MetLife sued the U.S. government last year, saying the Financial Stability Oversight Council (FSOC), made up of the chiefs of U.S. financial regulatory agencies, used a flawed process in determining it could hurt the U.S. financial system if it faced financial distress.

On March 30, U.S. District Judge Rosemary Collyer rescinded the designation and the federal government appealed in the U.S. District Court of Washington, D.C.

"The district court’s ruling in this case overturned the collective judgment of the heads of every U.S. financial regulatory agency and left one of the largest financial companies in the world subject to even less oversight than before the financial crisis," a Treasury spokesman said in a statement on Thursday, adding the government plans to "vigorously defend" the FSOC's work.

MetLife, the largest U.S. life insurer, has until August to respond and oral arguments are expected in the autumn. Both sides say the case could reach the U.S. Supreme Court.

Collyer's decision centered on the analysis FSOC conducted to make its 2014 determination that MetLife is a "systemically important financial institution." Saying that it had failed to review the likelihood that MetLife would fail, and in view of potential losses to counterparties, and costs imposed on MetLife by the label, she called the determination "arbitrary and capricious."

Passed after the financial crisis of 2008-2009 - which was aggravated by the way in which many large financial institutions were inter-connected - Dodd-Frank created the FSOC and gave it the power to label firms as systemically important, which triggers requirements to hold more capital and abide by other regulations.

Collyer's decision exempts MetLife from the regulations governing systemically important insurers that the Federal Reserve has proposed.

In its brief, the government said the council is not required to consider the likelihood of failure or "estimate specific counterparty losses or produce quantitative projections of the harm that would result."

"The 2008-2009 financial crisis demonstrated that the sudden, unforeseen failures of large financial companies can have sweeping, unpredictable ramifications," it added.

It also said Dodd-Frank does not call for a cost-benefit analysis, and instead focuses "on risk to the nation’s financial stability rather than on costs to large financial companies."

(Reporting by Lisa Lambert)