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U.S. to tighten rules on nonbank firms, risk assessment

Written on May 3, 2023

The Financial Stability Oversight Council (FSOC) has proposed guidance to make it easier to designate nonbank financial institutions for regulatory supervision and new procedures to better identify and respond to financial system risks. 

U.S. Treasury Secretary Janet Yellen has raised concerns about nonbank financial institutions, including hedge funds, private equity firms and pension funds, as a potential source of financial instability because of a lack of supervision. 

She said in remarks to the FSOC's meeting that the banking system remains sound but "we continue to be vigilant and monitor conditions closely." 

But the banking-sector turmoil showed that showed financial regulators' "work is not done" and supervisory and regulatory changes are needed "to help prevent financial disruptions from starting and spreading in the first place," Yellen said. 

FSOC, chaired by Yellen and including Federal Reserve Chair Jerome Powell and heads of other major financial regulators, was granted the ability to designate nonbank firms as systemically important, but this was made more difficult in 2019 with changes made under the Trump administration. 

Yellen said the new guidance removes some "inappropriate hurdles" to designating nonbank firms, causing the process to take up to six years. 

These will be replaced with a quantitative and qualitative analysis process under which the council determines whether "material financial distress at the company or the company's activities could pose a threat to U.S. financial stability," a Treasury official said. 

The new guidance drops requirements that FSOC consider the likelihood of a company's distress and conduct a cost-benefit analysis of each designation. But it allows for substantial communication and engagement with companies under review for designation. 

FSOC's proposed new risk assessment framework aims to enhance the council's ability to address financial stability risks by reviewing a broad range of asset classes, institutions and activities, according to a Treasury fact sheet. 

These include markets for debt, loans, short-term funds equities, digital assets and derivatives; counterparties, payment and clearing systems; and financial entities including banking institutions, broker dealers, asset managers, investment firms, insurers, and mortgage originators and services. 

The new framework also specifies vulnerabilities that FSOC and member regulators would consider when evaluating potential stability risks. These include leverage, liquidity risk and maturity mismatches, market interconnections and concentration, operational risks, and risk management activities.