Dodd-Frank: The Trump Remix
- The Trump administration appears to be serious about Dodd-Frank reform.
- The legislative mechanism for reform is likely to be The Financial CHOICE Act, expected to be reintroduced in the 115th Congress.
- Key aspects of that bill may require modification, or the potential addition of Glass-Steagall type provisions, to become politically palatable.
- No material modification of Dodd-Frank’s OTC derivatives provisions is expected, however the CFTC will likely loosen various implementing regulations.
Following his upset election in November, business leaders have spent significant time trying to interpret the statements made by President Trump, both on the campaign trail and thereafter, to help instruct their future planning. Many of Trump’s most hyperbolic statements – from “repealing” Obamacare to “getting rid of” Dodd-Frank – are regulatory in nature and have potentially massive ramifications. Of keen interest to finance professionals are reform proposals for Dodd-Frank.
Passed in response to the U.S. financial crisis of 2008-09, the Dodd-Frank Act (“Dodd Frank”) is a complex and far reaching piece of legislation designed to prevent a similar crisis in the future by specifically targeting areas thought to be causes or effects of the financial crisis. Among other things, it imposed comprehensive new regulations on banks, provided mechanisms for the support and/or unwind of large financial institutions and created an entirely new regulatory scheme for OTC derivatives.
Over six years later, now that many of its most complex rules have been completed, then candidate Donald Trump called for a broad repeal of Dodd-Frank. In contrast, President-elect Trump suggested a more moderate stance on his transition website, stating that he was “committed to regulatory reform that will produce sensible regulations that allow America to be great”.
Now that Trump has been sworn in, what will the new administration’s reform of Dodd-Frank look like? We believe the answer can be found by studying pending legislation in light of both the people involved and historical precedent.
The Financial Choice Act
Months before its introduction, in June 2016 Jeb Hensarling, Republican chair of the House Financial Services Committee, unveiled the basics of his plan for Dodd-Frank reform to a group of business leaders in New York. One can surmise that the bill he finally introduced in September 2016, dubbed The Financial CHOICE Act (“Choice Act”), incorporates the comments received from many external parties – including President Trump, who became his party’s nominee during that summer. To date, the Choice Act is the sole existing Republican proposal for Dodd-Frank reform.
In its Executive Summary, the Choice Act espouses certain glowing “Key Principles” including fostering economic growth, providing Americans with opportunity to achieve financial independence, consumer protection, ending government bailouts and simplifying regulation. A far more technical story is told by looking at the text of the Choice Act. Its major aspects include
- Provide preferential treatment and regulatory relief for banks that voluntarily choose to keep high levels of capital.
- Eliminate the designation of “systemically important financial institutions”, and replace the Title II orderly liquidation authority with a new chapter in the bankruptcy code to govern the failure of a large complex financial institution.
- Eliminate the designation of systemically important “financial market utilities” and eliminate their access to the Fed discount window.
- Eliminate the so called “Volker Rule”, limiting certain bank investment activities.
- Massively restructure the Consumer Financial Protection Bureau, to expand its mission to include fostering competitive markets and revamp its structure to become a bipartisan commission.
- Modify the SEC and the Federal Reserve.
- Various other provisions, including those related to capital formation, insurance regulations and community banks.
- No mention of modifications to Title VII, the OTC derivatives regulations.
While it is not a wholesale repeal of Dodd-Frank, the Choice Act proposes major surgery to it. It begs the question of what is achievable.
The precise language and outcomes of Dodd-Frank reform will result from the legislative process, which the Trump administration can’t fully control and will be subject to public scrutiny. For those reasons, we believe certain features proposed by the Choice Act will prove politically unpalatable and thus difficult to achieve, particularly in the area of banking regulation. In this area, we believe history provides strong guidance.
In a very real sense, we’ve been down this road before. The Great Depression was the most acute and extended period of financial decline in U.S. history. During the early shock waves, the entire banking system was shut down for four days and over 50% of American banks closed, resulting in over $400 million in lost depositor funds. Of particular note, the Federal Reserve allowed a number of large and public bank failures, which caused widespread panic and runs on smaller and local banks. In an attempt to stabilize the system, Congress and President Roosevelt worked together to enact the Banking Act of 1933, which had two main thrusts -- (1) it created a system of federal insurance for bank deposits and a new agency to administer it, the FDIC, and (2) it required a separation of commercial banking and depository activities from investment banking and securities activities. Also known as the Glass-Steagall Act, it was a turning point in the recovery from the Great Depression and resulted in an unprecedented period of financial stability.
