Notice2023-25055
Analytic Framework for Financial Stability Risk Identification, Assessment, and Response
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Published
November 14, 2023
Effective
November 14, 2023
Issuing agencies
Financial Stability Oversight Council
Abstract
The Financial Stability Oversight Council (Council) is publishing an analytic framework that describes the approach the Council expects to take in identifying, assessing, and responding to certain potential risks to U.S. financial stability.
Full Text
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<title>Federal Register, Volume 88 Issue 218 (Tuesday, November 14, 2023)</title>
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[Federal Register Volume 88, Number 218 (Tuesday, November 14, 2023)]
[Notices]
[Pages 78026-78037]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-25055]
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FINANCIAL STABILITY OVERSIGHT COUNCIL
Analytic Framework for Financial Stability Risk Identification,
Assessment, and Response
AGENCY: Financial Stability Oversight Council.
ACTION: Publication of analytic framework.
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SUMMARY: The Financial Stability Oversight Council (Council) is
publishing an analytic framework that describes the approach the
Council expects to take in identifying, assessing, and responding to
certain potential risks to U.S. financial stability.
DATES: Effective Date: November 14, 2023.
FOR FURTHER INFORMATION CONTACT: Eric Froman, Office of the General
Counsel, Treasury, at (202) 622-1942; Devin Mauney, Office of the
General Counsel, Treasury, at (202) 622-2537; or Priya Agarwal, Office
of the General Counsel, Treasury, at (202) 622-3773.
SUPPLEMENTARY INFORMATION:
I. Background
Section 111 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the Dodd-Frank Act) established the Financial Stability
Oversight Council (the Council).\1\ The statutory purposes of the
Council are ``(A) to identify risks to the financial stability of the
United States that could arise from the material financial distress or
failure, or ongoing activities, of large, interconnected bank holding
companies or nonbank financial companies, or that could arise outside
the financial services marketplace; (B) to promote market discipline,
by eliminating expectations on the part of shareholders, creditors, and
counterparties of such companies that the Government will shield them
from losses in the event of failure; and (C) to respond to emerging
threats to the stability of the United States financial system.'' \2\
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\1\ Dodd-Frank Act section 111, 12 U.S.C. 5321.
\2\ Dodd-Frank Act section 112(a)(1), 12 U.S.C. 5322(a)(1).
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The Council's duties under section 112 of the Dodd-Frank Act
reflect the range of approaches the Council may consider to identify,
assess, and respond to potential threats to U.S. financial stability,
which include collecting information from regulators, requesting data
and analyses from the Office of Financial Research (the OFR),
monitoring the financial services marketplace and financial regulatory
developments, facilitating information sharing and coordination among
regulators, recommending to the Council member agencies general
supervisory priorities and principles, identifying regulatory gaps,
making recommendations to the Board of Governors of the Federal Reserve
System (the Federal Reserve) or other primary financial regulatory
agencies,\3\ and designating certain entities or payment, clearing, and
settlement activities for additional regulation.
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\3\ ``Primary financial regulatory agency'' is defined in
section 2(12) of the Dodd-Frank Act, 12 U.S.C. 5301(12).
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The Council's Analytic Framework for Financial Stability Risk
Identification, Assessment, and Response (the Analytic Framework)
describes the approach the Council expects to take in identifying,
assessing, and responding to certain potential risks to U.S. financial
stability. The Analytic Framework is intended to help market
participants, stakeholders, and other members of the public better
understand how the Council expects to perform certain of its duties. It
is not a binding rule and does not establish rights or obligations
applicable to any person or entity.
The Council issued for public comment the Proposed Analytic
Framework for Financial Stability Risk Identification, Assessment, and
Response (the Proposed Framework) on April 21, 2023.\4\ The comment
period was initially set to close after 60 days; however, in response
to public requests for additional time to review and comment on the
Proposed Framework, the Council extended the comment period by 30
days,\5\ to July 27, 2023. Having carefully considered the comments it
received, the Council voted to adopt the Analytic Framework at a public
meeting on November 3, 2023.
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\4\ 88 FR 26305 (Apr. 28, 2023). In a rule codified at 12 CFR
1310.3, the Council voluntarily committed that it would not amend or
rescind certain guidance regarding nonbank financial company
determinations set forth in Appendix A to 12 CFR part 1310 without
providing the public with notice and an opportunity to comment in
accordance with the procedures applicable to legislative rules under
5 U.S.C. 553. Section 1310.3 does not apply to the Council's
issuance of rules, guidance, procedures, or other documents that do
not amend or rescind Appendix A, and accordingly, it does not apply
to the Analytic Framework. Nonetheless, in the interest of
transparency and accountability, the Council chose to publish the
Proposed Framework and provide an opportunity for public comment.
\5\ 88 FR 41616 (June 27, 2023).
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At the same time as the publication of the Proposed Framework, the
Council also published proposed interpretive guidance (the Proposed
Guidance) regarding its procedures for designating nonbank financial
companies for prudential standards and Federal Reserve supervision
under section 113 of the Dodd-Frank Act. At its public meeting on
November 3, 2023, the Council also adopted a final version of those
procedures (the Final Guidance).
In response to its request for public input, the Council received
37 comments on the Proposed Framework, of which nine were from
companies or trade associations in the investment management industry,
two were from trade associations in the insurance industry, six were
from other companies or trade associations, 10 were from various
advocacy groups, five were from current or former state or federal
government officials, two were from groups of academics, and three were
from individuals.\6\ Most public comments submitted with respect to the
Proposed Framework also commented
[[Page 78027]]
on the Proposed Guidance. For the convenience of the public, the
Council addresses many of the issues raised in such dual comments in
the preamble to the Final Guidance.
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\6\ The comment letters are available at <a href="https://www.regulations.gov/docket/FSOC-2023-0001">https://www.regulations.gov/docket/FSOC-2023-0001</a>.
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II. Adoption of the Analytic Framework Following Public Comment
The Analytic Framework provides a narrative description of the
approach the Council expects to take in identifying, assessing, and
responding to certain potential risks to U.S. financial stability.
Accordingly, this preamble omits a duplicative description of the
Analytic Framework's content and instead focuses on key changes from
the Proposed Framework and on comments received in response to the
Proposed Framework. Members of the public should refer directly to the
Analytic Framework for greater detail regarding the Council's approach.
A. Key Changes From the Proposed Framework
Following consideration of public comments on the Proposed
Framework, the Analytic Framework reflects several key changes from the
Proposed Framework, each as discussed further below:
<bullet> Description of ``threat to financial stability.'' To
provide additional transparency regarding how the Council expects to
interpret the phrase ``threat to the financial stability of the United
States,'' which is used in several instances in the Dodd-Frank Act
related to the Council's authorities, the Analytic Framework includes
an interpretation of this term that is based on the interpretation of
``financial stability'' that was included in the Proposed Framework.
<bullet> Additional sample metrics to assess vulnerabilities. To
provide more public transparency on the Analytic Framework's
description of how the Council assesses vulnerabilities that contribute
to risks to financial stability, the Council has added more examples of
the types of quantitative metrics it may consider in its analyses.
<bullet> Expanded discussion of transmission channels. To further
clarify the Council's consideration of the channels that it has
identified as being most likely to transmit risk through the financial
system, the Analytic Framework now identifies vulnerabilities that may
be particularly relevant to each of four listed transmission channels
and includes more detailed discussions of examples and analyses
relevant to the transmission channels.
<bullet> Emphasis on the Council's engagement with regulators. To
align more closely with the Council's practice and expectations, the
Analytic Framework includes additional emphasis on the Council's
extensive engagement with state and federal financial regulatory
agencies regarding potential risks and the extent to which existing
regulation may mitigate those risks.
B. Consideration of Public Comments
The Analytic Framework, like the Proposed Framework, describes the
approach the Council expects to take to identify, assess, and respond
to potential risks to U.S. financial stability and contains three
substantive subsections addressing these steps.
