February 2017

FINANCIAL DEREGULATION:

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Acknowledgments TheauthorswouldliketothankJonathonAdams-Kane,KeithSavard,andJakobWilhelmusforhelpfuldiscussionsrelatedtothispaper.

About the Milken Institute TheMilkenInstituteisanonprofit,nonpartisanthinktankdeterminedtoincreaseglobalprosperitybyadvancingcollaborativesolutionsthatwidenaccesstocapital,createjobs,andimprovehealth.Wedothisthroughindependent,data-drivenresearch,action-orientedmeetings,andmeaningfulpolicyinitiatives.©2017MilkenInstituteThisworkismadeavailableunderthetermsoftheCreativeCommonsAttribution-NonCommercial-NoDerivs3.0UnportedLicense,availableathttp://creativecommons.org/licenses/by-nc-nd/3.0/

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Financial Deregulation: Repeal or Adjust?

ClaudeLopezandElhamSaeidinezhad1

WhileamajoroverhaulofU.S.financialregulationmaybeunlikelyduringtheearlymonthsoftheTrumpadministration,changesshouldbeexpectedashisnomineestoleadtheTreasuryDepartmentandfinancialregulatoryagenciesareconfirmed.Thiswillbethebiggestturnoverinregulatoryleadershipsincethepassagein2010oftheDodd-FrankAct,anditmayprovetobeatestforBaselIII,themacroprudentialpolicyframeworkcreatedbytheG20countriesinresponsetothe2007-2008financialcrisis.

Dodd-Frank,whichhasneverbeenfullyimplemented,isthelegislativevehicleforU.S.integrationofBaselIIIrecommendations.2Theactaimstolimitsystemicrisk,allowforthesaferesolutionofthelargestintermediaries,increasescrutinyofriskynonbanks,andreformderivativestrading.TheFinancialChoiceAct,introducedintheU.S.HouseofRepresentativeslastyearasanalternativetoDodd-Frank,proposessignificantchangesinfinancialregulation.AlthoughitisunlikelythattheFinancialChoiceActwillpass,itisconsideredbymanytobetheblueprintfortheregulatoryrevisionstocome.3

Theremaybeuncertaintyaboutwhatwillbechangedandwhen,butthereisnodoubtthattherewillbeturnoveramongseniorstaffatregulatoryagencies.InadditiontoPresidentTrump’sappointmentstoleadtheTreasuryDepartment,theSecuritiesandExchangeCommission(SEC),andtheCommoditiesFuturesTradingCommission(CFTC),theincomingadministrationwillbeabletonominatenewheadsofthebankingauthorities,namelytheOfficeoftheComptrolleroftheCurrency(OCC),theFederalDepositInsuranceCorp.(FDIC),andtheFederalReserveBoardofGovernors,allwithinthenext18months.

Morespecifically,threenewcommissioners,themaximumallowedfromanyonepoliticalparty,willbenominatedforboththeSECandtheCFTC.ThetermsforcurrentleadershipoftheOCC,theFDICandtheFederalReserveexpireinApril2017,November2017,andFebruary2018,respectively.ThekeypositionofvicechairmanforsupervisionalsoisvacantattheFed.4(ThedirectorsoftheOCCandtheConsumerFinancialProtectionBoard[CFPB]serveontheFDIC’sboard.5)

ThediagrambelowprovidesanoverviewoftheU.S.financialregulatorystructure.Itshowsthatthesechangeswillaffecttheentirefinancialsector,includingbanks,insurancecompanies,financialmarketutilities(FMUs),andsecuritiesmarkets.Furthermore,sevenofthe10votingmembersoftheFinancial

1ClaudeLopez,PhD,leadstheInternationalFinanceandMacroeconomicsresearchteamattheMilkenInstitute.ElhamSaeidinezhad,PhD,isaresearcheconomistonthisteam.2Seehttp://www.milkeninstitute.org/publications/view/812formoredetailsontheDodd-FrankAct.3Theregulatoryeasingconcernsonlypartoftheregulatoryframework.Nochangeinstanceisexpectedregardingtheanti-moneylaundering(AML)regulations.4ThetermofthevicechairmanoftheFederalReserveBoardendsinJune2018.5TheCFPBdirector’stermexpiresinJuly2018.

