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FSOC seeks feedback on risk framework, nonbank determinations
On April 21, the Financial Stability Oversight Council (FSOC) released a proposed analytic framework for financial stability risks, “intended to provide greater transparency to the public about how [FSOC] identifies, assesses, and addresses potential risks to financial stability, regardless of whether the risk stems from activities or firms.” FSOC explained in a fact sheet that the proposed framework would not impose any obligations on any entity, but is instead designed to provide guidance on how FSOC expects to perform certain duties. This includes: (i) identifying potential risks covering a broad range of asset classes, institutions, and activities, including new and evolving financial products and practices as well as developments affecting financial resiliency such as cybersecurity and climate-related financial risks; (ii) assessing certain vulnerabilities that most commonly contribute to financial stability risk and considering how adverse effects stemming from these risks could be transmitted to financial markets/market participants, including what impact this can have on the financial system; and (iii) responding to potential risks to U.S. financial stability, which may involve interagency coordination and information sharing, recommendations to financial regulators or Congress, nonbank financial company determinations, and designations relating to financial market utility/payment, clearing, and settlement activities that are, or are likely to become, systemically important.
The same day, FSOC also released for public comment proposed interpretive guidance relating to procedures for designating systemically important nonbank financial companies for Federal Reserve supervision and enhanced prudential standards. (See also FSOC fact sheet here.) The guidance would revise and update previous guidance from 2019, and “is intended to enhance [FSOC’s] ability to address risks to financial stability, provide transparency to the public, and ensure a rigorous and clear designation process.” FSOC explained that the proposed guidance would include a two-stage evaluation and analysis process for making a designation, during which time companies under review would engage in significant communication with FSOC and be provided an opportunity to request a hearing, among other things. Designated companies will be subject to annual reevaluations and may have their designations rescinded should FSOC determine that the company no longer meets the statutory standards for designation.
Comments on both proposals are due 60 days after publication in the Federal Register.
Both CFPB Director Rohit Chopra and OCC acting Comptroller Michael J. Hsu issued statements supporting the issuance of the proposed interpretive guidance. Chopra commented that, if finalized, the proposed guidance “will create a clear path for the FSOC to identify and designate systemically important nonbank financial institutions” and “will accelerate efforts to identify potential shadow banks to be candidates for designation.” Hsu also noted that sharing additional details to improve the balance and transparency of FSOC’s work “would both make it easier for [FSOC] to explain its analysis of potential risks and create an opportunity for richer public input on the analysis.”
FSOC annual report highlights digital asset, cybersecurity, and climate risks
On December 16, the Financial Stability Oversight Council (FSOC or the Council) released its 2022 annual report. The report reviewed financial market developments, identified emerging risks, and offered recommendations to mitigate threats and enhance financial stability. The report noted that “amid heightened geopolitical and economic shocks and inflation, risks to the U.S. economy and financial stability have increased even as the financial system has exhibited resilience.” The report also noted that significant unaddressed vulnerabilities could potentially disrupt institutions’ ability to provide critical financial services, including payment clearings, liquidity provisions, and credit availability to support economic activity. FSOC identified 14 specific financial vulnerabilities and described mitigation measures. Highlights include:
- Nonbank financial intermediation. FSOC expressed support for initiatives taken by the SEC and other agencies to address investment fund risks. The Council encouraged banking agencies to continue monitoring banks’ exposure to nonbank financial institutions, including reviewing how banks manage their exposure to leverage in the nonbank financial sector.
- Digital assets. FSOC emphasized the importance of enforcing existing rules and regulations applicable to the crypto-asset ecosystem, but commented that there are gaps in the regulation of digital asset activities. The Council recommended that legislation be enacted to grant rulemaking authority to the federal banking agencies over crypto-assets that are not securities. The Council said that regulatory arbitrage needs to be addressed as crypto-asset entities offering services similar to those offered by traditional financial institutions do not have to comply with a consistent or comprehensive regulatory framework. FSOC further recommended that “Council members continue to build capacities related to data and the analysis, monitoring, supervision, and regulation of digital asset activities.”
