Regulators’ council urges monitoring of ‘non-financial business leverage’ based on rising debt levels

Monitoring levels of nonfinancial business leverage, and completion of the transition to a new, alternative reference rate, were among four recommendations made by the top-level council of financial regulators in its annual report, issued Wednesday.

In its 2018 annual report, the Financial Stability Oversight Council (FSOC) urged federal financial institution regulators in the upcoming year to continue monitoring nonfinancial business leverage, as well as trends in asset valuations and the potential implications for the financial firms they regulate, “in order to assess and reinforce their ability to manage severe, simultaneous losses in those markets.”

“Certain metrics indicate that nonfinancial corporate debt and leverage are elevated,” the recommendations state. “In addition, there are some indications that valuations may be elevated in key U.S. financial markets, including equities, corporate debt, and some commercial and residential real estate. Downturns in these markets can occur with little warning and in response to a range of factors. Elevated leverage and asset valuations can make such downturns more severe.”

The report asserts that “assuring that the relevant investors and intermediaries can manage such losses, rather than amplify or transmit them, will reduce the risk to financial stability such a scenario could pose.”

Regarding the transition away from the London Interbank Offered Rate (LIBOR) to a new, alternative reference rate (the new “SOFR,” or secured overnight financing rate), the council encouraged member agencies to “work closely with market participants to identify and mitigate risks from potential dislocations during the transition process.” (In July, Federal Reserve Board Vice Chairman for Supervision Randal Quarles said that implementation of SOFR is ahead of schedule and is on the verge of being adapted for use in other markets.)

Other recommendations from the council’s report included:

  • That regulators support cybersecurity efforts to ensure agencies have the necessary authorities to “supervise and enhance third-party service provider information security.”
  • That state and federal financial regulators should continue to work together to evaluate regulator overlap and duplication, and that the regulators work together to modernize regulations and, “where authority exists,” to tailor regulations based on size and complexity of financial institutions.

Financial Stability Oversight Council Releases Annual Report