At the end of April, the Financial Stability Oversight Council (“FSOC”) published for public comment two proposals that would make it easier for FSOC to designate nonbanks as systemically important financial institutions (“SIFIs”).  The proposals, on which public comments are due by June 27, 2023, revise and reverse the designation approach taken during the Trump Administration and are in line with the Biden Administration’s broader objective to reinvigorate FSOC.[1]

Specifically, the proposals released by FSOC are:

• proposed guidance (the “Proposed Guidance”) that would give FSOC greater flexibility in designating nonbanks as SIFIs by eliminating requirements imposed by 2019 Interpretive Guidance (the “2019 Guidance”) that FSOC first take an “activities-based approach” and conduct a cost-benefit analysis prior to designating an entity as a SIFI; and
• an analytic framework (the “Proposed Framework”) to identify, assess and respond to a company’s potential risk or threat to U.S. financial stability.

In this post, we (i) provide background that informs the issuance of the proposals, (ii) highlight certain key issues raised by the proposals (including notable changes between the proposals and existing legal and regulatory guidance) and (iii) discuss the potential impact that the proposals, if finalized, could have on nonbank financial companies.

I.  Background

FSOC has the authority, under the Dodd-Frank Act, to subject a nonbank financial company to Federal Reserve Board (“FRB”) supervision and enhanced prudential standards where FSOC either finds the company’s in material financial distress or the nature, scope, size, scale, concentration, interconnectedness or mix of the activities of the company could pose a threat to U.S. financial stability.[2]  In 2012, FSOC issued initial rules and interpretive guidance related to designation of nonbank financial companies as SIFIs (the “2012 Guidance”).[3]

During the Obama Administration, FSOC designated four nonbank financial companies, including three insurers, as SIFIs: (i) American International Group, Inc., (ii) General Electric Capital Corporation, (iii) Prudential Financial, Inc. and (iv) Metlife, Inc.  In April 2016, the U.S. District Court for the District of Columbia rescinded Metlife’s SIFI designation;[4] FSOC initially appealed the Metlife decision, but ultimately filed a joint motion with Metlife to dismiss that appeal in 2018.  Between June 2016 and October 2018, FSOC voted to rescind the designations of the remaining nonbank SIFIs.  Currently, there are no designated nonbank SIFIs.

To mark the Trump Administration’s shift to ease the stricter rules related to financial stability established under Dodd-Frank, FSOC in 2019 adopted new rules and the 2019 Guidance related to SIFI designations.  The 2019 Guidance replaced in its entirety the 2012 Guidance.  Notably, the 2019 Guidance required that FSOC first usean “activities-based approach” in its initial assessment of financial stability risks posed by institutions and “pursue entity-specific determinations . . . only if a potential risk or threat cannot be adequately addressed through an activities-based approach.”[5]  The 2019 Guidance also required FSOC to perform a cost-benefit analysis before making a SIFI designation and determine the likelihood of material financial distress at a company prior to designating that company as a SIFI.  The 2019 changes to FSOC’s SIFI assessment and designation process were at least in part responsive to the Metlife decision in which the Court found that in designating Metlife as a SIFI, FSOC (i) did not determine the likelihood of material financial distress, in violation of FSOC’s 2012 Guidance and (ii) did not conduct a cost-benefit analysis.[6]

II. Key Issues and Changes in the Proposals

A.  Proposed Guidance

In replacing the 2019 Guidance in its entirely, the Proposed Guidance would eliminate the 2019 Guidance’s requirements that, prior to designating any institution as a SIFI, FSOC must (i) initially take an activities-based assessment approach prior to designating any institution as a SIFI and (ii) conduct a cost-benefit analysis and determine the likelihood of material financial distress at an institution.  Some further details related to the Proposed Guidance are set forth below:

• Two-Stage Process. Under the Proposed Guidance, FSOC would implement a two-stage process of evaluation and analysis of any nonbank financial company prior to its designation as a SIFI.
  • Stage 1: Preliminary Evaluation of Nonbank Financial Companies. If the Proposed Guidance is finalized, a nonbank financial company identified for review will be notified by FSOC and subject to a preliminary analysis, based on quantitative and qualitative information available to FSOC primarily through public and regulatory sources.  FSOC will permit, but not require, the company to submit relevant information.  FSOC will also consult with the primary regulatory agency, as appropriate, of each significant subsidiary of the nonbank financial company.  During Stage 1, FSOC seeks to provide the company under review an opportunity to understand the focus of FSOC’s analysis.
  • Stage 2: In-Depth Evaluation. Any nonbank financial company selected for additional review (as a result of FSOC’s Stage 1 review) will be notified by FSOC that it is being considered for a proposed SIFI designation.  In its Stage 2 review and analysis, FSOC will evaluate additional, non-public information collected directly from the nonbank financial company.  The nonbank financial company will have the opportunity to submit written materials to FSOC during Stage 2.
• Proposed and Final Designations. Upon the completion of its two-stage review of a company, FSOC may consider whether to propose designating that company as a SIFI.  If FSOC decides to propose a SIFI designation, the nonbank financial company may request a hearing.  After making a proposed designation and holding any written or oral hearing, if requested, FSOC may vote to make a final designation.
• Annual Reevaluations of Previous Designations. Under the Proposed Guidance, FSOC will reevaluate a company’s SIFI designation at least annually and rescind the designation if FSOC determines that the company no longer meets the statutory standards for a designation.  During the annual reevaluations, the company will have an opportunity to meet with FSOC representatives to discuss FSOC’s review process and present information for FSOC’s consideration.  If FSOC does not rescind a designation, FSOC will provide the company with a written explanation addressing the material factors in its analysis.