- Climate-related financial risks. FSOC recommended that state and federal agencies should continue to work to advance appropriately tailored supervisory expectations for regulated entities’ climate-related financial risk management practices. The Council encouraged federal banking agencies “to continue to promote consistent, comparable, and decision-useful disclosures that allow investors and financial institutions to consider climate-related financial risks in their investment and lending decisions.”
- Treasury market resilience. FSOC recommended that member agencies review Treasury’s market structure and liquidity challenges, and continue to consider policies “for improving data quality and availability, bolstering the resilience of market intermediation, evaluating expanded central clearing, and enhancing trading venue transparency and oversight.”
- Cybersecurity. FSOC stated it supports partnerships between state and federal agencies and private firms to assess cyber vulnerabilities and improve cyber resilience. Acknowledging the significant strides made by member agencies this year to improve data collection for managing cyber risk, the Council encouraged agencies to continue gathering any additional information needed to monitor and assess cyber-related financial stability risks.
- LIBOR transition. FSOC recommended that firms should “take advantage of any existing contractual terms or opportunities for renegotiation to transition their remaining legacy LIBOR contracts before the publication of USD LIBOR ends.” The Council emphasized that derivatives and capital markets should continue transitioning to the Secured Overnight financing Rate.
CFPB Director Rohit Chopra issued a statement following the report’s release, flagging risks posed by the financial sector’s growing reliance on big tech cloud service providers. “Financial institutions are looking to move more data and core services to the cloud in coming years,” Chopra said. “The operational resilience of these large technology companies could soon have financial stability implications. A material disruption could one day freeze parts of the payments infrastructure or grind other critical services to a halt.” Chopra also commented that FSOC should determine next year whether to grant the agency regulatory authority over stablecoin activities under Dodd-Frank. He noted that “[t]hrough the stablecoin inquiry, it has become clear that nonbank peer-to-peer payments firms serving millions of American consumers could pose similar financial stability risks” as these “funds may not be protected by deposit insurance and the failure of such a firm could lead to millions of American consumers becoming unsecured creditors of the bankruptcy estate, similar to the experience with [a now recently collapsed crypto exchange].”
NYDFS's Harris to serve as the state banking representative on the FSOC
On December 13, the Conference of State Bank Supervisors (CSBS) announced that NYDFS Superintendent Adrienne A. Harris will serve as the state banking representative on the Financial Stability Oversight Council (FSOC). According to the announcement, in 2013, Superintendent Harris joined the Obama Administration as a Senior Advisor in the U.S. Department of Treasury prior to being appointed as the Special Assistant to the President for Economic Policy. In this role, she managed the financial services portfolio, focusing on the implementation of Dodd-Frank, and developed strategies for financial reform, consumer protections, cybersecurity and housing finance reform. According to James M. Cooper, president and CEO of CSBS, Harris’s “background and experience at both the federal and state level will be an asset for the council as it manages emerging risk during a time of economic uncertainty.”
Chopra discusses SIFI risks
On November 9, CFPB Director and FDIC Board Member Rohit Chopra delivered remarks before the FDIC Systemic Resolution Advisory Committee to discuss challenges facing systemically important financial institutions. Chopra began by raising concerns related to domestic systemically important banks (DSIBs) and the potentially disruptive impact facing consumers and small businesses should one of these bank fail. Chopra explained that, because DSIBs are heavily involved in retail banking with large consumer businesses and carry relatively high levels of uninsured deposits, “DSIB resolutions could pose serious technical challenges for the FDIC” that would necessitate serious consideration. Chopra also pointed out concerns raised by many experts that a large number of nonbank systemically important financial institutions (which have not yet been formally designated by the Financial Stability Oversight Council) pose systemic risk to the financial system. “Absent a designation, these institutions are not required to file a resolution plan,” Chopra said, noting that “[r]esolving these institutions without a plan would be an enormous challenge.” He also emphasized the importance of finding ways to eliminate bailout risks for global systemically important banks.
