FSOC Proposals Renew Threat of Nonbank "Systemically Important" Designations

In Short

The Situation: The Financial Stability Oversight Council ("FSOC") recently issued a "notification of proposed interpretive guidance" on updated procedures for designating nonbank financial companies as systemically important financial institutions ("SIFIs"), and a "proposed analytic framework" for assessing risks to U.S. financial stability (together, the "Proposals"). 

The Issue: The Proposals would remove procedural requirements previously imposed on FSOC's ability to designate nonbank SIFIs. The Proposals would revert to entity-level designations rather than taking an activities-based approach, without requiring a cost-benefit analysis or an assessment of the likelihood of a nonbank firm's financial distress. In this way, the Proposals take a "ready, fire, aim" approach to SIFI designation that may lack transparency for firms that find themselves in FSOC's crosshairs.

Looking Ahead: If the Proposals are adopted after their 60-day comment period, a broader field of nonbanks will face an increased risk of FSOC designation and "bank-like" regulatory requirements that follow. Asset managers, investment funds, private equity sponsors, nonbank lenders, insurers, digital asset firms, and payments companies are all at risk of designation.

The Dodd-Frank Act, Designation, and the MetLife Decision

In the wake of the 2008 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"). One of the hallmarks of Dodd-Frank was its focus on systemic risk, including its creation of FSOC. Charged with analyzing risks to U.S. financial stability, Congress also empowered FSOC to designate nonbank financial companies as systemically important ("Nonbank SIFIs") and thus subject to Federal Reserve supervision and enhanced prudential standards. In 2013, FSOC designated four nonbanks as systemically important: GE Capital, AIG, Prudential, and MetLife.

MetLife challenged its designation, and the U.S. District Court for the District of Columbia agreed with it, rescinding MetLife's designation in 2016. In doing so, the court held that FSOC deviated from its own guidance and failed to weigh the costs to MetLife of its designation with any benefits to U.S. financial stability. FSOC subsequently modified its guidance and procedures in 2019 in light of the MetLife decision. 

FSOC's Proposals

The Proposals comprise a "proposed analytic framework" for identifying financial stability risks ("Analytic Framework") and a "notice of proposed interpretive guidance" that contains a framework for making Nonbank SIFI determinations ("Designation Guidance").

Regarding the Designation Guidance, the formal two-step process for designating nonbanks is largely consistent with prior guidance: (i) FSOC notifies the nonbank that is being considered and conducts a preliminary analysis; and (ii) after notifying the nonbank it has moved to the next step, FSOC conducts more in-depth evaluation. Newly designated companies may request a hearing and a vote.

However, the updated Designation Guidance includes several important changes to FSOC's standards.

Activities-based approach: 

  • Pursuant to the 2019 guidance, FSOC focuses on an "activities-based approach." The "activities-based approach," as FSOC described it in 2019, means that FSOC will prioritize identifying potential risks on a "system-wide" basis, and then allow "relevant financial regulatory agencies" to address the risks identified, and deprioritize the option of classifying entities as Nonbank SIFIs to address those risks. 
  • Under the Designation Guidance, FSOC would no longer bind itself in all cases to following this "activities-based approach" before Nonbank SIFI designation. Under the Designation Guidance, FSOC expects to continue to work with other financial services regulators, but would no longer formally deprioritize Nonbank SIFI designations as an option to respond to perceived risks.

Cost-benefit analysis: 

  • The 2019 guidance states that FSOC would conduct a cost-benefit analysis before making a Nonbank SIFI designation.
  • The Designation Guidance eliminates this requirement, noting "evaluating the potential costs and benefits of a designation with reasonable specificity is not possible before a designation, and it is unlikely that performing a cost-benefit analysis for a nonbank financial company would yield a balanced picture."

Assessment of likelihood of distress: 

  • The 2019 guidance states that FSOC would assess the likelihood of a nonbank's distress or failure before making a Nonbank SIFI designation.
  • The Designation Guidance eliminates this requirement.

The Analytic Framework is largely consistent with the 2019 guidance and sets forth the following key vulnerabilities (and identifies corresponding sample metrics) FSOC will look for in evaluating systemic risk: 

  • Leverage;
  • Liquidity risk and maturity mismatch;
  • Interconnectedness;
  • Operational risk;
  • Complexity or opacity;
  • Inadequate risk management;
  • Concentration; and
  • Destabilizing activities.

The Analytic Framework also identifies four "transmission channels" for negative effects of risk to financial stability, and suggests that FSOC might deal with each differently: direct and indirect exposures to risk, rapid liquidation of assets at fire-sale prices, disruptions to critical functions or services with no ready substitutes, and contagion arising from perception of vulnerabilities.

Industry Response

In an accompanying statement, FSOC Chair Janet Yellen emphasized that the Proposals will increase transparency, explaining that they represent the first time FSOC has issued a document setting forth its approach to identifying, assessing, and mitigating risks to financial stability. Nevertheless, the designation process and the analytic framework for financial stability risk contained in the Proposals remain inherently subjective and unpredictable, leaving nonbanks to await next steps from FSOC on how it will apply the Proposals.

The Designation Guidance would make it easier for FSOC to make a Nonbank SIFI designation, and thereby impose onerous rules on nonbank financial institutions, such as asset managers, investment funds, private equity sponsors, nonbank lenders, insurers, digital asset firms, and payments companies. Such firms and others can submit comments by June 27, 2023, in order to highlight this uncertainty or other concerns or input regarding the Proposals.

Three Key Takeaways

  1. Under the Proposals FSOC would no longer prioritize an activities-based approach over an entity-specific designation process, nor would it undertake to conduct a cost-benefit analysis before designating a firm as systemically important.
  2. The Proposals leave nonbank financial institutions with no meaningful ability to anticipate how FSOC would assess the financial stability risks of their firms and industries or FSOC's next steps.
  3. FSOC's position that it is not required to undertake a cost-benefit analysis—seemingly in conflict with the district court's analysis in the 2016 MetLife decision—may leave its actions vulnerable to challenge.
Insights by Jones Day should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request permission to reprint or reuse any of our Insights, please use our “Contact Us” form, which can be found on our website at This Insight is not intended to create, and neither publication nor receipt of it constitutes, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.