Financial Stability: Continued Actions Needed to Strengthen New Council and Research Office
Published: 2013-03-14T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act created FSOC to identify and address threats to financial stability and OFR to support FSOC and Congress by providing financial research and data. This testimony primarily discusses findings from a September 2012 GAO report and addresses four topics (1) challenges FSOC and OFR face in carrying out their missions, (2) FSOC's and OFR's efforts to establish management mechanisms, (3) FSOC's and OFR's activities for supporting collaboration among their members and external stakeholders, and (4) FSOC's rules for designating nonbank financial firms that pose threats to financial stability.
For this testimony, GAO updated some information on the entities' response to the recommendations in its September 2012 report.
section_title: What GAO Found
paragraphs: The Financial Stability Oversight Council (FSOC) and Office of Financial Research (OFR) face challenges in achieving their missions. For example, collaboration among FSOC members can be challenging, as almost all members represent independent agencies that retain existing authorities. Additionally, OFR faces the challenge of building a world-class research organization while meeting shorter-term responsibilities.
FSOC and OFR have developed some management structures to carry out their missions and taken steps to promote collaboration among their members and stakeholders. For example, FSOC established several standing committees composed of members' and member agencies' staffs to support the council in carrying out its business. FSOC also issued rules on the process for designating nonbank financial firms for additional oversight. However, GAO reported in September 2012 that these efforts could be strengthened to conform to key standards and practices and made 10 recommendations.
FSOC should develop a systematic approach to help identify potential threats to financial stability that includes collecting and sharing key financial risk indicators. FSOC's Systemic Risk Committee, which is responsible for identifying risks to financial stability, has procedures to facilitate risk analysis but does not have a systematic approach or comprehensive information. FSOC member agencies on their own may not be well positioned to judge which potential threats will benefit from interagency discussions.
FSOC should develop more systematic approaches that are forward looking and help prioritize threats to the financial system in its annual reports. To date, FSOC's annual reports have not reflected a forward-looking process for identifying emerging threats.
To improve transparency, (1) FSOC should keep detailed records of closed-door sessions and (2) both FSOC and OFR should develop a communication strategy to improve communications with the public. Currently, public information on FSOC's and OFR's decision making and activities is limited.
OFR needs to further develop its strategic planning and performance management system to include some leading practices. OFR issued a strategic framework in March 2012 that did not, among other things, link activities to strategic goals and performance measurement systems.
FSOC should identify an agency or agencies to monitor or implement each recommendation from its annual reports within specified time frames. FSOC's annual reports have not consistently identified which entities should monitor or implement the identified recommendations.
FSOC should (1) develop policies to clarify when formal collaboration or coordination should occur, (2) more fully incorporate key practices for successful collaboration, and (3) clarify with OFR responsibility for implementing requirements to monitor risks to the financial system.
FSOC should develop a comprehensive framework for assessing the impact of its designation decisions. For example, FSOC has issued rules on processes for designating nonbank financial entities for additional oversight, but it has not developed plans to comprehensively evaluate whether the designations are having their intended impact.
section_title: What GAO Recommends
paragraphs: In its September 2012 report, GAO made 10 recommendations to FSOC and OFR, which among other things, recommends ways to improve the transparency and accountability of their decisions. In response to GAO's report, Treasury said, as Chairperson, that the council and OFR had considered the recommendations. In March 2013 Treasury and OFR officials described steps that each entity was considering or taking to address some of them.

section_title: Letter
paragraphs: Thank you for the opportunity to be here today to discuss the Financial  Stability Oversight Council (FSOC) and the Office of Financial Research  (OFR). As you know, the 2007-2009 financial crisis focused attention on  weaknesses in the U.S. regulatory structure, including the lack of an  agency or mechanism responsible for monitoring and addressing risks  across the financial system and a shortage of timely information to  facilitate that oversight. In response to the crisis, Congress passed the  Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank Act) in July 2010, which provided for a broad range of regulatory  reforms. Among other things, the act established FSOC to monitor the  stability of the U.S. financial system and take actions to mitigate risks that  might destabilize the system. The Dodd-Frank Act also created OFR to  support FSOC and Congress by providing financial research and data.
