On Tuesday, October 11, the Financial Stability Oversight Council (the "Council") held a meeting at which it approved the issuance of the proposed rule for the designation of non-bank financial institutions as systemically important. The proposed rule designates which nonbank financial institutions, such as hedge funds and insurance companies, could by their nature, scope, size, scale, concentration, or interconnectedness, pose a threat to the financial stability of the United States. These designated nonbank financial institutions would be subject to supervision by the Board of Governors of the Federal Reserve System and to enhanced prudential standards as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). Such designated nonbank financial institutions are commonly called Systemically Important Financial Institutions ("SIFIs").

In January of this year, the Council released a proposed rule addressing the designation of SIFIs. However, many industry groups regarded it as lacking specifics. With this new proposed rule, the Council provides a more detailed explanation of the designation process and the nonbank financial institution's role in that process.

The Council proposes using a three-part test to determine which nonbank financial institutions will be designated SIFIs. First, the Council will apply uniform quantitative thresholds to identify those nonbank financial institutions that will be subject to further evaluation. The quantitative threshold used in the first stage is crossed if the nonbank financial institution has at least $50 billion in total consolidated assets and meets or exceeds any one of the following thresholds:

  • $30 billion in gross notional credit default swaps outstanding for which the nonbank financial institution is the reference entity;
  • $3.5 billion in derivative liabilities;
  • $20 billion in outstanding loans borrowed and bonds issued;
  • 15-to-1 leverage ratio, as measured by total consolidated assets (excluding separate accounts) to total equity; or
  • 10 percent ratio of short-term debt (having a remaining maturity of less than 12 months) to total consolidated assets.

An institution that crosses this threshold moves into stage two of the designation process. Here, the Council analyzes the institution using a broad range of information available from existing public and regulatory sources. The third and final stage of evaluation requires the Council to obtain information directly from the nonbank financial institution being evaluated that was not available in the earlier two stages of evaluation. Each institution that reaches stage three of the evaluation process will be notified that it is under consideration and be given the opportunity to submit written materials to the Council addressing the institution's evaluation and possible designation as a SIFI.

After all three stages of evaluation are completed a two-thirds vote of the Council's voting members, including the affirmative vote of the Council's chairperson, the Secretary of the Treasury, would designate the evaluated nonbank financial institution as a SIFI. If such a designation is made, the Council will provide the newly designated SIFI with a written explanation of the basis for the designation. The institution may then request a hearing to contest the designation. A final determination again requires a two-thirds vote, including the affirmative vote of the Council's chairperson.

Comments on the proposed rule are due 60 days after publication in the Federal Register. The Council is not expected to designate any companies as SIFIs until early to mid-2012 at the earliest. Whenever it occurs, the designation and regulation of SIFIs will be the latest Dodd-Frank Act requirement to fundamentally alter the way financial institutions do business.