Approximately half of the comments on the Proposed Framework were
generally supportive, noting that the Proposed Framework's eight listed
vulnerabilities, associated sample metrics, and four transmission
channels were well chosen, were supported by expert research and
analysis, and provide appropriate transparency. A number of commenters
were supportive of the Council's proposal to issue the Analytic
Framework as a stand-alone document separate from procedures applicable
to specific authorities such as nonbank financial company designation
under section 113 of the Dodd-Frank Act.
Other commenters were generally critical of the Proposed Framework,
stating that its listed vulnerabilities and transmission channels, as
well as the interpretation of financial stability, were overly broad or
unclear. Several commenters stated that the Proposed Framework did not
adequately describe how the Council intended to use the listed
vulnerabilities, sample metrics, and transmission channels to assess
nonbank financial companies, activities, or risks. Some commenters also
noted that the 10 considerations that the Council is required to take
into account in a nonbank financial company designation under section
113 of the Dodd-Frank Act differ from the Proposed Framework's listed
vulnerabilities.
The Council appreciates and has considered the public comments as
described below, organized by the relevant section of the Analytic
Framework.
1. Introduction
The Analytic Framework's introduction generally describes the
Council's statutory purposes and duties, explains the Analytic
Framework's role and purpose, and provides background information
relevant to the sections that follow. This section of the Proposed
Framework included an interpretation of ``financial stability'' but did
not separately provide an interpretation of a ``threat'' to financial
stability. Public comments addressing the Proposed Framework's
introduction section focused on this element.
The Analytic Framework interprets ``financial stability'' as ``the
financial system being resilient to events or conditions that could
impair its ability to support economic activity, such as by
intermediating financial transactions, facilitating payments,
allocating resources, and managing risks.'' Some commenters were
supportive of the Proposed Framework's interpretation of financial
stability, stating that it appropriately accounts for key ways in which
the financial system supports economic activity and that it encourages
financial regulators to take action before events or conditions
undermine financial stability. Some commenters stated that the Analytic
Framework (or the Final Guidance) \7\ should include the Council's
interpretation of the phrase ``threat to the financial stability of the
United States,'' which is an element of the standard for designating
nonbank financial companies for prudential standards and Federal
Reserve supervision under section 113 of the Dodd-Frank Act, and which
(or close variations of which) are also used elsewhere in the Dodd-
Frank Act related to the Council's other authorities.\8\ Some of these
commenters stated that the Proposed Framework's interpretation of
``financial stability,'' read in isolation, implied that even
insubstantial impairments to the financial system's ability to support
economic activity could constitute threats to financial stability. One
commenter suggested adopting specific contrasting definitions of
financial instability and financial stability.
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\7\ The preamble to the Final Guidance contains a discussion of
the Council's reasons for removing a previous interpretation of
``threat to the financial stability of the United States'' from its
nonbank financial company designation procedures and not including
an interpretation of that phrase in the Final Guidance.
\8\ See Dodd-Frank Act sections 112 and 120, 12 U.S.C. 5322 and
5330.
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The Council continues to support the interpretation of ``financial
stability'' as proposed, which accurately captures generally accepted
aspects of this concept. However, the Council recognizes that the
``financial stability'' interpretation does not include an indicator of
significance, which may be important in cases where the Council is
considering that term in connection with a potential exercise of one or
more of its authorities. Therefore, in response
[[Page 78028]]
to public comments, the Analytic Framework includes an interpretation
of ``threat to financial stability'' that builds on the proposed
interpretation of ``financial stability.'' Specifically, the Analytic
Framework interprets ``threat to financial stability'' to mean events
or conditions that could ``substantially impair'' the financial
system's ability to support economic activity. This interpretation is
consistent with the view of commenters who recommended that ``threat to
financial stability'' should be interpreted consistently with the
Council's statutory purposes and duties, which direct it to respond to
potential and emerging, not just entrenched or imminent, threats to
financial stability.\9\
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\9\ See Dodd-Frank Act section 112(a), 12 U.S.C. 5322(a).
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2. Identifying Potential Risks
Section II.a of the Analytic Framework, like the Proposed
Framework, describes how the Council expects to identify potential
risks to financial stability and provides examples of the broad range
of asset classes, institutions, and activities that the Council
monitors for potential risks.
A number of commenters expressed their support for the Proposed
Framework's discussion of risk monitoring, noting that the Proposed
Framework is broad enough to cover a variety of events and conditions
that may pose risks to the financial stability of the United States.
Other commenters stated that the activities, products, and practices
listed in the Proposed Framework were overly broad or overlapping and
suggested changes to this section, including the incorporation of
certain aspects of the Council's guidance on nonbank financial company
designations issued in 2019, more detail on how risk identification
will be connected to the list of vulnerabilities in the Proposed
Framework, and additional sector-specific information. One commenter
suggested specifically describing how the asset classes, institutions,
and activities listed in the Proposed Framework relate to the
identification of risk in the asset management industry. Additional
commenters suggested that this section of the Analytic Framework should
address in greater detail certain climate-related financial risks or
risks to the credit needs of underserved communities.\10\
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\10\ These comments are discussed further in section II.B.5
below.
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The Council's statutory mission is broad: It encompasses risks to
financial stability irrespective of the source of the risk or the
specific sector of the financial system that could be affected.
Therefore, the Council's monitoring is similarly broad, and in response
to comments suggesting the addition of further examples, the Council
has added ``private funds'' to its list of financial entities in this
section. The list of asset classes, institutions, and activities in the
Analytic Framework is not intended to be exclusive or exhaustive, but
instead to reflect the Council's broad statutory mandate. As discussed
in section II.B.5 below, the purpose of the Analytic Framework is to
describe the Council's overarching approach to financial stability
risks, so sector-specific discussion would not provide useful clarity.
The Council encourages members of the public who are interested in the
Council's specific areas of focus to review the Council's regular
public statements, including its annual reports, public meeting
minutes, and other public reports, which describe in detail the
Council's analyses of various risks.
3. Assessing Potential Risks
The Analytic Framework describes how the Council expects to
evaluate potential risks to financial stability to determine whether
they merit further review or action. Section II.b of the Analytic
Framework sets forth a non-exhaustive and non-exclusive list of
vulnerabilities that most commonly contribute to risks to financial
stability and sample quantitative metrics that may be used to measure
these vulnerabilities.
(a) Vulnerabilities and Sample Metrics
The Council received a variety of feedback on the vulnerabilities
and sample metrics described in Section II.b of the Proposed Framework.
Some commenters supported the specified vulnerabilities and sample
metrics, stating that they were well chosen, were supported by expert
research and analysis, and provided appropriate transparency. One
commenter supported the inclusion of the ``interconnections'' and
``destabilizing activities'' vulnerabilities, noting that these
vulnerabilities can arise even when the underlying activities are
undertaken intentionally and permitted by law. Some commenters also
supported the descriptions of the vulnerabilities in the Proposed
Framework. Several commenters noted that the Proposed Framework offered
the Council flexibility to conduct analyses of financial sectors and
their interconnections as well as more focused assessments of risks
related to individual firms. Some commenters commended the Council for
issuing the Proposed Framework separately from the Proposed Guidance,
as this approach allows the Council to decide which authority to
exercise, if any, without committing itself in advance to a particular
response.
Other commenters stated that the listed vulnerabilities were vague
or did not clarify the language of the Dodd-Frank Act. The Council
believes that by describing the Council's analytic approach without
regard to the origin of a particular risk, the Analytic Framework
provides new public transparency into how the Council expects to
consider risks to financial stability. Several commenters addressed
whether issuing the Proposed Framework separately from the Proposed
Guidance was useful. The Council believes that separately issuing the
Analytic Framework and the Final Guidance provides more clarity because
they serve different purposes. The Final Guidance describes the
Council's procedures related only to nonbank financial company
designations, while the Analytic Framework explains how the Council
analyzes risks to financial stability across the range of risks that
arise and the authorities the Council may use to respond to those
risks.