Congress gave FSOC a number of significant authorities to help it  execute its broad mission, including to designate nonbank financial  companies for heightened supervision by the Board of Governors of the  Federal Reserve System (Federal Reserve) and to require financial  companies to provide data to OFR. Although Congress set up some  specific accountability mechanisms for FSOC and OFR, some members  of Congress have questioned whether more needs to be done to help  ensure that FSOC and OFR use their authorities as Congress intended.
My testimony today will address four topics: (1) the challenges FSOC and  OFR face in fulfilling their missions; (2) FSOC’s and OFR’s efforts to  establish management structures and mechanisms to carry out their  missions and attain their goals; (3) FSOC’s and OFR’s activities  supporting collaboration among members and external stakeholders,  including international bodies and regulators; and (4) FSOC’s rules for  designating nonbank financial companies that pose threats to financial  stability.
My remarks are primarily based on our September 2012 report on FSOC  and OFR. For that report, we reviewed our prior reports on financial  reform and the 2007-2009 financial crisis, statements by government  officials and academic experts, and agency documents, including  information on the entities’ budgeting, staffing, and planning. In addition,  we analyzed FSOC policies, procedures, and products to determine  whether and how their collaboration practices compared with key  elements of effective collaboration we have previously identified and to  determine processes FSOC used to issue products. We also interviewed  FSOC and OFR staff; officials from FSOC’s member agencies; and  external stakeholders, including foreign officials, industry trade groups,  and academics. In March 2013, we interviewed Treasury and OFR  officials to obtain updates on the progress FSOC and OFR had made in  implementing our recommendations. The work on which this statement is  based was conducted from November 2011 through September 2012 and  in March 2013 in accordance with generally accepted government  auditing standards. Those standards require that we plan and perform the  audit to obtain sufficient, appropriate evidence to provide a reasonable  basis for our findings and conclusions based on our audit objectives. We  believe that the evidence obtained provides a reasonable basis for our  findings and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: FSOC consists of 10 voting members and 5 nonvoting members (fig. 1).  The 10 voting members include 9 federal regulators and an independent  insurance expert. The 5 nonvoting members include state-level  representatives from bank, securities, and insurance regulators and  directors of OFR and the Federal Insurance Office. As the chairperson of  FSOC, the Secretary of the Treasury has certain powers and  responsibilities related to FSOC’s meetings, rulemakings,  recommendations, and reports and testimony to Congress. The  Secretary, in consultation with the other FSOC members, is also  responsible for regular consultation with the financial regulatory entities  and other appropriate organizations of foreign governments or  international organizations. FSOC has established seven standing  committees that are generally composed of staff of FSOC members and  member agencies to help carry out the council’s business.
The Dodd-Frank Act established OFR to serve FSOC and its member  agencies by improving the quality, transparency, and accessibility of  financial data and information; conducting and sponsoring research  related to financial stability; and promoting best practices in risk  management. The act requires OFR to set up a data center and a  research and analysis center to, among other things, perform applied and essential long-term research; develop tools for risk measurement and monitoring; and make the results of its activities available to financial regulatory  collect and provide data to FSOC and member agencies;  standardize the types and formats of data reported and collected;  agencies.
section_title: FSOC and OFR Face Challenges Achieving Their Missions
paragraphs: FSOC and OFR face several challenges as they work to carry out their  responsibilities and achieve their missions. First, FSOC’s missions—to  identify risks to U.S. financial stability and respond to emerging threats to  stability—are inherently challenging, for several reasons. Identifying risks  to financial stability is challenging because (1) key indicators, such as  market prices, often do not reflect threats to financial stability; (2) such  threats do not develop in precisely the same way in successive crises; (3)  financial innovations are not well understood; and (4) according to  experts, effectively monitoring and mitigating systemic risk is both vast  and procedurally complex. In addition, actions to preemptively mitigate  emerging threats may appear unnecessary or too costly at the time they  are proposed or taken.
