Taking on Wall Street and the “big banks” has been an issue of this presidential election, with Democratic presidential candidate Sen. Bernie Sanders (I-Vt.) campaigning to “break up too-big-to-fail financial institutions” and even Republican presidential candidate Sen. Ted Cruz (R-Texas) vowing not to bail out banks that fail.
Before the election got underway, Sens. Elizabeth Warren (D-Mass.), John McCain (R-Ariz.), Maria Cantwell (D-Wash.) and Angus King (I-Maine) reintroduced the 21st Century Glass-Steagall Act, a bill that would have reinstated the separation between commercial and investment banking.
All the debate and lawmaking may not be necessary, however, as a number of financial institutions that have been designated by regulators as systemically important financial institutions (SIFIs) or globally systemically important banks (G-SIBs) begin to decrease their asset sizes on their own.
Supporters of the Dodd-Frank Act say that this is proof that the law actually is working.
For instance, JPMorgan Chase – one of the three largest banks in the U.S. and also a G-SIB – released its fourth quarter (Q4) financial results for 2015, stating that its Method 2 G-SIB surcharge had been estimated at 3.5 percent (down from 4.5 percent in Q4 2014) and that its Method 1 G-SIB surcharge was estimated at or near 2 percent (down from 2.5 percent in Q4 2014).
Under a rule finalized July 20, 2015, by the Federal Reserve Board, G-SIBs must hold additional capital to increase their resiliency because of the greater threat their potential failures pose to financial stability of the U.S. The G-SIBs must calculate their risk-based capital surcharges using two methods and using the higher of the two.
The first method is based on the framework agreed to by the Basel Committee on Banking Supervision and considers a G-SIB’s size, interconnectedness, cross-jurisdictional activity, substitutability and complexity. The second method uses similar inputs but is calibrated to result in significantly higher surcharges and replaces substitutability with a measure of the firm’s reliance on short-term wholesale funding.
JPMorgan Chase and HSBC were designated by the G20 as the top two G-SIBs. Last year, JPMorgan Chase had been singled out by regulators for being the only bank with a 4.5 percent capital bucket. Since then, JPMorgan Chase’s executives have said that the bank is continuing to work to reduce that risk metric.
According to JPMorgan Chase’s financial report, the changes to its surcharges were “driven by continued execution of G-SIB actions since Q4 2014.”
The changes also were driven by reductions in its non-operating deposits of about $200 billion, decreases in level 3 assets of more than $15 billion and reductions of over-the-counter derivative notionals of more than $15 trillion.
JPMorgan Chase is not the only financial institution taking steps to decrease its size.
In January, MetLife, Inc. – which had been designated a SIFI by the Financial Stability Oversight Council (FSOC) in December 2014 – announced a plan to separate a substantial portion of its U.S. retail segment.
“MetLife is currently evaluating structural alternatives for such a separation, including a public offering of shares in an independent, publicly traded company, a spin-off, or a sale. The company is also undertaking preparations to complete the required financial statements and disclosures that would be required for a public offering or spin-off,” the company stated, adding that the decision was driven by “strategic review and regulatory environment.”
The transaction would depend on, among other things, market conditions and the completion of the Securities and Exchange Commission (SEC) filing and review process
According to MetLife’s announcement: “The new company would represent, as of Sept. 30, 2015, approximately 20 percent of the operating earnings of MetLife and 50 percent of the operating earnings of MetLife’s U.S. retail segment. The new company would have approximately $240 billion of total assets, including $45 billion currently reported in the corporate benefit funding and corporate and other segments. Approximately 60 percent of current U.S. variable annuity account values, including 75 percent of variable annuities with living benefit guarantees, are in entities that would be a part of the new company. The new company would also contain approximately 85 percent of the U.S. universal life with secondary guarantee business.”
The parts of the U.S. retail segment that will stay with MetLife include the life insurance closed block, property-casualty and the life and annuity business sold through Metropolitan Life Insurance Company (MLIC). MLIC no longer would write new retail life and annuity business post-separation.
The new business is to be led by MetLife Executive Vice President Eric Steigerwalt. The complete management team of the new company, as well as its board of directors, is to be defined over time as preparations for the transaction take shape.
“Even though we are appealing our SIFI designation in court and do not believe any part of MetLife is systemic, this risk of increased capital requirements contributed to our decision to pursue the separation of the business,” MetLife Chairman, President and CEO Steven A. Kandarian said, adding that an independent company would benefit from greater focus, more flexibility in products and operations and a reduced capital and compliance burden.