B.  Proposed Framework

FSOC included analytic frameworks within the 2012 Guidance and 2019 Guidance. Rather than include an analytic framework in the Proposed Guidance, FSOC instead issued a separate analytic framework in the form of the Proposed Framework (issued simultaneously with the Proposed Guidance).  FSOC stated that the Proposed Framework is intended to help market participants and stakeholders better understand how FSOC evaluates potential risks to financial stability.  Some further details related to the Proposed Guidance are set forth below:

• Purpose of Proposed Framework. FSOC noted that its use of the proposed analytic framework would not be limited to informing its SIFI designation review and assessment process.  Instead, in addition to informing nonbank SIFI designations, FSOC will also use the Proposed Framework to determine whether FSOC should take other actions in response to identified risks posed to U.S. financial stability, including (i) encouraging interagency coordination and information sharing, (ii) making nonbinding recommendations to agencies or recommendations to Congress, (iii) designating payment, clearing and settlement activities as systemically important or likely to become systemically important and (iv) pursuing financial market utility designations.
• Vulnerabilities for Assessment. The Proposed Framework identifies several vulnerabilities that FSOC would generally consider in evaluating potential risks to U.S. financial stability, regardless of whether those vulnerabilities arise from activities, firms or otherwise.  Examples of some of these potential vulnerabilities include: (i) leverage, (ii) liquidity risk and maturity mismatch, (iii) interconnections, (iv) operational risks, (v) complexity or opacity, (vi) inadequate risk management, (vii) concentration and (viii) destabilizing activities.  Many of these vulnerabilities, including with respect to leverage, interconnections and liquidity, track with statutory factors that FSOC must consider prior to making a nonbank SIFI designation and with vulnerabilities identified in previous FSOC guidance.
• Potential Risk Transmission Channels. Finally, the Proposed Framework identifies four potential transmission channels of financial stability risks: (i) direct or indirect exposures of market participants, (ii) asset liquidations, (iii) critical functions or services and (iv) contagion.  FSOC has long identified the first three transmission channels in its designation frameworks, but contagion appears to be a new addition.  The Framework notes that contagion may arise from the “perception of common vulnerabilities or exposures” even without “direct or indirect exposures” as well as from “a loss of confidence in financial instruments”.

III.  Significance of the Proposals

The Proposed Guidance would enhance FSOC’s ability to designate nonbank financial companies as SIFIs by removing what Secretary Yellen called “inappropriate hurdles” created by the 2019 Guidance.[7]  By removing the activities-based approach initial review requirement promulgated in the 2019 Guidance from the Proposed Guidance, FSOC would potentially limit companies’ ability to know in advance whether the activities in which they are engaged would increase their likelihood of SIFI designation and also could limit such companies’ abilities to plan their future activities in order to mitigate SIFI designation risk.  Further, the Proposed Guidance’s removal of the cost-benefit analysis, a key part of the court decision to de-designate Metlife, is likely to be controversial and draw significant public comment.

If finalized as written, the proposals could impact a wide swathe of companies, from insurers and hedge funds to fintechs and stablecoin issuers.  Under the Proposed Framework, FSOC will monitor a broad range of assets, entities and activities in order to assess any risks to financial stability.  The Proposed Framework highlights that FSOC will take a “rigorous approach to identify, assess and address” risks to financial stability by using all of its available authorities with respect to risks it identifies to U.S. financial stability.

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[1]        88 Fed. Reg. 26234 (Proposed Guidance), available here; 88 Fed. Reg. 26305 (Proposed Framework), available here.

[2]        12 U.S.C. § 5323(a)(1).

[3]        77 Fed. Reg. 21637, available here.

[4]        Metlife, Inc. v. Financial Stability Oversight Council, 177 F.Supp.3d 219 (D.D.C. 2016).

[5]        84 Fed. Reg. 71740, 71747.

[6]        Metlife, 177 F. Supp 3d. 238-39, 242.

[7]        U.S. Department of the Treasury, “Remarks by Secretary of the Treasury Janet L. Yellen at Financial Stability Oversight Council Meeting” (Apr. 21, 2023), available here.