FSOC Proposes Revised Framework for Nonbank Financial Company Designations
Commentary by Steven Lofchie
The Financial Stability Oversight Council ("FSOC") proposed revised guidance "on nonbank financial company determinations and its analytic framework for financial stability risks."
The FSOC stated that the interpretive guidance would replace the 2023 guidance and analytic framework, consolidating them into a single document and largely reinstating a 2019-era multi-step approach. The FSOC said that the new guidance prioritizes an "activities-based approach," under which it would monitor financial markets to identify systemic risks and pursue firm-specific designations only where such risks cannot be addressed through system-wide regulatory action. The Council stated this approach is intended to reduce "competitive distortions," leverage primary regulators’ expertise, and improve interagency coordination.
The Council highlighted the following updates to its analytical methodologies:
- Economic Growth and Security: The FSOC will now explicitly consider whether regulatory frameworks are "fit for purpose" or "impose undue burdens that ... constrain economic growth." The FSOC defined economic security as the nation’s ability to preserve fiscal capacity and access to critical resources, noting that "economic growth provides the strongest foundation for financial stability."
- New Vulnerabilities: The proposal adds "asset valuations" to the list of vulnerabilities it monitors, while removing "destabilizing activities," which the Council determined was poorly defined.
- Higher Threshold for "Threat": The FSOC proposed modifying its interpretation of a "threat to the financial stability of the United States" to mean an impairment sufficient to inflict "severe damage" on the broader economy. The FSOC noted this represents a higher threshold than the "substantial impair[ment]" standard established in 2023.
- Pre-Designation Off-Ramp: The FSOC proposed a new procedural step allowing it to identify actions a nonbank financial company or its regulators could take to address potential risks before a designation is made. This process provides an opportunity to remediate risks—generally within 180 days—and is intended to enhance transparency and promote a more targeted, effective response to potential threats to financial stability.
In a return to prior policy, the FSOC also committed to performing a rigorous cost-benefit analysis before making any nonbank financial company designation. The FSOC stated it will proceed with a designation only if the expected benefits to financial stability justify the expected costs to the company and the U.S. economy. In addition, the Council will assess the "likelihood of material financial distress" of a firm under review to evaluate whether the benefits of designation are speculative or substantial.
Comments on the proposed guidance are due 45 days after its publication in the Federal Register.
Commentary
Disbanding - or at least defanging - the FSOC entirely would be even better. Still, this proposal would be a substantial improvement over the FSOC's existing approach to identifying systemic risk and pursuing firm-specific designations. Given that the FSOC is inherently a political creature, acting in accordance with the party of the President, whichever party that happens to be, it is best if there are substantial barriers placed in the way of its exercising the rather awesome degree of discretionary power granted to the agency by Dodd-Frank. (See also, commentary in Treasury Secretary Links Financial Stability to Growth.)