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StabilityOversightCouncil(FSOC),whichcoordinatesU.S.macroprudentialpolicy,willbereplaced.Thesenewregulatorswillhavesubstantialauthority,bothasindividualagencychiefsandasmembersoftheFSOC,tochangethewayDodd-Frankisapplied.TheycandothiswithoutgoingthroughCongressoreventheirownformalrule-makingprocesses.Forexample,agencychiefscanchangeenforcementprioritiesby“amendingorrescindingandreplacingrelatedguidance,suchasinterpretationsofrules,internalpoliciesandmanuals.”6UnliketherepealofDodd-Frankorarulechange,anewdirectioninguidanceandinterpretationcanbeorderedandimplementedalmostimmediately.

Diagram: Overview of the U.S. Financial Regulatory Structure Sector CorrespondingRegulators

DepositoryInstitutions(DomesticandForeign)

FRB OCC FDIC StateBankingSupervisors

PaymentSystemandOtherFMUs

FRB SEC CFTC

ConsumerProtectionIssues

CFPB FRB FDIC

InsuranceProducts

AnInsuranceExpertAppointedbythePresident

AStateInsuranceRegulator

FIO

SecuritiesandBondProducts SEC

AStateSecuritiesCommissioner

Securities-basedSwaps SEC

Non-Securities-BasedSwaps CFTC

Government-sponsoredenterprises

FHFA

CreditUnions NCUA

6Seehttp://www.capmktsreg.org/wp-content/uploads/2016/11/NBTF_Regulatory_Reform_.pdf

U.S.Treasury(Chairperson)CFPB:ConsumerFinancialProtectionBureauCFTC:CommoditiesFuturesTradingCommissionFDIC:FederalDepositInsuranceCorporationFHFA:FederalHousingFinanceAgencyFRB:FederalReserveBoardNCUA:NationalCreditUnionAdministrationOCC:OfficeoftheComptrolleroftheCurrencySEC:SecuritiesandExchangeCommissioninsuranceexpertFIO:FederalInsuranceOfficeAstateinsuranceregulatorAstatebankingsupervisorAstatesecuritiescommissioner

FSOCNon-Votingmembers:

FSOCVotingMembers

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Inlightoftheleadershipoverhaulattheregulatoryagencies,theblueprintdefinedbytheFinancialChoiceAct,andthesoftertoneregardingDodd-Frankrevamping,theincomingadministrationmayfirstfocusonchangesthatwouldprovideregulatoryrelieftothefinancialsectorwithoutalteringtheformalrules.Inthatcontext,thefollowingarepotentialtargetsforearlychange:

• TheFSOC’sauthoritytodesignate“systemicallyimportant”nonbankinstitutions(FMUs,includingclearingorganizationsandpaymentsystems,andnonbankfinancialcompanies)hasbeencriticizedandchallenged,mostnotablyintheFSOC'srecisionofGECapital'sdesignationassystemicallyimportantlastyear.NewvotingFSOCmembersmaysimplychoosenottodesignatenewsystemicallyimportantfinancialinstitutions(SIFIs)andreverseexistingdesignations.Asaresult,nonbankcompanieswouldnolongerbesubjecttoenhancedFedsupervision.TheFSOCmayalsoshiftitsattentionawayfromassetmanagerstofocusonstreamliningregulationsacrossagenciesinsteadofcreatingnewregulations.

