Seven years ago today, President Obama signed in to federal US law The Dodd–Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank, as it became known, set the path for other regulators globally. It was the first regulator to respond post the financial crisis, it was the broadest regulation in terms of its scope and sheer volume, and it was totally focused on the needs to protect the consumer and financial markets in general. Dodd-Frank also reached well beyond the US shores imposing regulation in other jurisdictions that dealt with US counterparties or in US financial products. As it celebrates its 7th Birthday, we take a look at what it was and what the future holds for Dodd-Frank.
Dodd-Frank was the first set of regulations in response to the financial crisis of late 2000s by a major government and is considered to be the biggest regulatory reform since the Great Depression. It was focused on protecting the consumer from abusive financial services practices and to protect the American tax payer from future bail outs of “too big to fail” firms. Dodd-Frank was first but it was soon followed by similar regulation across Europe in the form of EMIR. Other major economies implemented similar reforms to their markets with significant changes in Asia in particular Hong Kong, Japan, Singapore, Australia.
For such a vast regulation what has changed can be summed up in one word, everything. If we look purely at the financial markets, there have been changes to what products financial firms can trade, and how they can trade them with clearing and margining required on many previously traded OTC products. There have been increased capital requirements and limitations on banks’ ability to take risk, otherwise known as proprietary trading. There has also been substantial reform in terms of what and when transactions traded by financial intuitions must be reported.
Dodd-Frank is highly detailed, prescriptive, and comprehensive. The EU regulations are, in comparison, open to more interpretation and are dispersed in terms of the various legislative components that make them up. In comparison to other systemic regulations, Dodd-Frank has therefore been ‘easier’ for firms to implement as there has been relatively less need for interpretation.
There has been a reduction in systemic risk with the Board of Governors of the Federal Reserve System reporting in June 2017 that large financial institutions across the US have doubled their capital levels over the past seven years. The strengthened banks’ balance sheets will enable firms to be more able to survive a financial crisis in the future.
Other positives including the mandatory clearing and the requirement to post margin have increased the markets’ resilience to financial shocks and put more structure and standardisation across the market.
Dodd-Frank has also been successful in standardising the reporting of transactions enabling regulators to more easily identify both parties to transactions. It has also been credited with standardisation of models and improved fiduciary standards for both firms and customers alike.
Dodd-Frank has had many detractors as well. The cost to implement such wide-ranging reforms has been criticized since its inception. As any student of economics will know, increasing the costs and the complexity of doing business will force a change in the market and this is true of Dodd-Frank’s impact. Smaller banks have looked to reduce trading activity where the compliance burden is too onerous; as have global banks where US markets were not their primary focus.
The stringent regulatory burden of holding increased capital has been criticized for reducing banks’ ability to lend to the wider economy reducing economic growth. Risk management standards involving CCAR (Comprehensive Capital Analysis Review) and LCR (Liquidity Coverage Ratio) have been seen as key contributors to this reduction.
The US regulatory landscape also has multiple regulators. Often these regulators do not align with CFTC and the SEC providing differing guidance which has made implementation more complex. The compliance effort for banks is significant in just responding to both regular and ad-hoc requests. Therefore, Dodd-Frank has not brought any efficiency in this respect.
Much has also been made of the impact of the Volcker, or proprietary trading, rules and their impact on the trading of illiquid products. When banks are limited in the ability to remove risk from counterparties, this potentially could have wider consequences to businesses. If they are unable to adequately hedge their risk when interest rates return to historically normally levels, this could have negative impacts on the sustainability of their business models.
Donald Trump’s presidency has included many objectives to reverse key legislative reforms made during the tenure of his predecessor. Most recently this has focused on Obamacare but Dodd Frank is also high on his list to reduce its impact and/or remove it completely. What is unclear with Donald Trump is how much of this is pure rhetoric and how much will come to pass. While this puts a cloud over the legislation’s future, the focus on better use of capital and the increased cost and compliance burden has improved both the transparency of financial data and a need for structural reform across the industry. So the key question is will Dodd-Frank be here in another 7 years or will Donald Trump condemn it to the pages of history?