both 50 billion and above and any nonbank companies designated by the council. the standards that we have proposed are focused on the banks, but we have been given the authority in dodd frank to tailor the standards to the characteristics of a particular company, a nonbank company that is designated. and we have said that we will use those -- that authorization to tailor the standards as appropriate. >> and has the fsoc conducted a thorough cost benefit analysis on the designation of nonbanks as systemically important, specifically in regards to asset managers? >> so the agencies are obviously concerned about their costs and

benefits of their actions and they want to bear in mind that this rule was not required in statute. the rule was designed to provide greater clarity about the purpose by which the process would engage in designations. >> and let me ask you also, have you all taken a look at or considered any adverse affects of the designation? >> so the affects of the designation are -- >> adverse effects. >> right. there are certain effects that require greater supervision, heightened capital standards, liquidity requirements. i don't think those are adverse effects. i think those are effects that

are appropriate to a firm that could pose a threat to the financial stability of the united states. >> okay. and involved in this, in an intricate way are, indeed, the asset managers. now, asset managers do not invest with their own balance sheets. they invest on behalf of their clients. so when a client changes asset managers, it does not result in an immediate portfolio liquidation. so, the point that i'm getting at is where will this process end, if nonbank financials are designated systemic, there will be other nonbank industries that

are systemic as well? >> the council's determination about a firm that can pose a threat about financial stability will be done not on an industry by industry basis but a firm by firm basis. so, to the degree that an asset management firm is largely -- has its activities in custody and on behalf of customers and as a result does not pose a threat to financial stability, it is unlikely to be designated. to the degree it engages in activities that could pose the threat to financial stability, the council would likely make a designation, but that assessment will be done on a firm by firm basis. will the fsoc evaluate business models, as intended by congress before further pursuing designations? >> so, as part of its designations, the council will look at all those factors you mentioned for each individual

firm to see whether or not, in total, that firm could pose a threat to the financial stability of the united states. >> thank you very much, miss chairwoman. >> thank you. mr. royce for five minutes. >> thank you, madame chairwoman. i would like to ask a question of mr. auer, just to get his feedback on a problem i see here, that i don't think is going to go away. and that is that the market is going to make a determination once that these firms are deemed significant by you. and it's reflected in the credit rating agencies, deciding already that the cost of borrowing, based upon their decision, they shared with us that they believe that implicitly there is a likelihood of government support. so the cost of borrowing is lower for these firms than their competitors. and the consequences of that are that when you're in a situation like that, you often can gobble up your competitors, your

smaller competitors especially. you can outperform them. frankly, you can overleverage. but you require your competition and the competition shrinks in the market as a result. liquidity was supposed to imply, i think at some point, liquidation. but these firms will never fail. i want to quote back to you the new head of the fdic and mr. gruenberg's recent comments and get your reflection on this. he said three of the goals are to ensure financial stability, accountability and viability, which means converting the failed firm into a new, well-capitalized and viable private sector entity. now, when the market hears that, they don't think that that's a

firm that is going to fail. the implication here -- and it may not be for the stockholders, but certainly for the creditors -- is that if you loan to that firm, there's a very good chance -- that's not to talk about, you know, death panels for what's going to happen to the firm. that sounds like the goal was the same as it was in 2008, unfortunately. although part of that goal is to stop the crisis from spreading, the other part is that nursing that insolvent firm back to health, eventually through

either public dollars or new debt, which although we can argue that it won't be, i think it likely will be guaranteed by the government. so, the assumption here again is that these firms will be punished by the market by being designated. that's what we would like to believe is going to happen. but that does not seem to hold water, given the reaction by the market, given the reaction when we talk to the credit rating agencies about this, because the presumption is they're going to receive very fair treatment by the agency task by unwinding it by the fsoc. and mr. gruenberg's comments certainly would imply that. i just wanted to get your take on that. >> so, i can't speak for mr. gruenberg's comments. i can say my understanding of the application of -- or liquidation authority is that when a firm is put into liquidation, all its equity holders would be wiped out. >> as i cited. >> yeah. and its debt holders would be given concern, paid back in part. the result in that would allow the new company that survives to be well capitalized. >> i understand that.

