FSOC Wants Expanded Ability to Regulate Nonbanks Creating Risk

The Financial Stability Oversight Council ("FSOC") proposed amending guidance on the process by which it may designate nonbank financial institutions for heightened Federal Reserve Board ("FRB") supervision and prudential standards.

The proposed amendments to the "Interpretive Guidance on Nonbank Financial Company Determinations" would require "significant engagement and communication" between FSOC and any nonbank financial institution under review for designation. FSOC said that that the proposal would update the interpretive guidance to:

• eliminate the requirement that FSOC must first rely on federal and state regulators to address financial stability risks before FSOC considers designating the financial institution;
• implement a "broader approach" to assess potential risks to U.S. financial stability which FSOC detailed in a separate "analytic framework" document for public comment (see below); and
• eliminate language requiring FSOC to conduct a cost-benefit analysis of a financial institution’s material financial distress (FSOC found the assessment to be "not useful or appropriate").

FSOC also proposed an analytic framework aimed at (i) evaluating risks to U.S. financial stability stemming from material financial stress or failure from nonbank financial institutions, (ii) encouraging market discipline and (iii) addressing emerging threats to the stability of the U.S. financial system. FSOC stated that the analytic framework would:

• identify potential risks to U.S. financial stability which would cover an "expansive range" of asset classes, entity types and financial activities;
• assess potential risks to evaluate whether further review or action is necessary by applying (i) a "highly fact-specific" evaluation of identified vulnerabilities that commonly lead to financial stability risks and (ii) quantitative metrics to measure the vulnerabilities; and
• address potential risks through various approaches, including using mitigation tools as needed to (i) reduce the risk of shock within the financial system, (ii) mitigate financial vulnerability and (iii) "improve the resilience of the financial system to shocks."

FSOC stated that if further action is required to address identified risks, FSOC may (i) pursue coordinated interagency remedial measures, (ii) recommend increased standards and safeguards to financial regulators or Congress and (iii) designate the financial institutions for FRB supervision or as "systemically important" under the Dodd Frank Act.

Comments on the proposed amendments and analytic framework are due 60 days after publication in the Federal Register.

Statements

Treasury Secretary Janet L. Yellen emphasized that the proposals would "improve the resilience of the financial system" following the failure of Signature Bank and Silicon Valley Bank. She added that the analytic risk framework addresses various financial vulnerabilities by not "broadly prioritizing" one type of risk mitigant approach over another. Further, Ms. Yellen said that the proposed amendments to FSOC guidance on nonbank designation addresses the "inappropriate hurdles" FSOC had to endure to designate a nonbank financial institution and "restore[s] the effectiveness" of FSOC’s designation authority.

SEC Chair Gary Gensler supported the proposed amendments. He said they would "reinvigorate" FSOC’s designation process. He underscored the SEC’s coordination with FSOC to promote resiliency within the U.S. financial system.