, settlement, clearance and 
other systemic activities; to improve investor protections; and to 
establish a new Consumer Financial Protection Bureau to look out for 
the interests of American households.
    The Act established the Financial Stability Oversight Council with 
authority to designate systemically important firms and financial 
market utilities for heightened prudential oversight by the Federal 
Reserve; to recommend that member agencies put in place higher 
prudential standards when warranted; and to look out for and respond to 
risks across the financial system. The Council is aided in these tasks 
by its own staff, the staff of member agencies, and the independent 
Office of Financial Research, which has a duty to standardize and 
collect data and to examine risks across the financial system.
    One of the major problems in the lead up to the financial crisis 
was that there was not a single, uniform system of supervision and 
capital rules for major financial institutions. The Federal financial 
regulatory system that existed prior to the
Dodd-Frank Act developed in the context of the banking system of the 
1930s. Major financial firms were regulated according to their formal 
labels--as banks, thrifts, investment banks, insurance companies, and 
the like--rather than according to what they actually did. An entity 
that called itself a ``bank,'' for example, faced tougher regulation, 
more stringent capital requirements, and more robust supervision than 
one that called itself an ``investment bank.'' Risk migrated to the 
less well-regulated parts of the system, and leverage grew to dangerous 
levels.
    The designation of systemically important nonbank financial 
institutions is a cornerstone of the Dodd-Frank Act. A key goal of 
reform was to create a system of supervision that ensured that if an 
institution posed a risk to the financial system, it would be 
regulated, supervised, and have capital requirements that reflected its 
risk, regardless of its corporate form. To do this, the Dodd-Frank Act 
established a process through which the largest, riskiest, and most 
interconnected financial firms could be designated as systemically 
important financial institutions and then supervised regulated by the 
Federal Reserve. The Council has developed detailed
interpretive guidance and a hearing process that goes beyond the 
procedural requirements of the Act, including extensive engagement with 
the affected firms, to implement the designation process outlined in 
Dodd-Frank. The approach provides for a sound deliberative process; 
protection of confidential and proprietary information; and meaningful 
and timely participation by affected firms. The Council has
already designated a number of firms under this authority.
    Critics of designation contend that it fosters ``too big to fail,'' 
but the opposite is true. Regulating systemically important firms 
reduces the risk that failure of such a firm could destabilize the 
financial system and harm the real economy. It provides for robust 
supervision and capital requirements, to reduce the risks of failure, 
and it provides for a mechanism to wind down such a firm in the event 
of crisis, without exposing taxpayers or the real economy to the risks 
of their failure. The FDIC is developing a ``single point of entry'' 
model for resolution that would allow it to wind down a complex 
financial conglomerate through its holding company with 
``resolution-ready'' debt and equity, while permitting solvent 
subsidiaries to continue to operate. Similar approaches are being 
developed globally.
    Other critics argue that the FSOC should be more beholden to the 
regulatory agencies that are its members, but again, the opposite is 
true: Congress wisely provided for its voting members, all of whom are 
confirmed by the Senate, to participate based on their individual 
assessments of risks in the financial system, not based on the position 
of their individual agencies, however comprised.
    Members must also individually attest to their assessments in the 
FSOC's annual reports. The FSOC, moreover, has the duty to call on 
member agencies to raise their prudential standards when appropriate, 
and member agencies must respond publicly and report to Congress if 
they fail to act. If anything, the FSOC's powers should be 
strengthened, so that fragmentation in the financial regulatory system 
does not expose the United States to enormous risk, as it did in the 
past.
    Some critics contend that certain types of firms in certain 
industries or over certain sizes should be categorically walled off 
from heightened prudential supervision, but such steps will expose the 
United States to the very risks we faced in the lead up to the last 
devastating crisis. The failure of firms of diverse types and diverse 
sizes at many points in even very recent memory--from Lehman and AIG to 