Several commenters recommended that the Analytic Framework
establish specific thresholds at which vulnerabilities would be deemed
to rise to the level of a threat to financial stability. One commenter
suggested that the Analytic Framework include examples of how
vulnerabilities will be assessed individually and in combination with
each other. Other commenters proposed that the Council provide a
sliding scale with minimum quantitative thresholds, where an assessment
that results in a score closer to the minimum threshold would require a
more rigorous qualitative assessment to determine whether a risk to
U.S. financial stability exists than a higher score would. In contrast,
some commenters expressed concern with the use of metrics generally to
assess vulnerabilities, because systemic risk analysis methods rapidly
evolve and specified metrics may become obsolete. One commenter
suggested omitting the sample metrics and instead expanding the
descriptions of the vulnerabilities in other ways. Some commenters
stated that that the metrics in the Proposed Framework were tailored to
banks and not appropriate for nonbank financial companies.
The Council believes that the vulnerabilities and sample metrics in
the Analytic Framework provide transparency regarding how the Council
[[Page 78029]]
assesses risks to financial stability across a range of issues and
sectors. As described in the Analytic Framework, the Council routinely
uses quantitative metrics and other data in its analyses, in addition
to qualitative factors. Further, in some circumstances, such as
evaluations of risks within a specific financial sector, the
application of particular metrics, tailored to the relevant sector and
to the risks under evaluation, can be beneficial. Accordingly, the
Analytic Framework describes risk factors and sample quantitative
metrics. However, the Council does not believe that uniform thresholds,
``sliding scales,'' or other weighting schemes adequately capture the
wide range of potential risks to financial stability that can arise
across the financial system. As some commenters noted, financial risks
vary across sectors, and thresholds that provide helpful insight into
risks in one sector may be irrelevant to another sector. While it would
not be feasible to generate an exhaustive list of metrics to measure
the full range of potential financial stability risks, the Council
believes that the sample metrics in the Analytic Framework offer
helpful clarity to understanding the listed vulnerabilities. Therefore,
the Analytic Framework sets forth sample metrics and does not provide
the types of thresholds suggested by some commenters.
Some commenters raised issues regarding specific vulnerabilities
addressed in the Proposed Framework. One commenter expressed concern
that the ``operational risks'' vulnerability would capture risks
associated with commercial companies. Another commenter questioned how
the Council would determine that vulnerabilities were not related to
normal market fluctuations. The Council is mindful of its purpose ``to
respond to emerging threats to the stability of the United States
financial system,'' and the vulnerabilities described in the Analytic
Framework are intended to support the identification and assessment of
potential risks to financial stability.
Some commenters were critical of the ``destabilizing activities''
vulnerability. Several commenters stated that this vulnerability was
circular or conclusory. Other commenters recommended that the Council
clarify this vulnerability. One commenter suggested that this
vulnerability would be measured better by qualitative factors rather
than quantitative measures. The Analytic Framework provides examples of
``destabilizing activities''--trading practices that substantially
increase volatility in one or more financial markets, or activities
that involve moral hazard or conflicts of interest that result in the
creation and transmission of significant risks--to provide insight into
this vulnerability. As with other vulnerabilities, the Council expects
its assessment of risks arising from destabilizing activities to be
rigorous and analytical.
One commenter stated that the ``liquidity risk and maturity
mismatch'' vulnerability did not explain how the mismatch between
short-term liabilities and longer-term assets is relevant for different
types of nonbank financial companies. While the Analytic Framework is
not focused on the assessment of individual nonbank financial companies
or sectors, the Council has further clarified this vulnerability by
including two additional sample metrics: the scale of financial
obligations that are short-term or can become due in a short period,
and amounts of transactions that may require the posting of additional
margin or collateral.
Some commenters stated that the Council should provide more detail
on how it considers other vulnerabilities listed in the Analytic
Framework. In response, the Analytic Framework includes additional
examples of the types of metrics the Council may consider with respect
to complexity or opacity (the extent of intercompany or interaffiliate
dependencies for liquidity, funding, operations, and risk management)
and inadequate risk management (levels of exposures to particular types
of financial instruments or asset classes).
One commenter stated that the sample metrics may incentivize firms
to manage their operations with respect to the metrics rather than
mitigating risk. To the extent that the vulnerabilities, sample
metrics, and transmission channels in the Analytic Framework provide
insights that enable firms or other stakeholders to take action to
mitigate potential risks to financial stability, those steps could help
accomplish the Council's statutory purposes of identifying risks to
financial stability, promoting market discipline, and responding to
emerging threats to financial stability.
A number of commenters suggested additional metrics for inclusion
in the Analytic Framework. For example, several commenters suggested
additional sample metrics for the ``operational risks'' vulnerability.
The sample metrics included in the Analytic Framework are quantitative
only, to provide further clarity as a supplement to the qualitative
descriptions of the listed vulnerabilities. Some of the metrics
recommended by commenters were not quantitative in nature and are not
suitable for inclusion in the Analytic Framework. Other recommended
metrics are not included because they would not be broadly applicable
across the financial system. One commenter recommended that the
Analytic Framework include a ``metric'' for existing regulatory
frameworks. One commenter suggested adding specific mitigating factors
as metrics. Both the Proposed Framework and the Analytic Framework note
explicitly that the Council takes into account existing laws and
regulations that have mitigated a potential risk to U.S. financial
stability. Additionally, as the Proposed Framework noted, the sample
metrics provided are indicative of how the Council expects to consider
the vulnerabilities but are not meant to be an exhaustive or exclusive
list of factors. While the Council expects to consider factors that are
likely to mitigate potential risks to financial stability, it does not
believe the inclusion of potential mitigants would enhance the Analytic
Framework. To the extent that mitigating factors exist, they are
reflected in the analysis of the risk itself, because they reduce
vulnerabilities or the transmission of risks.
Some commenters addressed the relationship between the
vulnerabilities and sample metrics in the Proposed Framework, on one
hand, and the statutory standard or considerations for designating
nonbank financial companies under section 113 of the Dodd-Frank Act, on
the other hand. As noted above, the Analytic Framework describes the
Council's analytic approach without regard to the origin of a
particular risk, including whether the risk arises from widely
conducted activities or from individual entities, and regardless of
which of the Council's authorities may be used to respond to the risk.
With respect to nonbank financial company designations, the Dodd-Frank
Act sets forth the standard for designations and certain specific
considerations that the Council must take into account in making any
determination under section 113. Consistent with the statutory
requirements, the Council will apply the statutory standard and each of
the 10 statutory considerations in any evaluation of a nonbank
financial company for potential designation. The vulnerabilities,
sample metrics, and transmission channels described in the Analytic
Framework will inform the Council's assessment of the designation
standard and mandatory considerations under section 113. Some
commenters
[[Page 78030]]
also addressed whether the vulnerabilities, sample metrics, or
transmission channels in the Analytic Framework take into account the
likelihood of a nonbank financial company's material financial distress
(referred to by some commenters as a company's ``vulnerability'' to
financial distress), including in the context of a designation under
section 113 of the Dodd-Frank Act. As also discussed in the preamble to
the Final Guidance, the Council does not intend to construe any of the
vulnerabilities, sample metrics, transmission channels, or other
factors described in the Analytic Framework as contemplating or
requiring an assessment of the likelihood of, or vulnerability to,
material financial distress, including in the context of a potential
designation under section 113 of the Dodd-Frank Act.
(b) Transmission Channels
The Analytic Framework includes a detailed discussion, expanded
from the Proposed Framework, regarding the Council's consideration of
how the adverse effects of potential risks could be transmitted to
financial markets or market participants and what impact the potential
risks could have on the financial system. The Analytic Framework notes
that such a transmission of risk can occur through various mechanisms,
or channels, and describes four transmission channels that the Council
has identified as most likely to facilitate the transmission of the
negative effects of a risk to financial stability.
Some commenters stated that the Proposed Framework's discussion of
the four transmission channels provided insufficient detail to
elucidate the Council's analyses. For example, one commenter suggested
adding a discussion that would map specific activities, products, and
practices that may pose risks onto each of the identified transmission
channels. Another commenter stated that the Council should specify the
value of daily losses or asset sales that would give rise to a threat
to financial stability. Other commenters stated that the relationship
between the transmission channels and the vulnerabilities described
above was unclear. Some commenters suggested adding more analyses or
requirements to the Council's consideration of the transmission
channels, including to address how the transmission channels may spread
risks to low-income, minority, or underserved communities; to mandate
that the Council focus on some channels more than others; or to notify
market participants when the transmission of risks becomes serious
enough to pose a potential threat to financial stability.
