Concentration Limits on Large Financial Companies: Federal Reserve Approves Final Rule Implementing Dodd-Frank’s Financial Sector Concentration Limit

Sullivan & Cromwell LLP - November 12, 2014

Last week, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) approved a final rule (the “Final Rule”) implementing Section 622 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which establishes a financial sector concentration limit (the “Section 622 Concentration Limit”). The Section 622 Concentration Limit generally prohibits insured depository institutions, bank holding companies, foreign banking organizations (“FBOs”) that are treated as bank holding companies, savings and loan holding companies, other companies that control an insured depository institution, as well as nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve (each, a “financial company”) from merging or consolidating with, or acquiring control of, another company if the resulting company’s total consolidated liabilities upon consummation would exceed 10 percent of the aggregate consolidated liabilities of all financial companies as calculated under Section 622 (“Total Financial Sector Liabilities”).

The Final Rule contains a number of notable revisions and clarifications from the Federal Reserve’s rule as originally proposed (the “Proposed Rule”), including:

  • Eliminating the Prior-Notice Requirement for Transactions that Do Not Cause a Financial Company to Exceed the Section 622 Concentration Limit: Under the Final Rule, financial companies are not required to provide written notice to the Federal Reserve in order to consummate a transaction that would cause the resulting financial company’s total consolidated liabilities to exceed eight percent of Total Financial Sector Liabilities immediately after consummation of the transaction, as would have been required under the Proposed Rule.
  • Subjecting Controlled Merchant Banking Investments to the Section 622 Concentration Limit: The Final Rule, in a departure from the Proposed Rule, eliminates the exclusion of merchant banking acquisitions from the Section 622 Concentration Limit. As a result, a financial company would need to include relevant merchant banking investments that are “controlled” for bank regulatory purposes by the financial company in its calculation of its share of Total Financial Sector Liabilities and would be prohibited from making a controlling merchant banking investment if the investment would increase the financial company’s total consolidated liabilities above the 10 percent limit.
  • Excluding Securitization Transactions from the Section 622 Concentration Limit: The Final Rule provides a new exception for certain securitization transactions by excluding from the definition of “covered acquisition” an acquisition of ownership or control of a company that is, or will be, an issuer of asset-backed securities (as defined in Section 3(a) of the Securities Exchange Act of 1934 (the “Exchange Act”)) so long as the financial company that retains an ownership interest in the company complies with the credit risk retention requirements of Section 941 of the Dodd-Frank Act.  
  • Introducing a General Consent Process for Approval of Certain De Minimis Transactions: In implementing Section 622’s exception for de minimis transactions, the Final Rule provides a general consent for transactions that result in an increase in a financial company’s total consolidated liabilities of less than $100 million, when aggregated with all other acquisitions by the financial company under this general consent authority during the preceding 12 months. Transactions that exceed the $100 million threshold must receive advance approval from the Federal Reserve, and all de minimis transactions are subject to an aggregate cap of $2 billion over the preceding 12-month period.
  • Adjusting the Calculation of Total Financial Sector Liabilities: The Final Rule provides adjustments to and clarifications of the Federal Reserve’s calculation of Total Financial Sector Liabilities, including that the Federal Reserve will calculate Total Financial Sector Liabilities for the initial compliance period beginning July 1, 2015 and ending June 30, 2016 (the “Initial Period”) using financial companies’ consolidated financial sector liabilities as of December 31, 2014, rather than as an average of the aggregate financial sector liabilities as of December 31, 2013 and December 31, 2014, as under the Proposed Rule. This change was in response to industry comment that it would be burdensome or impossible for certain financial companies that were not otherwise required to report this information as of December 31, 2013 to provide this data for purposes of Section 622. In all periods subsequent to the Initial Period, Total Financial Sector Liabilities will be calculated as the average of financial companies’ aggregate financial sector liabilities as of December 31 of each of the preceding two years.
The preamble to the Final Rule (the “Preamble”) states that the Final Rule is effective as of January 1, 2015. The Federal Reserve will not release its first measure of Financial Liabilities until “no later than July 1,” 2015, and the Preamble refers to the period beginning July 1, 2015 and ending June 30, 2016 as the “initial period.” Accordingly, it is likely that financial companies will not be expected to come into compliance with the Section 622 Concentration Limit until July 1, 2015 as a practical matter.