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From Banking and Finance Law Daily, February 5, 2015

FSOC adopts transparency-enhancing procedures

By Richard A. Roth, J.D.

In response to criticism over its process for deciding which nonbank financial companies should be designated systemically important financial institutions, the Financial Stability Oversight Council has changed some of its practices. The changes, which have immediate effect, will give companies an earlier notice if they come under consideration and give them a better opportunity to work with FSOC staff during the process. Also, companies that have been given the SIFI designation will have more opportunity to work with the FSOC staff during the annual reevaluation process. The Council also added in its announcement that it intends to make more information publicly available.

The Dodd-Frank Act gives the FSOC the task of deciding which financial institutions, including nonbank financial companies, could pose a danger to financial stability. These are known as systemically important financial institutions, or SIFIs. In the case of a nonbank, the decision is to be made based on whether material financial distress at the company, or the company’s size, complexity, and activities, could pose a danger (12 U.S.C. §5323). Designated companies are subject to supervision by the Federal Reserve Board and to enhanced prudential standards in order to mitigate the risk they pose.

The Council’s process for considering nonbank financial companies for designation has come under criticism. Currently, MetLife, Inc., is suing the FSOC in an effort to overturn a SIFI designation (see Banking and Finance Law Daily, Jan. 14, 2015). The Council’s current plan to consider asset management companies for SIFI designation also has raised objections, and the Council, along with adopting new procedures, is extending the public comment on that plan to March 25, 2015.

Existing procedures. The FSOC’s process for considering nonbanks for SIFI designation has three stages:

  • Stage 1—Six quantitative thresholds are applied to a large group of candidate companies to identify any that merit further consideration.

  • Stage 2—A preliminary analysis of the companies identified in Stage 1 is carried out, based on available information, to decide if any could pose a threat to financial stability.

  • Stage 3—An additional quantitative and qualitative analysis is performed for those companies that passed the Stage 2 screen. This might result in a proposal to designate a company as a SIFI. If a designation is proposed, the company is notified and given an opportunity to respond.

The supplemental procedures do not change this three-stage process. However, they do change how the process is carried out.

Critics have claimed that companies being considered for designation need to be notified earlier in the process and to have more information on the basis of the proposal. Companies also should be given an opportunity to work with the FSOC staff, the critics say. These changes could allow companies to find ways to satisfy the Council’s stability concerns in ways that would avoid SIFI designation.

Earlier notice, more involvement. Under the supplemental procedures, a company will be notified that it is being considered when a decision to carry out the Stage 2 analysis is made, but before the analysis begins. Since until now companies have been notified only if Stage 3 was reached, this is a much earlier notice. The company will be told which publicly available information is being considered and will be able to submit information for consideration during the analysis. The company also may be allowed to confer with the staff members who are involved.

The company will be notified of the FSOC’s decision when the Stage 2 analysis is finished. If the Council votes to move on to Stage 3, the staff members will meet with company representatives to explain the process and lay out the analytical framework. Any specific concerns that emerged from the Stage 2 analysis will be identified.

The company again will be able to submit information for FSOC staff consideration and to ask for additional meetings with staff members.

If a company already is supervised by a primary financial regulatory agency or home company supervisor, the FSOC will consult with that agency during Stage 2, before a vote to move to Stage 3 is taken. Again, this is earlier than in the past. Consultation will continue during Stage 3, before the Council votes on whether to propose a SIFI designation.

Annual reevaluations. A SIFI designation is to be revisited at least once each year to determine if it remains appropriate. Under the supplemental procedures, the company will be able to meet with the Council’s staff to discuss this review and to provide relevant information. This will give the company an opportunity to describe changes it has made that reduce the threat it presents, with a view toward demonstrating that the designation no longer is necessary.

If the Council votes to retain a SIFI designation, the company and any relevant primary financial supervisory agencies will be given a notice explaining the main basis for the FSOC’s continued concern. This notice will address the arguments raised by the company against continued designation.

Publicly available information. The Council intends to continue its practice of not volunteering the identity of a company being considered for designation. However, if a company announces that it is under Stage 2 or Stage 3 review, the Council will confirm that status if asked by a third party. This will allow news organizations and financial analysts to secure an official confirmation of a company’s statement.

The FSOC plans to include more information about nonbank designations in its future annual reports. Each report will give the number of companies that:

  • have moved to a Stage 3 analysis;

  • the FSOC voted not to move to Stage 3;

  • became subject to either a proposed or final SIFI designation; or

  • are subject to a final designation at the time of the report.

The FSOC also intends to disclose more information on the Stage 1 thresholds.

FAQs. In addition to the supplemental procedures, 22 frequently asked questions and answers have been published that are intended to better explain what the FSOC is and how it carries out its responsibilities. These plain-language FAQs include an explanation of the designation process and the meaning of a designation, including that a SIFI designation should not be treated as an official pronouncement that a company is “too big to fail.”

Favorable response. A subsequent response by the Bipartisan Policy Center said the supplemental procedures are significant improvements over the FSOC’s previous practices. The BPC noted that the increased transparency should reduce confusion over the Council’s activities.

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