One commenter stated that the transmission channels do not relate
to specific Council authorities under the Dodd-Frank Act and are
therefore inappropriate for the Council to consider. However, under
section 112 of the Dodd-Frank Act, one of the Council's purposes is
``to respond to emerging threats to the stability of the United States
financial system,'' and among the Council's relevant duties is to
``monitor the financial services marketplace in order to identify
potential threats to the financial stability of the United States.''
Accordingly, consideration of the channels most likely to transmit risk
through the financial system is well within the Council's remit.
In response to the public comments, the Analytic Framework contains
two types of additional information with respect to the transmission
channels. First, to clarify the relationship between the
vulnerabilities and the transmission channels described in the Analytic
Framework, each of the four transmission channel discussions now
highlights certain vulnerabilities that may be particularly relevant to
that channel. These explanations are intended to further clarify, for
the public, how the vulnerabilities and transmission channels will be
considered together. Second, the Analytic Framework includes expanded
discussions of the transmission channels, compared to the Proposed
Framework, to provide further insight into the Council's analyses under
those channels. The ``exposures'' transmission channel discussion now
includes additional examples of potentially relevant asset classes.
Consistent with input from a number of commenters, the Analytic
Framework also notes that risks arising from exposures to assets
managed by a company on behalf of third parties are distinct from
exposures to assets owned by, or liabilities issued by, the company
itself. The discussion of the ``asset liquidation'' transmission
channel now provides greater detail on the features of certain assets,
liabilities, and market behavior that could affect the Council's
analysis and further describes how actions by market participants or
financial regulators may influence the transmission of risks through
asset liquidation. Finally, the Analytic Framework's discussion of the
``critical function or service'' transmission channel further
elaborates on the Council's analysis with respect to this channel.
The Council recognizes that some commenters recommended that even
further detail be included in the transmission channel discussion. The
Council believes that this discussion in the Analytic Framework,
including the additional descriptions compared to the proposal,
provides the public with insight into the Council's assessments of
potential risks to financial stability, while maintaining the
flexibility needed for the Council to be able to respond to diverse and
evolving risks.
4. Addressing Potential Risks
Section II.c of the Analytic Framework describes approaches the
Council may take to respond to risks and multiple tools the Council may
use to mitigate risks. As described in the Analytic Framework, these
approaches may include interagency information sharing and
collaboration, recommendations to agencies and Congress, and
designation of certain entities or activities for supervision and
regulation.
Some commenters suggested that the Council should add further
detail to the Analytic Framework regarding how the Council intends to
use the tools described in this section. However, the Analytic
Framework is designed to describe how the Council evaluates and
responds to potential risks to financial stability in general, rather
than a process for using any specific authority. The Council has issued
separate documents, such as the Final Guidance, that describe in detail
the procedures the Council expects to follow when employing certain
statutory authorities.
Several commenters stated that the Analytic Framework should
include a more detailed description of how the Council will collaborate
with primary financial regulatory agencies to respond to risks to U.S.
financial stability. Others stated that the framework should address
how the Council considers the existing regulations that primary
financial regulatory agencies administer and require that the Council
only act when existing regulation is insufficient.
The Council has a long history of close engagement with financial
regulatory agencies and intends to continue to consult and coordinate
with regulators. The Proposed Framework referred numerous times to the
Council's consultation and coordination with primary financial
regulatory agencies, and noted that the Council works with relevant
financial regulators at the federal and state levels. The Proposed
Framework also noted that if existing regulators can address a risk to
financial stability in a sufficient and timely way, the Council
generally
[[Page 78031]]
encourages those regulators to do so. The Council routinely works with
federal and state financial regulatory agencies to identify, assess,
and respond to risks to financial stability, as noted in the Proposed
Framework's section on addressing potential risks. In response to the
public comments, the Analytic Framework further emphasizes the
importance of the Council's engagement with state and federal financial
regulators as it assesses potential risks. The Analytic Framework now
includes an additional statement that the Council engages extensively
with state and federal financial regulatory agencies, including those
represented on the Council, regarding potential risks and the extent to
which existing regulation may mitigate those risks.
One commenter suggested that the Council clarify that the emphasis
on engaging with existing regulators to address risks to financial
stability does not require the Council to prioritize interagency
coordination and information sharing over its other authorities,
including under sections 113 and 120 of the Dodd-Frank Act. The Council
agrees that such engagement does not imply, much less require,
prioritization of any of the Council's authorities over others. The
Council intends for all of its statutory tools to be available, as
appropriate, to respond to risks to financial stability.
5. Other Comments
In addition to comments regarding specific sections of the Proposed
Framework, the Council also received a number of more general or cross-
cutting comments. Several commenters stated that the Analytic Framework
should specifically address unique features of their industries,
including traditional asset managers, alternative investment managers,
life insurers, and payment and digital asset providers. The Council
affirms that its analyses of potential risks to financial stability
will account for relevant differences among various financial sectors.
For example, as noted in the Analytic Framework, under the exposures
transmission channel, risks arising from exposures to assets managed by
a company on behalf of third parties are distinct from exposures to
assets owned by, or liabilities issued by, the company itself. The
Analytic Framework also notes that the Council's analyses take into
account market participants' risk profiles and business models. But the
Analytic Framework's purpose is not to address such sector-specific
distinctions; instead, it describes the Council's overarching approach
to financial stability risks regardless of their origin.
The Council also received comments commending the Proposed
Framework for providing transparency and clarity with respect to the
Council's holistic and deliberative process for identifying, assessing,
and addressing risks. Other commenters recommended greater transparency
or detail, or stated that nonbank financial companies could not take
informed action based on the Proposed Framework to avoid designation
under section 113 of the Dodd-Frank Act. Commenters suggested that the
Council provide nonbank financial companies with additional guidance on
risk mitigants and corrective steps they could undertake to avoid
designation. One commenter indicated that the Proposed Framework should
take into account different accounting standards when applying metrics
and, in particular, incorporate certain accounting standards described
by the Council in the nonbank financial company designation context in
2015.\11\ The Council believes that the Analytic Framework provides the
public and industry participants with considerable transparency into
how the Council identifies, assesses, and addresses potential risks to
financial stability, regardless of whether the risks stem from widely
conducted activities or from individual entities. The Council also
believes that nonbank financial companies, market participants, and
other interested parties should be able to assess potential risks to
financial stability based on the vulnerabilities, sample metrics, and
transmission channels described in the Analytic Framework. For example,
while the Analytic Framework does not seek to establish a bright-line
test for the level of leverage or liquidity risk that could constitute
a risk to financial stability, the Analytic Framework identifies these
vulnerabilities, explains how the Council evaluates them, provides
sample metrics for their quantitative measurement, and describes the
channels through which those risks could create risks to financial
stability, including through the exposures and asset liquidation
transmission channels. The Council believes that the Analytic Framework
provides a transparent and constructive explanation of how the Council
considers risks to financial stability.
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\11\ The Council rescinded the referenced guidance in 2019. See
Financial Stability Oversight Council, Staff Guidance, Methodologies
Relating to Stage 1 Thresholds (June 8, 2015), available at <a href="https://home.treasury.gov/system/files/261/Staff%20Guidance%20Methodologies%20Relating%20to%20Stage%201%20Thresholds.pdf">https://home.treasury.gov/system/files/261/Staff%20Guidance%20Methodologies%20Relating%20to%20Stage%201%20Thresholds.pdf</a>; Minutes of the Council (Dec. 4, 2019), available at
<a href="https://home.treasury.gov/system/files/261/December-4-2019.pdf">https://home.treasury.gov/system/files/261/December-4-2019.pdf</a>.
