FSOC Issues Staff Guidance Regarding Methodology Determinations for Stage 1 Thresholds (with Lofchie Comment)

The Financial Stability Oversight Council ("FSOC") issued guidance ("Guidance") regarding the process for determining whether a non-bank financial company should be subject to enhanced supervision by the Board of Governors of the Federal Reserve System ("FRB").

Dodd-Frank Section 113 authorizes FSOC to make determinations based on whether a non-bank financial company might pose a threat to the financial stability of the United States. To that end, FSOC issued a previous rule and interpretive guidance to clarify the three-stage process used for identifying and analyzing companies in making potential determinations.

In the Guidance regarding Stage 1 of the process, FSOC explained it applies six quantitative thresholds to a broad group of non-bank financial companies to identify a subset that merits further evaluation. The Guidance describes the six thresholds, and explains that a non-bank financial company that is targeted for further evaluation in Stage 1 may be subject to active review in Stage 2.

According to the Guidance, FSOC relies solely on information made available through existing public and regulatory sources in Stage 1. The Guidance explains that the "fundamental purpose" of Stage 1 is "to narrow the universe of nonbank financial companies that may be subject to active review in Stage 2." The Guidance also notes that in Stage 2, FSOC retains the discretion to consider a non-bank financial company not identified by the Stage 1 thresholds if further analysis is needed to determine whether the company might pose a threat to financial stability in the United States.

Lofchie Comment: It is good that FSOC is making some effort to formalize and publicize a process for designating non-banks as systemically significant. At the end of the day, however, the process remains wholly discretionary. Such discretion should be considered unacceptable to a society operating under the rule of objective law.Some of the terms contained in the new guidance, terms that FSOC will rely on to pick systemically important financial institutions, seem to be completely inappropriate. For starters, it seems improper to regulate a firm because it is the subject of credit default swaps; companies should be regulated because of their own activities, and not because other firms enter into derivatives to which they are not parties. Second, it is odd that the banking regulators treat securities lending and repurchase agreements as the equivalent of unsecured debts.

See: FSOC Staff Guidance on Methodologies Relating to Stage 1 Thresholds.