Second, although the Dodd-Frank Act created FSOC to provide for a  more comprehensive view of threats to U.S. financial stability, it left most  of the fragmented and complex arrangement of independent federal and  state regulators in place and generally preserved their statutory  responsibilities. As a result, FSOC’s effectiveness in providing for a more  comprehensive view of threats to U.S. financial stability hinges to a large  extent on collaboration among its many members, almost all of whom  have their own independent regulatory responsibilities. In testifying on the  coordination of Dodd-Frank rulemakings assigned to specific FSOC  members before the U.S. House Financial Services Committee in  October 2011, the chairperson of FSOC recognized this challenge.  However, he also noted that certain agencies were working much more  closely together than before FSOC’s creation. The federal financial  regulators have also emphasized the importance of maintaining their  independence while serving as members of FSOC. For example, several  member agencies noted in our prior work on Dodd-Frank rulemakings  that any effort to coordinate rulemakings assigned to specific agencies  through FSOC would need to be balanced against the statutory  requirements of the independent agencies involved. Regulators have  also pointed to their differing statutory requirements to explain why they  have differing views on policy issues. During the Basel II deliberations  prior to the financial crisis, for instance, U.S. bank regulators—the  Federal Deposit Insurance Corporation (FDIC), Federal Reserve, and the  Office of the Comptroller of the Currency (OCC)—each had a different  view of various aspects of those requirements. The regulators traced  their differences back to their specific statutory responsibilities.
Third, OFR faces the challenge of trying to build a world-class research  organization from the ground up, including acquiring staff with the needed  skills, while meeting its short-term responsibility to support FSOC. The  researchers who supported the creation of OFR suggested that it would  take many years for the new entity to provide the insights that would  ultimately be expected of it. Though OFR now has a confirmed director,  these researchers had also noted that the long absence of a director for  the organization had slowed this process.
section_title: FSOC and OFR Could Strengthen Mechanisms to Fully Ensure Accountability and Transparency
paragraphs: FSOC and OFR have taken steps toward meeting the challenges they  face. For example, they have taken steps to build mechanisms to identify  potential threats to financial stability, provide information to the public  about their activities and progress, and establish management and  planning structures. However, additional actions could strengthen the  accountability and transparency of these efforts. As we have reported in  the past, agencies can manage or mitigate many of the challenges of  setting up new organizations by developing strong management  structures and control mechanisms.
subsections: section_title: Identifying Potential Risks and Emerging Threats to Financial Stability
paragraphs: FSOC has taken steps to meet its statutory responsibilities related to  identifying risks and potential emerging threats to U.S. financial stability  but has not yet developed comprehensive and systematic mechanisms to  realize these goals. These steps include setting up the Systemic Risk  Committee—one of the seven standing FSOC committees—that is  responsible for systemic risk monitoring and plays a key role in reviewing  sources of systemic risk. The committee is operating under draft  procedures, with member agency staff suggesting risks or threats that, in  their view, may benefit from interagency coordination.FSOC policy staff, if there is agreement that an issue warrants further  examination, an agency is assigned to develop it, including identifying  vulnerabilities in the financial system. When the committee determines  that the issue is sufficiently developed, it presents the issue to the  Deputies Committee. According to the draft procedures, if issues are  elevated beyond the Deputies Committee to FSOC members, agencies  may respond with a variety of actions, including enhanced monitoring,  additional analysis, the development of potential policy responses, or the  implementation of a particular policy response. Potential threats to  financial stability are also discussed at FSOC meetings; for example,   According to  FSOC officials noted that a teleconference was convened to discuss MF  Global’s bankruptcy.
OFR participates in the Systemic Risk Committee and is building capacity  to monitor the financial system for threats to financial stability. OFR has  developed the Financial Stability Monitor, a collection of metrics and  indicators related to financial stability that is to be continuously updated,  according to OFR and Treasury officials. According to these officials,  OFR began sharing the Financial Stability Monitor with the Systemic Risk  Committee and FSOC member agency staff in February 2012. OFR is  also assessing options for analyzing risks to financial stability and  produced a working paper in collaboration with outside researchers,  published in January 2012 to survey existing approaches. OFR and FSOC sponsored conferences in December 2011 and  December 2012 to discuss a range of issues related to risks to financial  stability. OFR staff said that they were evaluating a range of metrics and  methods for measuring and analyzing financial markets and systems and  were in the early stages of developing network maps and other tools to  assess financial stability. For example, OFR evaluated 11 measures  against a series of crises over time and reported on some of these efforts  in its 2012 Annual Report.