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Some commenters recommended that the Analytic Framework
specifically address climate-related financial risk, such as by
incorporating climate-related financial risk into the Council's
interpretation of financial stability, or explicitly accounting for
climate-related risks among the Analytic Framework's listed
vulnerabilities, sample metrics, or transmission channels. The Council
appreciates these comments and has published a number of analyses
regarding the emerging and increasing risks that climate change poses
to the financial system. However, the Council believes that potential
risks related to climate change may be assessed under the
vulnerabilities, sample metrics, and transmission channels in the
Analytic Framework. For example, to the extent that climate-related
financial risks could result in defaults on a company's outstanding
obligations, those risks may be considered, in part, through the
``interconnections'' vulnerability and the ``exposures'' transmission
channel.
Similarly, some commenters recommended that the Analytic Framework
discuss risks to the financial needs of underserved families and
communities. As with climate-related financial risks, the Council
agrees that risks to financial stability that affect the availability
of credit to underserved populations are important, and the Council
expects to consider such risks, as appropriate, as part of the approach
described in the Analytic Framework. For example, the Council would
expect to monitor markets for consumer financial products and services
for potential risks under the Analytic Framework's first section; in
assessing potential risks, the ``critical function or service''
transmission channel may be particularly relevant to risks concerning
the availability of financial services to underserved populations; and
to respond to an identified risk, the Council could take an action
described in section II.c of the Analytic Framework, including
promoting interagency coordination or making recommendations to primary
financial regulatory agencies.
Some commenters suggested adding certain other factors to the
Analytic Framework. These included assessments regarding the effects of
existing regulations, statements prioritizing certain approaches to
risk responses and statutory tools over others, and requirements to
perform cost-benefit analyses when assessing or responding to certain
risks to financial stability. Some of these suggestions were primarily
directed at the Proposed
[[Page 78032]]
Guidance and are addressed in the preamble to the Final Guidance. Some
were already reflected in the Proposed Framework, including its
discussions of the effects of existing regulation. Certain of these
comments were beyond the scope of the Analytic Framework.
III. Legal Authority of the Council and Status of the Analytic
Framework
The Council has numerous authorities and tools under the Dodd-Frank
Act to carry out its statutory purposes.\12\ As an agency charged by
Congress with broad-ranging responsibilities under the Dodd-Frank Act,
the Council has the inherent authority to promulgate interpretive
guidance that explains the approach the Council expects to take in
identifying, assessing, and responding to certain potential risks to
U.S. financial stability.\13\ The Council also has authority to issue
policy statements.\14\ The Analytic Framework provides transparency to
the public as to how the Council intends to exercise its discretionary
authorities. The Analytic Framework does not have binding effect; does
not impose duties on, or alter the rights or interests of, any person;
and does not change the statutory standards for the Council's actions.
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\12\ See, for example, Dodd-Frank Act sections 112(a)(2), 113,
115, 120, and 804, 12 U.S.C. 5322(a)(2), 5323, 5325, 5330, and 5463.
\13\ Courts have recognized that ``an agency charged with a duty
to enforce or administer a statute has inherent authority to issue
interpretive rules informing the public of the procedures and
standards it intends to apply in exercising its discretion.'' See,
for example, Prod. Tool v. Employment & Training Admin., 688 F.2d
1161, 1166 (7th Cir. 1982). The Supreme Court has acknowledged that
``whether or not they enjoy any express delegation of authority on a
particular question, agencies charged with applying a statute
necessarily make all sorts of interpretive choices.'' U.S. v. Mead,
533 U.S. 218, 227 (2001).
\14\ See Ass'n of Flight Attendants-CWA, AFL-CIO v. Huerta, 785
F.3d 710 (D.C. Cir. 2015).
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IV. Executive Orders 12866, 13563, 14094
Executive Orders 12866, 13563, and 14094 direct certain agencies to
assess costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health and safety effects, distributive impacts, and equity). Pursuant
to section 3(f) of Executive Order 12866, as amended by Executive Order
14094, the Office of Information and Regulatory Affairs within the
Office of Management and Budget has determined that the Analytic
Framework is not a ``significant regulatory action.''
Financial Stability Oversight Council
Analytic Framework for Financial Stability Risk Identification,
Assessment, and Response
I. Introduction
This document describes the approach the Financial Stability
Oversight Council (Council) expects to take in identifying, assessing,
and responding to certain potential risks to U.S. financial stability.
The Council's practices set forth in this document are among the
methods the Council uses to satisfy its statutory purposes: (1) to
identify risks to U.S. financial stability that could arise from the
material financial distress or failure, or ongoing activities, of
large, interconnected bank holding companies or nonbank financial
companies, or that could arise outside the financial services
marketplace; (2) to promote market discipline, by eliminating
expectations on the part of shareholders, creditors, and counterparties
of such companies that the government will shield them from losses in
the event of failure; and (3) to respond to emerging threats to the
stability of the U.S. financial system.\1\ The Council's specific
statutory duties include monitoring the financial services marketplace
in order to identify potential threats to U.S. financial stability and
identifying gaps in regulation that could pose risks to U.S. financial
stability, among others.\2\
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\1\ Dodd-Frank Act Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act) section 112(a)(1), 12 U.S.C. 5322(a)(1).
\2\ Dodd-Frank Act section 112(a)(2), 12 U.S.C. 5322(a)(2).
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Financial stability can be defined as the financial system being
resilient to events or conditions that could impair its ability to
support economic activity, such as by intermediating financial
transactions, facilitating payments, allocating resources, and managing
risks. Events or conditions that could substantially impair such
ability would constitute a threat to financial stability. Adverse
events, or shocks, can arise from within the financial system or from
external sources. Vulnerabilities in the financial system can amplify
the impact of a shock, potentially leading to substantial disruptions
in the provision of financial services. The Council seeks to identify
and respond to risks to financial stability that could impair the
financial system's ability to perform its functions to a degree that
could harm the economy. Risks to financial stability can arise from
widely conducted activities or from individual entities, and from long-
term vulnerabilities or from sources that are new or evolving.
This document describes the Council's analytic framework for
identifying, assessing, and responding to potential risks to financial
stability. The Council seeks to reduce the risk of a shock arising from
within the financial system, to improve resilience against shocks that
could affect the financial system, and to mitigate financial
vulnerabilities that may increase risks to financial stability. The
actions the Council may take depend on the nature of the vulnerability.
For example, vulnerabilities originating from activities that may be
widely conducted in a particular sector or market over which a
regulator has adequate existing authority may be addressed through an
activity-based or industry-wide response; in contrast, in cases where
the financial system relies on the ongoing financial activities of a
small number of entities, such that the impairment of one of the
entities could threaten financial stability, or where a particular
financial company's material financial distress or activities could
pose a threat to financial stability, entity-based action may be
appropriate. The Council's authorities, some of which are described in
section II.c, are complementary, and the Council may select one or more
of those authorities to address a particular risk.
Among the many lessons of financial crises are that risks to
financial stability can be diverse and build up over time, dislocations
in financial markets and failures of financial companies can be sudden
and unpredictable, and regulatory gaps can increase risks to financial
stability. The Council was created in the aftermath of the 2007-2009
financial crisis and is statutorily responsible for identifying and
preemptively acting to address potential risks to financial stability.
Many of the same factors, such as leverage, liquidity risk, and
operational risks, regularly recur in different forms and under
different conditions to generate risks to financial stability. At the
same time, the U.S. financial system is large, diverse, and continually
evolving, so the Council's analytic methodologies adapt to address
evolving developments and risks.
This document is not a binding rule, but is intended to help market
participants, stakeholders, and other members of the public better
understand how the Council expects to perform certain of its duties.
The Council may consider factors relevant to the assessment of a
potential risk or threat to U.S. financial stability on a case-by-case
basis, subject to applicable statutory requirements. The Council's
[[Page 78033]]
annual reports describe the Council's work in implementing its
responsibilities.
II. Identifying, Assessing, and Addressing Potential Risks to Financial
Stability
a. Identifying Potential Risks
To enable the Council to identify potential risks to U.S. financial
stability, the Council, in consultation with relevant U.S. and foreign
financial regulatory agencies,\3\ monitors financial markets, entities,
and market developments to identify potential risks to U.S. financial
stability.
