FSOC Hearing
Posted on by John Ebbert

Digital Assets And The Systemically Important Financial Institution – SIFI – Designation

The House Financial Services (HFS) Subcommittee on Digital Assets, Financial Technology and Inclusion gathered yesterday to consider the role of the Financial Stability Oversight Council (FSOC) in overseeing innovative technologies. Chair French Hill (R, AR) and Ranking Member Stephen Lynch (D, MA) presided.

The hearing’s title was “Regulatory Whiplash: Examining the Impact of FSOC’s Ever-Changing Designation Framework on Innovation” and reflected the skeptical view held by the Committee’s majority Republicans, and some Democrats, on the role of FSOC in regulation.

If you’re a nonbank entity in crypto offering some form of a bank’s functions, this hearing was for you.

In fact, from the prepared testimony of the witnesses, digital assets was top of mind along with AI and climate change when it comes to regulation and FSOC – which was established in 2010 by Dodd-Frank after the Great Financial Crisis. See hearing video.

Get witness testimony here:

Among the highlights of the prepared testimony, AEI’s Kupiec hinted at the main theme proffered by Republicans in the hearing: “Congress should reassert its authority and limit the FSOC’s ability to use its ‘systemic risk’ powers to advance a political agenda.” – i.e. the party of the chief executive in the White House.

Nevertheless, back in 2022, in response to President Joseph Biden’s Executive Order on Digital Assets, FSOC produced its opinion on regulation: “Report on Digital Asset Financial Stability Risks and Regulation.” Get it here. At the time, Janet Yellen addressed Congress in a statement, “This report provides a strong foundation for policymakers as we work to mitigate the financial stability risks of digital assets while realizing the potential benefits of innovation.”

opening

In his opening statement, Chair Hill called out FSOC as expected including its efforts in November to address non-bank entities which FSOC says can introduce instability. See the November release.  Hill said, “FSOC needs to tread very carefully when entertaining the idea of side-stepping Congress and Congressional intent. FSOC designations here, in my view, are not the proper approach or legislative fix.”

Also, Hill announced that Securities and Exchange Commission (SEC) Chair Gary Gensler (D) would be getting a letter (see it) from Hill, HFS Chair Patrick McHenry (R, NC), Rep. Ann Wagner (R, MO) and Rep. Bill Huizenga (R, MI) and his colleagues in regards to yesterday’s X account “hack” which erroneously announced the approval of Bitcoin spot market ETF applications. Read Hill’s statement.

Taking his turn, Ranking Member Lynch reminded the room the reasons FSOC exists and pointed to the problem of “shadow banking” introduced by non-bank entities.  FTX, Binance and “several other companies” were named as examples of instability and vulnerability for the financial system in the non-bank crypto sector. November’s new, approved FSOC framework for nonbanks was a welcome development according to Lynch.

During witness opening statements. Amias Gerety of QED Investors was in the minority as a supporter of FSOC among the witnesses.  He believed giving FSOC “designation authority”  – a risk assessment capability over nonbank entities – was the right idea.

Q&A

Chair Hill noted the creation of the digital asset market structure bill over this past summer to fill a gap that FSOC had previously noted. But the new designation capability was an over-reach according to Hill – a view re-affirmed by the U.S. Chamber of Commerce’s Hulse.

Commenting on FSOC making digital assets one of its “four priorities,” CCI’s Kim said that any clarity should come from Congress not FSOC on digital assets.

Ranking Member Lynch used his time to talk about artificial intelligence in the asset management business and asked QED’s Gerety about allowing FSOC have authority in reviewing AI technology in financial services.  Gerety admitted AI is a challenge when it comes to regulation, but he believed that AI does hold promise in helping remote and underserved communities.

Next up, Majority Whip Tom Emmer (R, MN) spoke about the immense power of the “unelected bureaucrats” of FSOC which stifles innovation. He believed Dodd-Frank created a loophole with FSOC in that it bypasses elected representatives adding that digital assets was a prime example of the unfettered “black box” in which the Financial Stability Oversight Council operates.