Dimitrios Bisias, Mark Flood, Andrew W. Lo, and Stavros Valavanis, A Survey of  Systemic Risk Analytics, Office of Financial Research Working Paper #0001 (Washington,  D.C.: Jan. 15, 2012). positioned to judge which potential threats will benefit from interagency  discussions. FSOC and OFR could improve their efforts to identify risks  and threats by collecting and sharing a common set of financial  indicators. Systematic collection, analysis, and sharing of financial  indicators of key risk factors such as leverage, liquidity, concentrations,  underwriting standards, collateral quality, and delinquencies should  provide insight into vulnerabilities affecting particular types of financial  intermediaries or reveal patterns occurring across the financial system.  OFR, through a mechanism such as the Financial Stability Monitor, could  play a role in collecting, analyzing, and reporting on these indicators. To  improve FSOC’s approaches for monitoring threats to financial stability,  we recommended that FSOC develop an approach that included  systematic sharing of key financial risk indicators across FSOC members  and member agencies to assist in identifying potential threats for further  monitoring or analysis.
In addition, FSOC does not have sufficient processes for identifying or  prioritizing potential emerging threats to U.S. financial stability for its  annual reports. FSOC’s annual reporting process is an ongoing  responsibility which, in the absence of a strategic plan, functions as its  major strategic planning document and method for communicating with  Congress and the public, especially regarding potential emerging threats  to U.S. financial stability. FSOC’s 2011 and 2012 annual reports generally  addressed the subjects mandated by the Dodd-Frank Act. These reports  also provided extensive information about the current economy and  complex issues, such as high-frequency trading and the MF Global  bankruptcy. In addition, the reports contained extensive discussions of  current known threats, such as those associated with money market  funds and the European sovereign-debt crisis, and made some  recommendations to address them. However, FSOC has not developed a  structure that supports having a systematic or comprehensive process for  identifying potential emerging threats. In particular, FSOC does not have  processes for consistently identifying such threats, separating them from  more current threats, or prioritizing them. For instance, certain potential  threats related to U.S. debt are not in the 2011 Annual Report. However,  the 2012 Annual Report identifies the U.S. debt as a potential threat but  does not explain what has changed since the 2011 report. Similarly, the  2011 or 2012 annual reports identify risks, such as those associated with  the European sovereign debt crisis or money market funds, which are  ongoing or have previously been identified as potentially emerging.  Further, FSOC identifies a large number of threats without explicitly  prioritizing them. In contrast, other entities, such as the International  Monetary Fund and European Central Bank, issue reports that explicitly  prioritize potentially significant threats. Treasury and FSOC officials and  staff noted that FSOC’s annual reports have a different purpose and  implicitly prioritize the threats in the recommendations sections of the  reports. As a result of FSOC’s limited processes for identifying and  prioritizing potential emerging threats to financial stability in its annual  reports, policymakers and market participants do not have the information  they need to develop effective and timely responses to those threats. We  recommended that FSOC develop more systematic approaches for  identifying emerging threats to financial stability that are forward-looking  and help prioritize such threats in annual reports.
section_title: Transparency
paragraphs: Although FSOC and OFR have adopted communication methods to  provide information on their activities to the public and Congress, some of  their methods could be strengthened. For example, both entities have  web pages on Treasury’s website. FSOC’s web pages include minutes of  the council’s meetings, annual reports, frequently asked questions, and  information on FSOC rulemakings. OFR has also posted key documents  on its web pages, including its annual report, strategic framework, and  updates on recent developments, such as the status of the legal entity  identifier.
However, FSOC does not keep detailed records of deliberations or  discussions that take place at the council’s meetings or at the committee  level. While no specific level of detail is required for FSOC minutes, the  limited documentation of their discussions makes it difficult to assess  FSOC’s performance. For instance, the minutes typically describe agenda  items for the meetings and information on the presenters for each agenda  item but lack additional detail even when the information being discussed  is not likely to be market sensitive or limit the quality of deliberations. As a  result, the public receives little information about FSOC’s activities and  deliberations, limiting its understanding of these activities.
FSOC policy officials recognized the need for transparency but also noted  that certain information was protected from disclosure under various  statutes and could not be released. FSOC staff also noted the need to  balance the desire for transparency with the need to provide an  environment that allows for open discussion and deliberation of issues  and policy options. However, similar bodies, such as the Federal Open  Market Committee, publish minutes that provide greater detail, and the  Federal Open Market Committee voluntarily releases transcriptions of its  meetings 5 years after a meeting occurs. As we have previously reported,  transparency is a key feature of accountability even when there is a need  to safeguard certain sensitive information to protect the marketplace. We  recommended that FSOC keep detailed records of closed door sessions  of key meetings. According to Treasury officials, the Deputies  Committee has reviewed FSOC’s existing transparency policy in light of  this recommendation and may be positioned to make a recommendation  to the Council on addressing our recommendation in the coming weeks.
