Guidance ‘transforms’ non-bank designation process with cost-benefit analysis, more

Final guidance that “substantially transforms” federal financial regulators’ system for designating non-bank financial firms as entities subject to Federal Reserve supervision – including by instilling a cost-benefit analysis for assessing the designation – was approved unanimously Wednesday by the council of regulators.

The Financial Stability Oversight Council (FSOC) said in a release that the revised guidance “implements an activities-based approach for identifying and addressing potential risks to financial stability.” The guidance, FSOC said, also enhances the analytical rigor and transparency of the council’s process for designating nonbank financial companies.

The revisions replace guidance first issued by the council in 2012.

The FSOC is made up of the secretary of the Treasury (designed chairman) and leadership of three federal banking regulators, the National Credit Union Administration (NCUA), the Consumer Financial Protection Bureau (CFPB), Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), Federal Housing Finance Agency (FHFA), and an independent member with insurance experience.

FSOC said the revised guidance addresses three broad areas:

  • It prioritizes an “activities-based” approach for the council to identify, assess, and address potential risks and threats to U.S. financial stability. “The Council will examine a range of financial products, activities, or practices that could pose risks to U.S. financial stability,” the group said. “The activities-based approach leverages the expertise of financial regulators to monitor markets and market developments. If a potential risk to U.S. financial stability is identified, the Council will work with federal and state financial regulators to seek the implementation of appropriate actions to address the identified potential risk.”
  • It “enhances” the analytic framework (including with a cost-benefit analysis) for a potential nonbank financial company designation. “If the activities-based approach does not adequately address a potential threat to U.S. financial stability, the Council may consider a nonbank financial company for potential designation,” the group said. “In those cases, the Council would consider the benefits and costs of a designation for the U.S. financial system and the relevant company.” The FSOC said it would designate a nonbank financial company only if the expected benefits justify the expected costs of the designation. The council also said it would consider the likelihood of the company’s material financial distress, based on its vulnerability to a range of factors. “This assessment will serve to focus the Council on those risks to U.S. financial stability that are most likely to be realized.”
  • It creates “a more efficient and effective nonbank financial company designation process.” FSOC said the guidance condenses a previous three-stage process into two stages and increases engagement with and transparency to nonbank financial companies under review and their regulators by creating both pre- and post-designation off ramps to allow firms to understand and address potential risks to U.S. financial stability.

The new guidance is slated to take effect 30 days after publication in the Federal Register; it was first proposed in March.

Financial Stability Oversight Council Issues Final Guidance on Nonbank Designations