but understand that the market, arguably, looks at that and says that haircut is not equivalent to what the haircut would be if they go through bankruptcy. and now because they have this potential path, we're going to evaluate that as a -- you know, as an advantage to creditors and as implied through the decisions by the credit rating agencies. last question. capital, capital and more capital. secretary geithner said that. it bears repeating. this is the only way to ensure that banks are going to be able to observe unforeseen losses and luckily banks have been increasing the amount of cash on their books, largely because of all three. and there were some that have been critical of the international work being done, having the potential to harm economic growth. i hope that recent incidents put that argument at rest. i think that these requirements for more capital have been born out here and i would like your view on that. >> so one of the requirements of any firm that is designated that would pose a threat to financial

stability is enhanced prudential standards, including increased capital to the risk that that firm poses. >> and i would certainly agree that the reforms we are putting in place to raise capital standards for the largest bank holding companies are an appropriate response to the crisis and are a necessity. >> thank you. i will yield back. >> thank you. five minutes. >> thank you for having the hearing today and thank you to the panelists for coming. mr. auer, your written testimony provides, i think, a pretty clear walk-through of the process for determination. i would kind of like to run through it and see if you could put a timetable for it and make

sure that i understand. so as you said in your remarks, the first to cut is stage one. and just these quantitative measures on page three of your written testimony, $50 billion, then $30 billion and gross swap, derivative, so on and so forth, you'll look at all these firms. when will that test -- when will the process start? >> the process has started. >> has started? >> the final rule was published in april. it went into effect this month. so, the council member agencies and office of financial research are collecting data to assess which firms pass the stage one threshold. >> so you're in the stage one assessment process, determining which firms meet these criteria, right? >> that's correct. >> so when you do that, will there be any notification of those firms? it's not clear here, will you then go to stage two? >> then we go to stage two.

>> explain that a little bit better. you mention additional quantitative and qualitative measures. what would they look like? >> it's designed around a six-factor framework for analysis. there are several factors that relate to sort of probability that a firm might get into distress, things like leverage, liquidity, existing regulatory scrutiny. there are also factors that indicate whether a firm might transmit that distress, including lack of substitutes, connectedness and size. the stage two process will look at all of those factors. it will take all publicly available data and any data available from already existing -- >> could you pull your mike up just a little bit? i think some members are having difficulty hearing.

thank you. >> my apologies. >> in stage two, it will look at all publicly available data as well as any data already available to regulators and try to provide in-depth analysis to how that firm might or might not pose a threat to financial stability. >> leading up to the stage three question, which you have here on page five, which says whether the company's material financial distress or nature, scope, size, scale, so on and so forth, could pose a threat to the u.s. financial stability, that's a judgment that is both subjective and objective? how would you characterize that judgment? >> the council used, in stage three the firm will be notified that it is under consideration by the council. the firm will have an opportunity to provide any arguments, information or data that it feels will be useful to the council in making its determination. the council may also ask the firm -- >> let me stop you there. that's after a two-thirds vote? of the council? >> no. >> there's this process first? >> right. >> then a two-thirds vote, then an additional hearing and

process? >> yes. >> and an additional vote if there's a hearing, correct? >> that's correct. >> so it's a pretty involved kind of back and forth and certainly enough or adequate opportunity for the firm to question, you know, some of the conclusions that are made, certainly a lot of opportunity for feedback. >> multiple points at which a firm can engage with the council and its member agencies about its designation. >> you get through this whole process and you determine here is a big firm that has a lot of this interconnectedness. meets all this quantitative and qualitative criteria in it. yet do you expect that many of these nonbank firms will meet the criteria at the end of the day? >> as we say in the final rule and guidance, we expect less than 50 firms will pass the stage one thresholds. stage one thresholds, however, are not meant to be definitive in any way.

they are more of a screening to identify those firms where the council will spend more of its time and effort. i think it would be premature and inappropriate to speculate how many firms would be designated before we analyze them. >> fair enough. thank you. i yield back. >> thank you. mr. henterling for five minutes. >> thank you madame chair. in your testimony, you stated that the dodd frank act addresses the market perception that such firms are too big to fail. it seems to be fairly well documented that the larger investment banks still enjoy funding advantages over their smaller competitors. and since the passage of dodd frank, we know that the big have gotten bigger and the small have gotten fewer, so i'm curious about your observation of market perception.