In our September 2012 report, we also recommended that both entities  develop a communication strategy to improve communications with the  public, which could include more fully developing their websites.  According to Treasury and OFR officials, both entities have taken steps to  improve their websites. In November 2012, a Treasury official noted that  OFR was actively engaged in redesigning its website but had still not  posted some information that would show the progress the agency was  making in standing up its operations. While the updated website includes  a copy of OFR’s organizational chart, that chart does not include the  names of its top managers or indicate which positions are filled, as we  noted in our report. In comparison, the Consumer Finance Protection  Bureau, which was also created by the Dodd-Frank Act, has for some  time had its own domain name, an easily identifiable website that includes  a detailed organizational chart, and online services that provide regular  updates to interested parties.
section_title: Management Structures and Strategic Planning
paragraphs: FSOC’s management structures include a dedicated policy office within  Treasury’s Office of Domestic Finance and an executive director.has also implemented bylaws, a transparency policy, and a consultation  framework, and members have signed a memorandum of understanding   FSOC  (MOU) on sharing confidential information to govern FSOC activities and  promote accountability and transparency. OFR has also taken steps to  set up needed management structures. It has developed an  organizational structure that is built around a Data Center and a Research  and Analysis Center—the two programmatic units established by the  Dodd-Frank Act.
FSOC is subject to the Government Performance and Results Act of 1993  (GPRA), as amended, which requires agencies to periodically produce  strategic plans, annual performance plans, and performance updates.  FSOC has begun planning how it can satisfy these requirements but may  request an exemption from some. Treasury’s strategic plan for fiscal year  2012-2015 does not include information on FSOC’s goals or describe  how it will measure FSOC’s progress in achieving them.
OFR, which is not independently subject to GPRA, received limited  discussion in Treasury’s 2012-2015 strategic plan and has begun its own  strategic planning process. OFR issued a strategic framework in March  2012 to cover fiscal years 2012-2014 that lists five strategic goals,  including:  supporting FSOC through the secure provision of high-quality financial  data and conducting the analyses needed to monitor threats to  financial stability; developing and promoting data-related standards and best practices; establishing a center of excellence for research on financial stability  and promoting best practices for financial risk management; providing the public with key data and analyses while protecting establishing OFR as an efficient organization and world-class  workplace.
OFR’s framework also highlights a number of objectives under those  goals and lays out implementation priorities for fiscal year 2012.However, OFR acknowledges that it has not yet put other key elements of  performance management in place, including linking programmatic,  human resources, and budgetary decision making to its strategic goals  and developing a performance measurement system. To support the  growth of OFR into a viable and sustainable entity, we recommended that  OFR build on its strategic framework by further developing its strategic  planning and performance management system so that it linked its  activities to its goals and used publicly available performance measures  to measure its progress. OFR officials said that they had developed  performance measures and planned to describe these in their fiscal year  2014 budget submission.
In the absence of a strategic plan, FSOC’s annual reports serve as a key  accountability document. FSOC staff noted that its annual reports  provided Congress and the public with a description of FSOC’s activities,  its views on potential emerging threats to U.S. financial stability, and  recommendations to enhance the integrity, efficiency, competitiveness,  and stability of U.S. financial markets. They added that the chairperson  was required to testify annually before Congress on the report, an activity  that served as another accountability mechanism.
When discussing accountability, FSOC members have noted the  importance of the statement contained in the front of the reports (and  signed by each member) that FSOC is taking reasonable steps to ensure  financial stability and mitigate systemic risk. FSOC members have also  acknowledged the need to follow up on the report’s recommendations,  and FSOC staff noted that recommendations would be monitored by  FSOC as a whole. However, the annual reports do not specify how FSOC  will conduct this monitoring. For example, they do not consistently  designate an FSOC member or members to monitor or implement the  recommendations or establish time frames for certain actions, such as  reporting to the council on the status of recommendations. Treasury  officials noted that the Dodd-Frank Act did not give the chairperson or  council authority to require that independent regulators take action or  impose time frames on member agencies. However, they noted that  some recommendations in the 2012 Annual Report were made to specific  agencies and put greater stress on more immediate action than others.  For example, the 2012 report emphasized the importance of a  recommendation to the Securities and Exchange Commission (SEC) to  take action to address money market fund risks by noting that wholesale  short-term funding markets were a critical component of a well-functioning  financial system. FSOC continues to be focused on structural  vulnerabilities in money market funds that could disrupt these markets  and has proposed specific recommendations for addressing these.  However, SEC has not taken further action, and FSOC does not have the  authority to require that its proposals be implemented.
