Alert February 01, 2011

FSOC Issues Proposed Rule on the Designation of Systemically Significant Nonbank Financial Companies

The Financial Stability Oversight Council (“FSOC”) issued a notice of proposed rulemaking (the “Proposed Rule”) setting forth the criteria and framework for determining whether a nonbank financial company should be designated systemically significant pursuant to section 113 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  For previous coverage of the designation of systemically significant nonbank financial companies and the Dodd-Frank Act generally, please see the July 28, 2010 Special Edition of the Alert

Under the Dodd-Frank Act, if any company has 85% or more of its annual gross revenues or consolidated assets related to activities that are predominately financial in nature (as defined by section 4(k) of the Bank Holding Company Act of 1956, as amended,) the company may be designated as systemically significant and become subject to regulation by the FRB, including heightened prudential standards and other restrictions.  The Proposed Rule does not indicate whether certain types of nonbank financial companies are per se subject to or safe from designation as systemically significant.  The Proposed Rule established six criteria to be used to determine whether a nonbank financial company is systemically significant:

  • Size;
  • Lack of substitutes for the financial services and products the company provides;
  • Interconnectedness with other financial firms;
  • Leverage;
  • Liquidity risk and maturity mismatch; and
  • Existing regulatory scrutiny.

The FSOC divides these six criteria into two groups.  The first three criteria are intended to assess the potential effect from a company’s distress on the broader financial system or the economy.  The second three criteria are intended to assess how vulnerable a company is to financial distress.  The Proposed Rule also states that the application of these criteria will be adapted to fit the risks presented by particular industry sectors and the business models of such sectors.  The Proposed Rule further notes that the metrics used to measure the six criteria likely will differ across industry sectors and will be reviewed and revised by the FSOC on a periodic basis. 

The Proposed Rule implements the provisions of the Dodd-Frank Act requiring the FSOC to give companies advance notice of a proposed designation as systemically significant and the opportunity for a hearing.  Additionally, under the Proposed Rule, the FSOC would give a company written notice that it is considering designating the company as systemically significant and allowing the company to submit written materials to the FSOC regarding whether the company would pose a threat to the financial stability of the United States.  The Proposed Rule also implements the provisions of the Dodd-Frank Act permitting the FSOC to request that the FRB conduct an examination of a nonbank financial company to determine whether it should be designated as systemically significant and requiring consultation with other regulatory agencies.  Comments on the Proposed Rule must be submitted by February 27, 2011.