The Federal Reserve recently adopted a final rule that establishes requirements for determining when a company is predominately engaged in financial activities for purposes of identifying a nonbank financial company as a systematically important financial institution (a “SIFI”). The final rule also defines the terms significant nonbank financial company and significant bank holding company.

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Financial Stability Oversight Council (the “FSOC”) may only designate a company as a SIFI if it is a “nonbank financial company” whose material financial distress or whose scope, size and scale of activities could pose a threat to the financial stability of the United States. Firms designated as SIFIs will be subject to enhanced regulatory scrutiny by the Federal Reserve. As discussed in more detail in a previous Alert, the FSOC released a final rule in April 2012 regarding the three-part process for determining whether nonbank financial firms are SIFIs. Before applying this process, a nonbank financial firm must first qualify as a “nonbank financial company.”

A “nonbank financial company” is defined as a company that is “predominately engaged in financial activities.” The Dodd Frank Act defines a company as “predominantly engaged in financial activities” if 85% or more of the company's annual gross revenues or consolidated assets are related to activities that are defined as financial in nature under Section 4(k) of the Bank Holding Company Act (the “BHC Act”). The final rule clarifies this definition in several respects:

  • First, the final rule provides that the 85% threshold applies to either of the two most recent fiscal years. Furthermore, the Federal Reserve or the FSOC may determine, based on all facts and circumstances, that a company meets the 85% threshold under either the revenue or asset tests, without regard to the two-year limitation.
  • Second, the final rule sets forth mechanics and rules to determine whether assets or revenues are related to financial activities. For instance, under these rules, cash is excluded from the financial assets because cash is not attributable to a particular activity. Cash equivalents would be included as assets related to financial activity because they represent investments and accounts receivable are presumed to be related to financial activity (by extension of credit) but may be excluded with evidence to the contrary.
  • Finally, the rule clarifies the scope of “financial activities.” “Financial activities” are defined by reference to Section 4(k) of the BHC Act. These activities include, among others, investing for others, leasing personal or real property, offering investment or financial advisory services, selling interests in asset pools and servicing loans. The final rule specifically notes that private equity funds (and their advisers and managers) are deemed to engage in financial activities.

The final rule also defines the terms significant nonbank financial company and significant bank holding company. A significant nonbank financial company is defined as any nonbank financial company (i) supervised by the Federal Reserve or (ii) that had $50 billion or more in total consolidated assets as of the end of its most recently completed fiscal year. A significant bank holding company is any bank holding company or company treated like a bank holding company in the United States that had $50 billion or more in total consolidated assets as of the end of the most recently completed calendar year. The FSOC will consider the extent and nature of a nonbank financial company’s transactions and relationships with significant nonbank financial companies and significant bank holding companies when determining whether to designate the company as a SIFI.

The text of the final rule can be found here. The final rule became effective on May 6, 2013.