To improve FSOC’s accountability, we recommended in September 2012  that FSOC should make recommendations in the annual report more  specific by identifying which FSOC member agency or agencies, as  appropriate, were recommended to monitor or implement such actions  within specified time frames. In March 2013, Treasury officials told us that  FSOC had begun the development process for the 2013 annual report  and that our recommendations about the annual reports were provided to  the team assigned to pull together this year’s annual report for their  consideration.
section_title: FSOC and OFR Have Taken Steps to Collaborate but Could Enhance Their Efforts
paragraphs: Title I of the Dodd-Frank Act directs FSOC to facilitate information sharing  and coordination among its member agencies and other federal and state  agencies regarding domestic financial services policy development,  rulemaking, examinations, reporting requirements, and enforcement  actions. The Dodd-Frank Act encourages collaboration between FSOC  and external stakeholders, especially state regulators and international  entities. It also specifies a number of duties for OFR that require  collaboration with FSOC members and others. In particular, OFR must  collect data on behalf of FSOC, provide the data to FSOC and member   These  agencies, and standardize data collection among the agencies.activities require collaboration not only with FSOC member agencies but  also with commercial data providers, publicly available data sources, and  the financial industry.
FSOC and OFR have taken steps to enhance collaboration among FSOC  members. Members’ staffs told us that FSOC’s organizational and  committee structures helped support collaboration among FSOC  members both on a formal and informal basis. In addition, FSOC is  working to standardize data reporting systems among FSOC member  agencies. OFR officials noted that the agency had begun a three-stage  process to assemble an inventory of data collected by FSOC member  agencies as a first step toward standardizing data, reducing duplication,  and eventually lowering costs for industry and regulators.
FSOC and OFR have taken some actions to collaborate by leveraging the  expertise of external stakeholders and coordinating U.S. activities  internationally. In particular, FSOC and OFR held joint conferences in  December 2011 and 2012 to discuss a range of issues related to risks to  financial stability. OFR has also initiated a working paper series in which  OFR researchers have collaborated with outside academics to catalog  systemic risk monitoring systems and ways to improve risk management  at financial institutions. In addition, OFR created the Financial Research  Advisory Committee in November 2012 to solicit advice,  recommendations, analysis, and information from academics,  researchers, industry leaders, government officials, and experts in the  fields of data and technology. Moreover, OFR is working with industry,  foreign government entities, and international bodies to create a legal  entity identifier, which OFR describes as an emerging global standard  that will enable regulators and companies around the world to quickly and  accurately identify parties to financial transactions.
However, FSOC could do more to promote collaboration and coordination  and apply key practices for successful collaboration that we have  previously identified, such as leveraging resources, agreeing on roles and  responsibilities, and establishing mutually reinforcing or joint strategies.  For example, FSOC has not taken advantage of opportunities to leverage  resources through its authority to appoint technical and professional  advisory committees. Industry representatives have commented on the  benefits of having industry input through such committees, but to date  FSOC has not established such committees. Moreover, while FSOC  members from federal regulatory agencies are able to draw on staff from  across their agencies, the independent insurance member and state  representatives have limited support structures—a shortcoming that could  be remedied by having other state regulators participate through advisory  councils.
In addition, FSOC and OFR have not defined their roles and  responsibilities for monitoring risks to the financial system. As noted  earlier, FSOC is tasked with monitoring the financial services marketplace  to identify potential threats to U.S. financial stability, and OFR must  develop and maintain metrics and reporting systems for risks to U.S.  financial stability as well as monitor, investigate, and report on changes in  systemwide risk levels. These responsibilities overlap somewhat, but this  overlap is not unexpected given OFR’s primary mission of supporting  FSOC. The Dodd-Frank Act defines certain responsibilities for FSOC and  OFR, but the lack of clear responsibility for implementation can lead to  duplication, confusion, and gaps in their efforts. This risk is further  compounded by the fact that many FSOC member agencies have risk  analysis and data collection functions associated with their supervisory  responsibilities. Some of these functions are explicitly focused on risks to  financial stability, and some member agencies have created their own  programs to examine them. To the extent that these programs provide  unique information to FSOC, they will be contributing to the overall effort.  However, if not properly coordinated, these separate efforts could be  duplicative, resulting in wasted time and resources. We recommended  that FSOC and OFR clarify responsibility for implementing requirements  to monitor threats to financial stability across FSOC and OFR, including  among FSOC members and member agencies.
