The Financial Stability Oversight Council has approved and released its 2016 annual report. Delivered each year to Congress, it addresses a range of issues, including financial market and regulatory developments, and potential emerging threats to financial stability.
“The Council’s annual report is a vital vehicle to publicly highlight potential threats to financial stability and is another example of how Wall Street reform has improved coordination among financial regulators,” Treasury Secretary Jacob Lew said in a statement. “In this year’s annual report, the Council outlines potential threats on the horizon and offers an important roadmap to help guide its focus in the coming years.”
U.S. financial regulators and market participants “made progress in addressing a number of structural vulnerabilities highlighted in the Council’s previous annual reports,” the report says. Developments included: the Federal Reserve finalizing a rule requiring that global systemically important banks increase their holdings of common equity relative to risk-weighted assets, in addition to proposed standards for mandatory long-term debt.
The Federal Reserve and Federal Deposit Insurance Corporation also completed their review of the 2015 resolution plans of eight of the largest, most complex U.S. bank holding companies and jointly determined that five of the firms had submitted plans that were not credible or would not facilitate an orderly resolution under bankruptcy. The agencies informed all eight firms of the steps they must take in response to the agencies’ findings.
Another highlight: the International Swaps and Derivatives Association expanded the scope of its Universal Resolution Stay Protocol to cover securities financing transactions. In February 2016, the Commodities Futures Trading Commission and the European Commission announced a common approach to the supervision of central counterparties operating in the U.S and the European Union. U.S. prudential regulators and the CFTC issued rules establishing minimum margin requirements for swaps that are not cleared through CCPs.
For its part, the Securities and Exchange Commission finalized reporting requirements for securities-based swaps and establishing a process for the registration of securities-based swap dealers and major securities-based swap participants. It also, since May 2015, has issued several proposed rules affecting the asset management industry, including enhancing data reporting for registered investment companies, strengthening liquidity risk management programs, and setting limits on the amount of leverage registered investment companies may obtain through derivatives transactions.
“These and other actions undertaken over the last year can be expected to make the largest, most interconnected financial institutions more resilient, improve regulators’ and firm managers’ ability to manage potential distress at such institutions, and reduce the impact of contagion that may arise from interconnections among firms and markets,” the FSOC report says. Nevertheless, it also identifies structural vulnerabilities and emerging threats in the financial system that will require action from regulators and policymakers. There are also, it says, financial stability risks that may arise from certain asset management products and activities.
FSOC’s concerns and objectives for the months ahead are divided into 12 categories.
Government agencies and the private sector should continue to work to improve and enhance information sharing, baseline protections such as security controls and network monitoring, and response and recovery planning.
Risks associated with asset management products and activities
The asset management industry’s increasing significance to financial markets and to the broader economy underscores FSOC’s ongoing consideration of potential risks to U.S. financial stability from products and activities in this sector, including further analysis of the activities of hedge funds.
Capital, liquidity, and resolution
Regulators should continue working to ensure that there is enough capital and liquidity at financial institutions to reduce systemic risk, including finalizing rules setting standards for the minimum levels of total loss-absorbing capacity and long-term debt maintained by certain large banking organizations operating in the U.S.
Member agencies should continue to evaluate whether existing rules and standards for CCPs and their clearing members are sufficiently robust to mitigate potential threats to financial stability, and should also continue working with international standard-setting bodies to implement more granular guidance with respect to international risk management standards in order to enhance the safety and soundness of CCPs.
Reforms of wholesale funding markets
T he potential for fire sales of collateral by creditors of a defaulted broker-dealer remains an important risk. Better data collection is needed to assist policymakers’ understanding of how the aggregate repo market operates. Also, regulators should continue to monitor and evaluate the effectiveness of structural reforms of money market mutual funds.
Reforms relating to reference rates
Regulators and market participants should continue their efforts to develop alternative benchmark interest rates and implementation plans to achieve a smooth transition to these new rates.
Data quality, collection, and sharing
Market participants should continue to work together to improve the scope, quality, and accessibility of financial data.
Housing finance reform
Housing finance reform legislation is needed to create a more sustainable system that enhances financial stability.
Risk management in an environment of low interest rates, asset price volatility
Depressed energy and metals commodities prices, large swings in equity valuations, and upward movement in high-yield debt spreads underscore the need for supervisors, regulators, and managers to remain vigilant in ensuring that firms and funds maintain robust risk management standards.
Changes in financial market structure
The growing importance in certain markets of propriety trading firms and automated trading systems may introduce new vulnerabilities, including operational risks associated with the very high speed and volume of trading activity. Increased coordination among regulators is needed to evaluate and address these risks.
Financial regulators will need to be vigilant in monitoring new and rapidly growing financial products and business practices, even if those products and practices are relatively nascent and may not constitute a current risk to financial stability.
Global economic developments
Market participants and regulators should be vigilant to potential foreign shocks that could disrupt financial stability in the U.S.
Voting Members of the council include: Treasury Secretary Jack Lew; Comptroller of the Currency Thomas Curry; Richard Cordray, director of the Consumer Financial Protection Bureau; SEC Chair Mary Jo White; Martin Gruenberg, chairman of the Federal Deposit Insurance Corporation; CFTC Chairman Timothy Massad; Melvin Watt, director of the Federal Housing Finance Agency; Rick Metsger, chairman of the National Credit Union Administration; and S. Roy Woodall, Jr., an independent member with insurance expertise