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FSOC Reproposes Nonbank Financial Companies Regulation

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  • fundlaw
    The Financial Stability Oversight Council has reproposed a rule and proposed interpretive guidance to describe the manner in which the FSOC intends to
    Message 1 of 1 , Oct 11, 2011
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      The Financial Stability Oversight Council has reproposed a rule and proposed interpretive guidance to describe the manner in which the FSOC intends to designate nonbank financial companies that must be supervised by the Federal Reserve Board. Under Section 113 of the Dodd-Frank Act, a nonbank financial company must be supervised by the Federal Reserve Board and be subject to prudential standards if the FSOC determines that material financial distress at the nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company, could pose a threat to the financial stability of the United States. The FSOC reproposal should ease concerns that money market funds may be designated as systemically important, but the proposal leaves open the possibility that other funds and large asset management companies may be so designated, particularly if they have significant debt or enter into derivatives contracts.

      Under the proposal, the FSOC would apply a three-stage process in making its determinations in non-emergency situations. Stage 1 is designed to narrow the universe to a smaller set of nonbank financial companies using quantitative thresholds to identify companies that should be subject to further evaluation. In Stage 2, the FSOC will conduct a comprehensive analysis of the potential for the identified nonbank financial companies to pose a threat to U.S. financial stability. Finally, in Stage 3 the FSOC will contact those nonbank financial companies that it believes merit further review and use quantitative and qualitative information collected directly from the company in further analysis of whether the company should be considered for a determination.

      While the overall process would include significant subjective considerations, therefore, only companies that meet the Stage 1 quantitative thresholds generally would be subject to further analysis under this process. However, the FSOC may, in limited cases, initially evaluate companies in Stage 1 based on other firm-specific qualitative or quantitative factors, such as substitutability and existing regulatory scrutiny. The Stage 1 thresholds would require that a nonbank financial company have total consolidated assets of at least $50 billion and, in addition, that it meet at least one other threshold:

      --Credit Default Swaps Outstanding: There are at least $30 billion in gross notional credit default swaps outstanding for which the company is the reference entity.

      --Derivative Liabilities: The company has at least $3.5 billion of derivative liabilities. Derivative liabilities equals the fair value of any derivatives contracts in a negative position after taking into account the effects of master netting agreements and cash collateral held with the same counterparty on a net basis, if elected.

      --Loans and Bonds Outstanding: The company has at least $20 billion of outstanding loans borrowed and bonds issued.

      --Leverage Ratio: There is a minimum leverage ratio of total consolidated assets (excluding separate accounts) to total equity of 15 to 1.

      --Short-Term Debt Ratio: There is a threshold ratio of debt with a maturity of less than 12 months to total consolidated assets (excluding separate accounts) of 10%.


      For purposes of applying these thresholds to investment funds under common management, the FSOC may consider the funds as a single entity if their investments are identical or highly similar. Note that even a large company, however, will not be designated as systemically important if it does not have significant debt or enter into derivatives contracts. There had been some concern that large money market funds might be designated, but money market funds generally do not incur significant debt or enter into derivatives contracts, so for now this concern appears to be eased. Large funds or groups of funds that do use leverage or derivatives, however, may be more at risk.

      The FSOC will consider whether to establish an additional set of metrics or thresholds tailored to evaluate hedge funds and private equity firms and their advisers. In addition, the FSOC will analyze the extent to which there are potential threats to U.S. financial stability arising from asset management companies, and the FSOC may propose additional guidance regarding potential additional metrics and thresholds relevant to asset manager determinations.


      The FSOC press release, with a link to the reproposal, is at

      http://www.treasury.gov/press-center/press-releases/Pages/tg1321.aspx

      For my post on the earlier FSOC proposal, see

      http://groups.yahoo.com/group/FundLaw/message/1313


      My earlier post also discussed the Dodd-Frank Act's Volcker rule, which will restrict the ability of banking entities to engage in proprietary trading and to sponsor or own hedge funds or private equity funds. The federal banking regulatory agencies today proposed implementing rules, and the Securities and Exchange Commission is expected to join the proposal tomorrow. The Federal Reserve Board's press release, with a link to the proposal, is at

      http://www.federalreserve.gov/newsevents/press/bcreg/20111011a.htm



      John M. Baker <JMB@...>
      Stradley Ronon Stevens & Young, LLP http://www.stradley.com
      1250 Connecticut Avenue, NW, Suite 500
      Washington, DC 20036
      202.419.8413
      202.822.0140 fax
      FundLaw Listowner http://groups.yahoo.com/group/fundlaw
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