The Deal: Prudential Now in 'Systemic' Risk Category

WASHINGTON, D.C. ( The Deal) -- A council of regulators set up to identify emerging threats to the economy on Friday, Sept. 20, officially designated Prudential ( PRU) as "systemically important," arguing that the big interconnected insurance firm would have a hard time selling assets in a period of financial stress, and as a result, it could eventually "inflict significant damage on the broader economy."

The categorization will likely eventually subject the insurance giant to additional capital, more liquidity and oversight by the Federal Reserve Board based on its potential risk to the financial system. Prudential is the third nonbank to receive the designation. A number of major U.S. banks have been given the designation.

Prudential said in a regulatory filing in June that it was preliminarily subject to the new capital and other requirements, but the official designation was announced by the group of regulators, the Financial Stability Oversight Council, on Friday. The company said in a filing Thursday that it was being designated.

The big insurer will likely be required to write a so-called "living will" and explain to regulators how it would dismantle itself in a way that does not cause collateral damage to the markets.

The government council, which is made up of bank and securities regulators, defended its action. It noted that because of Prudential's "interconnectedness, size, certain characteristics of its liabilities and products, and the potential effects of a rapid liquidation of a significant portion of its assets," financial distress at the insurer could "severely" inflict damage on the economy.

Whether a company is overly interconnected is a key consideration for regulators, which often point to American International Group ( AIG) as the poster child for a massively interconnected financial firm that did not have sufficient capital buffers or adequate oversight during the years leading up to the crisis. (AIG was formally designated by the council as systemically important, in July.)

Supporting their argument that the company is overly intertwined, the council added that Prudential's U.S. subsidiaries are "highly interconnected to each other through funding arrangements, derivatives exposures, guarantees and reinsurance."

The council acknowledged that a sale of large blocks of Prudential's business could limit harm resulting from major financial distress. However, it added that selling sizable business lines could be difficult, especially in a period of stress in the financial markets and in a weak macroeconomic environment.

"Such sales could be complicated by the amount of time required for such a transaction, intrafirm interconnectedness and complexity in light of Prudential's size and internal funding mechanisms, and the challenge of achieving a competitive valuation," the filing said.

The filing noted that a liquidation of a significant portion of Prudential's assets could cause "significant disruptions" to key markets including the corporate debt and asset-backed securities markets, particularly during a period of economic stress.

Is the designation good news or bad news for Prudential? Only time will tell. Some argue that it gives creditors and counterparties the impression that the firm is too-big-to-fail and will now be bailed out in a future financial crisis.

However, Obama administration policy makers and others contend that the new restrictions and capital buffer requirements will offset any market advantage the insurer would received from the designation. Those capital buffer requirements have not yet been set -- so only time will tell.

The designation also raises questions about who is next. Among nonbanks, the council had already designated AIG, a key contributor to the financial crisis, in the category, and GE Capital, a unit of General Electric ( GE), on July 9.

The Dodd-Frank Act, written in the wake of the 2008 financial crisis, gives Prudential 30 days to file a lawsuit challenging the designation.

"We are currently reviewing the rationale for the determination and our options," Prudential said in a statement.

--Written by Ronald D. Orol

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