Prudential Financial Inc.'s appeal against a designation that the firm is systemically important is unlikely to succeed, observers said, but could force the Federal Reserve Board to detail more about how it will supervise such companies.

The Newark, N.J.-based firm was the only one of three nonbank financial companies designated as a potential threat to the financial system by the Financial Stability Oversight Council that opted to challenge the decision.

But to prevail, it must convince regulators — the same ones that have been weighing the issue for three years — that its failure would not have a large economic impact.

"All appeals are a long shot," said Douglas Landy, a partner at Milbank, Tweed, Hadley & McCloy in New York, especially when the firm is appealing the same body that arrived at the decision.

If the FSOC were to reverse its decision, it could also set a dangerous precedent and wreak havoc on the council's ability to name other firms as systemically important.

"You have to assume first that these are the ones that are low-hanging fruit as far as FSOC is concerned, and in the future if there are other companies that are going to be designated, they're not going to be as easy for FSOC to make that determination as these three were," said Gil Schwartz, a partner at Schwartz & Ballen and a former attorney for the Fed. "As a result you can see the next group of companies saying, 'Well, Prudential was successful, let's challenge this as well' and tying up the agencies in an administrative burdens for quite a while, and that's why the chances of FSOC turning around for Prudential are very slim."

Prudential announced its decision in a securities filing shortly after markets closed on Tuesday, revealing that it had requested a nonpublic written and oral hearing with the FSOC to contest its designation as systemically risky.

"We continue to have faith in the integrity of the FSOC's review process, which provides for the ability to contest the proposed designation under the applicable regulations," Bob DeFillippo, a spokesman for the company said in a statement.

The company, he said, would continue to work closely with regulators to "demonstrate our belief that the company does not meet the requirements of the SIFI designation."

The other two firms, American International Group and GE Capital, in contrast, embraced the designation — as well as their new regulator. All companies designated as systemically important financial institutions, or SIFIs, will be supervised by the Fed.

Jon Diat, a spokesman for AIG, said the firm "welcomes" the designation and "is already working and operating with the Federal Reserve as its regulator." GE Capital's spokesman Russell Wilkerson said the company is "already supervised by the Fed" and so "decided not to appeal or ask for hearing. We have been and will be prepared to meet the requirements for SIFIs."

Because neither AIG nor GE Capital has requested an appeal, the council is required to make a final designation within 10 days. It has yet to announce any plans to vote or meet on the matter.

All three of the companies had been notified in June they were going to be designated by the council, which is a 10-member body headed by Treasury Secretary Jacob Lew, after they had been under consideration since September. Each company was given a 30-day window, which expired on Wednesday, to object to the designation by regulators. The council is now required to schedule a non-public hearing within 30 days for Prudential, after which it has another 60 days to make a final decision.

"While the council does not comment on proposed designations, the council anticipates that it will grant a hearing within 30 days for any company that contests it," a Treasury spokeswoman said in a statement.

The designation process has come under some criticism given that the new capital requirements that the firms will be subject to have yet to be finalized by the Fed. In 2011, the Fed proposed a batch of stringent capital and liquidity rules for bank holding companies with more than $50 billion of assets, but it has not issued a final rule. While such rules would apply to any nonbank firms designated as SIFIs, it's unclear how that would be done.

The decision by Prudential to appeal was expected, given how outspoken the company had been in not wanting to be designated. Some observers said the company may understand its odds of success are slim, but hopes to force regulators to reveal more information about how they will oversee the company.

"There's so little information from the Fed about what each entity will be subject to that in some ways perhaps Prudential is using the appeals process to try and figure out how it will play it out should they finally be so designated," said Landy.

The appeal also offers an opportunity for the company to try to convince regulators that "we're not as bad as the other guys" or show how it's changed over time to address areas of risk that regulators may be concerned over, he says.

Landy said Prudential could try to make that case that it has changed the dynamics of its business, or even cite macro-economic standards that have changed that might reflect lower risk sensitivities. They could say, "We recognize that some of the stuff we have done in the past may lead you to the conclusion we should be designated, but we've taken the following steps and are taking more steps to change because we want to sensitize our business to these risks," Landy said.

But observers largely agreed Prudential was unlikely to succeed, particularly given the laborious process the FSOC has gone through before making a designation.

"It seems to me they are going to be spending a lot of time and effort testing the system and given what the FSOC has done in terms of the preliminary work, I think Prudential has a high wall to climb to overcome that designation," said Schwartz.

Still, some wondered why FSOC singled out Prudential in the first place based on the six criteria it said regulators would use to designate a firm as risky, including size, complexity and interconnectedness.

"It's not clear what the basis of FSOC's thinking was that they would present systemic risk," said Oliver Ireland, a partner at the law firm Morrison & Foerster.

In previous crises with Lehman Brothers and Bear Sterns, for example, the tipping point has always been when firms run out of liquidity, Ireland said, but an insurance company may not have such particularly volatile liabilities.

"An awful lot of systemic risk runs off volatile short-term liabilities and the problems that can arise because funding dries up," he said. "It's not clear to me why FSOC would have included Prudential in that group."

This story originally appeared at American Banker.

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