FSOC Issues Proposed Rule on Systemically Important Non-Bank Financial Companies

Proposed guidelines for determining whether non-bank financial companies are "systemically important" under Dodd-Frank have been released, and the potential impact on the insurance industry may be less than previously feared.

The Financial Stability Oversight Council ("FSOC") recently released proposed guidelines for determining whether non-bank financial institutions, including insurance companies, should be deemed "systemically important" under the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). Despite concerns that FSOC could impose federal regulatory oversight on insurers and other non-bank entities that are traditionally state regulated, the proposed criteria seem to limit the potential impact on insurers.

The proposed criteria seem to limit the potential impact on insurers.

The designation of Non-bank Systemically Important Financial Institutions ("SIFIs") under Dodd- Frank is essentially a three-step process under the proposed FSOC rules.[1]

The trigger for detailed review by FSOC under the proposed rules is an entity that has at least $50 billion in total consolidated assets and that meets or exceeds one or more of the following thresholds:

• $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;
• Leverage ratio of total consolidated assets (excluding separate accounts) to total equity of 15 to 1; and
• Short-term debt ratio of debt with a maturity of less than twelve (12) months to total consolidated assets (less separate accounts) of ten percent (10%).

Once a detailed review of a non-bank financial entity by FSOC is triggered, the second step of analysis is a detailed internal review of the entity based on information from public and regulatory sources.[2]

The third phase of the evaluation under the proposed rules involves FSOC requesting additional information directly from the subject non-bank financial company.

If the FSOC determines that a systemically important designation is appropriate, the entity is afforded an opportunity to object.

Finally, if the FSOC determines that a systemically important designation is appropriate, the entity is afforded an opportunity to object to that determination with written reasons. Thereafter, FSOC votes on the systematically important designation. After the vote, the subject company may request a hearing as well as an additional vote of the FSOC after the hearing.[3]

Insurance industry insiders are welcoming the proposed rule, encouraged by the fact that size alone is not the sole factor in determining systematic risk. According to an article by Business Insurance, J. Stephen Zielezienski, senior vice president and general counsel of the American Insurance Association had this to say:

This guidance suggested that while size is a required threshold at Stage 1, it is not the sole factor for that screening process…

I think Stage 1 provides quantifiable metrics that should help all nonbank financial companies determine whether or not they will be screened out of the designation process at Stage 1.

Ben McKay, senior vice president in the Property Casualty Insurers Association of America also welcomed the proposed rules as good news, according to Business Insurance. However, McKay suggested that the proposed rules should also include cyclicality as a criterion, noting that insurance companies tend to have sources of income that are more steady than the rise and fall of the stock market and therefore the economic downturns that can affect other financial institutions may have less impact on the insurance industry. [4]

The proposed rule is available in PDF form here.

1.  United States: FSOC Clarifies SIFI Designation Process; Mondaq; October 16, 2011; Kara Baysinger, Mike Zolandz, John Finston and Jerome Walker.
2.  United States…; Id.
3.  United States…; Id.
4.  Property/casualty insurers may dodge FSOC scrutiny; Business Insurance; October 16, 2011; Mark A. Hofmann.

FSOC Issues Final Rule on Nonbank SIFI Designation But Questions, Concerns Remain

The Financial Stability Oversight Council (FSOC) has issued a final rule regarding how it will evaluate nonbank financial institutions for designation as Systematically Important Financial Institutions (SIFIs) subject to further federal regulation under the Dodd-Frank Act; nevertheless, questions and concerns about the designation process remain.

The Financial Stability Oversight Council (FSOC or the Council) has published a final rule laying out the three-step process by which it determines those nonbank financial institutions that pose a "systematic risk" to the national economy such that they are subject to heightened regulation under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Dodd-Frank opened the door for the Treasury to oversee "systemically risky" nonbank financial companies.

The Dodd-Frank Act "opened the door for the U.S. Treasury to oversee nonbank financial companies that presented a systemic risk to the U.S. financial system." The final rule, which takes effect May 11 of this year, is another step towards regulating nonbank financial companies, such as insurance companies, deemed to be systemically risky.[1]

The Financial Stability Oversight Council ("the Council") today took another key step toward increasing oversight and addressing risks to U.S. financial stability by issuing the final rule and guidance that details the analysis and process the Council intends to use when determining which nonbank financial companies should be subject to enhanced prudential standards and to supervision by the Board of Governors of the Federal Reserve System.[2]

The FSOC rule identifies certain initial financial thresholds that will serve as the first step of the three-stage process to designate a nonbank company as a Systemically Important Financial Institution (SIFI).

