Federal regulators proposed Friday to place nonbank financial institutions (NBFIs), such as hedge and money market funds, under supervision of the Federal Reserve Board if their activities are deemed to pose a systemic risk to the U.S. financial system.

The Financial Stability Oversight Council (FSOC), comprised of regulators including Fed Chair Jerome Powell and Securities and Exchange Commission Chair Gary Gensler, voted unanimously to adopt a new framework for designating NBFIs under the Fed’s supervision.

The framework will “be subject to prudential standards” that “will be firm-specific and may include an assessment of quantitative and qualitative information that the council deems relevant to a particular [NBFI],” FSOC said.

Under FSOC’s proposed guidance, nonbanks again can be designated “systemically important financial institutions,” a provision rolled back under President Donald Trump.

The proposed guidance reverses other requirements contained in FSOC’s 2019 interpretive guidance, including designating an NBFI only if a risk could not be addressed through an activities-based approach that evaluates risky practices, as well as following a cost-benefit analysis.

Both requirements would be lifted in the new guidance. The guidance also describes FSOC’s analytic approach as being “without regard to the origin of a particular risk, including whether the risk arises from widely conducted activities or from individual entities.”

“Today’s proposals are important to ensuring the council has a rigorous approach to identify, assess, and address risks to our financial system,” said Treasury Secretary Janet Yellen, FSOC’s chair, in a press release. Yellen noted the proposal “would make us better equipped to handle risks to the financial system, whether they come from activities or firms.”

Acting Comptroller of the Currency Michael Hsu, another FSOC member, said in a press release the proposals “would make clear that the council has access to all tools provided to it by the Dodd-Frank Act so that we can monitor and address risks to financial stability effectively.”

According to the proposed framework, FSOC can designate an NBFI to Fed supervision if the council determined “material financial distress” at the nonbank or “the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities” of the nonbank could pose a threat to the financial stability of the United States.

Some of the vulnerabilities that could tilt an NBFI toward designation include issues with leverage caused by ratios of assets, debt, and other factors; liquidity risk and maturity mismatch; interconnectedness between the NBFI and other market participants, including exposures of creditors, counterparties, investors, and borrowers; operational risks; the complexity or opacity of a particular firm’s governance structure; inadequate risk management; concentration in a particular industry, investment, or sector; and potentially destabilizing activities, even those that might be intentional and permitted by applicable law.

The proposals will be available for a 60-day public comment period following their publication in the Federal Register.

Aaron Nicodemus covers regulatory policy and compliance trends for Compliance Week. He previously worked as a reporter for Bloomberg Law and as business editor at the Telegram & Gazette in Worcester, Mass.

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