Regulators to expand definition of 'systemically important' financial institutions beyond banks and insurers

Out-Law News | 10 Jan 2014 | 9:52 am | 2 min. read

Investment funds with more than $100 billion worth of assets under management could be subject to stricter regulation by virtue of being 'too big to fail' under plans put forward by the Financial Stability Board (FSB) and International Organisation of Securities Commissions (IOSCO).

The global regulators are consulting on expanding their definition of 'systemically important financial institutions' (SIFIs) beyond banks and insurers. The consultation deals with the criteria that the FSB will use to identify such institutions rather than how these will be regulated; however it has previously said that 'systemically important' banks and insurers could be subject to stricter capital and more detailed reporting requirements.

FSB chairman Mark Carney, who also chairs the Bank of England, said that the proposals were "an essential first step towards addressing the risks to global financial stability and economic stability posed by the disorderly failure of financial institutions other than banks and insurers".

"They are integral to solving the problem of financial institutions that are too big to fail," he said.

The consultation closes on 7 April.

SIFIs are broadly defined as those institutions that could cause "significant disruption" to the wider financial system and economic activity if they were to fail or fall into difficulties. This could be because of their size, complexity or the way in which they connect to other institutions within the wider financial system. In the non-bank, non-insurer (NBNI) context, this can apply to a wider range of entities with very different legal forms, business models and risk profiles.

In its consultation paper, the FSB said that its methodology for identifying SIFIs had to "allow sufficient flexibility to capture different risks". However, it proposes a "materiality threshold" to provide an "initial filter" to limit the pool of firms that would be assessed. Smaller firms could be added to the assessment pool by national supervisors if they are considered potentially globally systemic, as is already the case with banks and insurers.

Initial thresholds have been set by the FSB in conjunction with IOSCO, the global securities regulator. The thresholds set out for consultation are $100bn in 'balance sheet total assets' for finance companies, market intermediaries and broker-dealers; $100bn in net assets under management for investment funds; and $100bn in 'balance sheet total assets' for other NBNI entities. The paper also proposes an alternative threshold of between $400-600bn in gross notional exposure for hedge funds.

In addition to the size thresholds, the FSB's framework also considers firms' complexity, whether the services that they provide can be easily substituted in the event of failure, and their interconnectedness with the rest of the financial market. The FSB identifies three main "channels" through which an entity could affect other firms: through exposure to creditors, investors and counterparties; through the liquidation of an asset which could disrupt trading or funding in key markets; and where there is no substitute for a critical function that a firm performs.

The FSB said that its indicators were "broadly similar" to the ones used to identify globally systemic banks and insurers. However, the FSB noted that it was more difficult to obtain "appropriate and consistent data/information" about NBNI entities because of the way in which they have traditionally been regulated. Because of this, it said that "supervisory judgement likely need to play a bigger role" in classification of an NBNI as an SIFI than it does in relation to banks or insurers.

Financial services regulation expert Monica Gogna of Pinsent Masons, the law firm behind Out-Law.com, said that the consultation was part of an increasing drive towards tighter regulation of fund managers as regulators were keen to ensure that the global financial system was genuinely safe.