"Covered Companies" and Other Institutions (§§ 102 & 112)

The most important question for US and foreign businesses is which entities will be subject to the soon-to-emerge systemic risk rules promulgated by the Council and enforced by the Federal Reserve. The dark days of autumn 2008 revealed that many companies outside the traditional banking sector were systemically important. To be sure, large commercial banks were among the hardest hit by the crisis, and their potential failure arguably threatened the stability of the financial system as a whole. But the same was true of a number of large investment banks, broker-dealers, asset management firms, diversified financial companies, and insurance companies—particularly those active in the overthe-counter (OTC) derivatives and overnight repo markets. During the crisis, some entities reincorporated as bank holding companies (BHCs) or obtained other charters to take advantage of various programs offered by the Federal Reserve and the Troubled Asset Relief Program (TARP) established by Congress. Through the legislation, Congress has createda mechanism by which a range of financial firms may be swept into a new systemic risk regulatory and supervisory framework. The following categories of entities will be subject to the Council’s registration and reporting requirements and to direct supervision by the Federal Reserve.

“Large, Interconnected” Bank Holding Companies (§§ 102, 112, 115D & 116)

BHCs with consolidated assets of $50 billion or more that are determined to be large and interconnected BHCs will potentially be subject to a host of supervisory measures, including enhanced capital and leverage requirements, additional liquidity provisioning, and new requirements for contingent capital, resolution plans, credit exposure reports, and concentration limits. All BHCs are currently regulated and supervised by the Federal Reserve for safety and soundness, but those entities falling into the “large, interconnected” category will be separately and additionally regulated under the legislation for systemic risk containment. Along with US-based BHCs, the “large, interconnected” category includes foreign banking organizations treated like BHCs under current law.

Nonbank Financial Companies (§§102, 112 – 115 & 117)

On the premise that systemic importance reaches beyond traditional banks, the legislation creates a broad category of “nonbank financial companies” that is designed to capture any entity predominantly engaged in financial services. To fit within this category, at least 85% of a particular company’s consolidated revenues or assets must stem from “activities that are financial in nature”—a defined term under existing law that largely covers banking, lending, underwriting, insurance, investment, and other activities unrelated to general commercial services or manufacturing. In crafting
this initial requirement, Congress made a crucial decision not to include large companies outside the confines of the financial sector, even though their demise might threaten US financial stability. The “nonbank financial company” category is nevertheless quite large, extending possibly to thrifts and their holding companies, broker-dealers, investment advisers (potentially including managers of
hedge funds and private equity funds), investment banks, and other asset management firms.

What constitutes a Nonbank Financial Company?
Assuming a company is predominantly engaged in “activities that are financial in nature,” the Council—by a supermajority vote—may designate it as a nonbank financial company (subjecting it to enhanced supervisory measures) based upon, among other things, the following criteria:

  • the degree of leverage at the company
  • the amount and nature of the company’s assets
  • the amount and types of the company’s liabilities
  • the amount of off-balance sheet exposures
  • the company’s relationships with other nonbank financial companies and BHCs
  • the importance of the company as a source of credit for households, businesses, and state and local governments, and as a source of liquidity for the US financial system
  • the extent to which assets are managed—as opposed to owned—by the company, and whether the assets are diffuse

Non-US businesses also may be classified as nonbank financial companies if they satisfy certain criteria (see box above) and the Council determines their US presence meets sufficient quantitative and qualitative thresholds. The details of the thresholds for both US and non-US businesses and their application  largely left to the Council to articulate. The Council is also permitted to establish a safe harbor for entities otherwise subject to this classification.

Designated entities will have the benefit of a pre-designation, informal hearing process and potential appeal to a US district court. Moreover, the Council is instructed to consult with the federal agency with primary authority over the specific nonbank financial company before making any final determination. If the Council’s determination stands, the company will be required to register with the Federal Reserve within 180 days and thereafter be subject to enhanced regulatory and supervisory measures for systemic risk.

The legislation also includes a “Hotel California” provision that automatically places any former $50 billion-plus BHC that received TARP assistance into the nonbank financial company category until the Council determines otherwise. Like the poor souls described in The Eagles’ classic hit, those companies may “check out [of being a BHC] any time [they] like . . . but [they] can never leave” absent the
Council’s approval.

Financial Market Utilities  (§§ 802 – 805)

The legislation includes the Payment, Clearing, and Settlement Supervision Act of 2010, which authorizes the Council to designate for supervision by the Federal Reserve, the Securities and Exchange Commission (SEC), or the Commodity Futures Trading Commission (CFTC), as appropriate, entities that engage in systemically important payment, clearing, or settlement activities. These specially designated “financial market utilities” and related payment, clearing, or settlement activities will be designated by a supermajority vote of the Council members based on:

  • the value of the transactions processed by the entity or carried out through the activity
  • the exposure of the entity to particular counterparties
  • the connections between the entity or activity and similar financial market utilities or activities
  • the effect that the failure of, or a disruption to, the entity or activity would have on critical markets or the broader financial system
  • other factors the Council deems important

The underlying rationale is that certain entities and the activities they carry out are a critical part of the financial system’s infrastructure and therefore may be systemically important even if their consolidated assets are small relative to other financial sector firms. These designated financial market utilities and related activities will be subject to a set of systemic risk management standards suitable for their role—such as enhanced collateral, margin, and capital requirements.