In April 2012, the Financial Stability Oversight Council (“FSOC”) issued its Final Rule (the “Rule”) and interpretive guidance on the regulation of systemically important nonbank financial companies, or what many refer to as SIFIs (i.e., “systemically important financial institutions”). Under Section 113 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), FSOC is authorized to determine that a nonbank financial company (e.g. insurers and reinsurers) will be supervised by the Board of Governors of the Federal Reserve System (“FRB”) and subject to prudential standards if:
- “material financial distress” at the nonbank financial company could pose a threat to the financial stability of the U.S.; or
- the nature, scope, size, scale, concentration, interconnectedness, or mix of the nonbank financial company’s activities could pose a threat to U.S. financial stability.1
FSOC will use a three-stage process to determine whether a nonbank financial company is a SIFI, as follows:
- First Stage – FSOC will apply uniform quantitative thresholds to measure size, interconnectedness, leverage, and liquidity risk and maturity mismatch, based on information obtained through public and regulatory sources. A nonbank financial company would be subject to further review if it meets, both, the size threshold -- which is established at $50 billion in consolidated assets -- and any one of the other enumerated quantitative thresholds.2
By disclosing these thresholds, FSOC believes this stage will provide some predictive value for companies. However, FSOC has indicated that it may subject any nonbank financial company to further review if it believes that additional analysis is warranted to determine if the company could pose a threat to U.S. financial stability, irrespective of whether the company meets the thresholds above.
- Second Stage – Nonbank financial companies identified in the first stage or otherwise deemed to warrant further review, will be subject to further consideration through a more qualitative lens of the following factors:
- Size. For insurers, factors which may be considered include the amount of direct written premiums and risk in force.
- Interconnectedness. E.g., Exposure of counterparties to the material financial distress of the nonbank financial company.
- Substitutability. E.g., Are other firms able to provide similar financial services without market disruption if the nonbank financial company withdraws from a particular market?
- Liquidity risk and maturity mismatch.
- Existing regulatory scrutiny.
- Third Stage – Before a determination that a nonbank financial company will be subject to regulation by the FRB (i.e., that it is a SIFI), FSOC will provide the nonbank financial company with a notice and an opportunity to submit written materials to contest FSOC’s consideration of a proposed determination. FSOC may consult with the subject company’s primary regulator and will consider the views of such entity.
The nonbank financial company may then request a hearing before FSOC to contest FSOC’s proposed determination in accordance with section 113(e) of the Dodd-Frank Act and § 1310.21(c) of the Rule. If FSOC proceeds with its proposed determination, the company may bring an action under section 113(h) of the Dodd-Frank Act in U.S. district court in the jurisdiction in which the company’s home office is located, or in the U.S. district court for the District of Columbia, seeking an order requiring that the final determination be rescinded. The relevant standard is whether the determination was arbitrary and capricious.