Thursday, January 19, 2017

Financial CHOICE Act to Take Center Stage

Author: David Schwartz J.D. CPA

Republican control of Congress and the White House has put financial regulatory reform back on the legislative agenda. As an indication of Republicans' preliminary plans, the Financial CHOICE Act (H.R. 5983), proposes a regulatory capital “off-ramp” for banks which restrain their leverage and self-insure against losses.[1]  The centerpiece of the Financial CHOICE Act is the optional exemption from many Dodd-Frank regulations in exchange for higher capital reserves. The bill achieves this by creating a single leverage limit.

Elimination of Risk-Based Capital Requirements

Banks and bank holding companies willing to maintain a 10% ratio of “common equity Tier 1" capital (CET 1) to “total leverage exposure” would be exempt from other Dodd-Frank regulations, such as: 

  • Risk-Weighted Capital Requirements, including:
    • Supplementary Leverage Ratio (SLR),
    • Net Stable Funding Ratio (NSFR),
    • Liquidity Coverage Ratio (LCR);
    • Single Counterparty Credit Limit (SCCL),
  • Limits on distributions,
  • Some aspects of stress testing,
  • “Systemic risk” determinations in receiving regulatory approvals for acquisitions and other activities.[2]

The Financial CHOICE Act’s leverage ratio-based capital election provision is premised on the notion that firms that absorb their own risks, as highly capitalized banks do, need not be heavily regulated.[3] This is a boon for smaller and mid-sized banks, and community banks, because the CHOICE Act’s simpler leverage ratio calculation methodology rewards banks with no trading assets or liabilities and limited interest rate and foreign exchange swaps.  Whether large banking organizations would take advantage of these regulatory exemptions in exchange for higher capital reserves is not clear. So, large banks will need to do some significant examination of their business lines, profitability, and cost-benefit calculus to determine if they come out ahead and remain competitive by exchanging higher capital charges for regulatory relief. Presumably, however, banks not opting into the CHOICE Act leverage ratio would remain subject to the Basel III and Dodd-Frank Act framework to the extent it is left intact. 

Leverage Ratio Compliance

Banks opting into the CHOICE Act’s regime that fail to maintain the required leverage percentage would have a year’s grace period to restore its leverage ratio. However, if they fail to do so, the bank would lose its status as a qualified banking organization and all of the accompanying regulatory exemptions.  During the grace period, banks would still enjoy regulatory exemptions but would be required to:

  • face restrictions on distributions,
  • submit a capital restoration plan.

Elimination of the Volcker Rule and Various Dodd-Frank Regulations

In addition to the “off ramp from Basel III,” the Financial CHOICE Act eliminates a host of Dodd-Frank regulations, including:

  • the Volcker Rule,
  • the risk retention rule,
  • the DOL's fiduciary rule for broker-dealers,
  • the “Durban Amendment” price controls on debit card interchange fees,
  • the small business data collection requirements,
  • executive pay ratio disclosures.

Fed and Agency Reforms

The CHOICE Act makes many major improvements to the Federal Reserve’s emergency lending authority and to the Fed’s regular operating procedures.[4] In addition, the CHOICE Act:

  • revokes most of the powers of the Financial Stability Oversight Council (FSOC), limiting it to reviewing financial stability and reporting to Congress its analysis;
  • eliminates the Office of Financial Research (OFR);
  • limits the powers and increases Congressional oversight of the CFPB, SEC, and CFTC;
  • increases the enforcement powers of the SEC;
  • converts the OCC, Federal Housing Finance Agency, and CFPB into bipartisan commissions.

Limits on Agency Rulemaking

Notably, the Act would not only require all proposed federal financial regulations to be subjected to enhanced cost benefit analyses, but would also require that “major regulations” issued by financial regulators only become effective if approved by Congress. This provision, if enacted, could raise some interesting separation of powers issues in the courts. Also, the CHOICE Act would repeal the “Chevron Doctrine” requiring the judiciary to give deference to financial regulatory agencies’ interpretation of the law.


Too Big to Fail

The CHOICE Act would repeal parts of the Dodd-Frank Act[5] by eliminating the power of the FSOC to designated non-banks, financial market utilities, and clearing organizations as Systemically Important Financial Institutions. In addition, the Act also:

  • repeals the Dodd-Frank Act’s orderly liquidation authority;
  • eliminates Dodd-Frank rules establishing "heightened prudential standards," including living wills;
  • creates a new subchapter in the Bankruptcy Code to address the failure of large, complex financial institutions;
  • prohibits the use of the Treasury’s Exchange Stabilization Fund to bail out financial firms or their creditors;
  • imposes significant restrictions on the Fed’s emergency lending authority;
  • restricts Fed discount window borrowing to solvent banks with good collateral at high rates.

Community Bank Relief

Community and small banks receive a number of exemptions from CHOICE Act requirements applicable to larger and more complex financial institutions, including:

  • relief from certain mortgage origination restrictions,
  • simpler requirements regarding call reports,
  • a mechanism for appealing exam findings,
  • repeal of pending Dodd-Frank business data collection requirements,
  • a requirement that federal regulators tailor regulations for smaller banks and credit unions,
  • exemption from the attestation requirements of the Sarbanes-Oxley Act (section 404(b)),
  • increase in the threshold for the Fed’s Small Bank Holding Company Policy Statement from $1 billion to $5 billion,
  • expansion of the definition of “accredited investor,”
  • some relief from “say on pay” executive compensation requirements,
  • permitting thrifts to elect to be regulated as Covered Savings Associations, enabling them to operate with the full range of national bank powers.


In its present form, the Financial CHOICE Act is a sweeping piece of legislation proposing a regulatory framework and provisions some see as a wish list for the financial industry.  At this point, the Trump administration has yet to weigh in on the specifics of Hensarling's bill.  Steven Mnuchin, Donald Trump’s Treasury Secretary designee, has stated that rolling back parts of Dodd-Frank would be a Treasury Department priority should he be confirmed. However, whether the solutions proposed by Rep. Hensarling conform to Mr. Mnuchin's remains to be seen.


[1]  The bill was introduced in July, 2016, by Representative Jeb Hensarling (R-TX), Chairman of the House Financial Services Committee, and reported out in September, 2016. However, the bill failed to make the legislative calendar prior to the start of the election season recess. A revised version is expected to be introduced in the new Congress.

[2] The Act’s language expressly exempts “Qualifying Banking Organizations” (i.e., those opting into the capital reserve regime) from all Dodd-Frank Section 165 “enhanced standards” other than subsection (c) public disclosures and subsection (k) inclusion of off-balance sheet exposures in capital computations. It would also perforce eliminate risk-based capital requirements. The Act would also require banks opting in to the leverage ratio to maintain a Camels rating of 1 or 2.

[3] While higher leverage requirements contemplated by the CHOICE Act may be desirable, the stricter leverage requirements cannot in themselves replace the Basel III risk weighted asset, leverage, and liquidity requirements implemented in Dodd-Frank. Relying solely on leverage requirements ignores entire categories of risk.

[4] The Act basically adopts the text of the 2015 Fed Oversight Reform and Modernization Act (H.R.3189)

[5] The Fed finalized its Total Loss Absorbing Capacity Rules (TLAC) on December 15, 2016, after Rep. Hensarling released his latest draft of the Act. Subsequent drafts of the legislation will presumably eliminate TLAC.