In the wake of considerable political and industry scrutiny, the Financial Stability Oversight Council (FSOC) released its proposed criteria for assessing the systemic risk of non-bank financial institutions. In recent months, the absence of such criteria was the subject of extensive bipartisan criticism, particularly given that non-bank entities such as insurers have not previously been subject to federal regulation. The FSOC proposal will now be open to public comment until December 12, 2011.

The manner in which the FSOC would implement the statutory mandate under Section 113 of Dodd-Frank has been a topic of considerable focus since the law was enacted in July 2010. The FSOC has the authority to require any enterprise, regardless of whether it is currently regulated by federal oversight, to be supervised by the Federal Reserve in circumstances where the FSOC determines that the enterprise poses "a threat to the financial stability of the United States." An earlier set of criteria proposed by the FSOC in January had been uniformly criticized as vague, forcing the Council to revisit its approach and develop a more detailed series of factors to be used in evaluating the risk quantum of non-bank companies.

Among the most watched aspects of Dodd-Frank, the designation of Non-bank Systemically Important Financial Institutions (SIFIs), represents what has been described as a "central" aspect of Dodd-Frank implementation. The FSOC proposal would create a three stage framework for evaluating companies across industry sectors, and would also attempt to harmonize the FSOC review process through a set a standardized criteria. The first stage would be to identify companies subject to further review using the criteria set forth below. The second stage would be for the FSOC to conduct an internal review based on information available from public and regulatory sources. The final stage would entail the FSOC contacting companies that the FSOC believes merit further review to obtain additional information. If, based on this three stage process, the FSOC concludes a company may be a SIFI, the company will be provided the opportunity to submit written materials contesting the determination. After the three stage review, the FSOC will vote on the recommended determination, and the company will have the right to request a hearing and request an additional vote of the FSOC at the conclusion of the hearing. The proposed rule can be found on the US Department of the Treasury's website.

Importantly, the criteria established by the FSOC would have widespread application across industries, as the standards for review are closely linked to a company's use of the financial system as a proxy for risk. For example, the FSOC criteria for more detailed review and potential designation include any nonbank financial company with at least $50 billion in total consolidated assets and meet one of more of the following:

  • $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 outstanding loans borrowed and bonds issued
  • 15 to 1 leverage ratio, as measured by total consolidated assets (excluding separate accounts) to total equity
  • 10 percent ratio of short-term debt (having a remaining maturity of less than 12 months) to total consolidated assets

In the coming weeks, these criteria will face extensive review -- along with the timing and "phased" approach proposed by the FSOC for reviewing non-bank SIFIs. The stakes are significant for companies potentially facing the gauntlet of review, as a SIFI designation will carry with it a series of requirements for regulatory oversight, the development of wind down of "funeral" plans, and the potential for forced capital raises or termination of business practices deemed too "risky" in the context of Dodd-Frank.