Further, although FSOC has taken action to better coordinate members’  rulemakings, additional action is needed. In October 2010 it issued an  integrated implementation road map for the Dodd-Frank Act that included  a list of the rules regulators were required to promulgate, provided a time  line for those rulemakings, and identified the agencies responsible for  each one. FSOC has also developed a consultation framework for the  agencies involved in rulemakings. In a November 2011 report, we noted  that although FSOC’s road map and consultation framework were a  positive development in facilitating coordination, they had limited   For example, the consultation framework does not provide,  usefulness.nor according to FSOC staff is it intended to provide, any specifics about  staff responsibilities or processes to facilitate coordination. It also does  not describe when interagency coordination is required or what happens  when rules conflict with or duplicate each other. We recommended that  FSOC work with federal financial regulators to (1) develop formal  coordination policies that would clarify issues such as the timing of  coordination, the process for soliciting and addressing comments, and  FSOC’s role in facilitating coordination and (2) more fully incorporate the  key practices for successful collaboration that we have previously  identified.
section_title: FSOC Has Not Yet Designated Nonbank Financial Companies for Enhanced Supervision
paragraphs: The Dodd-Frank Act gave FSOC the authority to designate financial  market utilities (FMUs) as systemically important if FSOC determines that  the failure of an FMU or a disruption in its functioning could threaten U.S.  financial stability. Similarly, the Dodd-Frank Act provided FSOC with the  authority to designate nonbank financial companies for supervision by the  Federal Reserve under its enhanced prudential standards. The act  stipulates that FSOC may designate these companies if material financial  distress at that company, or the nature, scope, size, scale, concentration,  interconnectedness, or mix of the activities of the company could pose a  threat to U.S. financial stability. While individual designations are not  made through rulemakings, in an effort to be more transparent FSOC has  issued rulemakings for designating FMUs as systematically important and  designating nonbank firms for Federal Reserve supervision. FSOC issued  final rules, which explain the processes and criteria FSOC intends to use  in making the individual designations, in July 2011 and April 2012,  respectively.
Each rule, with any accompanying interpretive guidance, outlines a  multistage process that FSOC intends to follow in designating these  entities. For example, the interpretive guidance that accompanies the rule  for designating nonbank financial companies for Federal Reserve  supervision includes a number of thresholds that a firm must meet to  move beyond the first stage of the process. Financial companies must  meet a size threshold of $50 billion in assets and one of five other  thresholds, including measures of leverage and debt. In its 2012 Annual  Report, FSOC reported that it had designated eight FMUs as systemically  important. However, FSOC is still engaged in its process for designating  nonbank financial companies, and therefore no company has yet been  designated.
FSOC is subject to laws and executive orders that require certain  regulatory analyses as part of its rulemaking processes, including the  Paperwork Reduction Act and the Regulatory Flexibility Act, as well as  Executive Orders 12866 and 13563. However, FSOC was required to  consider costs and benefits of its FMU and nonbank financial company  rules only as they related to the Paperwork Reduction Act. FSOC did not  conduct a benefit-cost analysis for the rules designating FMUs or  nonbank financial companies because the Office of Management and  Budget determined that these rules were not economically significant.  Treasury officials noted that the rule did not impose substantive  requirements on specific entities but only laid out the process by which  they could become subject to other rules and regulations. In addition,  FSOC member staff noted that the costs and benefits of the designation  were not among the factors that the Dodd-Frank Act directed FSOC to  consider when making a designation.
Nonetheless, the designations were intended to address certain risks to  financial stability posed by these entities and have the potential to confer  other benefits and costs on the wider economy as well as on the  individual entities designated. For example, some research has shown  that certain large, interconnected financial institutions considered too big  to fail may have lower borrowing costs than would otherwise be  warranted. But being designated would impose a significant regulatory  burden on the designated companies according to some of those who  commented on the nonbank financial company rule during the rulemaking  process. FSOC has some limited processes in place to review its  designations of nonbank financial companies, including an annual review  of material changes for a designated company and a review of the stage  one thresholds stated in dollar terms at least every 5 years. However, it  has not set up processes to conduct a comprehensive assessment of the  overall impact of the designations and to determine whether they are  achieving the intended result.
