In May 2014, the Board of Governors of the Federal Reserve System (“Federal Reserve”) issued a notice of proposed rulemaking (the “Proposed Rule”) that would implement the financial sector concentration limit established in Section 622 (“Section 622”) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  According to the Financial Stability Oversight Council (“FSOC”), the Section 622 concentration limit is intended to promote U.S. financial stability by restricting “the ability of the largest financial companies to engage in acquisition transactions that substantially increase their size.”  The limit is also intended to serve as a supplement to the nationwide cap on deposits under the Riegle-Neal Interstate Banking Act of 1994 that limits banking groups to holding no more than 10% of nationwide deposits.

 Summary of Section 622 and the Proposed Rule

Section 622 establishes a financial sector concentration limit that generally prohibits a financial company from merging or consolidating with, or acquiring, another company if the resulting company’s consolidated liabilities would exceed 10% of the aggregate liabilities of all financial companies operating in the U.S.  Section 622 only restricts growth by acquisition; it is not intended to prevent companies from growing their business through internal, organic growth.    

Section 622’s concentration limit applies to banking organizations operating in the U.S. – including insured depository institutions and their parent holding companies – as well as systemically important non-bank financial institutions designated by the FSOC for supervision by the Federal Reserve.  The limit also applies to the U.S. operations of foreign-based banking institutions. 

 Section 622 required that (i) the FSOC complete a study on how the concentration limit would affect financial stability, as well as make recommendations on how to more effectively implement Section 622 (the FSOC report was released in January 2011), and (ii) the Federal Reserve adopt regulations to implement the concentration limit in a manner that reflects recommendations by the FSOC.  Pursuant to this process, the Proposed Rule would implement Section 622 taking into account technical recommendations made in the January 2011 FSOC report.  

 Specifically, in accordance with the FSOC report, the Proposed Rule establishes methodologies to calculate (i) a financial company’s liabilities for purposes of the concentration limit, and (ii) the aggregate liabilities of all financial companies (the aggregate financial sector liabilities), which the Federal Reserve estimated to be approximately $18 trillion as of year-end 2013.  In addition, the Proposed Rule:

 1)      Imposes a prior-notice requirement (the “Prior Notice Requirement”) on certain transactions that would result in a financial company’s liabilities exceeding 8% of the aggregate financial sector liabilities;

2)      Further defines and specifies criteria for several exceptions to the 10% concentration limit included by Congress in the statute, including exceptions for a financial company to (i) acquire an insured depository institution in default or in danger of default, and (ii) make an acquisition, with prior Federal Reserve approval, that would result only in a de minimis increase in the liabilities of a financial company; and

3)      Identifies certain classes of “ordinary course business transactions” that are outside the scope of transactions restricted by the concentration limit.   

   The Clearing House View

The Clearing House Association believes that the Section 622 concentration limit should be implemented and applied in a manner that is transparent, predictable and, most importantly, avoids unnecessary and unintended restrictions on ordinary course business activity that clearly is outside of Section 622’s intended scope.  To this end, The Clearing House recommends the following modifications to the Proposed Rule to help mitigate practical challenges associated with its implementation while still furthering the important policy objectives of Section 622.

Exclude Ordinary Course Business Transactions from the Concentration Limit.  Ordinary course business transactions, including community development investments and investments in small business investment companies, may, in certain cases, fall within the scope of the Proposed Rule even though they should not give rise to the types of policy concerns that Section 622 was intended to address.  These transactions should be excluded so as to avoid the possibility of reduced credit and financial services access to U.S. households, businesses and communities.

 Modify the Implementation of the Statutory De Minimis Exclusion to Ensure that it is Workable and Effective in Practice.  The cap on de minimis transactions should be set at an increase in liabilities of $5 billion (rather than $2 billion as proposed) on a 12-month rolling basis.  In addition, a pre-approval process for certain small de minimis transactions should be implemented, and the Federal Reserve should articulate the standard by which de minimis transactions will be assessed.  Such adjustments will help provide financial companies with the necessary flexibility to continue to engage in transactions that have a negligible impact on financial sector concentration, yet should provide meaningful benefits to customers.

Eliminate the Proposed Rule’s Prior Notice Requirement.  The Proposed Rule’s prior notice requirement is neither mandated by Section 622 nor recommended by the FSOC.  If included, it should take the form, at most, of an after-the-fact notice requirement.  At a minimum, the threshold should be appropriately adjusted above 8.0% to 9.5% to ensure that only transactions that actually approach the 622 concentration limit are subject to a prior notice requirement and, accordingly, avoid imposing an unnecessary administrative burden on financial companies and the Federal Reserve.

Provide Greater Disclosure of Information Underlying the Proposed Section 622 Limit Methodology.  Additional details of the methodology for calculating financial sector liabilities should be published to provide financial companies greater opportunity to develop their business strategies in a manner that comports with the concentration limit of Section 622.  

For additional information, please contact Jill Hershey (jill.hershey@theclearinghouse.org, 202-649-4601) or John Van Etten (john.vanetten@theclearinghouse.org, 202-649-4617).  The Clearing House’s comment letter responding to the Federal Reserve’s Proposed Rule is available here.

Past issues of The Clearing House Banking Brief are available here.