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On April 11, 2012, the Financial Stability Oversight
Council (the "Council") gave more shape to the framework of systemic risk
regulation by publishing a final rule (the "Rule") that sets forth the process
for the designation of nonbank financial institutions as systemically
important. Once designated, these systemically important financial institutions
("SIFIs") will be supervised by the Federal Reserve Board (the "Board") in much
the same way that it supervises bank holding companies with $50 billion or more
in consolidated assets. This supervision will involve the use of more rigorous
"enhanced prudential standards" than apply to bank holding companies below the
$50 billion floor. The Board proposed such standards earlier this year. Large
nonbank financial companies should review the Rule with care, given the onerous
consequences of designation and the intricacies of the designation process.
The designation of nonbank financial firms as SIFIs is
one tool, but perhaps not the most efficient tool, for addressing systemic risk
in the financial services industry. The Dodd-Frank Act Wall Street Reform and
Consumer Protection Act ("Dodd-Frank" or the "Act") provides two other tools:
the identification and regulation of systemically risky activities across all
financial institutions and authority to resolve distressed SIFIs in an
organized manner outside the bankruptcy and bank receivership processes.
Because many firms are likely to engage in any given line
of business that presents a high level of risk, the identification and
regulation of these activities across the financial services industry is the
most effective way to address systemic risk. The regulators will be able to collect
information on how several firms operate the business and manage the attendant
risks, which will enable the regulators to establish a sophisticated
industry-wide approach. By contrast, the designation of particular firms will
focus on idiosyncrasies and unique risks to financial stability that can only
be handled on an institution-specific basis. This approach will create at best
a materially smaller body of knowledge that can be applied to the regulation of
other large firms. Nevertheless, the Council has chosen to concentrate on the
designation of nonbank financial firms as presenting threats to U.S. financial
stability. The review of activities that may lead to systemic risk seems to be
a lower priority.
Important consequences will flow from designation as a
SIFI. Designation would adversely affect the ability of these institutions to
compete with their undesignated competitors due to increased costs and
supervisory impact on their decision making process. Under the Rule, a significant
number of large financial firms could be pulled into the Council's designation
process. The Rule establishes quantitative thresholds to identify firms subject
to the process, which appear to be at least in part "reverse
engineered" based on experiences from the financial crisis. However, the
metrics would also sweep up firms that would pose widely divergent levels and
types of risk to financial stability, including many firms that do not warrant
designation. Moreover, the Council has made clear that the universe of covered
firms may go beyond those firms that meet the quantitative thresholds.
The Council has declined to provide any kind of exemption
or safe harbor for sectors of the financial services industry that would seem to present no
real threat to financial stability, either because regulation of particular activities would more
effectively and more equitably address any risks posed, or because the bank holding company
model would not effectively address any risks posed.
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For more legal analysis in
financial industry regulation, visit Morrison
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