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\3\ References in this document to ``financial regulatory
agencies'' may encompass a broader range of regulators than those
included in the statutory definition of ``primary financial
regulatory agency'' under section 2(12) of the Dodd-Frank Act, 12
U.S.C. 5301(12).
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In light of the Council's broad statutory mandate, the Council's
monitoring for potential risks to financial stability may cover an
expansive range of asset classes, institutions, and activities, such
as:
<bullet> markets for debt, loans, short-term funding, equity
securities, commodities, digital assets, derivatives, and other
institutional and consumer financial products and services;
<bullet> central counterparties and payment, clearing, and
settlement activities;
<bullet> financial entities, including banking organizations,
broker-dealers, asset managers, investment companies, private funds,
insurance companies, mortgage originators and servicers, and specialty
finance companies;
<bullet> new or evolving financial products and practices; and
<bullet> developments affecting the resiliency of the financial
system, such as cybersecurity and climate-related financial risks.
Sectors and activities that may impact U.S. financial stability are
often described in the Council's annual reports. The Council reviews
information such as historical data, research regarding the behavior of
financial markets and financial market participants, and new
developments that arise in evolving marketplaces. The Council relies on
data, research, and analysis including information from Council member
agencies, the Office of Financial Research, primary financial
regulatory agencies, industry participants, and other sources.\4\
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\4\ See Dodd-Frank Act section 112(d), 12 U.S.C. 5322(d).
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b. Assessing Potential Risks
The Council works with relevant financial regulatory agencies to
evaluate potential risks to financial stability to determine whether
they merit further review or action. The evaluation of any potential
risk to financial stability will be highly fact-specific, but the
Council has identified certain vulnerabilities that most commonly
contribute to such risks. The Council has also identified certain
sample quantitative metrics that are commonly used to measure these
vulnerabilities, although the Council may assess each of these
vulnerabilities using a variety of quantitative and qualitative
factors. The following list is not exhaustive or exclusive, but is
indicative of the vulnerabilities and metrics the Council expects to
consider.
<bullet> Leverage. Leverage can amplify risks by reducing market
participants' ability to satisfy their obligations and by increasing
the potential for sudden liquidity strains. Leverage can arise from
debt, derivatives, off-balance sheet obligations, and other
arrangements. Leverage can arise broadly within a market or at a
limited number of firms in a market. Quantitative metrics relevant for
assessing leverage may include ratios of assets, risk-weighted assets,
debt, derivatives liabilities or exposures, and off-balance sheet
obligations to equity.
<bullet> Liquidity risk and maturity mismatch. A shortfall of
sufficient liquidity to satisfy short-term needs, or reliance on short-
term liabilities to finance longer-term assets, can subject market
participants to rollover or refinancing risk. These risks may force
entities to sell assets rapidly at stressed market prices, which can
contribute to broader stresses. Relevant quantitative metrics may
include the scale of financial obligations that are short-term or can
become due in a short period, the ratio of short-term debt to
unencumbered short-term high-quality liquid assets, amounts of funding
available to meet unexpected reductions in available short-term
funding, and amounts of transactions that may require the posting of
additional margin or collateral.
<bullet> Interconnections. Direct or indirect financial
interconnections, such as exposures of creditors, counterparties,
investors, and borrowers, can increase the potential negative effect of
dislocations or financial distress. Relevant quantitative metrics may
include total assets, off-balance-sheet assets or liabilities, total
debt, derivatives exposures, values of securities financing
transactions, and the size of potential requirements to post margin or
collateral. Metrics related to the concentration of holdings of a class
of financial assets may also be relevant.
<bullet> Operational risks. Risks can arise from the impairment or
failure of financial market infrastructures, processes, or systems,
including due to cybersecurity vulnerabilities. Relevant quantitative
metrics may include statistics on cybersecurity incidents or the scale
of critical infrastructure.
<bullet> Complexity or opacity. A risk may be exacerbated if a
market, activity, or firm is complex or opaque, such as if financial
transactions occur outside of regulated sectors or if the structure and
operations of market participants cannot readily be determined. In
addition, risks may be aggravated by the complexity of the legal
structure of market participants and their activities, by the
unavailability of data due to lack of regulatory or public disclosure
requirements, and by obstacles to the rapid and orderly resolution of
market participants. Factors that generally increase the risks
associated with complexity or opacity may include a large size or scope
of activities, a complex legal or operational structure, activities or
entities subject to the jurisdiction of multiple regulators, and
complex funding structures. Relevant quantitative metrics may include
the extent of intercompany or interaffiliate dependencies for
liquidity, funding, operations, and risk management; the number of
jurisdictions in which activities are conducted; and numbers of
affiliates.
<bullet> Inadequate risk management. A risk may be exacerbated if
it is conducted without effective risk-management practices, including
the absence of appropriate regulatory authority and requirements. In
contrast, existing regulatory requirements or market practices may
reduce risks by, for example, limiting exposures or leverage,
increasing capital and liquidity, enhancing risk-management practices,
restricting excessive risk-taking, providing consolidated prudential
regulation and supervision, or increasing regulatory or public
transparency. Relevant quantitative metrics may include levels of
exposures to particular types of financial instruments or asset classes
and amounts of capital and liquidity.
<bullet> Concentration. A risk may be amplified if financial
exposures or important services are highly concentrated in a small
number of entities, creating a risk of widespread losses or the risk
that the service could not be replaced in a timely manner at a similar
price and volume if existing providers withdrew from the market.
Relevant quantitative metrics may include market shares in segments of
applicable financial markets.
[[Page 78034]]
<bullet> Destabilizing activities. Certain activities, by their
nature, particularly those that are sizeable and interconnected with
the financial system, can destabilize markets for particular types of
financial instruments or impair financial institutions. This risk may
arise even when those activities are intentional and permitted by
applicable law, such as trading practices that substantially increase
volatility in one or more financial markets, or activities that involve
moral hazard or conflicts of interest that result in the creation and
transmission of significant risks.
The vulnerabilities and sample metrics listed above identify risks
that may arise from broadly conducted activities or from a small number
of entities; they do not dictate the use of a specific authority by the
Council. Risks to financial stability can arise from widely conducted
activities or from a smaller number of entities, and the Council's
evaluations and actions will depend on the nature of a vulnerability.
While risks from individual entities may be assessed using these types
of metrics, the Council also evaluates broader risks, such as by
calculating these metrics on an aggregate basis within a particular
financial sector. For example, in some cases, risks arising from
widespread and substantial leverage in a particular market may be
evaluated or addressed on a sector-wide basis, while in other cases
risks from a single company whose leverage is outsized relative to
other firms in its market may be considered for an entity-specific
response.
In addition, in most cases the identification and assessment of a
potential risk to financial stability involves consideration of
multiple quantitative metrics and qualitative factors. Therefore, the
Council uses metrics such as those cited above individually and in
combination, as well as other factors, in its analyses.
The Council considers how the adverse effects of potential risks
could be transmitted to financial markets or market participants and
what impact the potential risk could have on the financial system. Such
a transmission of risk can occur through various mechanisms, or
``channels.'' The Council has identified four transmission channels
that are most likely to facilitate the transmission of the negative
effects of a risk to financial stability. These transmission channels
are:
<bullet> Exposures. Direct and indirect exposures of creditors,
counterparties, investors, and other market participants can result in
losses in the event of a default or decreases in asset valuations. In
particular, market participants' exposures to a particular financial
instrument or asset class, such as equity, debt, derivatives, or
securities financing transactions, could impair those market
participants if there is a default on or other reduction in the value
of the instrument or assets. In evaluating this transmission channel,
risks arising from exposures to assets managed by a company on behalf
of third parties are distinct from exposures to assets owned by, or
liabilities issued by, the company itself. The potential risk to U.S.
financial stability will generally be greater if the amounts of
exposures are larger; if transaction terms provide less protection for
counterparties; if exposures are correlated, concentrated, or
interconnected with other instruments or asset classes; or if entities
with significant exposures include large financial institutions. The
leverage, interconnections, and concentration vulnerabilities described
above may be particularly relevant to this transmission channel.
