FSOC Interprets Its Own Authority To Regulate Nonbank Financial Companies

The Financial Stability Oversight Council (“FSOC”) finalized interpretive guidance on its authority to require the supervision and regulation of certain nonbank financial companies.

In the final guidance, FSOC referred to Dodd-Frank Section 113, which permits FSOC to place a nonbank financial company under the supervision of the Federal Reserve Board (“FRB”) and prudential standards if it determines that (i) “material financial distress” could pose a systemic threat or (ii) the “nature, scope, size, scale, concentration, interconnectedness, or mix of the [company’s] activities” could pose a systemic threat.

FSOC said it will use a two-step activities-based approach to identify companies that pose a threat to U.S. financial stability. FINRA said it will (i) monitor a broad swath of different “financial products, activities, and practices” to identify potential risks, and (ii) consider characteristics like the “extension of credit, maturity and liquidity transformation, market making and trading” to determine the extent of the threat. Once threats are identified, FSOC said it will work with financial regulators to address the potential risks.

FSOC stated that a nonbank financial company determined to be a threat to the financial stability of the United States will be (i) supervised by the FRB and (ii) subject to prudential standards. If the activity-based approach fails to properly address a potential risk, FSOC can transition to an entity-specific approach to “evaluate a nonbank financial company for a potential determination.”

In a statement at an FSOC meeting, SEC Chair Gary Gensler supported the FSOC action and provided updates on SEC regulatory actions concerning money market funds, open-end bond funds, and hedge funds. Mr. Gensler stated that money market funds and open-end bond funds have a potential “liquidity mismatch” between investors’ ability to redeem daily and the possible lower liquidity of funds’ securities, which he said raises systemic issues during “stress times.” He also emphasized the financial resiliency risks hedge funds present through “leverage or derivatives positions.”