FSOC makes six recommendations in annual report, leading with addressing nonbank financial intermediation, crypto oversight

Addressing risks of nonbank financial intermediation and enforcing existing rules and regulations applicable to the “crypto-asset ecosystem” were among the recommendations made by the council of federal financial regulators in their annual report, issued Friday.

The Financial Stability Oversight Council (FSOC) said its annual report was approved unanimously by its members, which includes all federal financial institution regulators and other agencies that supervise financial markets and products. The report, according to FSOC, reviews financial market developments, describes potential emerging threats to U.S. financial stability, identifies vulnerabilities in the financial system, and makes recommendations to its regulator members to mitigate those threats and vulnerabilities.

For 2023, the report makes six recommendations for protecting the financial system:

  • Address risks presented by investment funds through support for initiatives by the Securities and Exchange Commission (SEC) and other agencies. “These include proposed data-collection improvements to Form PF (an SEC regulatory filing requirement that mandates private fund advisers report regulatory assets under management to FSOC in order to monitor risks to the US financial system), as well as new rules proposed by the SEC to address the liquidity mismatch in open-end funds and money market funds.” The report noted that FSOC’s Hedge Fund Working Group will continue to evaluate potential risks to financial stability posed by hedge funds.
  • Enact legislation providing for rulemaking authority by federal financial regulators over the spot market for crypto-assets that are not securities, which FSOC has identified as a gap in regulation. In the meantime, the council recommended, agencies should continue to enforce existing rules and regulations applicable to the crypto-asset ecosystem. “Steps should be taken to address regulatory arbitrage, since crypto-asset entities offer services similar to traditional financial institutions but do not have a consistent or comprehensive regulatory framework,” FSOC further recommended. “An assessment should be made of whether vertically integrated market structures can or should be accommodated under existing laws and regulations.” The council also recommended that its members “continue to build capacities related to data and the analysis, monitoring, supervision, and regulation of digital asset activities.”
  • Identify, prioritize, and procure the necessary data for assessing climate-related financial risks through state and federal agencies’ coordination. “The Council also recommends state and federal agencies continue their work to advance appropriately tailored supervisory expectations of regulated entities’ risk management practices,” the report stated. “Financial regulators should continue to promote consistent, comparable, and decision-useful disclosures that allow investors and financial institutions to consider climate-related financial risks in their investment and lending decisions. The Council recommends enhanced coordination of data and risk assessment through the Council’s Climate-related Financial Risk Committee.”
  • Review Treasury market structure and liquidity challenges in the context of changes in the technology and the counterparties providing market liquidity, as well as the growth in Treasury debt outstanding, to enhance market resilience. “Policies should continue to be considered for improving data quality and availability, bolstering the resilience of market intermediation, evaluating expanded central clearing, and enhancing trading venue transparency and oversight,” the report stated. “The Council also supports and encourages efforts by the Treasury Department to continue to enhance collection and transparency in post-trade transactions in the cash market for Treasury securities.”
  • Continue gathering additional information for managing cyber risk to monitor and assess cyber-related financial stability risks and build cyber resilience.
  • Firms should take advantage of any existing contractual terms or opportunities for renegotiation to transition their remaining legacy LIBOR contracts before the publication of USD LIBOR ends at the end of June, 2023. “Council members have emphasized that derivatives and capital markets should continue moving to SOFR, a broad and robust measure of borrowing rates,” the report stated.

The FSOC also said it has identified “certain vulnerabilities related to the nonfinancial corporate credit sector, as well as the commercial and residential real estate sectors.” The report recommended that both financial supervisors and institutions continue to monitor credit risks and exposures to those sectors.

2022 Annual Report, Financial Stability Oversight Council