February 2017 Issue
The Dodd-Frank Act, as well as the Volker Rule and other landmark pieces of financial services regulation, have had a huge influence on the financial industry since their implementation. Though many of the measures introduced have been unpopular with banks and other financial institutions, in the wake of the financial crisis and the recession that followed it was clear that action needed to be taken, not only to stabilise the global economy, but also to repair much of the damage done to the reputation of the financial services sector.
Nearly a decade has passed since the crisis first took hold, yet the process of implementing new financial regulations and legislation is ongoing. Dodd-Frank, for example, may continue to be rolled out for some time to come. Such reforms were a direct response to the crisis. “Financial regulation in the US is still responding to the financial difficulties that arose in 2007 and 2008. Dodd-Frank and the capital changes flowing out of Basel III and the Financial Stability Boards TLAC are still in the process of implementation and regulatory changes will not be fully phased in for several more years,” says Oliver Ireland, a partner at Morrison Foerster. Dodd-Frank has played a key role in helping to shape and stabilise the financial world since it passed into law in 2010, and it has left an indelible mark on the financial services industry.
Yet, despite the stability it brought when confidence and trust in the sector was at an all time low, the Act has received criticism from both sides of the political spectrum. There are some on the left who believe Dodd-Frank has not been forceful enough, and should have required banks to hold more capital. On the right, the accusation has been that the Act is anti-business and has done more harm than good. Small firms have felt crushed by its enormous regulatory burden. The sheer size of the Act itself – around 400,000 words – has alarmed many in the financial services industry. Critics also point to the implementation of around 400 new rules, the creation of the Financial Stability Oversight Council (FSOC) and the creation of the Consumer Financial Protection Bureau (CFPB) as evidence of Dodd-Frank’s overblown regulatory outlook. The estimated $36bn cost of implementation has also contributed to the negativity around Dodd-Frank.
President-elect Donald Trump spoke out against the Act during his election campaign. According to Mr Trump, “Dodd-Frank is a very negative force, which has developed a very bad name”. He added, “Dodd-Frank has made it impossible for bankers to function. It makes it very hard for bankers to loan money, for people to create jobs, for people with businesses to create jobs. And that has to stop.” Mr Trump’s campaign website also claimed that the new administration’s financial services policy implementation team “will be working to dismantle the Dodd-Frank Act and replace it with new policies to encourage economic growth and job creation", in the event that he won the presidential campaign.
Despite the Act’s many detractors, it has been, in some respects, a qualified success. The new capital requirements to which banks and financial institutions must adhere have helped to stabilise the financial services industry and return some confidence to the sector. However, there are many outside of Mr Trump’s administration who want to repeal the Act, or elements of it, and remove some of its more onerous obligations. “The US has been experiencing a sluggish recovery from the recession and there is a case to be made that regulatory policy has had a constraining effect on economic growth even while monetary policy has been focused on stimulating the economy. A rebalancing of regulatory policy is needed. This rebalancing should include a close look at Dodd-Frank but also other factors that may be constraining, or increasing, the cost of financial services, unnecessarily,” says Mr Ireland.
A full repeal of the Act has been mooted, but such drastic action may not be required. “We are not asking for wholesale throwing out Dodd-Frank,” said J.P. Morgan Chase & Co. chief executive James Dimon, at a financial services conference in December. Yet some investors have taken a different view. By December, bank stocks had jumped around 20 percent since the election, in anticipation of reduced regulatory obligations. Understandably, there are many interested and conflicting parties when it comes to the future of financial services regulation.
“In all likelihood, though the Dodd-Frank Act may be changed by the election of Mr Trump, it will probably survive in some form, though it may be scaled back in application.”
Mr Trump’s victory in November may have brought the future of Dodd-Frank into sharper focus, but plans to replace or reform the Act have been in place for some time. Mr Trump’s administration appears to be less than keen on regulatory oversight, both in the financial services industry and beyond. Nominated Treasury Secretary Steven Mnuchin has insisted that the next administration will “roll back” parts of Dodd-Frank. How financial services regulation will evolve over the next four years is likely to be a contentious issue, given the Trump campaign’s anti-establishment rallying cry. However, at the time of writing, neither Mr Trump nor anyone in the incoming administration has confirmed that Dodd-Frank will be replaced. Regardless, for the second time in a decade, major changes are likely coming to the financial services space. A balance must be struck between ensuring that banks and financial institutions are not crushed under the weight of unnecessarily complex regulations and the unrestrained banking sector of the pre-financial crisis era, which saw firms enjoy carte blanche. If regulators and lawmakers can agree on more light touch regulation, the sector may benefit. Whether a compromise is achievable remains to be seen.
