In November, FSOC finalized guidance that changes the process for designating nonbanks — including digital asset companies, asset managers and other types of financial institutions — as systemically important financial institutions, or SIFIs, therefore placing them under Federal Reserve supervision. The council finalized the guidance in tandem with a new framework for identifying, evaluating and addressing risks to financial stability, following its proposal in April.
Committee Chairman Sherrod Brown, D-Ohio, asked Yellen why FSOC's designation authorities are important.
Pointing to the financial crisis of 2008, Yellen responded, "There are nonbanks that … their failure can pose tremendous spillovers and risks to the entire financial system, and when the council identifies such a firm, designation may be the appropriate way to handle that."
The new guidance replaces 2019 guidance, promulgated under the Trump administration, and removes certain steps FSOC was previously required to take before moving toward SIFI designation. Those included an "activities-based approach," meaning FSOC would work with other federal and state regulators to determine certain activities that might pose risks and take action to address them. Another feature was a cost-benefit analysis, in which FSOC would assess a company's likelihood of financial distress before turning toward designation.
Under the new process, FSOC must conduct a primary analysis, based on quantitative and qualitative information, to determine companies that may be subject to SIFI designation and give them a chance to respond. If it moves forward with the process, the council would then consult with the company and its primary regulator, and an official designation would require a two-thirds vote from FSOC's 10 voting members.
Some asset management industry players have raised concerns about the updated guidance, as did Sen. Tim Scott, R-S.C., who serves as the top Republican on the committee.
"When you eliminate actual standards that people can understand, and you go to something far more flexible and subjective, I think it makes it even more difficult for companies to figure out when they are in threat and when they are not in threat of becoming a SIFI," Scott said at the hearing.
However, Yellen pushed back on Scott's remarks, asserting that the changes were needed.
"We revised the 2019 guidance because it made it all but impossible to designate a firm as a SIFI and deprived FSOC of a tool that Congress in (the Dodd-Frank Wall Street Reform and Consumer Protection Act) clearly intended for it to have," Yellen said.