WASHINGTON — The Trump administration has implemented an apparent role reversal for the Financial Stability Oversight Council, leaving the true intended role of the post-crisis systemic risk body unclear.

The interagency body’s primary concern since its creation has been designating nonbanks as systemically risky so that those firms could face higher regulations. But the new administration has shifted it in the opposite direction, as it reportedly nears dedesignating American International Group, a firm that was once the poster child for financial contagion.

Some say the shift away from SIFI designation will allow the FSOC to focus on the Trump administration’s priority of deregulation, or focus on spotting the next crisis instead of pursuing individual firms.

Treasury Secretary Steven Mnuchin
“I intend to use FSOC as a very important tool as part of the administration’s policies to make sure that there is proper coordination across the different regulators,” Treasury Secretary Steven Mnuchin said in April. Bloomberg News

"It would be a lot more efficient and effective for FSOC to focus on global early warning signs … so that we can prevent the next global financial crisis rather than reacting to it,” said Thomas Vartanian, a partner at Dechert LLP.

Yet critics charge that the FSOC risks becoming little more than a working group, a coordinating body of regulators that meets periodically but does little.

“History has shown the complete and utter inadequacy of coordinating bodies. Turning FSOC into a book club is just asking for trouble,” said Dennis Kelleher, president of the financial watchdog Better Markets.

The FSOC, which is now chaired by Treasury Secretary Steven Mnuchin, met Sept. 22 in an executive session for the fourth time since President Trump took office in January. The topics discussed included the “ongoing annual reevaluation of its designation of a nonbank financial company” and approving the minutes of the previous meeting on July 28.

The relatively slim agenda to some extent reflects the administration's regulatory priorities. Rather than add to the list of nonbanks designated as "systemically important" started by the prior administration, the current council seems more focused on re-examining the two remaining nonbanks on that list — AIG and Prudential Financial — for possible dedesignation.

Meanwhile, officials have also signaled a role for the FSOC of coordinating the different agencies that comprise the council around the administration's efforts to unwind certain Obama-era rules.

David Portilla, a partner at Debevoise & Plimpton and former senior policy adviser to the FSOC, said the council has the flexibility to take on whatever shape the Treasury secretary — and, by extension, the administration — chooses. This administration’s emphasis is on deregulation, he said, and that’s a safe bet for what the policy agenda will be in the coming years.

“The types of issues that FSOC focuses on naturally would change in different periods of time and in different administrations,” Portilla said. “It seems, by all indications, the current administration is using FSOC to pursue its financial services regulatory agenda, and I wouldn’t expect that to change.”

Vartanian said he thinks dedesignation should be the beginning of a broader redeployment of the FSOC’s resources toward developing globally agreed-upon metrics for identifying sources of systemic risk.

“Whether [the FSOC is] properly constructed or not, it is what it is and you’ve got to deal with what it is,” Vartanian said.

The FSOC was created by the Dodd-Frank Act as a potential venue for identifying the kinds of systemic risks that the financial regulatory agencies had notably missed before 2007 and 2008 because of their siloed jurisdictional limitations.

The council is made up of the heads of each of the banking regulators, market regulators, the Consumer Financial Protection Bureau, Federal Housing Finance Agency, National Credit Union Administration and a presidentially appointed expert in insurance matters.

But even though the council was created to address systemic risks, it was vested with only limited direct authorities to respond to those risks. The council can designate a nonbank financial company as a "systemically important financial institution" — the same designation that automatically applies to banks with more than $50 billion in assets — but even in that instance, a designation only subjects the firm to heightened prudential regulations established and enforced by the Federal Reserve.

Karen Shaw Petrou, managing partner at Federal Financial Analytics, said that leaves the FSOC as a relatively toothless agency, so no matter the priorities of the administration presently in power, the council would not be equipped to fulfill the task it was created to perform.

“The only thing Congress authorized FSOC to do if they spotted systemic risk is issue a press release or, to the extent it’s relevant, ask a primary regulator to do something about it,” Petrou said. “The law intentionally neutered FSOC with respect to all but its designation and bully pulpit.”

Yet the Treasury under Mnuchin seems to have identified the value of the council’s podium. Treasury's June report on the "core principles" for financial regulation suggested that the FSOC be vested with the power to appoint a lead agency for matters with interagency jurisdiction, thus giving the council “a larger role in the coordination and direction of regulatory and supervisory policies.”

Mnuchin echoed that vision in an interview in April with the Financial Times, saying he envisioned the council primarily as a coordinating body.

“I intend to use FSOC as a very important tool as part of the administration’s policies to make sure that there is proper coordination across the different regulators,” he said.

Kelleher noted that the previous administration’s use of the FSOC to designate only a handful of nonbanks was far less strenuous than was warranted by the extensive role that nonbanks played in the financial crisis. But he said the Trump administration appears to have no interest in preventing future crises by essentially closing the door on any future designations.

“FSOC’s job, its statutory mandate … is to look for potential systemic risks. If they are in fact systemic risks, it means it’s too late,” Kelleher said.

But Vartanian said a sole focus on regulating more harshly, including the designation of more SIFIs, is not the right answer either. Whatever the ultimate direction the council takes, he said it should be judged by other metrics than however many nonbanks it designates or dedesignates.

“If constantly taking regulation to a higher level was the complete answer, we wouldn’t have [the] financial crisis and we wouldn’t have bank failures,” Vartanian said. “And guess what? We always have and probably always will.”

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