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From Banking and Finance Law Daily, June 9, 2015

FSOC clarifies Stage 1 thresholds calculations

By John M. Pachkowski, J.D.

Following its February 2015 efforts to make the three-stage process of designating nonbank financial companies as systemically important financial institutions more transparent, the Financial Stability Oversight Council has released further information on how it calculates the quantitative thresholds used during Stage 1 of its process.

The three stages under the FSOC’s SIFI designation process are:

  • 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 designation process is controlled by a regulation—Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies—which FSOC adopted in 2012 and that is codified at 12 CFR part 1310.

Greater transparency. In its earlier efforts, FSOC began giving companies an earlier notice if they come under consideration and a better opportunity to work with FSOC staff during the process. Also, companies that have been given the SIFI designation will now have more opportunity to work with the FSOC staff during the annual reevaluation process (see Banking and Finance Law Daily, Feb. 5, 2015).

Stage 1 methodologies. In the latest guidance, FSOC staff has provided the methodologies for calculating the Stage 1 thresholds. Specifically, the guidance discusses:

  1. the threshold components;

  2. application of accounting standards;

  3. data sources;

  4. entities included in calculations;

  5. frequency of calculations; and

  6. periodic review of Stage 1 thresholds.

The guidance noted that the Stage 1 thresholds “are designed to be uniform, transparent, and readily calculable by the Council, nonbank financial companies, market participants, and other members of the public.”

Threshold components. Under Stage 1, the first threshold component for a nonbank financial company is a consolidated assets threshold of $50 billion. For a foreign nonbank financial company, only the U.S. assets of the company and its consolidated subsidiaries are included.

Other components making up the threshold are:

  • $30 billion in gross notional credit default swaps (CDS) outstanding for which a nonbank financial company is the reference entity with guidance on calculating the gross notional value and identifying the “reference entity;”

  • $3.5 billion of derivative liabilities with further guidance on calculating liabilities with embedded derivative liabilities or netting agreements;

  • $20 billion in total debt outstanding with examples of what comprises debt;

  • 15 to 1 leverage ratio with the guidance on how to calculate the leverage ratio; and

  • 10 percent short-term debt ratio with guidance on how calculate Commercial paper, repurchase agreements, and securities lending liabilities.

A nonbank financial company that meets both the $50 billion consolidated assets threshold and any one of the other thresholds is moved in Stage 2 and may become subject to active review by the Council.

Accounting standards. The guidance noted that FSOC applies the Stage 1 thresholds using generally accepted accounting principles in the United States (GAAP) when such information is available. If GAAP information is not available, FSOC may rely on data reported under state statutory accounting principles (SAP), data based on international financial reporting standards, or other such available data.

If using SAP, the guidance provides a number of adjustments that will be used to the SAP information to improve their comparability with financial statements reported under GAAP to promote consistency and uniformity in the application of the Stage 1 thresholds. These adjustments relate to “non-admitted” assets; the reporting of surplus notes; and calculating the leverage ratio.

Data sources. The guidance noted that FSOC will acquire its Stage 1 threshold data from existing public and regulatory sources. These sources include: filings with the Securities and Exchange Commission, filings with the National Association of Insurance Commissioners, credit union call reports provided by National Credit Union Administration, certain private-sector data vendors, and the Trade Information Warehouse, which is operated by a subsidiary of the Depository Trust & Clearing Corporation (with respect to CDS data).

In those cases, where consolidated financial statements for a company are not available, circumstance, the data for those subsidiaries for which data are available are aggregated to calculate the thresholds.

Entities included thresholds. When evaluating a particular nonbank financial company for a potential determination, FSOC considers the company and its subsidiaries. If a nonbank financial company that is a subsidiary of another nonbank financial company meets the Stage 1 thresholds, FSOC may evaluate the parent nonbank financial company and all of its subsidiaries, even if the parent company or another individual subsidiary does not meet the Stage 1 thresholds.

The guidance noted that this approach enables FSOC to consider potential risks arising across the consolidated organization, while retaining the ability to make a determination regarding either the parent or an individual nonbank financial company subsidiary (or neither), depending on which entity FSOC determines could pose a threat to financial stability.

Frequency of calculations. The guidance indicated that Stage 1 thresholds are calculated quarterly using the most recently available data.

Periodic review of thresholds. Finally, the guidance noted that FSOC retains the ability to revisit the Stage 1 thresholds and to develop additional thresholds. In addition, FSOC also intends to review the appropriateness of both the current Stage 1 thresholds and the levels of the thresholds that are specified in dollars as needed, but at least every five years, and to adjust the thresholds and levels as FSOC may deem advisable.

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