The Dodd-Frank Act provided the Financial Stability Oversight Council (“FSOC”) with the authority to require federal supervision of certain non-bank financial companies and to impose prudential standards upon such firms if it is determined that the financial distress or the size, interconnectedness or activities of such firms pose a threat to the financial stability of the United States. On 18 January 2011, the FSOC met to discuss certain aspects of implementation of the Dodd-Frank Act.  

Supervision and Regulation of Certain Nonbank Financial Companies

The FSOC published a proposed rule on 18 January 2011 identifying the framework that could be used to determine whether a non-bank financial company could pose a threat to the financial stability of the entire United States and implementing the process under which a firm would be considered for federal supervision and the imposition of prudential standards. A large insurer could be subject to this framework. The proposed framework for assessing systemic importance includes factors such as size, lack of substitutes for the financial services and products the company provides, interconnectedness with other financial firms, leverage, liquidity risk and maturity mismatch, and existing regulatory scrutiny. This proposed rule has a 30-day public comment period that will close on 25 February 2011. It is expected that further action by FSOC on the final designation criteria and process will take place later this year.

The Volcker Rule

The Volcker Rule limits the proprietary trading and the investments in hedge funds and private equity funds of certain financial institutions that benefit from federal deposit insurance or the discount window of the Federal Reserve System. The Dodd-Frank Act generally exempts from the proprietary trading ban traditional investment activities of regulated insurance companies, subject to compliance with applicable state insurance laws. However, there are two types of insurance companies subject to the Volcker Rule, insurance companies that are affiliates of federally insured banks or thrifts and those that are subject to supervision by the Federal Reserve Board. On 18 January 2011, the FSOC released a study on the Volcker Rule that sets forth recommendations to identify and eliminate prohibited proprietary trading activities and prohibited investments in (or sponsorships of) hedge funds and private equity funds by banking entities. The study addresses proprietary trading by outlining criteria for defining prohibited trading activities, recommending indicia-based tests to identify permitted activities, and then identifying the grounds upon which certain high-risk activities could be prohibited. The study addresses investments or sponsorship of hedge funds and private equity funds by recommending certain substantive criteria to guide federal agencies in rulemaking and by recommending a framework for compliance and supervision.  

Agencies have nine months after the completion of this study to adopt rules to implement the Volcker Rule. Agencies must consider the recommendations of the FSOC in drafting their regulations. Agencies must also communicate with one another to harmonize their respective regulations to ensure for level execution of Volcker Rule principles between parallel agencies.