• TheSECandtheCFTCarelikelytolimitthescopeoffuturesecuritiesregulations.Thisincludescurrenteffortstoregulatehigh-frequencytradingandsecurity-basedswaps.Furthermore,theissuanceoffiduciaryrulesforfinancialadvisersandrulesforassetmanagerstresstestingwillnotremainapriorityfortheSEC.7Bothagenciesmayemphasizepenaltiesagainstindividualsratherthanagainstcorporationsinanefforttoholdindividualsaccountable.Theresultwouldbemorecivilandcriminalprosecutionsforfraudandself-dealing.

• TheFDICiscurrentlythe“orderlyliquidationauthority”underTitleIIofDodd-Frankand,assuch,itcantheoreticallyliquidateaSIFIindifficultyoutsideofthenormalbankruptcycode.However,theFDICcanactonlyafterthesecretaryofthetreasurydecidestoplacetheSIFIunderFDICreceivership.Thisprocedurehasneverbeenused,anditseemsratherunlikelythatitwillbeunderthenewadministration.ThepotentialamendmentofthefederalbankruptcycodetofacilitateprocedureswhenitcomestoSIFIsisdirectlyrelatedtothispoint.

• BankingorganizationsmaybenefitfromanincreaseinDodd-Frank’s$50billionassetthreshold,whichautomaticallydesignatesthemasSIFIsandsubjectsthemtohighersupervisionstandards.8TheFedproposedinSeptember2016toexemptthecapitalplansofsmallerbanksfromscrutinytestingunderComprehensiveCapitalAnalysisandReview(CCAR)stresstestingandresolutionplanning.9Theincreaseinthethresholdhasbipartisansupport;however,itwouldhavelimitedimpactbecausebankingagencieshavealreadyeasedregulatorypressureforbankswithlessthan$100billioninassets.10

7Onasimilarnote,theDepartmentofLabor’s(DOL)fiduciarydutyrulewilllikelysurvivebutmayencountersignificantdelayinitsimplementation.8ABankingOrganizationisdefinedtoinclude1)insureddepositoryinstitutions2)bankholdingandsavingsandloancompaniesand3)allcompaniesthataretreatedasbankholdingcompaniesundertheInternationalBankingAct.9Seehttps://www.federalregister.gov/documents/2016/09/30/2016-23629/amendments-to-the-capital-plan-and-stress-test-rules10Seehttps://www.federalreserve.gov/newsevents/speech/tarullo20140508a.htm

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Similareasingseemsratherunlikelyforthelargestbanksintheshortterm,buttheymaybenefitfrompotentialchangesorfurtherdelayintheimplementationoftheVolckerRule’slimitsonproprietarytrading.Concernsregardingtherule’scomplexityaswellasitsimpactonmarketliquidityarewidespread,whichmayexplaintherecurringpostponementofitsfullimplementation.ThenewdeadlineforconformanceisJuly2017.

• TheCFPB’sleadershipstructurehasoftenbeencalledintoquestion,especiallysinceNovember2016,whenafederalcourtruleditunconstitutionalbecauseitssingledirectorcanberemovedonly“forcause”duringhisfive-yearterm.ChangeswillbelikelyiftheCFPB’sappealfails.

Tosumup,morethansixyearsaftertheadventofDodd-Frank,manyarecallingforareassessmenttoeasetheburdenitplacesonfinancial-servicescompanies,especiallybanks.Thesoftenedrhetoricofthenewadministrationisquitedifferentfromtheaggressivecallsforrepealthatwerecommonduringthecampaign,andsuggestsamoresubtleapproachtoregulatorychange.Thisnewtackalsoismoreinlinewiththebroaderinternationaldebate.ThepressureforregulatorychangeisnotconfinedtotheU.S.ThelatestdelaysinthefinalizationofBaselIII’sbankingrulesshowthatthepost-crisisregulatoryframeworkitselfisunderscrutiny.11

11TheGroupofCentralBankGovernorsandHeadsofSupervision(GHOS),theoversightbodyoftheBaselCommitteeonBankingSupervision,postponedaJan.8meetingduetodisagreementovernewcapitalrequirementsforlenders.