On January 26, 2011, the Financial Stability Oversight Council ("FSOC"), which was created under the Dodd-Frank Wall Street Reform and Consumer Protection Act, published a Notice of Proposed Rulemaking describing the criteria the FSOC will apply to determine if nonbank financial companies should be designated as systemically important and, therefore, subject to heightened supervision by the Federal Reserve. The proposed rule would establish a regulatory framework for determining systemic importance based on regulatory considerations in a number of broad categories, closely tracking the standards set forth in the Dodd-Frank Act.

The proposed rule states that a nonbank firm that falls into financial distress is more likely to pose a systemic threat to the US economy if the firm is large, provides critical financial services for which there are few substitutes, and is highly interconnected with other financial firms or markets. Moreover, the proposed rule notes that firms that are highly leveraged, have a high degree of liquidity risk or maturity mismatch, and are under little or no regulatory scrutiny are more vulnerable to financial distress and therefore pose a greater systemic threat to US financial stability. The FSOC will apply criteria such as leverage, liquidity risk and maturity mismatch, as well as existing regulatory scrutiny to assess a firm’s vulnerability to financial distress, and will use quantitative metrics and its own judgment to determine whether a firm should be designated as systemically important and supervised by the Board.

Insurers and reinsurers have expressed concern over the details – or, rather, the lack of details – in the proposed rule, noting that the proposed standards lack the specificity companies need to determine if they will be considered systemically important. Insurance industry commentators have also noted that the proposed rule does not take into consideration unique aspects of the insurance sector and insurance regulation.

Finally, there has been significant concern raised across the spectrum – from industry, state regulators, and members of Congress, including Rep. Barney Frank – noting that FSOC is drafting rules that affect the insurance industry when two of the three FSOC members with insurance expertise have yet to be appointed. Missouri Insurance Director John Duff is the only insurance representative on the FSOC. He is a nonvoting member. The two open slots are to be filled by an independent insurance expert and the director of the Federal Insurance Office.