The Glass-Steagall Act
If Dodd-Frank is eventually rolled back, one possible replacement could come from the New Deal era Glass-Steagall Act, which itself was replaced in the 1990s. Glass-Steagall kept depository banks separate from investment banks and insurance companies. Mr Trump has previously touted the merits of the Glass-Steagall Act, echoing calls from Democrats Bernie Sanders and Elizabeth Warren.
Under Glass-Steagall, banks that were members of the Federal Reserve System were prohibited from underwriting most types of securities; banks were also restricted from affiliating with securities dealers. Securities companies were prohibited from acting as depository institutions and directors and officers of banks were prohibited from being directors and officers of securities companies. It is conceivable that a retooled Glass-Steagall Act could have a positive role to play. Indeed, it could be seen as an olive branch extended to more sceptical Democrats, in exchange for deregulating other areas of the sector.
Some critics of Glass-Steagall, however, suggest that it may have contributed to the onset of the financial crisis. Additionally, the Glass-Steagall Act lacks the support of some of the larger banks and financial institutions which have flourished following the crisis. The appointment of several Wall Street executives to senior cabinet positions in the new Trump administration would render reinstatement of the Glass-Steagall Act unlikely.
Repeal or reform?
One of the most viable tools available to the new administration, in terms of re-writing financial services regulation, may be the Financial Choice Act, one of a raft of bills introduced over the last two years which have been designed to repeal or significantly alter Dodd-Frank. The FCA is a piece of proposed legislation spearheaded by Republican, and head of the House Financial Services Committee, Jeb Hensarling. Its aim is to free companies and smaller businesses from many of the regulations which, according to Dodd-Frank’s many critics, have hamstrung businesses for years.
One of the effects of the FCA, as it is currently written, would be to modify the enforcement activities of the Securities and Exchange Commission (SEC). Parties involved in legal action would be able to move the action out of an SEC tribunal and into US district court. Section 418 of the Act allows any person who is a party to a proceeding brought by the SEC under securities law, and who may be targeted by a cease and desist order or other penalty at the conclusion of the proceeding, to terminate the proceeding and force the SEC to instead seek civil action in federal court rather than an in-house tribunal. Ultimately, the FCA would present banks and financial services companies with a choice: put up with Dodd-Frank's myriad rules or meet a 10 percent capital requirement.
However, while the FCA may have won supporters, not everyone is convinced. “With the new administration, I expect to see renewed efforts to roll back Dodd-Frank. The FCA will be a natural starting point but I expect that some compromises will have to be made in any legislation that ultimately is enacted. It is too soon to know how specific issues will play out. In the meantime, changes in appointments at some of the financial regulatory agencies could also have a significant effect on the regulatory tone, and in some cases, on specific rules,” says Mr Ireland.
The FCA would also take away the government’s ability to determine whether a bank is “systemically important”, which could be disastrous. The availability of such a label allows the government to impose strict regulatory requirements.
The FCA has also been seen as a means of curtailing the independence of the SEC, which may hurt its chances of passing into law. Enforcement, too, may prove difficult for the FCA; any bank which is unable to meet the 10 percent capital requirement will have one year to achieve compliance.
Looking forward
2016 was a surprising year in many respects; arguably the biggest surprise was the election victory of Mr Trump. The Trump campaign swept to office on a wave of anti-establishment fervour, with pledges to repeal and replace influential legislation including Dodd-Frank and the Affordable Care Act. While the Trump administration is in a nascent stage, it will be interesting to see whether the anti-establishment approach will be carried over into the White House.
In all likelihood, though the Dodd-Frank Act may be changed by the election of Mr Trump, it will probably survive in some form, though it may be scaled back in application. The future of financial services regulation may be uncertain, but given the emerging challenges facing the industry – with disruptive forces such as FinTech integral to the sector’s future – now is not the time to return to the ‘unregulated’ days of the past. “I expect financial regulation to enter a phase that might be characterised as deregulatory – focusing on reducing unnecessary costs and impediments to providing financial services,” says Mr Ireland. “I expect these efforts to start small and to grow over time. As the financial markets evolve this process is likely to evolve, into a more forward looking process as opposed to merely focusing on Dodd-Frank. Growth in FinTech and changes in world financial markets will raise new issues and identify new constraints.”
Financial regulation may not be popular, but it will likely remain in place, albeit in a changed form.
© Financier Worldwide
BY
Richard Summerfield