Nonbank financial companies (“nonbank companies”) looking for some hints regarding the likelihood that they could be designated as a systemically sig-nificant (“significant nonbank”) by the Financial Stability Oversight Council (“FSOC”) under Title I of the Dodd-Frank Act (“Act”) were disappointed on January 18, 2011, when FSOC issued its Notice of Proposed Rulemaking (“Proposal”). The FSOC provided only limited guidance as to how it intends to apply the criteria to various industries or whether any particular compa-nies or industries are more or less likely to be targeted for designation. Fur-ther, the limited guidance offered is contained in the preamble of the Pro-posal rather than in the proposed rule itself, presumably in order to leave the FSOC with broad discretion in making these determinations. Comments on the Proposal will be due 30 days after its publication in the Federal Register.

Analysis of the Proposal

In the wake of the serious financial dislocations experienced over the last few years, Section 113 of the Act empowers the FSOC to designate a non-bank company for special supervision by the Board of Governors of the Federal Reserve System. Such a designation would occur if the FSOC determined that material financial distress at the company or the nature, scope, size, scale, concentration, inter-connectedness, or mix of the activities of the com-pany could pose a threat to the financial stability of the United States (i.e., that the nonbank com-pany is systemically significant). Special supervi-sion would include enhanced prudential standards and the requirement for a living will. The Act lists 10 specific factors the FSOC must consider in de-termining whether a nonbank company is systemi-cally significant, in addition to any other risk fac-tors that the FSOC deems appropriate.

The Proposal follows the FSOC’s October 6, 2010 issuance of an advanced notice of proposed rule making (“ANPR”), which received significant public comment.1 In the ANPR, the FSOC sought guid-ance with respect to each of the statutory factors and how they should be weighed through a series of specific questions. The specificity of those ques-tions may have led some to expect that the FSOC would provide specific regulatory guidance regard-ing how the FSOC proposes to weigh and consider the statutory factors when contemplating or mak-ing a determination. However, as noted above, the preamble of the Proposal provides only limited guidance as to the FSOC’s likely analytical ap-proach. It essentially restates the statutory factors, apparently with the intent of leaving the FSOC with the broadest possible discretion to make whatever judgment it deems appropriate in any given case.

In its preamble, the Proposal restates the specific ques-tions that were raised for comment in the ANPR, and provides a short summary of the comments received in response to each question. However, the Proposal gen-erally does not provide any indication of the FSOC’s views with respect to those comments. The preamble to the Proposal merely sorts the statutory factors into six broad categories that the FSOC would consider when determining whether to designate a nonbank company as a significant nonbank and further organizes these categories into two groups. One group of factors— (i) a nonbank company’s size, (ii) the lack of substitutes for the financial services and products the nonbank company provides, and (iii) interconnectedness with other financial firms—would assess the potential for contagion from a firm’s distress to the broader financial system or the economy. The other group of factors— (i) leverage, (ii) liquidity risk and maturity mismatch, and (iii) existing regulatory scrutiny—would assess how vulnerable a nonbank company is to financial distress. The preamble also includes a chart that specifies under which of the six broad categories each individual statu-tory criterion would be considered.

The preamble also indicates that the FSOC would use the six categories when reviewing all industry sectors, although the FSOC would apply these categories differ-ently to different industries as appropriate. The pream-ble does not provide any specific guidance as to how the FSOC would go about determining how to weigh the categories with respect to particular entities or indus-tries. The preamble does clarify that the fact that a nonbank company has received federal assistance would not be considered as a separate criterion in the FSOC’s proposed evaluation framework.

In addition, the FSOC indicates its intention to retain the right to consider any other risk-related factors it deems appropriate, either through regulation or on a case-by-case basis. While the preamble indicates that the FSOC would use “quantitative metrics” when possible in evaluating a nonbank company, the preamble specifi-cally states that the FSOC would be free to use its in-formed judgment when making a determination.

In addition to the statutory factors discussed above, the proposed regulation would implement other provisions of Section 113 of the Act regarding (i) the anti-evasion authority of the FSOC, (ii) notice to and hearings for nonbank companies regarding their proposed systemi-cally significant determinations and (iii) consultation, coordination and judicial review with respect to deter-minations.

One procedural note: the notice and hearing portions of the regulation include a provision that is not contained in the Act which would require the FSOC to provide a nonbank company with written notice that the FSOC is considering whether to determine that the nonbank company is systemically significant. Once this notice is issued, the nonbank company would have the opportu-nity to submit written materials setting forth its views. If the FSOC then determined that it intended to proceed, it would provide a subsequent written notice to the non-bank company, including an explanation of the basis for the proposed determination. At that time, the nonbank company would have an opportunity to request and re-ceive an oral or written hearing before the FSOC to con-test the proposed determination. Only after any hearing or opportunity for hearing would the FSOC make a final determination.2 Allowing nonbank companies to provide relevant materials to the FSOC before it makes an initial determination may be intended to help the FSOC de-termine how to apply the six categories in a given case, without adopting a formal procedure to do so.