United States: Can Undue Concentration In Financial Companies Threaten Market Stability? New Federal Reserve Merger And Acquisition Regulation Seeks To Prevent Risk

Last Updated: November 18 2014
Article by Michael E. Bleier and Brian Willett

Most Read Contributor in United States, October 2017

The new year will bring new restrictions on banks and certain large financial institutions, as the Federal Reserve Board issued a final rule prohibiting financial companies from merging if the ratio of the resulting entity's liabilities would exceed 10 percent of the aggregate consolidated liabilities of all financial companies.1 The limit is intended to prevent too many assets from being concentrated under the control of just a few companies, such that a decline in the financial health of a single institution would cause significant market instability. This concentration-limit rule complements the nationwide deposit cap2 of the Riegle-Neal Act by placing an additional restriction on attempted acquisitions by financial companies.3

The rule, issued November 5, 2014, implements section 622 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), and will be effective January 1, 2015. As a result, a wide range of financial institutions will find their ability to combine with other institutions significantly impacted, although the rule does feature an exemption for securitization activities.

Which Institutions Will Be Affected? The scope of the Federal Reserve Board's final rule is broad, as it applies to insured depository institutions; bank holding companies; savings and loan holding companies; companies controlling insured depository institutions; financial companies other than banks supervised by the Federal Reserve Board; and foreign companies or banks considered bank holding companies for purposes of the Bank Holding Company Act.4 Additionally, the final rule applies to nonbank financial companies designated by the Financial Stability Oversight Council for Federal Reserve Board supervision pursuant to section 113 of Dodd-Frank. The Board has noted that entities with assets of $550 million or less are unlikely to be affected because of their inability to make acquisitions placing them above the 10 percent threshold.

Which Transactions Will Be Affected? The Federal Reserve Board's final rule places the value of total aggregate financial sector liabilities at approximately $18 trillion as of December 31, 2013. Thus, acquisitions resulting in organizations possessing total assets of $1.8 trillion are prohibited. As a result, institutions already possessing at least $1.8 trillion or close to the amount are effectively barred from making acquisitions, because an acquisition of nearly any size would cause the institution to exceed 10 percent of aggregate financial sector liabilities. Regarding the type of transactions covered, the rule applies to "a transaction in which a company directly or indirectly merges or consolidates with, acquires all or substantially all of the assets of, or otherwise acquires control of another company."5

Where transactions involve a foreign acquiring entity and a foreign target, only the liabilities of the company's United States operations are considered, with foreign operations liabilities excluded.6 Where the acquisition involves one American and one foreign entity, the liability calculation includes the liabilities of both the American and foreign subsidiaries of the American company. Additionally, an acquisition involving a financial company and a company of a type not included in the definition of "financial company" in section 622 will be subject to the concentration limit if the resulting company is a financial company.7

The Federal Reserve Board's proposed version of this rule would have also required financial companies to provide written notice to the Board prior to initiating a transaction that would increase its liabilities by more than $2 billion when combined with all other covered acquisitions during the preceding 12-month period, and result in post-acquisition liabilities of more than 8 percent of the aggregate financial sector liabilities. However, the final rule removed this requirement after commenters pointed out the increased administrative burden on financial companies, and the abilities of companies to keep track of potential compliance issues internally.

How Will Financial Company Liabilities Be Calculated? Of critical importance in determining which transactions will be scrutinized is the calculation of financial company liabilities. For U.S. companies, this calculation depends on whether the company is subject to risk-based capital rules. For companies not subject to such rules, consolidated liabilities are "equal to the total liabilities of such company on a consolidated basis, as determined under applicable accounting standards."8 The rule defines such standards as U.S. generally accepted accounting principles, or "such other accounting standard or method of estimation that the Board determines is appropriate."9

For companies subject to risk-based capital rules, liabilities are determined by calculating the company's total risk-weighted assets per the risk-based capital rules that apply to bank holding companies, and adjusting that figure to "reflect exposures that are deducted from regulatory capital."10 From that result, total regulatory capital of the company under the applicable risk-based capital rules is subtracted, producing the final liabilities figure.11

How Will Total Financial Sector Liabilities Be Calculated? The final rule dictates that financial sector liabilities will equal the average of the year-end financial sector liabilities – an aggregate of total consolidated liabilities of all top-tier U.S. financial companies, as well as the U.S. liabilities of all top-tier foreign financial companies12 – for the two preceding calendar years.13 The preceding year's financial sector liabilities measure will remain in effect until June 30 of the following year.14 For the initial period of regulation ending June 30, 2016, the figure used for financial sector liabilities will be the year-end financial sector liabilities as of December 31, 2014.15