Long-Term Capital Management--suggest that blindspots in the system 
should at the very least not be intentionally chosen in advance by the 
Congress. The way to deal with the diversity of sizes and types of 
institutions that might be subject to supervision by the Federal 
Reserve is to develop regulation, oversight and capital requirements 
that are graduated and tailored to the types of risks that such firms 
might pose to the financial system, as the agencies have been doing. 
FSOC and member agencies also have other regulatory tools available 
with respect to risks in the system for firms not designated for Fed 
supervision, including increased data collection and transparency, 
collateral and margin rules for transactions, operational and client 
safeguards, risk management standards, capital requirements, or other 
measures.
    Some critics complain that the FSOC's work is too tied to global 
reforms by bodies such as the Financial Stability Board (FSB). But 
global coordination is essential to making the financial system safe 
for the United States, as well as the global economy. The United States 
has led the way on global reforms, including robust capital rules, 
regulation of derivatives, and effective resolution authorities. These 
global efforts, including designations by the FSB, are not binding on 
the United States. Rather, the FSOC, and U.S. regulators, make 
independent regulatory judgments about domestic implementation based on 
U.S. law. And U.S. regulators follow the normal notice and comment 
process when developing financial regulations. The FSB itself has 
become more transparent over time, adopting notice and comment 
procedures, for example, but it could do more to put in the place the 
kind of protections that the FSOC has established domestically.\1\
---------------------------------------------------------------------------
    \1\ See Michael S. Barr, Who's in Charge of Global Finance?, 
Georgetown Journal of International Affairs.
---------------------------------------------------------------------------
    As with designation, global coordination--and independent 
regulatory judgment--is essential to capital rules. Strong capital 
rules are one key to a safer system. There's already double the amount 
of capital in the major U.S. firms than there was in the lead up to the 
financial crisis. Globally, regulators are developing more stringent 
risk-based standards and leverage caps for all financial institutions, 
and tougher rules for the biggest players. In the United States, 
regulators have proposed even stronger leverage and capital 
requirements for the largest U.S. firms, and other countries are 
putting in place stricter approaches when warranted by their local 
circumstances.
    In my judgment, the local variation based on a strong minimum 
standard is healthy for the system, taking into account the different 
relative size of financial sectors and differing local economic 
circumstances. There's been progress on the quality of capital--
focusing on common equity--and on better and more comparable measures 
of the riskiness of assets, but more could be done to improve 
transparency of capital requirements across different countries and to 
make them stronger buffers against both asset implosions and liquidity 
runs. We need to continue to insist that European capital standards and 
derivatives regulations are strong--and enforced even-handedly across 
the board.
    The United States has taken a strong lead in pursuing global 
reforms, galvanizing the G-20, pushing for the creation of the global 
Financial Stability Board, and pursuing strong global reforms on 
capital, derivatives, resolution, and other matters.
    The G-20 has been driving financial reforms at a global level; the 
Financial Stability Board pursues agreement among regulators; and 
technical teams at the Basel Committee on Banking Supervision, the 
International Organization of Securities Commission, and the 
International Association of Insurance Supervisors hash out industry-
relevant reforms. While the process of reaching global agreement has at 
times been quite messy, divisive, and incomplete, the last thing we 
need is to hamstring global cooperation or U.S. regulation. These 
mechanisms should be strengthened and improved, not ignored or 
weakened.
    Strong U.S. financial rules are good for the U.S. economy, American 
households and businesses, and we also need a stronger, harder push to 
reach global agreement on core reforms. In fact, such an approach is 
essential in order to reduce the chances of another devastating global 
financial crisis that crushes the U.S. economy.
    The task of financial reform is not over. We need to keep pushing 
forward if we are to have a financial system that is safer, fairer, and 
better serves our economy.
                                 ______
                                 