>> so, it certainly is true that some market perception still exists, as was mentioned previously by rating agencies and others. the market does not seem to be fully convinced that the tools given under dodd frank will be used. and i think we, the regulators, still have a ways to go to prove to the market that we will use those tools in a way -- >> so the market perception is just that the market doesn't understand it, is that what you're trying to tell me? >> i think the market is skeptical that the regulators will have the means and the will

to use the tools and they're waiting to see. >> count me as part of the market. the other question i have, i think the gentleman from ohio, mr. renacci, asked a somewhat similar question. but when we're looking at potentially designating nonbank entities and we're looking at the first part test of the financial activities, i mean, a company that the market may not perceive to be financial -- if they, for example, import some type of raw material from overseas, potential security risk, monetary risk, operational shipping risk and i think the chamber for their upcoming testimony in helping elucidate

this question. if these activities are found to be financial in nature, if this helps trigger the threshold test, isn't it possible that some firms who wish to -- nonbank financial firms who wish to -- nonbank firms may indeed decide not to hedge certain risks. in which case, have we not perhaps concentrated more risk where we don't want it? maybe they will go naked on these positions. and so has that been considered by fsoc? mr. gibson, i will go to you first. >> so, the federal reserve has a proposed rule out for comment on the definition of what our financial activities that would make a firm potentially subject

to designation. there has to be predominantly financial, very high percentage financial. >> the activities i described financial or not financial or does it depend upon the motives? does it depend upon the underlying business entity? what does it depend on? >> it depends on the particular activities as they're defined in the current bank holding company regulations for what are permissible financial activity. hedging or financing, a small amount typically would not be deemed predominantly financial. however, it depends on the facts

and circumstances of the particular company. >> but also included in fsoc's rules, once you outline the criteria by which one is adjudged in stage one to potentially be a nonbank entity to go to stage two, isn't your last criteria essentially we can ignore all our other criteria and still decide to send a potential firm to stage two? in which i'm trying to figure out, if you're trying to add some clarity to the definition, you seemingly take whatever you provide with one hand you take away with another. where is the clarity here? >> so, let me just make one point. in order for a firm to be designated and determined to be a nonbank financial company, at least 85% of its assets or 85% of its revenues must be financial in nature. so, that should be very effective in limiting the types of firms that are merely engaging in some hedging activities with their commercial

business. such firms would be very unlikely to trip the 85% threshold. the council in designing the stage one thresholds want to provide clarity with the types of firms it is likely to focus on. and for further evaluation and to give some clarity about its thinking in that regard. and to act as an initial screen. however, the council was reluctant to put itself into a position where a very risky firm that through whatever sort of gaming techniques was able to avoid the stage one threshold that thereby -- >> mr. auer, my time has expired. if i could, as i read the guidance provided from fsoc, it says that irrespective of whether such company meets the thresholds in stage one. again, i see no clarity here. >> mr. green for two minutes -- i mean five minutes. excuse me. >> thank you, madame chair. i thank you and the ranking member again. >> to a good many members of th public, it is sci-fi.

it really is. perhaps we can find a way to explain this in a much more intelligible fashion for persons who are not privy to much of the intelligence that you two fine witnesses are sharing with us. let's start with the very basic question. was aig a nonbank financial institution? mr. gibson? thank you. >> yes. >> i tend to ask questions that you can answer yes or no. was aig into many different kinds of products, if you will, credit swaps, derivatives? was aig into what we now refer to as exotic products, mr. gibson? >> well, with the caveat that the federal reserve was not the

supervisor of aig, i'm pretty sure the answer to your question was yes. >> i understand that the federal reserve was not and i'm not going there. but i am going here. was aig the type of institution that fsoc would be designed to have an impact on? you want to pass mr. gibson -- i'm still with you. >> i would say that looking at the quantitative screens in stage one of the fsoc's process, aig would trip many or maybe all of those. >> of course it would. it was over $50 billion, wasn't it? >> yes. >> go on. elaborate. tell us why aig would come under the auspices of fsoc. >> under fsoc's rule, the

