[Federal Register Volume 88, Number 218 (Tuesday, November 14, 2023)]
[Notices]
[Pages 78026-78037]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[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 https://www.regulations.gov/docket/FSOC-2023-0001.
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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

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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

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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.
---------------------------------------------------------------------------

    \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 https://home.treasury.gov/system/files/261/Staff%20Guidance%20Methodologies%20Relating%20to%20Stage%201%20Thresholds.pdf; Minutes of the Council (Dec. 4, 2019), available at 
https://home.treasury.gov/system/files/261/December-4-2019.pdf.
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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).
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------

    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