Rethinking Regulation

Real Clear Policy

Washington, DC is witnessing a regulatory race between agencies, sometimes covering each other’s areas, creating unnecessary and burdensome rules with significant economic impacts. Despite policymakers from both parties complaining about regulatory overload, the introduction of new regulations has continued full speed ahead in the political void created by the current partisan divide.

The most recent example of this is the efforts of the Federal Deposit Insurance Corporation (FDIC) to increase oversight of large asset managers, such as BlackRock, Vanguard, and State Street, once they reach a ten percent ownership threshold in U.S. banks. According to a January speech given by FDIC board member Jonathan McKernan, the goal of these regulations is to prevent asset managers from leveraging “their passive index funds to advance ESG objectives or otherwise influence corporate policy” that could create a “real and significant problem.”

As a result, the FDIC board is scheduled to discuss this issue at their upcoming April 25 meeting.

Director McKernan has valid reasons to worry about how certain asset managers or other large investors could use or intend to use ESG to direct business decisions, ranging from choosing Board Members to charting the future course of the organizations that they are significant shareholders of. This aligns with the recent surge in ESG-related shareholder proposals – which proxy advisory firms have notably supported considerably more than asset managers.

But when it comes to regulations, there are important questions to ask: What is the aim of the intended regulation? Is it needed? And how will it improve or hurt the current system?

Obviously, Director McKernan and others are worried about the potential influence of asset managers on the banks’ operations. But currently, these asset managers function under the “passivity commitments,” based on long-established Federal Reserve Rulemaking: Through self-certification, they stay out of certain influential activities and as a result they are subject to less onerous regulations.

This Federal Reserve framework was finalized in 2020, and uses various factors to determine whether a company has a control over a bank looking at “the company’s total voting and non-voting equity investment in the bank; director, officer, and employee overlaps between the company and the bank; and the scope of business relationships between the company and the bank.”  While the Fed framework has significant details in terms of what could trigger control issues between a company and a bank, it also provides the flexibility needed for current economic conditions as every business relationship is unique and one-size-fits-all regulations might not be appropriate for every occasion.

Asset managers have strictly adhered to their passive investor roles under the control of the Federal Reserve. Since one agency is already effectively regulating these businesses, whether it is through self-certification or other means, any potential regulations by the FDIC would be duplicative, unnecessary, distortionary, and potentially costly, both for the big three (as well as any other growing passive investors) and the banks that they are passive investors in.

For example, any arbitrary threshold that could trigger the FDIC regulations can change the behavior of the asset managers and limit their investments in the banks below that set amount. This could potentially limit access to capital, especially for small regional banks, impacting their lending to their clients, including small businesses who have close relationships with their regional banks. This behavioral impact can be seen in other regulations. For example, the Securities and Exchange Commission’s (SEC) mandatory reporting requirements increased the regulatory compliance costs for public companies decreasing the number of companies going public in the U.S.

It is not surprising that the ultimate cost impact of any regulation ends up falling on small businesses or low-income households. According to recent testimonyby Professor Casey Mulligan of the University of Chicago before the House Committee on Oversight and Accountability, while households in the bottom twenty percent of income distribution would incur 15.3 percent of their total income in terms of regulatory costs in the form of reduced wages and diminished purchasing power due to higher prices, the top twenty percent would only lose 2.2 percent.

Although Director McKernan has good intentions, any duplicative and unnecessary regulations will end up distorting the economy further, introducing more costs, especially for the groups that need more economic help.

While regulatory vigilance is crucial, the approach must be strategic and not merely duplicative. The FDIC’s proposed regulations on asset managers highlight the necessity for more coherent regulatory frameworks that avoid redundancy and minimize economic disruption. Effective regulation should enhance the system, not encumber it with unnecessary costs and complexity, especially on a solution in search of problem that will beset vulnerable groups with the hardest economic burden.

Dr. Pinar Çebi Wilber is Executive Vice President and Chief Economist for the American Council for Capital Formation