characteristics that make up systemic importance, which have already been listed off -- some of the most important ones are size of the company and the interconnectedness of the company. what we learned about aig after its near failure was that its size was of an extent that was seen to pose a systemic risk and interconnectedness with other large financial firms was substantial. >> who knew that aig was part of the glue that was holding the economic order together? mr. auer, am i pronouncing your name correctly, sir? >> yes. >> aig, after the fact, we recognized was part of the glue holding the order together, true? >> aig was intimately involved and highly interconnected with a great number of other financial firms. >> that is your way of saying yes? >> yes. >> thank you. now, given that we know that there are other aig's -- not in

the sense that they are right now about to go out of business, but there are other big businesses that may pose systemic risk. they may become sifis. and because we know that they may become -- or maybe they are sci-fis, or sifis, is this not a means by which we can deal with them without making attempt to prevent them from making bad business decisions? here is what i'm saying. we can't stop businesses from making bad business decisions. my belief is that that happens and that's part of the ebb and flow of doing business. but we can deal with the consequences of bad decisions. and is that what we're attempting to do here, mr. gibson, deal with the consequences of bad decisions by

these mega businesses? >> yes. and one of the enhanced prudential standards that nonbank companies that are designated by the council will be subject to is enhanced capital requirements that will make sure that a buffer exists to cover unexpected losses of the type you're describing. >> and for those who would like to go back to the stock market crash, read about how the resistance that took place when we were trying to put fdic in place, and fdic has proven to be very beneficial when we are looking for an orderly means by which we can liquidate banks. true, mr. gibson? >> yes. >> are we trying to do the same thing now with nonbank institutions? >> that is the intention of the title 2 orderly liquidation authority, to extend what the fdic has for banks to nonbanks. >> and we can do this and not overregulate.

i think that's what we're trying to accomplish today. do you agree, mr. gibson? >> that is what we're trying to do. >> mr. auer? >> i would agree. >> thank you very much. thank you, madame chair. >> thanks for coming today, gentlemen. a couple of questions with regards to fsoc. coming from the small bank, community bank perspective, some of the things that have come down, there are a lot of rules. i believe this dodd/frank was sort of shotgun approach. are we going to come back and take some of the pellets out of the bullets and go back to a rifle approach? take some of those back off the smaller institutions and nonbank lending folks? >> so the fsoc regularly discusses existing upcoming regulations part of dodd slash

fra -- dodd/frank and i suspect it will continue to do so. consistency across the agencies as they develop their rule making process and that help ensure that any rules that are -- regulations that are promulgated are dealt with appropriately. >> they're not going to make them more streamlined or more appropriate to just the bigger folks who are the problem areas here and alleviate the smaller folks? >> fsoc itself is only -- not a regulatory agency and most of the -- >> certainly could provide some guidance, could it not? >> its members, many of its members are regulatory entities and they do discuss the -- their upcoming regulations with other council members. i don't know what those agencies plans are for --

>> okay. with the rules that are promulgated, are there any on those rules. >> which rules? >> fsoc rules. >> has issued at least two rules i'm aware of. one is the rule we're discussing today that was finished, published in april. that is a rule that does not directly impose any restrictions or -- >> my time is limited, mr. auer. can you give me yes or no? >> so there is no need to do a cost benefit analysis on a rule that nearly describes the council's process. >> that's fine. what enforcement mechanisms are in place? >> to enforce what? >> the rules. >> this rule does not -- as i said, put in place any restrictions or limitations on firms. what it does is it helps explain the council's process by which you will identify nonbank financial entities.

>> we leave it up to the regulators to enforce? >> yes. >> as a regulator, what's your enforcement mechanism? >> the same enforcement tools for enforcing the enhanced prudential standards on nonbank companies that we currently have. >> which are what? >> supervisory tools, examinations. >> what's your enforcement? if they're bad actors and do something wrong, what will you do? >> impose upon them written agreements, memorandum of understandings, civil money penalties, the full range of tools we currently have with bank holding companies. >> whenever you designate someone as a sifi, is this going to be public knowledge or something that's internal between your agencies and the individual company? >> the final designation of any particular firm for enhanced