Treasury officials have recently suggested that the Financial Stability Oversight Council (FSOC) may soon designate the first round of systemically significant nonbank financial companies (Nonbank SIFIs). In March, Under Secretary for Domestic Finance Miller and Deputy Assistant Secretary for the FSOC Gerety stated that designations could occur “in the next few months.”

Moreover, the Board of Governors of the Federal Reserve System (Federal Reserve) recently finalized its rule on determining when a company is “predominantly engaged in financial activities,” thus making the company potentially subject to FSOC designation. The final rule is notable for stating that an investment firm that does not comply with the Merchant Banking Rule’s investment holding periods and routine management and operation limitations may nonetheless be determined, on a case- by-case basis, to be engaging in “financial activities.” In addition, the final rule rejected the argument that mutual funds — including money market mutual funds — are “not engaged in a financial activity” and therefore not capable of designation.

…continue reading: FSOC Designation: Consequences for Nonbank SIFIS

On March 26, the Basel Committee on Banking Supervision (“Basel Committee”) published a Consultative Document in which it proposes a revised supervisory framework for measuring and controlling large counterparty exposures (“Proposal,” or “Exposure Framework”) of systemically important financial institutions (“SIFIs”). Comments on the Proposal are due by June 28, 2013.

…continue reading: Basel Committee Proposes to Double Down on Counterparty Exposure Limits

On December 10, 2012, the Federal Deposit Insurance Corporation (“FDIC”) and the Bank of England released a white paper, Resolving Globally Active, Systemically Important, Financial Institutions, [1] describing how each would resolve a materially distressed or failing financial institution that is globally active and systemically important (“G-SIFI”) in order to maintain the G-SIFI’s ongoing and viable operations, and contain any threats to financial stability. The paper reflects the work of U.S. and UK authorities [2] in developing resolution strategies for the failure of G-SIFIs in accordance with standards developed by the Financial Stability Board, [3] but does not go into detail on the strategic options that may be available.

The white paper warrants the close attention of G-SIFIs and their stakeholders, particularly their unsecured debtholders. The paper memorializes the consensus view of the FDIC and the Bank of England that a top-down or single-point-of-entry approach is the preferred (although not the sole) method of resolving a G-SIFI. [4] This approach could transform certain unsecured debt into equity or convertible debt and should cause G-SIFIs to review their organizational structure. Also of interest are the FDIC’s and Bank of England’s perspectives on the critical powers and preconditions for a successful resolution and what legislative or regulatory changes may be necessary.

…continue reading: FDIC and Bank of England Release White Paper

Implementation of the Dodd-Frank Act: Measures to Address Systemic Risk

The economic dislocations we have experienced in recent years, which have far exceeded those associated with any recession since the 1930s, were the direct result of the financial crisis of 2007-08. The reforms enacted under the Dodd-Frank Act were aimed at addressing the root causes of the crisis. Foremost among these reforms were measures to curb excessive risk-taking at large, complex banks and non-bank financial companies, where the crisis began. Title I of the Dodd-Frank Act includes new provisions that enhance prudential supervision and capital requirements for systemically-important financial institutions (SIFIs), while Title II authorizes a new orderly liquidation authority that significantly enhances the ability to resolve a failed SIFI without contributing to additional financial market distress.

SIFI Resolution Authorities

The most important new FDIC authorities under the Dodd-Frank Act are those that provide for enhanced resolution planning and, if needed, the orderly resolution of SIFIs. Prior to the recent crisis, the FDIC’s receivership authorities were limited to federally insured banks and thrift institutions. There was no authority to place the holding company or affiliates of an insured institution or any other non-bank financial company into an FDIC receivership to avoid systemic consequences. The lack of this authority severely constrained the ability of the government to resolve a SIFI and contributed to the excessive risk taking that led to the crisis.

…continue reading: Enhancing Bank Supervision and Reducing Systemic Risk

On April 3, 2012 the Financial Stability Oversight Council issued its final rule and interpretive guidance governing its process for designating a nonbank financial company as a systemically important financial institution under the Dodd-Frank Act. The adoption of the Final Rule marks the completion of the highly anticipated standards for designating SIFIs, a process that first began in October 2010. While there have been changes made to the process, much remains to be understood how the FSOC will use its authority to determine whether a nonbank financial company should be supervised and subject to prudential standards. It is widely anticipated that designations of some SIFIs will be made before year-end, making us wonder whether the designation process has been underway without final rules being in place.

The Statute

Section 113 of the Dodd-Frank Act [1] authorizes the Financial Stability Oversight Council (“FSOC”) to designate a nonbank financial company to be supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and be subject to prudential standards. [2] The FSOC will make a designation after determining that material financial distress at the company or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company could pose a threat to the financial stability of the United States.

…continue reading: Final Rule Issued on Systemically Important Firms, Many Unknowns Remain