FSOC Approves Analytic Framework for Financial Stability Risks and Guidance on Nonbank Financial Company Determinations

The U.S. Department of the Treasury, USDT, has published a press statement to inform that it has finalized the analytical framework for the identification, assessment, and response of the USDT’s Financial Stability Oversight Council (FSOC) to potential risks to U.S. financial stability and the interpretive guidance for the determination of whether or not a non-bank financial company should be „designated“ and thus be subject to Federal Reserve supervision and prudential requirements. Both documents were published for public consultation in May this year (please see EventID 20857 in this context for more information).
#### The finalized analytical framework entails the following key steps:
(1) Identification of risks: Mandated by the Dodd-Frank Act, the FSOC continuously monitors and will continue to monitor various sectors and activities within the financial market to detect potential threats to economic stability. The Analytic Framework thereby defines „threats to financial stability“ as events or conditions that could significantly impair the financial system’s ability to support economic activities.
(2) The risk assessment process: Upon identifying a potential risk, the Council will undertake a comprehensive assessment of such. This assessment is fact-specific and considers vulnerabilities known to commonly contribute to risks in the financial system such as increased leverage, liquidity risk and maturity mismatch, interconnections of financial market participants, high concentrations among market players, etc. Corresponding quantitative metrics for such assessment are provided in the framework. The assessment will further include an evaluation of the transmission channels through which risks could affect the financial system.
(3) Addressing and mitigating risks: The Council possesses a range of statutory powers and its response to identified risks will depend on a risk’s nature and context. Potential measures to respond to identified risks may involve:
– collaborating with regulatory agencies for timely actions.
– making formal, nonbinding recommendations to primary financial regulators or Congress after consultation and public input.
– evaluating nonbank financial companies for potential Federal Reserve supervision.
– designating systemically important payment, clearing, and settlement activities or financial market utilities under Title VIII of the Dodd-Frank Act.
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In response to the feedback received, the FSOC
– has revised its interpretation of „Threat to Financial Stability“ to more closely align with prior interpretations;
– is providing more examples of quantitative metrics used by the Council to assess vulnerabilities contributing to financial risks; and
– offers a more detailed explanation of the transmission channels identified by the Council. It specifically highlights vulnerabilities relevant to each of the four listed transmission channels and includes in-depth discussions, examples, and analyses pertaining to these channels.
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#### The interpretive guidance
As far as the „interpretive guidance“ is concerned – which outlines the procedure the Council will follow for the determination of whether or not a non-bank financial company should be „designated“ and thus be subject to Federal Reserve supervision and prudential requirements – the final version now includes the following key steps:
In a first step, the Council conducts a preliminary analysis of a nonbank financial company using available quantitative and qualitative information from public and regulatory sources. The company in question is notified at least 60 days before the Council’s vote on a further evaluation. During this step, the company has the opportunity to voluntarily provide relevant information and meet with Council staff involved in the analysis.
In a second step, companies selected for further review after step 1 undergo a detailed evaluation. This involves significant engagement between the Council, the company under review, and its primary financial regulator. The Council requests information from the company and facilitates meetings to explain the evaluation process and analysis framework.
At the end of this process, the FSOC may propose a designation for a nonbank financial company. A proposed designation requires a two-thirds vote by the Council’s voting members, including the Chairperson’s affirmative vote. The company receives a written explanation for the proposed determination and can request a hearing, followed by a vote for a final designation using the same voting threshold. The Council publicly releases the basis for any final designation.
Designated companies will subsequently be required to mitigate any identified risks and the Council will conduct annual reevaluations of a firm’s designation. The company or its regulators are invited to discuss the review and submit information during these reevaluations. FSOC representatives, on the other hand, offer feedback on proposed risk mitigation measures.
If the FSOC determines that a company no longer meets the statutory standards for designation, it may rescind the designation. If the Council decides against rescinding the designation, it provides the company with a written explanation addressing key factors in the analysis.
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To conclude, the FSOC notes that most commenters strongly supported the proposed interpretive guidance. Hence, the revisions to the draft version are only minor, non-material in nature.