           PREPARED STATEMENT OF CHRIS BRUMMER, J.D., Ph.D. *
---------------------------------------------------------------------------
    * Chris Brummer is Professor of Law at Georgetown University Law 
Center and Faculty Director of the law school's Institute of 
International Economic Law. He is also Project Director for the 
Transatlantic Finance Initiative and C. Boyden Gray Fellow at the 
Atlantic Council, as well as senior fellow at the Milken Institute's 
Center for Financial Markets.
---------------------------------------------------------------------------
           Professor of Law, Georgetown University Law Center
                              July 8, 2015
What's in it for the United States?: On the Constitutionality and 
        Legitimacy of the FSB (and International Financial Regulation)
    The fact that legislators discuss and grapple with FSB policies is 
in itself a testament to just how far ``soft law''--nonbinding, 
international accords between regulators--has come. When discussing 
policies, international policymakers routinely reference FSB principles 
and best practices, and even domestically, in the United States, 
administrative agencies from the Federal Reserve to the Securities and 
Exchange Commission grapple with and publicly acknowledge notions of 
international regulatory ``commitments'' and ``obligations.''
    That U.S. agencies take the FSB and other international standard 
setters seriously does not, however, a constitutional crisis make. By 
definition, international soft law standards do not create any formal 
obligations. They are not treaties under the Vienna Convention on the 
Law of Treaties or under Article II of the U.S.
Constitution. Instead, both the FSB's original charter and its revision 
(as well as virtually all other international standards) explicitly 
state: ``This Charter is not intended to create any legal rights or 
obligations.''\1\
---------------------------------------------------------------------------
    \1\ See Article 16, FSB Charter, http://
www.financialstabilityboard.org/wp-content/uploads/
r_090925d.pdf?page_moved=1; see also Article 23, http://
www.financialstabilityboard.org/wp-content/uploads/FSB-Charter-with-
revised-Annex-FINAL.pdf (amended).
---------------------------------------------------------------------------
    As informal organizations, the FSB, Basel Committee, IOSCO and 
other regulatory bodies instead rely on their members to participate in 
discussions, and after participating, to voluntarily implement those 
standards at home by crafting them to their local conditions. In the 
United States, this implementation is done in accordance with the 
Administrative Procedure Act and other internal agency policies, as 
well as in keeping with the mission and mandate of the specific 
regulator involved. A bilateral or multilateral memorandum of 
understanding on enforcement coordination, for example, is justified 
and operationalized on the basis of the SEC's core mission of investor 
protection (which necessarily requires cross-border cooperation in 
today's globalized financial markets); similarly, articulations on 
interest rate benchmarks speak to concerns regarding capital allocation 
in global markets (and again require cross-border cooperation). Even 
the more recent but controversial rule on asset managers speaks to core 
concerns among regulatory agencies on the impact of shadow banking on 
financial and price stability, and capital allocation.
    Furthermore, as a tool for achieving the mission of regulatory 
agencies, international standard setting bodies like the FSB enjoy both 
functionality and usefulness--and even as informal instruments can 
exhibit considerable ``compliance pull.'' Markets, for one, often take 
direction from best practices in an assumption that they provide an 
indication or roadmap of future regulatory rulemaking. Meanwhile, 
regulators recognize that in order to influence other countries, they 
can't lead from behind. Instead, they have to lead by example.
    Fortunately for the United States, its ability to impact global 
standard setting bodies is in many ways unmatched:

    The United States was a founding member of every major 
        international regulatory forum--distinguishing it from China, 
        Russia, Brazil India and even
        Germany and (depending on how one dates the founding of IOSCO) 
        the United Kingdom;

    In most agencies, consensus expectations for decisionmaking 
        give the United States a de facto veto authority on most 
        international initiatives;

    The United States hosts the world's largest and most liquid 
        capital markets giving it unparalleled capabilities to impact a 
        number of fields including securities, accounting and auditing;

    Emerging markets have been noticeably subdued on Basel 
        Committee and even FSB, leaving comparatively like-minded 
        countries of the G10 (under U.S. leadership) to dominate 
        discussions on core banking and financial stability matters;

    Although Europe technically has more countries sitting on 
        some bodies (since individual member states can participate), 
        they are often constrained by a necessity to act in unison and 
        EU-level policymaking capabilities are in many sectors still in 
        early stages; and

    The United States boasts the largest (though not best-paid) 
        workforce and thus has a home regulatory ``back office'' 
        allowing the United States to process and present data and 
        reforms with unparalleled sophistication.

    With all this in mind, however, let me be clear: the FSB (and 
indeed global standard-setting more generally) is no panacea. A number 
of issues can and do confound the process. In part because of their 
informality, mandates and missions of international standard setting 
bodies can (and at times do) overlap. This causes intermittent turf 
wars (most notably between the FSB and IOSCO--two relatively young 
standard-setting bodies seeking to establish credibility) that do not 
always speak well of international diplomacy or financial regulation.
    Furthermore, even though the FSB and other standard-setting bodies 
may be constitutional, they do not always boast the kind of popular or 
policy legitimacy some U.S. stakeholders would prefer. This lies in 
part from the turf wars described above. Dissension between 
international standard setting bodies, which can be an expression of 
honest disagreement or the political posturing of competing 
bureaucracies, by definition leads outsiders to conclude that one party 
is ``wrong,'' undermining the sense that the substantive output, 
perhaps of both agencies is of the highest quality. Furthermore, 
legitimacy can be undermined because of the complicated institutional 
arrangement supporting the rulemaking, and the at times opaque nature 
of decisionmaking. Indeed, some standard setting bodies do not always 
practice notice and comment procedures allowing for the same levels of 
nongovernmental and stakeholder participation that one expects here in 
the United States.
    In my opinion, however, these challenges, do not merit a wholesale 
unwinding the work of cross-border standard setting, or the FSB in 
particular. For one, the turf wars played out internationally also have 
domestic drivers. The SEC, for example, does not participate in G20 
meetings like the Federal Reserve and Treasury do, and is overshadowed 
by both in the FSB. Thus its best opportunity to articulate and advance 
its vision internationally is through IOSCO, which it dominates and 
where neither the Federal Reserve or Treasury have a seat. That policy 
discord can subsequently arise at the international level, given the 
varying priorities of prudential and market supervisors, should thus 
not be surprising.
    Second, jettisoning or (erroneously) maligning the international 
architecture as unconstitutional would undermine, as already spelled 
out above, an important strategic advantage the United States currently 
enjoys--the ability (to resuscitate the objectives of the TPP) to 
``write the rules of the 21st century,'' with if not an American pen, 
at least with a good dose of U.S. ink.
    Third--and this is a point opponents to international financial 
regulation often miss--the FSB, and international standard setting 
bodies more generally, do not only write rules, but they also serve as 
the basis of more streamlined cross-border financial services. To the 
extent to which, for example, the FSB is able to articulate shared 
paths on issues like capital, margin, interest rate policy, and 
reducing credit rating agency reliance, it is facilitating the 
interoperable and harmonized provision of cross-border services. 
Moreover, regulators use the logic and principles embedded in the 
standards to justify the recognition of market participants (including 
those in the United States) as equivalent. And when this is done, it is 
done via the mechanism of soft law (and often explicitly referencing 
FSB, IOSCO or Basel Committee reforms). From this standpoint, some 
intellectual consistency is required: if international standard setting 
bodies are to be applauded for establishing the conditions for more 
efficient cross-border finance, and effectively lower regulatory 
burdens, they can't be condemned as illegitimate when they raise them 
in order to safeguard markets.
    Again, I do not wish to downplay the considerable challenges of 
international regulatory policymaking. Even with the overwhelming 
influence practiced by the United States, we still have to negotiate 
with our partners, and occasionally make compromises. And compromise is 
slow, and won't always get to the best results for the United States. 
So we have to be agile and tailor our domestic practice in ways that 
speak to international commitments credibly while also achieving our 
own prudential and market objectives. Furthermore, turf wars can 
compromise the effectiveness of international financial regulation, and 
even undermine the robustness of global reforms. That said, these are 
procedural and institutional challenges--indeed, challenges that the 
United States is in an enviable position to address with the right 
political (and regulatory) will. The ideal Congressional oversight 
would elevate these concerns to the top of the regulatory agenda, and 
not promote strategically maladroit initiatives targeting our very 
tools of economic statecraft.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
```