05 July 2013

Risk.net: Prudential Financial SIFI appeal 'futile'

US insurer Prudential Financial's attempt to challenge its status as a non-bank systemically important financial institution (SIFI) will ultimately prove ineffectual, claim lawyers.

On Tuesday July 2, Prudential Financial announced it had submitted a request to the US Treasury's Financial Stability Oversight Council (FSOC) for a private hearing to appeal the proposed designation. It is the first US firm to contest a SIFI designation by the FSOC. But legal experts say the challenge is likely to be unsuccessful as the FSOC has the power under the Dodd-Frank Act to re-designate Prudential as a SIFI even if the insurer wins its initial appeal.

Don Lamson, head of the Washington, DC, regulatory practice at law firm Shearman & Sterling, says: "It could be viewed as a futile effort, both because the markets tend to view a designated SIFI as just that [regardless of whether the designation is sustained], and because, even if you do win [an appeal], the government may come back, refine its arguments after losing the first time, and argue more convincingly a second time".

The FSOC has broad discretion in both selecting the information used for assessing the systemic risk posed by an insurer and interpreting that information in making its designation. It is permitted to request non-public data directly from a firm and through the Office of Financial Research as well as utilising publicly available sources. The firm is assessed against six categories: size, interconnectedness, leverage, liquidity risk, maturity mismatch and existing regulatory scrutiny.

The appeal, says Lamson, will hinge on Prudential's ability to refute the FSOC's interpretation of the data used to designate it. It could argue the FSOC's analysis of the data was flawed, or that it ignored certain data in coming to its conclusion.

The initial proposed designation was based on a three-stage review. However, Lamson claims that only the first stage – the analysis of the firm's size – contains clear assessment criteria, and that the following two stages were largely opaque in terms of what they were testing. The second stage assesses whether the resolution of the company poses a threat to US financial stability, while the third stage tests whether the company would cause financial market instability if it became distressed; the document does not specify, however, any quantitative thresholds for these two stages.

Prudential Financial is also expected to be designated a global systemically important insurer (G-SII) by the Financial Stability Board (FSB) later this month. The insurer's challenge of its proposed SIFI designation by the FSOC raises questions about the consistency of the FSB's and FSOC's process for designating systemically risky insurance groups, say lawyers.

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