<bullet> Asset liquidation. A rapid liquidation of financial assets
can pose a risk to U.S. financial stability when it causes a
significant fall in asset prices that disrupts trading or funding in
key markets or causes losses or funding problems for market
participants holding those or related assets. Rapid liquidations can
result from a deterioration in asset prices or market functioning that
could pressure firms to sell their holdings of affected assets to
maintain adequate capital and liquidity, which, in turn, could produce
a cycle of asset sales that lead to further market disruptions. This
analysis takes into account amounts and types of liabilities that are
or could become short-term in nature, amounts of assets that could be
rapidly liquidated to satisfy obligations, and the potential effects of
a rapid asset liquidation on markets and market participants. The
potential risk is greater, for example, if leverage or reliance on
short-term funding is higher, if assets are riskier and may experience
a reduction in market liquidity in times of broader market stress, and
if asset price volatility could lead to significant margin calls.
Actions that market participants or financial regulators may take to
impose stays on counterparty terminations or withdrawals may reduce the
risks of rapid asset liquidations, although such actions could
potentially increase risks through the exposures transmission channel
if they result in potential losses or delayed payments or through the
contagion transmission channel if there is a loss of market confidence.
The leverage and liquidity risk and maturity mismatch vulnerabilities
described above may be particularly relevant to this transmission
channel.
<bullet> Critical function or service. A risk to financial
stability can arise if there could be a disruption of a critical
function or service that is relied upon by market participants and for
which there are no ready substitutes that could provide the function or
service at a similar price and quantity. This channel is commonly
referred to as ``substitutability.'' Substitutability risks can arise
in situations where a small number of entities are the primary or
dominant providers of critical services in a market that the Council
determines to be essential to U.S. financial stability. Concern about a
potential lack of substitutability could be greater if providers of a
critical function or service are likely to experience stress at the
same time because they are exposed to the same risks. This channel is
more prominent when the critical function or service is interconnected
or large, when operations are opaque, when the function or service uses
or relies on leverage to support its activities, or when risk-
management practices related to operational risks are not sufficient.
The interconnections, operational risks, and concentration
vulnerabilities described above may be particularly relevant to this
transmission channel.
<bullet> Contagion. Even without direct or indirect exposures,
contagion can arise from the perception of common vulnerabilities or
exposures, such as business models or asset holdings that are similar
or highly correlated. Such contagion can spread stress quickly and
unexpectedly, particularly in circumstances where there is limited
transparency into investment risks, correlated markets, or greater
operational risks. Contagion can also arise when there is a loss of
confidence in financial instruments that are treated as substitutes for
money. In these circumstances, market dislocations or fire sales may
result in a loss of confidence in other financial market sectors or
participants, propagating further market dislocations or fire sales.
The interconnections and complexity or opacity vulnerabilities
described above may be particularly relevant to this transmission
channel.
The presence of any of the vulnerabilities listed above may
increase the potential for risks to be transmitted to financial markets
or market participants through these or other transmission channels.
The Council may consider these vulnerabilities and transmission
[[Page 78035]]
channels, as well as others that may be relevant, in identifying
financial markets, activities, and entities that could pose risks to
U.S. financial stability.
The Council may assess risks as they could arise in the context of
a period of overall stress in the financial services industry and in a
weak macroeconomic environment, with market developments such as
increased counterparty defaults, decreased funding availability, and
decreased asset prices, because in such a context, the risks may have a
greater effect on U.S. financial stability.
The Council's work often includes efforts such as sharing data,
research, and analysis among Council members and member agencies and
their staffs; consulting with regulators and other experts regarding
the scope of potential risks and factors that may mitigate those risks;
and collaboratively developing analyses for consideration by the
Council. As part of this work, the Council may also engage with market
participants and other members of the public as it assesses potential
risks. In its evaluations, the Council takes into account existing laws
and regulations that have mitigated a potential risk to U.S. financial
stability. The Council also engages extensively with state and federal
financial regulatory agencies, including those represented on the
Council, regarding potential risks and the extent to which existing
regulation may mitigate those risks. The Council also takes into
account the risk profiles and business models of market participants.
Empirical data may not be available regarding all potential risks. The
type and scope of the Council's analysis will be based on the potential
risk under consideration. In many cases, the Council provides
information regarding its work in its annual reports.
c. Addressing Potential Risks
In light of the varying sources of risk described above (such as
activities, entities, exogenous circumstances, and existing or emerging
practices or conditions), the Council may take different approaches to
respond to a risk, and may use multiple tools to mitigate a risk. These
approaches may include acting to reduce the risk of a shock arising
from within the financial system, to mitigate financial vulnerabilities
that may increase risks to financial stability, or to improve the
resilience of the financial system to shocks. The actions the Council
takes may depend on the circumstances. When a potential risk to
financial stability is identified, the Council's Deputies Committee
will generally direct one or more of the Council's staff-level
committees or working groups to consider potential policy approaches or
actions the Council could take to assess and address the risk. Those
committees and working groups may consider the utility of any of the
Council's authorities to respond to risks to U.S. financial stability,
including but not limited to those described below.
Interagency coordination and information sharing. In many cases,
the Council works with the relevant financial regulatory agencies at
the federal and state levels to seek the implementation of appropriate
actions to ensure a potential risk is adequately addressed.\5\ If they
have adequate authority, existing regulators could take actions to
mitigate potential risks to U.S. financial stability identified by the
Council. There may be various approaches existing regulators could
take, based on their authorities and the urgency of the risk, such as
enhancing their regulation or supervision of companies or markets under
their jurisdiction, restricting or prohibiting the offering of a
product, or requiring market participants to take additional risk-
management steps. If existing regulators can address a risk to
financial stability in a sufficient and timely way, the Council
generally encourages those regulators to do so.
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\5\ See Dodd-Frank Act sections 112(a)(2)(A), (D), (E), and (F),
12 U.S.C. 5322(a)(2)(A), (D), (E), and (F).
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Recommendations to agencies or Congress. The Council may also make
formal public recommendations to primary financial regulatory agencies
under section 120 of the Dodd-Frank Act. Under section 120, the Council
may provide for more stringent regulation of a financial activity by
issuing nonbinding recommendations to the primary financial regulatory
agencies to apply new or heightened standards and safeguards for a
financial activity or practice conducted by bank holding companies or
nonbank financial companies under their jurisdiction.\6\ In addition,
in any case in which no primary financial regulatory agency exists for
nonbank financial companies conducting financial activities or
practices identified by the Council as posing risks, the Council can
consider reporting to Congress on recommendations for legislation that
would prevent such activities or practices from threatening U.S.
financial stability.\7\ The Council will make these recommendations
only if it determines that the conduct, scope, nature, size, scale,
concentration, or interconnectedness of the activity or practice could
create or increase the risk of significant liquidity, credit, or other
problems spreading among bank holding companies and nonbank financial
companies, U.S. financial markets, or low-income, minority, or
underserved communities.\8\ The new or heightened standards and
safeguards for a financial activity or practice recommended by the
Council will take costs to long-term economic growth into account, and
may include prescribing the conduct of the activity or practice in
specific ways (such as by limiting its scope, or applying particular
capital or risk-management requirements to the conduct of the activity)
or prohibiting the activity or practice.\9\ In its recommendations
under section 120, the Council may suggest broad approaches to address
the risks it has identified. When appropriate, the Council may make a
more specific recommendation. Prior to issuing a recommendation under
section 120, the Council will consult with the relevant primary
financial regulatory agency and provide notice to the public and
opportunity for comment as required by section 120.\10\
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\6\ Dodd-Frank Act section 120(a), 12 U.S.C. 5330(a).
\7\ Dodd-Frank Act section 120(d)(3), 12 U.S.C. 5330(d)(3).
\8\ Dodd-Frank Act section 120(a), 12 U.S.C. 5330(a).
\9\ Dodd-Frank Act section 120(b)(2), 12 U.S.C. 5330(b)(2).
\10\ See Dodd-Frank Act section 120(b)(1), 12 U.S.C. 5330(b)(1).
