Federal Reserve Board Approves Final Rules Defining When Significant Nonbank Firms are “Predominantly Engaged in Financial Activities”

Federal Reserve Board Approves Final Rules Defining When Significant Nonbank Firms are “Predominantly Engaged in Financial Activities”

On April 3, the Federal Reserve Board ("Board") published a final rule ("Rule") specifying when a financial company that may be made subject to systemic regulation under Title I of the Dodd-Frank Wall Street Accountability and Consumer Protection Act ("Dodd-Frank Act") is "predominantly engaged in financial activities" for purposes of being designated for systemic regulation under the Dodd-Frank Act. The Rule is effective on May 6, 2013.

As discussed below, the net effect of the Rule would be to expand the types of activities that might qualify as financial activities for purposes of applying the "predominantly engaged" test, and thus broaden the population of large nonbank firms that might be designated as systemically important financial firms, under the Dodd-Frank Act. Accordingly, large nonbank financial firms should pay close attention to the Rule's requirements and its potential impact on them.

Background

The authority of the Financial Stability Oversight Council (the "Council") to designate a firm as systemically important is limited to those firms that meet the definition of "nonbank financial company" under section 102(a)(4) of the Dodd-Frank Act. The term is limited to any firm "predominantly engaged in financial activities." In turn, section 102(b) charges the Board with defining the term "predominantly engaged in financial activities" through rulemaking, but is constrained by specific statutory requirements. Under section 102(a)(6), financial activities are those that are financial in nature under section 4(k) of the Bank Holding Company Act ("BHCA"). Under the same provision, a company is "predominantly" engaged in financial activities if one of two conditions exists: either (i) the annual gross revenues derived by the company and all of its subsidiaries from financial activities, as well as from the ownership or control of an insured depository institution, represent 85 percent or more of the consolidated annual gross revenues of the company; or (ii) the consolidated assets of the company and all of its subsidiaries related to financial activities, as well as related to the ownership or control of an insured depository institution, represent 85 percent or more of the consolidated assets of the company.

In February 2011, the Board proposed regulations ("First NPR") that would apply both of the 85 percent tests to each of the past two calendar years. An institution that met either test in either of the two years would be regarded as being "predominantly" engaged in financial activities. This proposal provided no further explanation of "financial activity."

In April 2012, the Board revised the February 2011 proposal to address "financial activities" in greater detail, in response to several comments on the First NPR concerning the applicability of the BHCA restrictions on the conduct of certain financial activities, particularly investment-related activities, by bank holding companies. The principal thrust of the Board's Second NPR was to define a financial activity as "any activity referenced in [BHCA] section 4(k)...without regard to conditions that were imposed on bank holding companies that do not define the activity itself." Conditions not applicable to the definition of "predominantly engaged" include those "that were imposed to ensure that the activity is conducted in a safe and sound manner, to prevent a financial holding company from controlling a commercial firm, or to comply with another provision of law." [footnotes omitted]

© Copyright 2013 Morrison & Foerster LLP. Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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