Memories being what they are, within a generation various regulatory reforms began to modify and weaken Glass-Steagall (e.g. the Bank Holding Company Act of 1956) and new financial crises began to emerge (e.g. Savings & Loan Crisis). This trend was hastened by a series of governmental activities that further loosened Glass-Steagall (e.g. the 1987 Federal Reserve vote to allow banks back into securities underwriting), and was capped off by its full repeal in 1999 via the Financial Modernization Act (aka Gramm-Leach-Bliley). Less than a decade later, America was embroiled in the 2008-09 financial crisis, the greatest decline since the Great Depression and the genesis of Dodd-Frank. We’ve really come full circle.
When viewed in light of this history, we believe one key portion of the Choice Act – the abolition of bank monitoring, support and resolution outside the bankruptcy process – may face political headwinds. Financial institution bankruptcies, even with federal deposit insurance intact, are simply too scary. While few of the legislators tasked with reform actually lived through the Great Depression, we believe enough have studied the relevant history to oppose condoning bank failures. Further, during the 2008-09 financial crisis the large public bankruptcy of Lehman Brothers was simply ineffective to stop contagion in the financial markets. Had it existed, something like the Title II orderly liquidation authority might have been helpful. Hopefully that recent history won’t be lost on legislators. We also believe a full repeal of the Volker Rule, which limits speculative investment activities of financial institutions, may be similarly unpalatable to the American electorate. One possible compromise might be the addition of something like Glass-Stegall, which would require speculative activities to be conducted in separate non-federally insured entities.
Noticeably absent from the Choice Act is any mention of modifications to Dodd-Frank’s derivatives provisions. We believe this is for two primary reasons. First, financial institutions and other commercial parties have spent significant sums complying with the existing law. We believe the banking lobby in particular would not support changes, and in fact may have already communicated its views to Hensarling when the Choice Act was being drafted. Second, derivatives were “blamed” for the 2008-09 financial crisis, and for that reason Dodd-Frank created a wholly new framework for regulating OTC derivatives where none existed before. These new derivatives regulations are a crucial piece of Dodd-Frank, and would be politically difficult to repeal or materially modify.
Turning next to the people involved, Trump’s choices for cabinet positions and key advisors are consistent with strong deregulation generally and a significant reform of Dodd-Frank. In particular, we believe his selection of Paul Atkins to form relationships with the CPFB, FDIC and OCC during the transition process as part of the so-called “landing team”, signals the incoming administrations plans to enact Dodd-Frank reform containing many of the key provisions of The Choice Act. These three agencies are at the core of that bill, and we believe it’s no coincidence that their reform has been placed in the hands of one person, who is a critic of Dodd-Frank.
Another important player in Dodd-Frank reform will be Christopher Giancarlo, who became Acting Chairman of the CFTC coincident with the inauguration. Previously an outspoken Republican CFTC commissioner, Giancarlo has communicated various reform proposals, from his 2015 SEF whitepaper to the present. Even without any material modification to the Dodd-Frank derivatives provisions, Giancarlo is expected to effectuate many changes to implementing regulations designed to simplify or loosen existing regulation.
Throughout the process of Dodd-Frank reform, there will undoubtedly be tension between the Trump administration’s desire for quick results, the banking lobby which is expected to advocate for strong deregulation and oppose any version of Glass-Stegall, and the legislators themselves who must answer to an electorate that lived through the 2008-09 financial crisis and may remember the Great Depression.
Given that the Choice Act is expected to be reintroduced in the 115th Congress, we believe the most expedient reform process will be to work with that bill, prune some of the more challenging aspects and add certain enhancements, perhaps including a simplified and modern version of Glass-Stegall. While one should never underestimate the unpredictability of President Trump, we believe this will be the likely path forward.
Direct Swap is keenly interested in potential Dodd-Frank reform, and will be monitoring the process closely as it plays out. Our business is well-positioned to thrive under the expected reform scenario.
By: Chip Horton, January 24, 2017
About This Insight
Direct Swap is the premier network for commercial hedging. We securely connect members with traditional and unique sources of liquidity, and provide exclusive access to bespoke solutions for precision hedging and counterparty management. To form the opinions expressed here, we’ve collected both publically available information and input from our proprietary sources, including industry experts, former regulators and sources close to the Trump administration. However, all opinions expressed here are the views of the writer, and should not be attributed to any other person or organization.