November 30, 2023 - The Financial Stability Oversight Council (FSOC) recently published updated guidance on its process for determining that nonbank financial companies are systemically important. These revisions, initially proposed in April 2023, update the interpretive guidance adopted in 2019. A determination as a systemically important financial institution (SIFI) would subject a nonbank to supervision by the Federal Reserve and the prudential standards under section 113 of the Dodd-Frank Act (such as the imposition of capital and liquidity requirements).

The new guidance makes it easier for FSOC to designate nonbanks as SIFIs – should FSOC determine that the material distress or failure of a business could pose a risk to U.S. financial stability, such businesses may be designated as systemically important. While FSOC does not seem to have designations in mind at the moment (Cravath Executive Summary), the update does put nonbank entities on alert.  A recent Sidley note warns: “FSOC is likely to use the frameworks adopted under the Final Guidance to scrutinize, among others, insurance companies, asset managers, private equity funds, hedge funds, nonbank lenders, nonbank payment service providers, digital asset companies, and mortgage originators.”

As a refresher, FSOC was created as part of the Dodd-Frank Act and its voting members are heads of major U.S. financial services regulators. FSOC’s mandate is protecting the stability of the U.S. financial system.

The final guidance aims “to establish a durable process for the Council’s use of its nonbank financial company designation authority, maintain rigorous procedural protections for nonbank financial companies reviewed for potential designation, and remove unwarranted hurdles to designation imposed by the 2019 Interpretive Guidance.”

Designation is now authorized if FSOC determines that either (1) material financial distress at the nonbank financial company could pose a threat to U.S. financial stability, or (2) the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company could pose a threat to U.S. financial stability.

FSOC declined to take on board industry comments that entity-based designation is not suitable for certain industries, such as asset managers, mutual funds (including money market mutual funds), private funds, and issuers of asset-backed securities. Like the 2019 interpretive guidance, the updated guidance does not categorically exclude any particular financial sectors or types of nonbank financial companies from its assessment of potential threats to financial stability.

In a change from the 2019 guidance, the revised guidance puts a systemically important designation on equal footing with FSOC’s other authorities, rather than restricting it to a measure of last resort. Additionally, the final guidance enables FSOC to designate a company as systemically important without conducting a cost-benefit analysis and removes the requirement that FSOC consider the likelihood that a company will experience material financial distress before making a SIFI determination.

The guidance becomes effective January 16, 2024.

In conjunction with the revised guidance, FSOC adopted an Analytic Framework that describes its approach to identifying and assessing a threat to U.S. financial stability (which it defines as events or conditions that could substantially impair the financial system’s ability to support economic activity). The framework lays out the authorities that FSOC has at its disposal to address the potential threat, including the nonbank SIFI designation. It became effective November 14th.

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