FSOC Issues Final Rule on Nonbank SIFI Designation But Questions, Concerns Remain

The Financial Stability Oversight Council (FSOC) has issued a final rule regarding how it will evaluate nonbank financial institutions for designation as Systematically Important Financial Institutions (SIFIs) subject to further federal regulation under the Dodd-Frank Act; nevertheless, questions and concerns about the designation process remain.
The Financial Stability Oversight Council (FSOC or the Council) has published a final rule laying out the three-step process by which it determines those nonbank financial institutions that pose a "systematic risk" to the national economy such that they are subject to heightened regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Dodd-Frank opened the door for the Treasury to oversee "systemically risky" nonbank financial companies.
The Dodd-Frank Act "opened the door for the U.S. Treasury to oversee nonbank financial companies that presented a systemic risk to the U.S. financial system." The final rule, which takes effect May 11 of this year, is another step towards regulating nonbank financial companies, such as insurance companies, deemed to be systemically risky.[1]
The Financial Stability Oversight Council ("the Council") today took another key step toward increasing oversight and addressing risks to U.S. financial stability by issuing the final rule and guidance that details the analysis and process the Council intends to use when determining which nonbank financial companies should be subject to enhanced prudential standards and to supervision by the Board of Governors of the Federal Reserve System.[2]
The FSOC rule identifies certain initial financial thresholds that will serve as the first step of the three-stage process to designate a nonbank company as a Systemically Important Financial Institution (SIFI).

Stage 1 includes a financial threshold of $50 billion of total consolidated assets.
A Nonbank financial institution will be subject to further analysis for SIFI designation if the company has at least $50 billion of total consolidated assets, and it meets or exceeds any one of the following thresholds:
  • $30 billion in gross notional credit default swaps outstanding for which the nonbank financial company is the reference entity;
  • $3.5 billion in derivative liabilities;
  • $20 billion of total debt outstanding;
  • 15-to-1 leverage ratio, as measured by total consolidated assets (excluding separate accounts) to total equity; or
  • 10% ratio of short-term debt (having a remaining maturity of less than 12 months) to total consolidated assets.[3]
FSOC has indicated that, with respect to foreign nonbank financial companies, the Council intends to calculate these "Stage 1 thresholds" based solely on the United States "assets, liabilities and operations of the foreign nonbank financial company and its subsidiaries."[4]
In addition, the Council may consider any nonbank financial company for a determination if the Council believes the company could pose a threat to U.S. financial stability.[5]
The fact that a company meets the Stage 1 thresholds and therefore comes under additional scrutiny by FSOC through this process does not mean that the company will necessarily be subject to a final designation as a SIFI by the Council.[6]

At Stage 2 of the process under the final rule, FSOIC will analyze those companies passing the Stage 1 thresholds using "a broad range of information available to the Council primarily through existing public and regulatory sources."[7]

Stage 3 involves direct contact between FSOC and companies under SIFI designation analysis.
The final step of the process, Stage 3, involves direct contact by FSOC with each nonbank financial institution that has passed through Stages 1 and 2 of the SIFI designation analysis. FSOIC will notify the company that it is under consideration for SIFI designation, and the Council will request additional information directly from the company. The company will also have "an opportunity to submit written materials related to the Council’s consideration of the company for a proposed determination."[8]
At the end of Stage 3, based on the results of the analyses conducted during each stage of review, the Council may, by a vote of at least two-thirds of the Council’s voting members then serving, including an affirmative vote by the Chairperson of the Council, make a proposed determination regarding the company. If a proposed determination is made, the Council will provide the nonbank company with a written explanation of the basis of the proposed determination. The company may request a hearing to contest the proposed determination. In order to make a final determination, the Council must again vote by a two-thirds majority, including an affirmative vote by the Chairperson.[9]
While the thresholds relating to Stage 1 are clearly defined, many parts of the rules remain unclear. For example, the final rule lists eleven (11) considerations that FSOC will consider in making a SIFI determination, including the extent of the leverage of the target company and its subsidiaries, the nature and extent of the off-balance-sheet exposures of the target company and its subsidiaries, and the importance of the target company and its subsidiaries as a source of liquidity for the U.S. financial system.[10]

Details of the application of these considerations to the SIFI designation analysis include, without limitation:
  • How will leverage be measured?
  • How will the nature and extent of off-balance-sheet exposures be quantified?
  • What metrics will be employed to determine the quantitative or qualitative importance of a company as a source of liquidity for the U.S. financial system?
Thus, although FSOC suggests that the final rule has provided important clarifications of issues raised during the rule-making process, many questions and concerns still remain with respect to the SIFI designation process.



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