Non-bank financial companies-including mutual fund operators-should get ready to find out whether they will be designated a "systemically important financial institution," aka, SIFI, now that the Financial Stability Oversight Council released final rules on April 3, according to Federal Reserve Chairman Ben Bernanke.
"The FSOC's issuance of this rule is an important step forward in ensuring that the systemically critical nonblank financial firms will be subject to strong consolidated supervision and regulation," he said, addressing the Financial Markets Conference on April 9. "Once designated, these firms would be subject to consolidated supervision by the Federal Reserve and would be required to satisfy enhanced prudential standards established by the Federal Reserve under Title I of Dodd-Frank Wall Street Reform and Consumer Protection Act."
The decision on which firms will and will not be designated a SIFI will be determined by the criteria set forth in Section 113 of the Act. "Systemically important financial institutions" under the new rules would be supervised by the Board of Governors of the Federal Reserve, which would implement new stringent, but yet to be written, regulations.
Although the various government regulators are ready to separate the SIFIs from the less critical non-SIFIs, some of the larger mutual fund companies are questioning whether they deserve the less-than-coveted designation.
"We are still in the process of reviewing and evaluating the recently published final rule," according to a T. Rowe Price spokesperson, Bill Benintende. "However, although we understand that the Financial Stability Oversight Council is responsible for analyzing the business models of various asset managers, we believe traditional asset management businesses should not be deemed non-bank SIFIs."
According to Ari Gabinet, general counsel at OppenheimerFunds, it does not appear that most normal mutual funds would fit the definition of SIFI. "Although it is still possible that a handful of very large funds might be technically within the terms of the rules," he observed. "The mutual fund industry is heavily regulated as it is, and really was not implicated in the kind of 'interconnectedness' risk that was the hallmark of the 2008 financial crisis.''
Although it took a while, mutual funds have been able to successfully unwind most, if not all, of their derivative transactions with Lehman Brothers, the "systemically important" investment bank that failed in September 2008.
Some money market funds appeared to be vulnerable to the dislocation in the markets, but the enhancements that the SEC has made to money market fund regulation have substantially addressed any weakness in that side of the industry.
"My personal view is that the additional overlay of regulatory jurisdiction that would come with SIFI designation adds expense and complexity to mutual funds without materially improving the risk profile of the US economy," says Gabinet.
The Investment Company Institute drew attention to the vagueness of the 10 SIFI criteria [see sidebar] and the lack of a framework for how the FSOC will make its determinations as to who is a SIFI and who is not.
"The Release gives little indication as to the Council's view on the specific criteria, and simply summarizes the views of the commenters on its advance notice of proposed rule making (ANPR)," wrote ICI president and CEO Paul Stevens, in a February 2012 letter to FSOC members.
Stevens pointed out that investment advisers should not be considered SIFIs since funds are separate legal entities; that shareholder recourse for losses are with respect to the fund, absent of wrongdoing by the adviser, that advisers cannot pledge fund assets to advance their own interests, advisers do not take on leverage to manage their portfolios and that advisers must manage the fund assets as a fiduciary in accordance with the fund's own investment objectives and restrictions.
"We realize that the Council may wish to preserve sufficient flexibility to respond, as circumstances dictate, to new or emerging risks to the financial system. The need for flexibility must be balanced, however, against the needs of the financial market participants for clarity regarding the 'rules of the road,'" added Stevens.
The FSOC, nonetheless, appears ready to move ahead with adoption of some rules and interpretive guidance before a number of regulatory issues are resolved, such as how to determine if a company is "predominately engaged in financial activities," the creation of Section 165 of Dodd-Frank's "enhanced prudential standard" or the final definition of "major swap participant" and "major security-based swaps participant."
10 Signs That You Might Just be a SIFI
When the Financial Stability Oversight Council (FSOC) begins evaluating nonblank financial companies for systematically important financial institution (SIFI) status, its members will examine potential SIFI by looking at 10 different characteristics defined in the Dodd-Frank Act. Depending on how the Financial Stability Oversight Council evaluates each characteristic, your firm just might be a "systemically important financial institution," depending on:
1. The extent of the leverage of the company
2. The extent and nature of the off-balance-sheet exposure of the company
3. The extent and nature of the transactions and relations of the company with other significant nonblank financial companies and significant bank holding companies
4. The importance of the company as a source of credit for households, businesses, and State and local governments and as a source of liquidity for the United States financial system
5. The importance of the company as a source of credit for low-income, minority or underserved communities, and the impact that the failure of such a company would have on the availability of credit in such communities
6. The extent to which assets are managed rather than owned by the company, and the extent to which the ownership of assets under management is diffuse
7. The nature, scope, size, scale, concentration, interconnectedness and mix of the activities of the company
8. The degree to which the company is already regulated by one or more primary financial regulatory agencies
9. The amount and time of liabilities of the company, including the degree of reliance on short-term funding
10. Any other risk-related factors that the Council deems appropriate
Source: Sec. 113 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.