Stage 1 includes a financial threshold of $50 billion of total consolidated assets.

A Nonbank financial institution will be subject to further analysis for SIFI designation if the company has at least $50 billion of total consolidated assets, and it meets or exceeds any one of the following thresholds:

• $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 total debt outstanding;
• 15-to-1 leverage ratio, as measured by total consolidated assets (excluding separate accounts) to total equity; or
• 10% ratio of short-term debt (having a remaining maturity of less than 12 months) to total consolidated assets.[3]

FSOC has indicated that, with respect to foreign nonbank financial companies, the Council intends to calculate these "Stage 1 thresholds" based solely on the United States "assets, liabilities and operations of the foreign nonbank financial company and its subsidiaries."[4]

In addition, the Council may consider any nonbank financial company for a determination if the Council believes the company could pose a threat to U.S. financial stability.[5]

The fact that a company meets the Stage 1 thresholds and therefore comes under additional scrutiny by FSOC through this process does not mean that the company will necessarily be subject to a final designation as a SIFI by the Council.[6]

At Stage 2 of the process under the final rule, FSOIC will analyze those companies passing the Stage 1 thresholds using "a broad range of information available to the Council primarily through existing public and regulatory sources."[7]

Stage 3 involves direct contact between FSOC and companies under SIFI designation analysis.

The final step of the process, Stage 3, involves direct contact by FSOC with each nonbank financial institution that has passed through Stages 1 and 2 of the SIFI designation analysis. FSOIC will notify the company that it is under consideration for SIFI designation, and the Council will request additional information directly from the company. The company will also have "an opportunity to submit written materials related to the Council’s consideration of the company for a proposed determination."[8]

At the end of Stage 3, based on the results of the analyses conducted during each stage of review, the Council may, by a vote of at least two-thirds of the Council’s voting members then serving, including an affirmative vote by the Chairperson of the Council, make a proposed determination regarding the company. If a proposed determination is made, the Council will provide the nonbank company with a written explanation of the basis of the proposed determination. The company may request a hearing to contest the proposed determination. In order to make a final determination, the Council must again vote by a two-thirds majority, including an affirmative vote by the Chairperson.[9]

While the thresholds relating to Stage 1 are clearly defined, many parts of the rules remain unclear. For example, the final rule lists eleven (11) considerations that FSOC will consider in making a SIFI determination, including the extent of the leverage of the target company and its subsidiaries, the nature and extent of the off-balance-sheet exposures of the target company and its subsidiaries, and the importance of the target company and its subsidiaries as a source of liquidity for the U.S. financial system.[10]

Details of the application of these considerations to the SIFI designation analysis include, without limitation:

• How will leverage be measured?
• How will the nature and extent of off-balance-sheet exposures be quantified?
• What metrics will be employed to determine the quantitative or qualitative importance of a company as a source of liquidity for the U.S. financial system?

Thus, although FSOC suggests that the final rule has provided important clarifications of issues raised during the rule-making process, many questions and concerns still remain with respect to the SIFI designation process.

1. FSOC Rule Begins Definition of Insurers Posing Systemic Risk, Anthony O'Donnell, Insurance & Technology, April 12, 2012.
2. Financial Stability Oversight Council Approves Rule To Designate Nonbank Financial Companies For Enhanced Oversight, Help Prevent Future Financial Crises, U.S. Department of the Treasury, April 4, 2012.
3. Nonbank Financial Company Designations Final Rule and Interpretive Guidance Fact Sheet, U.S. Department of the Treasury.
4. Nonbank Financial Company Designations Final Rule…, id.
5. Nonbank Financial Company Designations Final Rule…, id.
6. Nonbank Financial Company Designations Final Rule…, id.
7. Nonbank Financial Company Designations Final Rule…, id.
8. Nonbank Financial Company Designations Final Rule…, id.
9. Nonbank Financial Company Designations Final Rule…, id.
10. Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies, 12 CFR § 1310.11(a).