The surprise court decision in March to overturn US group MetLife's designation as a systemically important financial institution (Sifi) could weaken the case for systemic regulation both in the US and abroad.
Even though the Financial Stability Oversight Council (FSOC), which designated MetLife as a Sifi, is appealing the decision and despite the judgement being made largely on procedural grounds, judge Rosemary Collyer has tipped the debate on systemic regulation of insurers back in favour of the designated firms.
Collyer said the FSOC made three main mistakes. First, it did not follow its own rules on how designations would be made, and failed to make clear to MetLife the changes in methodology and explain them. Second, the council fell short in showing how MetLife's failure could damage the functioning of the financial markets. And, third, it failed to conduct a cost-benefit analysis of the designation.
If unsuccessful in appealing the decision, the FSOC could still change its approach in each of these areas. Yet making such changes and renaming MetLife in the next round of Sifi designations would be far from straightforward.
Collyer criticised the FSOC heavily for failing to prove MetLife could get into the kind of financial difficulty that would create a risk to the financial system – a criticism that goes to the heart of the debate over systemic regulation. Insurers have always argued they are not vulnerable to policyholder runs in the same way that banks might face a rash of customer withdrawals.
The FSOC could change its methodology and say the vulnerability of Sifis does not matter, only their potential to create systemic damage. But such a change would undermine the credibility of the designation process, which has been heavily criticised already.
Alternatively, the FSOC could seek to prove MetLife is vulnerable to a run. But many in the industry think that would be hard or impossible to achieve, particularly after the insurer spins off its variable annuity business.
If the FSOC fails to overturn Collyer's decision and cannot change its methodology, MetLife would be left designated as systemically important at a global level but not in the US. However, the insurer would be regulated by a supervisor – the New York Department of Financial Services (NY DFS) – that has opposed Sifi designations from the start. The NY DFS would be unlikely to enforce international rules that lack any legal basis at home.
Meanwhile, the deeper damage to the argument for regulating systemically risky insurers might be the reopening of the debate on whether insurers are vulnerable in the same way as banks. For the industry, it is an argument that has never been properly resolved. The MetLife judgement means it cannot be ignored.