WHAT’S THE RULE? The Financial Stability Oversight Council on July 18 approved a final rule that would designate large payment-clearing and settlement companies as systemically important, which would allow regulators to impose greater oversight and capital standards upon them.
WHY IS IT IMPORTANT? The regulation will empower regulators, especially the Federal Reserve, to better monitor this industry, which ranges from firms that process credit card transactions to clearinghouses that guarantee trillions of dollars in derivatives trades. These firms aggregate risk so their failure could have an enormous effect, especially given how interconnected they are to the entire financial system – potentially resulting in a Lehman-like crisis.
WHAT DID BETTER MARKETS ARGUE? We argued the council should adopt a test for systemic risk that includes historic as well as future analysis. During the last crisis, regulators relied too heavily on backward-looking historical analysis, failing to provide a complete picture of the marketplace. Better Markets specifically proposed a standard of “extreme but plausible market conditions” that might occur. We also advocated that FSOC reject industry lobbying that would set a bright-line test to determine systemically important clearinghouses. Such a test would provide a safe harbor for some risky firms to fall under the radar.
WHAT DID THE AGENCY DO? The council wisely adopted rules that would both look back at what has happened and forward to conditions that might occur in the future using a standard of “extreme but plausible market conditions.” It also rejected the bright-line test and instead adopted a broader and more flexible measure as advocated by Better Markets. The standard will consider the crucial market relationships between the volume of business, volatility of risk exposure, and interconnectedness with other firms.