Vanguard Speaks Out Against New Approach to Financial Risk

What You Need to Know

FSOC wants a way to step in quickly when nonbanks seem likely to crash the economy.
Better Markets says the sudden collapse of Silicon Valley Banks shows why FSOC needs the ability.
A bipartisan group of SEC and CFTC commissioners suggests that an entities-based approach could increase bailout pressure.

The Vanguard Group is warning the Financial Stability Oversight Council that applying the same, one-size-fits-all risk management rules to all types of financial services companies could backfire, by increasing the odds that different types of companies will crash at the same time.

Vanguard talks about the dangers of promoting regulatory “groupthink” in a letter it sent to FSOC last week, in a response to FSOC efforts to regain the ability to take over specific potentially risky nonbank financial services companies quickly.

Vanguard says FSOC seems to be moving toward replacing the different sets of solvency rules  that regulators have developed for insurers, housing finance providers and other nonbank financial firms with one set of rules based on the Federal Reserve regulations for banks

That could “lead to increased correlation of risk management practices,” Vanguard says. “Relying on a single, even if Federal Reserve-approved, risk management approach may increase the likelihood of herding behavior. This is a suboptimal way to mitigate macroprudential risk.”

What It Means

Vanguard and its competitors have helped you convince your clients that diversification is a good approach to retirement planning.

Now, they’re trying to sell FSOC on the idea that diversification might also help with financial system risk management.

The Background

Congress put the statutory language creating FSOC in the Dodd-Frank Act, in an effort to keep the kind of complicated, previously obscure financial system problems that nearly crashed the world financial system in 2008 from cropping up in the future.

The U.S. Treasury secretary, Janet Yellen, is the chair of FSOC.

FSOC also includes heads of agencies such as the Federal Reserve Board and the U.S. Securities and Exchange Commission, a voting member with insurance expertise, the head of the Treasury Department’s Federal Insurance Office, and a representative from the National Association of Insurance Commissioners.

Federal bank regulators already had the goal to swoop in and manage risk when a bank seemed to be likely to failure. One of FSOC’s goals was to find a way to identify nonbanks as “systemically important financial institutions” (or SIFIs) and to give the Federal Reserve Board the ability to apply some of the same discipline they applied to banks to nonbank SIFIs.

FSOC began by taking an aggressive approach to identifying SIFIs. The SIFIs quickly escaped SIFI designations by taking steps such as restructuring their operations or going to court.

In 2019, FSOC agreed to back away from aggressive SIFI designation efforts; defer to nonbanks’ primary regulators, when possible; and to emphasize the regulation of potentially risky activities rather than oversight over specific companies.

Originally, FSOC was going to set a June 27 deadline for comments. It then responded to commenters’ requests for more time by pushing the deadline back to July 28.