(After the hearing, Whip Emmer announced re-introduction of the Financial Stability Oversight Council Reform Act which “will bring the FSOC under congressional appropriations and oversight, which is designed to help increase transparency, restore accountability, and protect American innovation.” See the release.)

Referencing his FSOC Improvement Act, Rep. Bill Foster (R, IL) talked about how a nonbank – insurance underwriter AIG – during the Great Financial Crisis almost brought down the U.S. financial system. He believed oversight of nonbank entities by FSOC through systemically important financial institution (SIFI) designation authority was essential.

Rep. Warren Davidson (R, OH) said he was concerned about how FSOC was able to seize Signature Bank and cited former Rep. Barney Frank’s (D, MA) belief that it was part of the war on crypto and part of a “choke point” type of operation. AEI’s Kupiec agreed with Davidson’s themes and, when prodded by Davidson, he admitted that smaller banks, community banks “certainly have experienced a large reduction in numbers” suggesting a potential “choke points” on small banks.

Rep. Brad Sherman (D, CA) took his 5 minutes to briefly reprise his well-known anti-crypto role in Congress and chiding the digital assets industry for its changing priorities and messaging.  He then moved on to the value of SIFI designations more broadly and appeared to support FSOC’s capabilities in a brief conversation with Mr. Gerety.

Rep. Frank Lucas (R, OK) explored SIFI designations and its impact on firms operationally. Lucas appeared suspicious of FSOC power enabled by this designation authority. Digital assets was not discussed.

Referencing Signature Bank and Silicon Valley Bank closures early last year, Rep. Sean Casten (D, IL) brought up the financial instability introduced by stablecoins and whether another “run” on stablecoins could lead to bigger challenges. Mr. Gerety compared stablecoins to uninsured deposits that are trying to be responsible and its something to be worried about.  Casten wanted a “robust audited balance sheet for Tether” which referenced his Q&A at a previous House Financial Services hearing in November.

Rep. John Rose (R, TN) promoted the digital asset market structure bill for digital asset oversight instead of FSOC – i.e. the Financial Innovation and Technology for the 21st Century Act [H.R. 4763].

Rep. Al Green (D, TX) used his time to explore climate change with Mr. Gerety and where FSOC intersects. Green wants FSOC involved before the climate threat gets any bigger and, therefore, threatening the U.S. financial system.

During his Q&A time, Rep. Bryan Steil (R, WI) noted the “general aversion across most regulators in Washington” to digital assets and the importance of digital asset bills passed in House Financial Services markups this past summer. He asked Mr. Kim about international competitiveness for the U.S. given the frameworks being created offshore and whether the recent stablecoin and digital asset market structure bills would help bill an importaant gap. Mr. Kim said they would.

Rep. William Timmons (R, SC) also touted HFS’ new digital asset bills which are now eligible for a vote on the House Floor. Timmons quickly sprayed questions across the panel including one focused on whether there was coordination among FSOC members. He made the point that FSOC would “front run” Congress and stifle innovation with the pretext of preventing systemic risk. Timmons wasn’t having it.

Rep. Erin Houchin (R, IN) believed digital assets could bring important innovation to rural areas such as hers but believed the Biden Administration was forcing innovation overseas. She wanted to know about stablecoin authority for FSOC. Mr. Hulse seemed to believe that FSOC would not act with the detailed expertise required. Mr. Dinwoodie discussed the creation of SIFI standards and how long it takes to become designated “SIFI”… more or less up to 3 years. Rep. Houchin believed FSOC is overstepping its authority and lacks expertise as it relates to digital assets.

Rep. Mike Flood (R, NE) was the last Member to go in the Q&A portion of the hearing. He noted FSOC has shifted its tone in its latest comments suggesting a heightened awareness by FSOC of risks with digital assets.  Going around Congress seemed to be FSOC’s purpose as it related to digital assets and innovation according to Flood. Like others, he promoted the recent digital asset bills. And then he moved on to AI and where it intersects with FSOC’s mandate. Flood believed AI presented risks, but undiluted power to any regulator was unacceptable – that was Congress’ domain.

With that, Chair Hill adjourned the meeting.