Frameworks come, frameworks go — and frameworks are fluid.
To that end, in a hearing scheduled for Wednesday afternoon (Jan. 10) before the Subcommittee on Digital Assets, Financial Technology and Inclusion, panelists will weigh in on the ways emerging technologies and digital startups — nonbanks among them — should be regulated and gauged for risk.
The tone is implied by the title of the hearing itself: “Regulatory Whiplash: Examining the Impact of FSOC’s Ever-Changing Designation Framework on Innovation.”
The FSOC is the Financial Stability Oversight Council, established through the Dodd-Frank Act of 2010 as part of the Treasury Department and charged with identifying risks to the U.S. financial system.
In developing priorities for risk assessment, the FSOC has been focusing on nonbank financial institutions and cryptocurrency assets, the latter of which, per the FSOC’s own language, “could pose risks to the stability of the U.S. financial system if their interconnections with the traditional financial system or their overall scale were to grow without adherence to or the development of appropriate regulation, including enforcement of the existing regulatory structure.”
The FSOC announced in November that it approved a new analytic framework, as well as rules that require nonbanking financial institutions, such as mortgage brokers, motor vehicle dealers and payday lenders, to report data security breaches that impact the information of 500 people or greater. The Safeguards Rule already requires nonbanking financial institutions to protect customer information.
The witness list for the Wednesday hearing includes lawyers, members of business organizations and FinTech investors. The testimony offered before the hearing gives a glimpse into their key concerns and positions.
Among the panelists is Jeffrey T. Dinwoodie, partner at Cravath, Swaine and Moore.
He said in written testimony that in identifying systemically important financial institutions (SIFIs), the “FSOC’s approach to and use of its nonbank SIFI designation authority has, as noted, been controversial over the years — and has evolved.”
He also noted that the November changes had the impact of “liberalizing the key designation threshold of ‘threat to the financial stability of the United States’ by introducing a more speculative standard: events or conditions that could substantially impair the ability of the financial system to support economic activity.”
Under the 2023 guidance, “it is significantly easier” for the FSOC to designate companies as nonbank SIFIs, he said. Those designations could “change the competitive landscape and could create distortions in the market and/or broader economy.”
Amias Gerety, partner at QED Investors, said in his written testimony: “Moreover, designation is not supposed to act as an early warning sign of a company’s financial weakness or potential distress.”
He said public “confidence can be fickle, especially in periods of market disruption. If the council’s action, based on a thorough review of nonpublic information, were seen as a prediction of a nonbank company’s failure, it could easily precipitate the very risk the council has a mandate to prevent.”
Separately, in his testimony before the subcommittee, Paul H. Kupiec, senior fellow at the American Enterprise Institute, said that “policy uncertainty created by the politicization of the FSOC discourages private sector investment and financial services innovation.”
In addition, with the collapse of FTX as a key example — where FTX had not been identified as a systemic risk — “the FSOC and its bank regulatory agency members failed to identify and proactively take steps to mitigate the risk caused by maturity mismatches, and massive unrealized interest rate losses in several banks which lead to depositor runs and bank failures,” Kupiec said.
Government and state actors, not just the private sector, should be analyzed for risks as well, he added.
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