Which Transactions Will Be Exempt from Acquisition Prohibitions? The final rule also features carve-outs for certain activities of financial institutions. The definition of a "covered acquisition" specifically excludes acquisitions made:

  • "solely in connection with a corporate reorganization;"16
  • "in a fiduciary capacity in good faith...if the acquired securities or assets are held in the ordinary course of business and not acquired for the benefit of the company or its shareholders, employees, or subsidiaries;"17
  • in connection with bona fide market-making or underwriting activities;18 and
  • "in the ordinary course of collecting a debt previously contracted in good faith," provided the acquired assets or securities are divested within a certain time period.19

The Board's final rule allows for financial companies to consummate certain acquisitions that exceed the concentration limit after obtaining written consent from the Board. The Board may consent to an acquisition exceeding the concentration limit if an acquisition, for example:

  • is of an insured depository institution in danger of default or in default;20
  • is a transaction for which the FDIC provides assistance;21 or
  • would not increase the financial company's liabilities by more than $2 billion, when aggregated with all other covered acquisitions within the preceding 12 month period.22

What Kind of Information Is Required for Consent Requests? A request for consent requires information such as the projected increase in liabilities, as well as a description of the acquisition and any other information requested by the Board.23 In deciding whether to grant consent, the Board considers whether "consummation of the covered acquisition could pose a threat to financial stability."24 No written consent request is required where the acquisition would result in an increase in liabilities of $100 million or less when aggregated with all other covered acquisitions made during the preceding 12-month period.

What Kind of Diligence Efforts Should Be Undertaken? The new rule covers a broad scope of transactions and takes into consideration acquisitions over 12-month periods, meaning significant planning and diligence efforts are necessary to prevent companies from running afoul of the rule. The rule also features a reporting requirement provision25 and a specific anti-evasion clause,26 so deals must be carefully structured to avoid the appearance of evasion.

To ensure transactions do not violate the rule's provisions, forward-looking legal regulatory guidance is crucial. Because the rule is effective January 1, 2015, provisions such as the consideration of previous transactions and consent requirement indicate financial companies need to initiate planning and compliance efforts sooner rather than later. 


1. 12 C.F.R. § 251.3(a).

2. 12 U.S.C. § 1842(d)(2)(A).

3. The Riegle-Neal Act's nationwide deposit cap prohibits the Federal Reserve Board from permitting a bank or bank holding company's proposed acquisition if that acquisition would result in the entity – including "all insured depository institutions which are affiliates of the [bank]" – controlling more than 10 percent of the total amount of deposits of all insured depository institutions in the nation. 12 U.S.C. § 1842(d)(2)(A). The restriction reflected concerns over cross-state acquisitions by large banks and bank holding companies.

4. 12 C.F.R. § 251.2(g).

5. 12 C.F.R. § 251.2(f).

6. 12 C.F.R. § 251.3(b).

7. For purposes of the rule, the definition of "financial company" includes (a) insured depository institutions; (b) bank holding companies; (c) savings and loan holding companies; (d) companies controlling insured depository institutions; (e) non-bank financial companies supervised by the Board; and (f) foreign banks or companies treated as bank holding companies under the Bank Holding Company Act. 12 C.F.R. § 251.2(g)(1)-(6).

8. 12 C.F.R. § 251.3(c)(2).

9. 12 C.F.R. § 251.2(a).

10. 12 U.S.C. § 1852(a)(3)(A).

11. Id.

12. 12 C.F.R. § 251.3(a)(2)(iii).

13. 12 C.F.R. § 251.3(a)(2)(i).

14. Id.

15. 12 C.F.R. § 251.3(a)(2)(ii).

16. 12 C.F.R. § 251.2(f)(4).

17. 12 C.F.R. § 251.2(f)(2).

18. 12 C.F.R. § 251.2(f)(3).

19. 12 C.F.R. § 251.2(f)(1).

20. 12 C.F.R. § 251.4(a)(1).

21. 12 C.F.R. § 251.4(a)(2).

22. 12 C.F.R. § 251.4(a)(3).

23. 12 C.F.R. § 251.4(b)(2).

24. 12 C.F.R. § 251.4(b)(3)(ii).

25. 12 C.F.R. § 251.6.

26. 12 C.F.R. § 251.5.

Client Alert 2014-303

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