FSOC reports on cryptocurrency systemic risks
On October 3, the Financial Stability Oversight Council (FSOC) released its Report on Digital Asset Financial Stability Risks and Regulation. As called for by Executive Order 14067, “Ensuring Responsible Development of Digital Assets” (covered by InfoBytes here), the report reviewed financial stability risks and regulatory gaps posed by various types of digital assets and provided recommendations to address such risks. Among other things, the report noted three gaps in the existing cryptocurrency regulatory framework: (i) limited direct federal oversight of the spot market for crypto-assets that are not securities; (ii) opportunities for regulatory arbitrage; and (iii) whether vertically integrated market structures can or should be accommodated under existing laws and regulations. The report stated that FSOC recommended that Congress pass legislation that would create “a comprehensive prudential framework for stablecoin issuers that also addresses the associated market integrity, investor and consumer protection and payments system risks, including for entities that perform services critical to the functioning of the stablecoin arrangement.” FSOC further recommended that the member agencies should follow several guiding principles, including “same activity, same risk, same regulatory outcome,” and “technology neutrality.” The report also requested that agencies consider whether “vertical integration” or other business models where retail customers can directly access markets instead of going through a broker-dealer “can or should be accommodated.” The report noted that if banks “scale up their participation in the crypto-asset ecosystem, such activity could potentially entail much greater access to the crypto-asset market by a broad range of institutional investors, corporations, and retail customers than currently exists.” The U.S. Treasury Department released a Fact Sheet summarizing the report’s key findings and recommendations.
Treasury Secretary Janet Yellen noted in a statement that the “report adds to analysis of digital asset issues that have been covered in other recent reports, including on the future of money and payments; consumers and investor protection; illicit finance; and a framework for international engagement.” Acting Comptroller of the Currency Michael J. Hsu released a statement supporting the report, emphasizing that “it is critical for the Council and Congress to prioritize Recommendation 4 regarding interagency coordination, Recommendation 5 regarding a federal prudential framework for stablecoin issuers, and Recommendation 6 regarding regulatory visibility and authorities over all of the activities of crypto-asset entities.” SEC Chair Gary Gensler also expressed his support in a statement, noting that he looks “forward to working with Congress to achieve our public policy goals, consistent with maintaining the regulation of crypto security tokens and related intermediaries at the SEC.” Texas Banking Commissioner and FSOC state banking representative Charles G. Cooper released a statement of support through the Conference of State Bank Supervisors saying that the report should “inform the work that we do as individual agencies and on an interagency basis to balance responsible innovation with safeguarding our financial markets and consumers.”CFPB Director Rohit Chopra released a statement, noting that “agencies have already taken steps to address discrete issues related to deposit insurance misrepresentation and to lay groundwork to address concerns related to fraud, hacks, and scams,” and emphasized the need “to tackle broader risks to the financial system.”
Treasury says financial system is critical in addressing climate change
On September 9, the U.S. Treasury Department’s Under Secretary for Domestic Finance Nellie Liang spoke at the Office of Financial Research’s Climate Implications for Financial Stability Conference discussing the Department’s efforts to assess climate-related risks to the economy, financial institutions, and investors. Pointing to several studies showing the increasing economic and financial costs of climate change, Liang noted that the financial system has a “critical role to play” in addressing climate-related financial risks and that regulators and standard setters have a “responsibility to make the financial system more resilient to climate change.” In particular, Liang identified a Financial Stability Oversight Council (FSOC) report that contained numerous recommendations for its members to consider to address climate change-related threats to financial stability. She also discussed interagency working groups created by FSOC to “bring together the agencies and leverage their efforts to improve data quality and availability, data infrastructure, climate risk metrics, and scenario analysis.” According to Liang, ongoing research—such as that presented at the event regarding how a bank’s climate commitments, the tax code, or borrowers’ scope disclosures “affect the cost and availability of credit, and the sensitivity of market-based measures of financial firms’ stress to climate risks”—is “important for regulators and policymakers to better understand private behavior and how incentives can help to manage climate-related financial risks.”
Senate Banking Committee sends letter to Yellen on consumer data activities
On June 7, Chairman of the Senate Committee on Banking, Housing, and Urban Affairs, Senator Sherrod Brown sent a letter to Treasury Secretary Janet Yellen requesting that the Financial Stability Oversight Council conduct a review on the effect of the collection and sale of consumer data by financial institutions to determine whether such activities pose a systemic threat to U.S. financial stability and security. The letter raised concerns that such data could be used for nefarious purposes including "glean[ing] consumers’ tolerance for price hikes, or using certain people’s spending patterns to target them for blackmail or ransomware.”
