Federal Reserve Board Issues Final Rule Related to Designating Systemically Important Nonbank Financial Institutions | Practical Law

Federal Reserve Board Issues Final Rule Related to Designating Systemically Important Nonbank Financial Institutions | Practical Law

The Federal Reserve Board issued a final rule for determing when a company is predominantly engaged in financial activities and potentially subject to regulation as a systemically important nonbank financial company.

Federal Reserve Board Issues Final Rule Related to Designating Systemically Important Nonbank Financial Institutions

by PLC Finance
Published on 04 Apr 2013 • USA (National/Federal)
The Federal Reserve Board issued a final rule for determing when a company is predominantly engaged in financial activities and potentially subject to regulation as a systemically important nonbank financial company.
On April 3, 2013, the Federal Reserve Board (FRB) issued a final rule under Section 113 of the Dodd-Frank Act to further identify and define systemically important financial institutions (SIFIs).
The Dodd-Frank Act requires the FRB to define terms that the Financial Stability Oversight Counsel (FSOC) uses to determine if companies are SSFIs. The final rule:
  • Identifies criteria for determining if a company is predominantly engaged in financial activities and therefore potentially subject to SIFI regulation. A company is engaged predominantly in financial activities if:
    • the company's consolidated annual gross financial revenues in either of its two most recently completed fiscal years represent 85% or more of the company's consolidated annual gross revenue (as determined in accordance with applicable accounting standards) in that fiscal year; or
    • the company's consolidated total financial assets as of the end of either of its two most recently completed fiscal years represent 85% or more of the company's consolidated total assets (as determined in accordance with applicable accounting standards) as of the end of that fiscal year.
    The test is based on the relevant company's annual financial revenue in, or financial assets at the end of, either of its two most recent fiscal years.
    The rule defines "financial activities" as all activities that are determined to be "financial in nature" under Section 4(k) of the Bank Holding Company Act of 1956. It includes an appendix of activities considered to be "financial in nature" under that authority. The rule clarifies that any conditions imposed on any Section 4(k) activity in order to ensure bank holding companies conduct those activities in a safe and sound and legally compliant manner will be disregarded for purposes of determining whether a nonbank company is engaging in that financial activity. For example, the requirement that a bank holding company have a securities affiliate as condition to engaging in merchant banking activities (see Practice Note, Private Equity Investments by Banks (Merchant Banking)) does not apply when determining whether a nonbank financial company is engaged in merchant banking activities. On the other hand, Section 4(k) conditions that speak to the "essential elements" of an activity are preserved for these purposes. For example, a nonbank company that acquires and holds shares for the period permitted under the Section 4(k) merchant banking authority will be presumed to be engaged in the financial activity of merchant banking.
  • Defines "significant nonbank financial company" and "significant bank holding company." Part of a SIFI determination involves measuring exposures between the candidate nonbank financial company and other significant nonbank financial and bank holding companies. Institutions already designated as SIFIs are also required to report these exposures. The final rule defines "significant nonbank financial company" to mean:
    • any nonbank financial company supervised by the FRB; and
    • any other nonbank financial company having $50 billion or more in total consolidated assets at the end of its most recently completed fiscal year.
    It defines "significant bank holding company" as any bank holding company or foreign bank or company treated as a bank holding company that had $50 billion or more in total consolidated assets as of the end of the most recently completed calendar year, based on the bank holding company's consolidated worldwide assets.
The final rule largely follows the February 2011 proposed rule and its April 2012 amendment (see Legal Update, Federal Reserve Board Proposes Rule Related to Designation of Systemically Important Nonbank Financial Companies and Federal Regulators Clarify How They Will Designate Systemically Significant Nonbank Financial Companies). However, a small number of modifications were made to the April 2012 proposed rule that addressed which conditions to the Section 4(k) activities would be used for the purposes of a SIFI determination. Perhaps most significantly, the final rule reinstates Section 4(k) conditions requiring cash-settlement for permissible derivatives activities so that engaging in physically-settled derivatives transactions will not be considered a financial activity.
The final rule takes effect on May 6, 2013.
For more information on the final rule, see the FRB's press release.
To learn more about the regulation of systemically significant financial institutions under the Dodd-Frank Act, see Practice Note, Summary of the Dodd-Frank Act: Regulation of Systemically Significant Financial Institutions.