Doing a comprehensive analysis to assess whether designations are  having their intended impact of providing greater financial stability and the  extent of any other impacts will be challenging, but FSOC is uniquely  positioned to address that challenge. Establishing a baseline from which  to evaluate the overall impact of various rules will likely be complex  because the impact of being designated will depend on the application of  a number of rules being written by multiple independent regulatory  agencies—Commodity Futures Trading Commission (CFTC), FDIC, the  Federal Reserve, and SEC—and issued over a span of time. For  example, the Federal Reserve has not issued final rules on the enhanced  prudential standards that designated nonbank financial companies will be  subject to, but other final rules that will apply to these entities have been  issued. These rules include one on resolution plans or “living wills” that  was jointly issued by the Federal Reserve and FDIC and that will require  designated nonbank financial companies to prepare resolution plans.  Treasury has also issued a rule that establishes an assessment schedule  for the Financial Research Fund, which finances OFR and FSOC under  the Dodd-Frank Act.conduct cost-benefit analyses that might be useful in establishing a  baseline. Finally, while some regulatory agencies may conduct periodic  retrospective reviews of their rules, these reviews tend to focus only on  the rules issued by their agency.
Moreover, not all of these agencies are required to  Because FSOC is responsible for designating FMUs and nonbank  financial companies and its member agencies are responsible for writing  the rules that will impact these designated entities, it has certain  advantages in conducting a comprehensive analysis. Moreover, FSOC  can rely on OFR for some data collection and analysis. However, FSOC  members would need to collaborate on such an assessment, because  FSOC policy and OFR staff, who are Treasury employees, may not have  access to all of the needed information. In addition, collaboration is  needed because, according to Treasury officials, it would be inappropriate  for FSOC staff to review rules drafted by independent agencies unless  those agencies agreed to participate in the comprehensive  assessment. Without such an assessment, decision makers may not  have the information they will need to determine whether designating new  entities for enhanced supervision and other requirements and restrictions  is addressing a perceived gap in the regulatory system and improving the  stability of the financial system or whether policy changes should be  considered. To strengthen the accountability of FSOC’s decisions, FSOC  should establish a collaborative and comprehensive framework for  assessing the impact of decisions for designating FMUs and nonbank  financial companies on those entities and the wider economy.
section_title: Concluding Remarks
paragraphs: Over the past 2 ½ years, FSOC and OFR have made progress in  establishing their operations and approaches for monitoring threats to  financial stability. Both entities have also worked to establish  accountability and transparency mechanisms and promote collaboration  among FSOC members and with external stakeholders. However, as we  reported in September 2012, continued efforts are needed. We made 10  recommendations to FSOC and OFR to strengthen the accountability and  transparency of their decisions and activities as well as enhance  collaboration among FSOC members and with external stakeholders.
In its November 2012 response to our report and recommendations,  Treasury noted that FSOC and OFR had considered the  recommendations. In March 2013, Treasury officials described steps that  each entity was considering or taking to address some of the  recommendations, such as reviewing FSOC’s transparency policy and  updating the websites. Although fully addressing the recommendations  will likely take time, doing so will help FSOC and OFR shed more light on  their decision making and activities and allow Congress to hold them  accountable for results. Furthermore, addressing our recommendations  can help FSOC and OFR enhance collaboration among FSOC’s  members and with external stakeholders, activities that are critical to their  ability to achieve their missions. We will continue to monitor FSOC’s and  OFR’s progress in implementing our recommendations and stand ready  to assist Congress as it continues its oversight of these entities.
Chairman McHenry, Ranking Member Green, and Members of the  Subcommittee, this completes my prepared statement. I would be  pleased to respond to any questions that you may have at this time.
section_title: GAO Contact and Staff Acknowledgments
paragraphs: For questions regarding this testimony, please contact A. Nicole Clowers  at (202) 512-8678 or clowersa@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this statement. Other individuals who made key contributions to this  testimony statement include Kay Kuhlman (Assistant Director), Nancy  Barry, Emily Chalmers, Christopher Forys, Michael Hoffman, and Rachel  Siegel.
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