Biden calls for coordinated approach to digital asset innovation
On March 9, President Biden issued an Executive Order (E.O.) on digital assets outlining the first “whole-of-government” strategy to coordinate a comprehensive approach for ensuring responsible innovation in digital assets policy. (See also White House fact sheet here.) The White House highlighted that “non-state issued digital assets reached a combined market capitalization of $3 trillion” last November (up from $14 billion five years ago) and noted that many countries are currently exploring, or in certain cases introducing, central bank digital currencies (CBDC). The Executive Order on Ensuring Responsible Development of Digital Assets stressed that “we must take strong steps to reduce the risks that digital assets could pose to consumers, investors, and business protections,” and mitigate “illicit finance and national security risks posed by misuse of digital assets,” including money laundering, cybercrime and ransomware, terrorism and proliferation financing, and sanctions evasion. The E.O. cautioned that future digital assets systems must also promote high standards for transparency, privacy, and security.
The E.O. outlined several principal policy objectives, including that:
- Federal agencies are directed to coordinate policy recommendations to address the growth in the digital asset sector.
- Federal agencies are directed to explore the need for a potential U.S. CBDC. Treasury, along with heads of other relevant agencies, are ordered to submit “a report on the future of money and payment systems, including the conditions that drive broad adoption of digital assets; the extent to which technological innovation may influence these outcomes; and the implications for the United States financial system, the modernization of and changes to payment systems, economic growth, financial inclusion, and national security.” The Federal Reserve Board is also encouraged to continue researching, developing, and assessing efforts for a CBDC, including developing a broad government action plan for a potential launch. The E.O. also directed an assessment of whether legislative changes would be necessary in order to issue a CBDC.
- The Secretary of the Treasury will work with relevant agencies to produce a report on the future of money and payment systems, which will include implications for economic growth, financial growth and inclusion, national security, and the extent to which technological innovation may influence these areas. The approach to digital asset innovation must also address the risk of disparate impact, the E.O. stressed, adding that any approach should ensure equitable access to safe and affordable financial services.
- The Attorney General, FTC, and CFPB are “encouraged to consider what, if any, effects the growth of digital assets could have on competition policy.” The agencies are also “encouraged to consider the extent to which privacy or consumer protection measures within their respective jurisdictions may be used to protect users of digital assets and whether additional measures may be needed.” Additional federal agencies are also encouraged to consider the need for investor and market protections.
- The Financial Stability Oversight Council and Treasury are directed to identify and mitigate systemic financial risks posed by digital assets and develop policy recommendations to fill any regulatory gaps.
- Federal agencies are directed to work with allies and partners to ensure international frameworks, capabilities, and partnerships are aligned and responsive to risks posed by the illicit use of digital assets. Agencies should also explore “the extent to which technological innovation may impact such activities,” and explore “opportunities to mitigate these risks through regulation, supervision, public‑private engagement, oversight, and law enforcement.”
- Federal agencies are directed to establish a framework for interagency international engagement with foreign counterparts to adopt global principles and standards for how digital assets are used and transacted, and to promote digital asset and CBDC technology development.
CFPB Director Rohit Chopra and Treasury Secretary Janet Yellen issued statements following Biden’s announcement. “Today’s Executive Order recognizes that the dramatic growth in digital asset markets has created profound implications for financial stability, consumer protection, national security, and energy demand,” Chopra said. “The [CFPB] is committed to working to promote competition and innovation, while also reducing the risks that digital assets could pose to our safety and security. We must make sure Americans in all financial markets are protected against errors, theft, or fraud.” Yellen stated that in addition to partnering with interagency colleagues to produce a report on the future of money and payment systems, Treasury will also work with international partners to promote robust cross-border standards and a level playing field. “As we take on this important work, we’ll be guided by consumer and investor protection groups, market participants, and other leading experts. Treasury will work to promote a fairer, more inclusive, and more efficient financial system, while building on our ongoing work to counter illicit finance, and prevent risks to financial stability and national security,” she said.
