Friday, December 16, 2016

Dodd-Frank Won't Go Gently into that Good Night

Regulators are dedicated to the unfinished work of Dodd-Frank

Listening to the pundits, the press, and the political class, one gets the impression that the repeal of the Dodd-Frank Act and its new regulatory landscape is imminent and certain.  But to paraphrase Mark Twain, the rumors of Dodd-Frank’s death have been greatly exaggerated. Lately, regulators at the Fed, CFTC, and OCC have been giving full-throated rhetorical support to the post-crisis financial reforms already in place, and have both tacitly and explicitly been signaling their commitment to completing what they believe is the unfinished work of the new financial regulatory regime.  While the electoral triumph of those long opposed to Dodd-Frank almost certainly will introduce a strong deregulatory assault against the legislation, it does not necessarily mean the death of every aspect of Dodd-Frank Act. 


Federal Reserve


In speeches last week, New York Fed President and CEO William C. Dudley and Fed board member Daniel K. Tarullo both remarked that though the capital, liquidity, and leverage reforms put in place have made U.S. banks stronger, less risky, and more stable since the financial crisis, the work of financial reform is not yet over. Notwithstanding the significant progress toward ending “too big to fail,” Mr. Dudley said there is still much more to do. Addressing the unfinished work in this area, according to Mr. Dudley, should remain priorities of the Fed in the near term, particularly with respect to total loss-absorbing capacity and cross-border resolutions,


"While the risk of failure of a global systemically important financial institution has diminished, it has not been eliminated.  Without a well-functioning resolution process, the consequences of such a failure could still be catastrophic.  Much headway has been made in the U.S. in developing a Single Point of Entry resolution regime with a layer of total loss-absorbing capacity (TLAC) that would facilitate recapitalization and enable an orderly resolution.  However, significant challenges remain, especially on managing resolution on a cross-border basis.”  


Dudley made clear that he sees completing the remaining work needed to end “too big to fail” as a top priority:  "Still, there is more to do before we can say that we have ended 'too big to fail.'  This is work that we absolutely must complete."


For his part, Mr. Tarullo said that he remains committed to seeing through reform efforts other than setting capital reserves. Increasing capital reserves was an obvious and vital initial step in making banks more resilient post-crisis. Equally important, said Tarullo, is mitigating risk associated with the dependence of financial firms on runnable funding sources. Once such regulations are in place, Mr. Tarullo said that he is open to considering adjusting capital requirements provided limits on runnable funding sources are in place.  


"As important as capital is to promoting systemic stability, it is not the only relevant consideration. The relative presence or absence of other regulations that mitigate risk should affect capital levels. To my mind, the most important of these are regulations limiting dependence of financial firms on runnable funding sources.”


Tarullo joined Dudley in championing the unfinished business of ending “too big to fail.”  This means continued work by the Federal Reserve and the FDIC to require these firms to develop their resolution plans, and more importantly, modify their organizational structures and day-to-day practices such as liquidity management so as to enable an orderly resolution, should it become necessary.




The Comptroller of the Currency, Thomas J. Curry, also spoke up last week about his commitment to the unfinished work of Dodd-Frank. Curry said that there is room to discuss whether capital requirements have gone too far or unduly restrict lending and economic growth. Those are policy questions that should be asked, and he is willing to entertain them. However, when it comes to leverage ratios introduced by Dodd-Frank, there is still much more technical work to be done. What should be included and excluded from these ratio calculations is something that Curry feels strongly must be addressed, and he intends to continue to do so. Curry said that he wants to focus attention on the unfinished task of ironing out what truly belongs in the leverage ratios, ensuring the ratios remain meaningful.


"[S]ome want to water down the ratios by manipulating what is included or excluded from consideration. Weakening the ratio through special exclusions only undermines our original intent and weakens the protection against excessive leverage. The essence of assessing a bank’s leverage is about comparing its equity to its assets and carving out various assets would cut against the very meaning of leverage.  In addition, if a relatively simple and straightforward metric is riddled with exceptions, it will become more complicated and difficult to understand, which will make market participants less trusting at the most critical points of a downturn, and when investors most need a clear understanding of a bank’s leverage and capital.”




CFTC Chairman Timothy Massad gave perhaps the week's most strident and enthusiastic defenses of the value of Dodd-Frank reforms to date, along with a plea not to roll them back and continue to work to see them to completion. Though clearly not perfect by any means, according to Chairman Massad, the much-maligned legislation is not the bête noire its detractors have made it out to be. And it should not be tossed aside without careful though as to what it has achieved, what about it works, and what should replace it.  


"Those who supported President-elect Trump because of his promises to working-class voters, many of whom may believe the government has been captured by powerful interests, will have been sold a bill of goods if wholesale repeal of Dodd-Frank is made out to be a critical part of the solution to concerns about economic stagnation or lack of opportunity."


"We can choose to refight the last war, as I mentioned at the outset—and debate or even unwind the basic framework that has clearly strengthened our derivatives markets. Or we can choose to recognize that while we should continue to make improvements to these reforms, we should focus on other challenges that require our attention.”


Given the remit of the CFTC, it follows that Chairman Massad vigorously defended the Dodd-Frank reforms implemented by the CFTC to bring transparency and oversight to the swaps market. Massad argued that these regulations made sense, and therefore it would be a mistake to change them significantly. It is clear that Chairman Massad intends for the CFTC to fight for them.  In addition to protecting reforms already in place, Massad also pointed to the ongoing and unfinished work of harmonizing regulations globally, bringing U.S. regulations in line with global counterparts to head off regulatory arbitrage and strengthen joint enforcement and surveillance.  


"We also need to continue to work with other regulators from around the world. We cannot have modern, global regulation of markets without extensive international coordination and cooperation. This includes harmonizing rules as much as possible, and working together on oversight. We have made great strides here. This is true not just with Europe and the U.K. We are actively engaged with China, India, Japan, Hong Kong, Australia, Singapore and others on important initiatives, including clearinghouse regulation, automated trading, cybersecurity and surveillance and enforcement matters.”


Open Minds


It is noteworthy that all four of last week’s speeches were not merely defenses of the Dodd-Frank status quo, however.  While the regulators highlighted the positive effects off post-crisis reforms, each plainly stated an openness, a willingness, to look at regulations currently in place in light of what is actually happening to financial firms in the market. This recognition that regulation does not happen in a vacuum, that conditions change, and that the initial models or assumptions used to formulate regulatory solutions in the heat of a financial crisis were likely flawed is a welcome opportunity for academics and industry experts to marshal real world data and focus regulators on adjusting statutory or regulatory provisions that are not needed for, or are less efficient means for achieving financial stability. Regulators like these who recognize that they do not possess the market data and analysis they need for calibrating capital surcharges or setting appropriate limits on leverage or liquidity ratios may indeed save the Dodd-Frank framework from going gently in to that good night.