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MetLife's court win rattles FSOC, deals blow to nonbank SIFI process

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MetLife's court win rattles FSOC, deals blow to nonbank SIFI process

scored a landmarkvictory in its bid to dodge additional regulatory oversight, after a federalcourt struck down thecompany's designationas a nonbank systemically important financial institution.

TheU.S. District Court for the District of Columbia on March 30 sided with theinsurance giant's lawsuitagainst the Financial Stability Oversight Council on multiple counts, findingthat the FSOC violated its own rules in evaluating MetLife and failed to provethat the company is too big to fail. The decision immediately revoked MetLife'snonbank SIFI tag, in a move that shocked industry analysts and struck a majorblow to the federal government's power to monitor the largest nonbank entities.

"Iwasn't expecting [MetLife] to win," Raymond James analyst Steven Schwartzsaid in an interview soon after the verdict. "This is a big positive."

Thesurprise ruling issued by Judge Rosemary Collyer rippled through the insuranceindustry, pushing MetLife shares more than 5% higher during the day's tradingsession. Fellow nonbank SIFIs PrudentialFinancial Inc. and AmericanInternational Group Inc. also saw a small bump soon after thedecision became public, with both stocks finishing the day up at least 2%. Averdict was not expected until later this spring and more importantly was notexpected to find in MetLife's favor.

Fromthe start, few industry or legal experts had put much faith in MetLife's 2015challenge to the FSOC procedures for deciding which companies could be risks tothe broader financial system. Prudential and AIG accepted their respectivedesignations with little protest, while General Electric Co. opted to break up subsidiaryGeneral Electric Capital Corp.soon after it was tagged as a nonbank SIFI as well. Even MetLife, while stillarguing that its legal case had merit, planned to off its U.S. retail business inresponse to a higher anticipated regulatory burden.

Yetthe court took an unexpectedly favorable view toward MetLife's position, whichhinged on its argument that the FSOC violated the standards laid out inDodd-Frank and acted in an "arbitrary and capricious" manner. Thatincluded running afoul of an obligation to determine whether the company waslikely to fail during a financial crisis, rather than starting with theassumption that it could fail. The court also sided with MetLife's argumentthat the FSOC did not conduct a sufficient cost-benefit analysis of the impactthat a nonbank SIFI designation would have on MetLife's business.

Thecase's full opinion is sealed until MetLife and the FSOC decide what elementsshould be made public. The federal government is likely to appeal the decisionwithin its 30-day window, after the U.S. Treasury Department in a statementpledged to "defend the council's designations process vigorously."

Strong Dodd-Frank Act supporters also came to the FSOC'sdefense, with Better Markets President and CEO Dennis Kelleher warningthat the case would give global giants "license to be a too-big-to-failsystemic threat without any increased supervision to protect the country."He added that hampering the nonbank SIFI process could also create a dividedsystem where big banking institutions face high regulatory standards butsimilarly sized nonbanks operate free from additional oversight.

Federal Reserve Bank of Minneapolis President Neel Kashkari,who during the financial crisis supervised the Troubled Asset Relief Program,also came out against the court's ruling in a March 31 tweet.

"MetLife fighting SiFi designation is like getting madat your doctor for diagnosing your disease," he wrote. "Reality iswhat it is."

ButMetLife's first-round win exposed vulnerabilities in the FSOC's nonbank SIFIprocess, analysts said. Perhaps most notably, the government's own legal stanceappears to have contributed to its undoing. The FSOC established in its courtfilings that its primary job is to determine whether a company could bevulnerable to material distress, instead of focusing on what would happen if acompany were to become distressed. That allowed MetLife to argue that the grouphanded down a nonbank SIFI designation before definitively demonstrating howthe company could be destabilized.

"Theycould've come out and said, 'We don't need to decide whether you're vulnerable;we just need to decide what happens if you have material distress.' But theydidn't," Schwartz said. "The FSOC was hoisted on its own petard bynot following its own decisions about how it would go about it."

Evenif the federal government does appeal, he added that the initial ruling islikely to hinder the FSOC's work over the next several months. The group hasmost recently taken a hard look at asset managers and their impact on thefinancial system; making any new designations now would likely be unpalatable,Washington Analysis analyst Ryan Schoen said in a note to clients.

"Wedo not expect FSOC to designate any additional nonbank SIFIs during 2016 andthink it is an open question as to whether additional nonbanks are everdesignated," he said, adding that it could also further slow the FederalReserve's already-delayed development of insurance capital standards.

Theruling should also fuel the political scrutiny of the FSOC, which has comeunder fire from Republican lawmakers for its lack of transparency. HouseFinancial Services Committee Chairman Jeb Hensarling, R-Texas, touted thedecision as a rebuke of the Fed's "near de facto management authority oversuch institutions," saying in a statement that the FSOC has served only toperpetuate companies' too-big-to-fail status. He promised to introduce newlegislation aimed at crippling the FSOC.

Theremaining nonbank SIFIs must now decide whether to launch their own campaignsagainst additional oversight. The companies cannot mimic MetLife's approach,because MetLife challenged its designation during the 30-day window created byDodd-Frank to seek a judicial review. That means that they would likely have tofind an alternative legal approach, analysts said, and argue that they deserveequal protection under the law.

Prudential,AIG and GE Capital all declined to comment soon after the court's ruling. AIGPresident and CEO Peter Hancock said during a March 31 that MetLife'svictory opens up an opportunity for AIG, but it is not immediately applying foran exemption.

GECapital, though, followed through on prior plans to ask the FSOC to remove its nonbank SIFIdesignation. The company has significantly shrunk its operations over the pastyear in a concerted effort to avoid federal oversight.

ForMetLife, the court ruling is likely to buoy both its stock price and its futurefinancial prospects, but nothing is certain until the government exhausts itsappeals. The insurer has set aside capital for the last few years inanticipation first of a nonbank SIFI designation and then of tighter capitalstandards. Its decision to seek a separation of its U.S. retail business cameafter determining that the additional regulatory requirements would put thebusiness at a competitive disadvantage to smaller rivals.

MetLifein a statement didnot address those spinoff plans, saying only that the court decision validatesits view that its "business model does not pose a threat to the financialstability of the United States." But it is largely expected to push aheadbased on its belief in the potential strategic benefits of a separation and thecontinued overhang of the Department of Labor's rule tightening the reins oncertain retirement investment products. Roughly 60% of MetLife's U.S. variableannuity account values would be taken on by the new U.S.-based entity under itsbreakup proposal.

Therealso remains the possibility that the FSOC could dig in and put the insurerthrough the nonbank SIFI evaluation process all over again, using the court'sruling as a roadmap for conducting itself the right way. Yet for the timebeing, MetLife's lawsuit succeeded in poking holes in the FSOC's authority todetermine which companies could fail and what impact those failures would haveon the broader economy.

"Idon't know how the FSOC ever gets around that," Schwartz said. "Itmay very well be that these companies are so big that assumptions are alwaysattackable."