Treasury also recently announced that the Financial Literacy and Education Commission (led by Yellen and Chopra and comprised of the heads of 21 federal agencies and entities, including the OCC, Fed, FDIC, SEC, FTC, and HUD, among others) is forming a new subgroup on digital asset financial education to analyze the impact of digital assets on consumer and investor protections. “History has shown that, without adequate safeguards, forms of private money have the potential to pose risks to consumers and the financial system,” U.S. Under Secretary of the Treasury for Domestic Finance Nellie Liang said.
FSOC reports on NBFIs
On February 4, the Financial Stability Oversight Council (FSOC) released a statement regarding nonbank financial intermediation. According to the statement, FSOC received updates on progress over the past year regarding three types of nonbank financial institutions (NBFIs), which include hedge funds, open-end funds, and money market funds (MMF). The statement noted that FSOC reestablished its Hedge Fund Working Group in 2021, with the primary objective of providing updates to FSOC’s “assessment of potential risks to U.S. financial stability from hedge funds, their activities, and their interconnections with other market participants.” FSOC “supports the Hedge Fund Working Group’s recommendation that the Office of Financial Research (OFR) consider ways to obtain better data on the uncleared bilateral repurchase agreement market, an important source of leverage for hedge funds.” In 2021, FSOC also established an interagency staff-level Open-end Fund Working Group, which assessed potential risks to U.S. financial stability arising from open-end funds. FSOC noted that it “supports the Open-end Fund Working Group’s continued analysis of the potential risks to financial stability that may arise from liquidity transformation at open-end funds.” In respect to MMF, FSOC noted that it supports the SEC’s efforts to reform MMFs and strengthen short-term funding markets.
Biden Administration releases stablecoin recommendations
On November 1, the U.S. Treasury Department announced that the President’s Working Group on Financial Markets (PWG), with the FDIC and the OCC (collectively, “agencies”), released a report on stablecoins, which are a kind of digital asset intended to maintain a stable value relative to the U.S. dollar. The report noted that stablecoins may be more widely used in the future as a means of payment, which Secretary of the Treasury Janet L. Yellen said could increase “risks to users and the broader system.” Additionally, Secretary Yellen considers current stablecoin oversight to be “inconsistent and fragmented.” Among other things, the report discussed gaps in regulatory authority to reduce these risks. The report recommended that Congress promptly enact legislation to address the risks of payment stablecoins and ensure that payment stablecoins and payment stablecoin arrangements are subject to consistent and comprehensive federal oversight and to “increase transparency into key aspects of stablecoin arrangements and to ensure that stablecoins function in both normal times and in stressed market conditions.” According to the announcement, “[s]uch legislation would complement existing authorities with respect to market integrity, investor protection, and illicit finance, and would address key concerns,” including: (i) risks to stablecoin users and stablecoin runs; (ii) payment system risk; and (iii) systemic risk and concentration of economic power.
While Congress examines legislation on stablecoin, the report recommended that the Financial Stability Oversight Council consider steps for addressing risks, such as “the designation of certain activities conducted within stablecoin arrangements as, or as likely to become, systemically important payment, clearing, and settlement (PCS) activities,” which would be subject to an examination and enforcement framework. The report also recommended that stablecoin issuers “comply with activities restrictions that limit affiliation with commercial entities,” to maintain the separation of banking and commerce. Additionally, the report discussed that, in addition to existing AML/CFT regulations, stablecoin arrangements and activities may implicate the jurisdiction of the SEC and/or CFTC. Therefore, to prevent misuse of stablecoins and other digital assets, the announcement noted that Treasury “will continue leading efforts at the Financial Action Task Force (FATF) to encourage countries to implement international AML/CFT standards and pursue more resources to support supervision of domestic AML/CFT regulations.”
The same day, Treasury released a fact sheet on the PWG report, which clarified, among other things, the purpose of the report, risks posed by stablecoins, and the agencies’ recommendations. In a statement released by OCC acting Comptroller of the Currency Michael J. Hsu, he emphasized his support for the recommendations highlighted in the report pointing out that, “[s]tablecoins need federal prudential supervision to grow and evolve safely.” In a statement released by CFPB Director Rohit Chopra, he noted that though the CFPB was not a member of the PWG, the Bureau “will be taking several steps related to this market,” such as the CFPB’s orders to six large U.S. technology companies seeking information and data on their payment system business practices (covered by InfoBytes here), among other things.