“This separation would also bring significant benefits to MetLife as we continue to execute our strategy to focus on businesses that have lower capital requirements and greater cash generation potential,” Kandarian continued. “In the U.S., it would allow us to focus even more intently on our group business, where we have long been the market leader. Globally, we will continue to do business in a mix of mature and emerging markets to drive growth and generate attractive returns.”
Under Section 113 of the Dodd-Frank Act, the Financial Stability Oversight Council (FSOC) has the authority to determine whether nonbank financial institutions pose a threat to U.S. financial stability. MetLife is an insurance company that became the fourth company to be designated a SIFI by the FSOC in December 2014. It joined Prudential, American International Group (AIG) and General Electric Capital Corporation (GE).
Shortly after making its announcement, MetLife’s stock soared, according to The Wall Street Journal’s blog. This has analysts wondering whether the other SIFIs will continue downsizing. In April 2015, GE announced that it would reduce the size of its financial businesses by selling most of its capital assets and by focusing more on its industrial businesses.
Will AIG and Prudential follow GE and MetLife’s strategy?
With support from lawmakers, Prudential may continue to fight the designation as opposed to taking steps to dodge it.
For instance, in a House Financial Services Committee meeting Dec. 8, 2015, in which eight out the of 10 voting members of FSOC appeared to testify, several representatives – including Rep. Sean Duffy (R-Wis.) and Blaine Luetkemeyer (R-Mo.) – took issue with the fact that the only voting member with insurance experience voted against designating Prudential Financial, Inc. as a SIFI.
On Jan. 28, FSOC held a meeting in which it approved the minutes from its Dec. 17, 2015, meeting (nine days after the House hearing). According to those minutes, FSOC had considered the annual re-evaluation of Prudential’s SIFI designation. It had been recommended that FSOC not rescind its designation.
According to a Bloomberg Gadfly article by Brooke Sutherland, Prudential seems to be the only SIFI without a plan to shake off the designation through downsizing.
“Prudential has thus far been content to remain on the sidelines,” Sutherland wrote. “When MetLife launched a lawsuit against the U.S. government over its SIFI label last year, Prudential – which had previously considered similar legal action – considered reviving its own efforts to break free of the designation, the Wall Street Journal reported in June [2015]. Any move would be dictated by the MetLife proceedings, though. Because the two companies are similar, Prudential could use a MetLife victory to contest its own SIFI label when it came up for review with regulators.”
However, as Sutherland points out, with MetLife adopting the option of breaking up, the chances of turning to legal precedent might not be the best strategy for Prudential anymore.
“The bottom line is that AIG and Prudential will need to assure shareholders that they’re taking as much action as possible to reduce the amount of capital they have to set aside as nonbank SIFIs so that it is available for shareholders, analysts said. Under the Fed’s oversight, they’re expected to have ample money on hand as a capital cushion to address unexpectedly large losses and avoid harming the broader economy in a collapse,” Leslie Scism wrote in The Wall Street Journal.
In an October 2015 letter to AIG CEO Peter Hancock, AIG shareholder Carl Icahn stressed that the company needed to break up into three smaller companies.
“The regulators have made clear that the best outcome is for SIFIs to shrink and reduce their systemic footprint,” Icahn wrote. “If nothing is done, returns and AIG’s competitive position will continue to suffer as the SIFI regulation, including its costs and capital requirements, is fully implemented.”
On Jan. 26, AIG announced a series of strategic actions, organizational changes and operating improvement to create a leaner, more profitable and focused insurer.
“The board of directors has committed to return at least $25 billion of capital to shareholders over the next two years via buybacks and dividends without compromising the utilization of the company’s deferred tax assets (DTA); approved the IPO of up to 19.9 percent of United Guaranty Corporation (UGC) as a first step towards a full separation; and approved the sale of AIG Advisor Group to Lightyear Capital LLC and PSP Investments,” AIG announced.
AIG’s board of directors also had approved the creation of nine “modular” business units with greater end-to-end accountability, each with its own specific financial metrics.
“With these actions, AIG has taken another major step in simplifying our organization to be a leaner, more profitable insurer, while continuing to return capital to shareholders and improve shareholder returns,” Hancock stated. “The creation of more nimble, standalone business units that can grow within AIG or be spun out or sold allows us to do what is in our shareholders’ best interests.”
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