The Council also has authority to issue recommendations to the Board
of Governors of the Federal Reserve System (Federal Reserve Board)
regarding the establishment and refinement of prudential standards
and reporting and disclosure requirements applicable to nonbank
financial companies subject to Federal Reserve Board supervision and
large, interconnected bank holding companies (Dodd-Frank Act section
115, 12 U.S.C. 5325); recommendations to regulators, Congress, or
firms in its annual reports (Dodd-Frank Act section 112(a)(2)(N), 12
U.S.C. 5322(a)(2)(N)); and other recommendations to Congress or
Council member agencies (Dodd-Frank Act sections 112(a)(2)(D) and
(F), 12 U.S.C. 5322(a)(2)(D) and (F)).
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Nonbank financial company determinations. In certain cases, the
Council may evaluate one or more nonbank financial companies for an
entity-specific determination under section 113 of the Dodd-Frank Act.
Under section 113, the Council may determine, by a vote of not fewer
than two-thirds of the voting members of the Council then serving,
including an affirmative vote by the Chairperson of the Council, that a
nonbank financial company will be supervised by the Federal Reserve
Board and be subject to prudential standards if the Council determines
that (1) material financial distress at the nonbank financial company
could pose a threat to the
[[Page 78036]]
financial stability of the United States or (2) the nature, scope,
size, scale, concentration, interconnectedness, or mix of the
activities of the nonbank financial company could pose a threat to the
financial stability of the United States. The Council has issued a
procedural rule and interpretive guidance regarding its process for
considering a nonbank financial company for potential designation under
section 113.\11\ The Dodd-Frank Act requires the Council to consider 10
specific considerations, including the company's leverage,
relationships with other significant financial companies, and existing
regulation by primary financial regulatory agencies, when determining
whether a nonbank financial company satisfies either of the
determination standards.\12\ Due to the unique threat that each nonbank
financial company could pose to U.S. financial stability and the nature
of the inquiry required by the statutory considerations set forth in
section 113, the Council expects that its evaluations of nonbank
financial companies under section 113 will be firm-specific and may
include an assessment of quantitative and qualitative information that
the Council deems relevant to a particular nonbank financial company.
The factors described above are not exhaustive or exclusive and may not
apply to all nonbank financial companies under evaluation.
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\11\ See 12 CFR part 1310.
\12\ Dodd-Frank Act sections 113(a)(2) and (b)(2), 12 U.S.C.
5323(a)(2) and (b)(2).
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Payment, clearing, and settlement activity designations. The
Council also has authority to designate certain payment, clearing, and
settlement (PCS) activities ``that the Council determines are, or are
likely to become, systemically important'' under Title VIII of the
Dodd-Frank Act.\13\ PCS activities are defined as activities carried
out by one or more financial institutions to facilitate the completion
of financial transactions such as funds transfers, securities
contracts, futures, forwards, repurchase agreements, swaps, foreign
exchange contracts, and financial derivatives. Under the Dodd-Frank
Act, PCS activities may include (1) the calculation and communication
of unsettled financial transactions between counterparties; (2) the
netting of transactions; (3) provision and maintenance of trade,
contract, or instrument information; (4) the management of risks and
activities associated with continuing financial transactions; (5)
transmittal and storage of payment instructions; (6) the movement of
funds; (7) the final settlement of financial transactions; and (8)
other similar functions that the Council may determine.\14\ Before
designating a PCS activity, the Council must consult with certain
regulatory agencies and must provide financial institutions with
advance notice of the proposed designation by Federal Register
publication. A financial institution engaged in the PCS activity may
request an opportunity for a written or, at the sole discretion of the
Council, oral hearing before the Council to demonstrate that the
proposed designation is not supported by substantial evidence. The
Council may waive the notice and hearing requirements in certain
emergency circumstances.\15\ Following any designation of a PCS
activity, the appropriate federal regulator will establish risk-
management standards governing the conduct of the activity by financial
institutions.\16\ The objectives and principles for these risk-
management standards will be to promote robust risk management, promote
safety and soundness, reduce systemic risks, and support the stability
of the broader financial system.\17\ The risk-management standards may
address areas such as risk-management policies and procedures, margin
and collateral requirements, participant or counterparty default
policies and procedures, the ability to complete timely clearing and
settlement of financial transactions, and capital and financial
resource requirements for designated financial market utilities, among
other things.\18\
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\13\ See Dodd-Frank Act section 804(a)(1), 12 U.S.C. 5463(a)(1).
\14\ Dodd-Frank Act section 803(7), 12 U.S.C. 5462(7).
\15\ Dodd-Frank Act section 804(c), 12 U.S.C. 5463(c).
\16\ Dodd-Frank Act section 805(a), 12 U.S.C. 5464(a).
\17\ Dodd-Frank Act section 805(b), 12 U.S.C. 5464(b).
\18\ Dodd-Frank Act section 805(c), 12 U.S.C. 5464(c).
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Financial market utility designations. In addition, the Council has
authority to designate financial market utilities (FMUs) that it
determines are, or are likely to become, systemically important.\19\
Subject to certain statutory exclusions, an FMU is defined as any
person that manages or operates a multilateral system for the purpose
of transferring, clearing, or settling payments, securities, or other
financial transactions among financial institutions or between
financial institutions and the person.\20\ The Council has issued a
procedural rule regarding its authority to designate FMUs.\21\ In
determining whether designation of a given FMU is warranted, the
Council must consider (1) the aggregate monetary value of transactions
processed by the FMU; (2) the FMU's aggregate exposure to its
counterparties; (3) the relationship, interdependencies, or other
interactions of the FMU with other FMUs or PCS activities; (4) the
effect that the failure of or a disruption to the FMU would have on
critical markets, financial institutions, or the broader financial
system; and (5) any other factors that the Council deems
appropriate.\22\ A designated FMU is subject to the supervisory
framework of Title VIII of the Dodd-Frank Act. Section 805(a)(1)(A)
requires the Federal Reserve Board to prescribe risk-management
standards governing the FMU's operations related to its PCS activities
unless the FMU is a derivatives clearing organization or clearing
agency.\23\ Specifically, section 805(a)(2) grants the Commodity
Futures Trading Commission or the Securities and Exchange Commission,
respectively, the authority to prescribe such risk-management standards
for a designated FMU that is a derivatives clearing organization
registered under section 5b of the Commodity Exchange Act or a clearing
agency registered under section 17A of the Securities Act of 1934.\24\
Such standards are intended to promote robust risk management, promote
safety and soundness, reduce systemic risks, and support the stability
of the broader financial system.\25\ In addition, the Federal Reserve
Board may authorize a Federal Reserve Bank to establish and maintain an
account for a designated FMU or provide the designated FMU with access,
in unusual or exigent circumstances, to the discount window.\26\ A
designated FMU is subject to examinations at least once
[[Page 78037]]
annually by the relevant federal supervisory agency.\27\
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\19\ Dodd-Frank Act section 804(a)(1), 12 U.S.C. 5463(a)(1).
\20\ Dodd-Frank Act section 803(6), 12 U.S.C. 5462(6).
\21\ 12 CFR part 1320.
\22\ Dodd-Frank Act section 804(a)(2), 12 U.S.C. 5463(a)(2). See
also 12 CFR 1320.10.
\23\ Dodd-Frank Act section 805(a)(1)(A), 12 U.S.C. 5464(a)(1).
\24\ Dodd-Frank Act section 805(a)(2), 12 U.S.C. 5464(a)(2); see
also Dodd-Frank Act section 803(8), 12 U.S.C. 5462(8).
\25\ Dodd-Frank Act section 805(b), 12 U.S.C. 5464(b).
\26\ Dodd-Frank Act sections 806(a) and (b), 12 U.S.C. 5465(a)
and (b).
\27\ Dodd-Frank Act section 807, 12 U.S.C. 5466.
Nellie Liang,
Under Secretary for Domestic Finance.
[FR Doc. 2023-25055 Filed 11-13-23; 8:45 am]
BILLING CODE 4810-AK-P-P
</pre></body>
</html>Indexed from Federal Register on November 14, 2023.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.