WASHINGTON — Financial companies that are not banks but have more than $50 billion in assets and $20 billion in debt could be regulated by the Federal Reserve and required to meet tougher standards, according to a proposed rule issued Tuesday by the nation’s top financial regulatory board.
The Financial Stability Oversight Council voted unanimously to seek public comment on a proposed rule that laid out the standards by which insurance companies, hedge funds, asset managers and the like could fall under stricter regulation.
Many companies and trade groups lobbied hard for months in hopes that their companies would not fall under the purview of the law, fearing increased regulation. Treasury Department officials declined to estimate how many nonbank financial companies might meet the proposed standards. There are approximately 30 banks in the United States with more than $50 billion in assets.
Several companies are obvious candidates, and a number of them have already submitted comments to the council or had meetings with Treasury Department officials on earlier drafts of the proposed rule.
Among those companies are big insurers like the Mass Mutual Financial Group and Zurich Financial Services; hedge funds like Citadel and Paulson & Company; and asset management and mutual fund companies like BlackRock, Fidelity Investments and the Pacific Investment Management Company.
The new standards and the creation of the oversight council stem from the Dodd-Frank regulatory act, which, in response to the financial crisis, expanded the ability of financial regulators to oversee big companies that could prove to be a threat to the financial system. The council comprises the heads of the major regulatory agencies and other financial industry representatives.
Timothy F. Geithner, the Treasury secretary and chairman of the council, said the ability to designate so-called nonbank financial companies for heightened supervision was “one of the most important things that the Dodd-Frank Act did.”
“The United States in the decades before the crisis allowed a large amount of risk to build up in a wide variety of institutions outside the formal banking system,” Mr. Geithner said. “When the storm hit,” he said, “that put enormous pressure on that parallel financial system, causing a lot of tension and trauma across financial markets, amplifying the pressure on the formal banking system and adding to the broader damage to the economy as a whole.”
Several of the large financial companies that posed the biggest threats during the financial crisis — like Lehman Brothers, Bear Stearns and A.I.G. — were not supervised by a single agency charged with monitoring their financial stability.
Those companies would most likely fall under the newly proposed rules. In addition to applying only to financial companies holding at least $50 billion in assets, the rules would require companies to also meet one of several other characteristics.
These would include having $20 billion in debt, $3.5 billion in derivative liabilities, a 15-to-1 leverage ratio of total assets to total equity, short-term debt measuring 10 percent of total assets or credit-default swaps written against the company with at least $30 billion in notional value.
Companies that meet those standards will then go through another evaluation, where the council will analyze a broad range of industry-specific measures to determine whether significant financial distress at the company could pose a threat to the country’s overall financial stability.
If a company passes the first two hurdles, it would then be considered for heightened regulation and be given a chance to rebut the assertions. Finally, two-thirds of the oversight council, including its chairman, must vote to designate the company as systemically important, a finding that must be renewed annually.
Some insurance trade groups, which have lobbied aggressively against having their members subject to more stringent federal oversight, made the case again on Tuesday that they did not threaten the financial system.
“Property casualty insurers are not highly leveraged or interconnected and have a fundamentally different business model than banks, a fact that warrants different regulatory treatment,” said Ben McKay, a lobbyist for the Property Casualty Insurers Association, a group that counts giants like Ameriprise, Liberty Mutual and Geico as members.
Treasury Department officials, who briefed news reporters on the condition of anonymity after the council’s meeting, said the council would be particularly interested in comments on how to treat asset managers who invested money on behalf of others. The comment period will last 60 days.
BlackRock, for example, manages roughly $3.5 trillion for institutional and individual clients. But in a letter filed in February with regulators, it argued that, as an asset manager, it did not own those assets. They are not on its balance sheet, and the company does not employ significant leverage that magnifies the risk of its investments.
The Treasury Department officials said a decision about whether or not companies fell under its proposed rules would be made on a case-by-case basis.
The Dodd-Frank Act requires the council to assess 10 considerations when evaluating a nonbank financial company, and the proposed rule anticipates grouping those into six categories.
Three of those are meant to assess the potential impact of a company’s financial trouble on the broad economy. They are size; substitutability, or the degree to which other companies could provide the same service if a firm left the market; and interconnectedness, or linkages that might magnify a company’s financial distress and cause that distress to spread through the financial system.
The other three categories seek to measure the vulnerability of a company to financial distress: leverage, or level of borrowing; liquidity risk and maturity mismatch, or its ability to meet short-term cash needs; and existing regulatory scrutiny.