The Designation of Non-Bank Financial Companies for Enhanced Oversight
On Tuesday, the Financial Stability Oversight Council (“FSOC” or “Council”) adopted a new final rule implementing Section 113 of the Dodd-Frank Act, which authorizes the Council to require a nonbank financial company to be supervised by the Federal Reserve Board and be subject to prudential standards if the Council determines that: (1) material financial distress at the nonbank financial company could pose a threat to the financial stability of the United States, or (2) the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company could pose a threat to the financial stability of the United States.
Together with appended interpretive guidance, the new rule describes the manner in which the Council intends to apply the statutory standards and considerations, and the processes and procedures that the Council will consider in making determinations under Section 113 of the Dodd-Frank Act.
The Statute. The Dodd-Frank Act defines a “nonbank financial company” as a domestic or foreign company that is “predominantly engaged in financial activities,” other than bank holding companies and certain other types of firms. The Dodd-Frank Act provides that a company is “predominantly engaged” in financial activities if either (1) the annual gross revenues derived by the company from financial activities, as well as from the ownership or control of insured depository institutions, represent 85 percent or more of the consolidated annual gross revenues of the company; or (2) the consolidated assets of the company related to financial activities, as well as related to the ownership or control of insured depository institutions, represent 85 percent or more of the consolidated assets of the company. The Dodd-Frank Act requires the Board of Governors to establish the requirements for determining whether a company is “predominantly engaged in financial activities” for this purpose.
The Board’s Proposal. On Monday, the Federal Reserve Board published for comment a proposed amendment to its Notice of Proposed Rulemaking issued February 11, 2011 (“NPR”), to establish requirements for determining whether a company is “predominantly engaged in financial activities.” Commenters to the February 2011 NPR asked whether conditions imposed on the conduct of financial activities by the Bank Holding Company Act and the Board’s regulations should be considered in defining financial activities. The Board therefore proposes to amend the NPR to clarify the activities that are financial for purposes of the Dodd-Frank Act. Comments should be submitted on or before May 25, 2012.
FSOC Guidance. The interpretive guidance appended to the FSOC’s new rule addresses, among other things, (1) key terms and concepts related to the Council’s determination authority, including “material financial distress” and “threat to financial stability”; (2) the uniform quantitative thresholds that the Council intends to use to identify nonbank financial companies for further evaluation; (3) the six-category framework that the Council intends to use to consider whether a nonbank financial company meets either of the statutory standards for a determination, including examples of quantitative metrics for assessing each category; and (4) the process that the Council intends to follow when considering whether to subject a nonbank financial company to supervision by the Board of Governors and prudential standards.
The rule and interpretive guidance provide a detailed description of (1) the profile of those nonbank financial companies that the Council likely will evaluate for potential determination, and (2) the factors that the Council intends to use when analyzing companies at various stages of the determination process, including examples of the metrics that the Council intends to use when evaluating a nonbank financial company under the six-category analytic framework. The Council’s ultimate assessment of whether a nonbank financial company meets a statutory standard for determination will be based on an evaluation of each of the statutory considerations, taking into account facts and circumstances relevant to each nonbank financial company.
The Three-Stage Process. As described in the interpretive guidance, the FSOC’s determination process will occur in three stages. The first stage of the process (“Stage 1”) will narrow the universe of nonbank financial companies by applying uniform quantitative thresholds that are broadly applicable across the financial sector. The thresholds are size, interconnectedness, leverage, and liquidity risk and maturity mismatch. A nonbank financial company would be subject to additional review if it meets both the size threshold and any one of the other quantitative thresholds.
In the second stage of the process (“Stage 2”), the Council will analyze the nonbank financial companies identified in Stage 1 using the six-category analytic framework.
Based on the Stage 2 analysis, the Council will identify the nonbank financial companies which the Council believes merit further review in the third stage (“Stage 3”). The Council will send a notice of consideration to each nonbank financial company that will be reviewed in Stage 3, and will give those nonbank financial companies an opportunity to submit materials within a time period specified by the Council (which will be not less than 30 days). Stage 3 will build on the Stage 2 analysis using quantitative and qualitative information collected directly from the nonbank financial company, generally by the Office of Financial Research, in addition to the information considered during Stages 1 and 2. The Council will determine whether to subject a nonbank financial company to Board of Governors supervision and prudential standards based on the results of the analyses conducted during this three-stage review process.
The FSOC does not intend to provide industry-based exemptions from potential determinations.
The new rule and interpretive guidance are effective 30 days after publication in the Federal Register, which is expected during the week of April 9.