The New Face of US Financial Regulation

What issues will be confronted?

Originally published in the November | December 2016 issue

While we have a new President elect in the United States, history suggests that the identity and leanings of the future Secretary of the Treasury and the appointees to the regulatory agencies may be just as important to the future of financial regulation. When all is said and done, it is the regulators who actually articulate, implement and enforce (or not) day-to-day financial services policies.

Though we may not yet know who those regulators will be, we do know some of the important issues that they will confront.

Perhaps one of the more significant issues is the increasing cost and burden of regulation. No comprehensive government analysis of the costs or benefits of the Dodd-Frank Act was done before it was enacted into law, and none has been done since. While no one can argue that financial institutions should not be closely supervised, the financial impact of the regulatory correction since the crisis has been staggering. On October 20, 2016, The Wall Street Journal reported that global banks have incurred $275 billion in costs penalties and compliance charges since 2008. The more meaningful point is the impact on the market – a $5 trillion reduction in lending capacity.

How global financial regulation is applied is also an important issue. The American Banker recently characterized the European Union’s indication that it will not follow the Basel Committee’s recommendation on standardized credit or operational market risk rules for fear of stifling economic growth as a “stunning move.” This underscores a concern in the United States that US regulators seem to enforce global standards with less exceptions for market-related considerations.

Similarly, the G-20s’ Financial Stability Board, which includes three US agencies, has been a particular subject of concern, having launched aggressive efforts to include many U.S firms among the globally significant financial institutions that it has identified, a result for which there is effectively no legal recourse by any targeted company. In a recent Congressional hearing, Congressman Bill Huizenga criticized the delegation of US financial regulation to “European bureaucrats.” To add some additional contrast, in September 2016, federal banking regulators seemed to be further retrenching, having recommended to Congress that it repeal the authority previously given to financial holding companies to invest in merchant banking and certain commodities activities.

The realignment of investor capital that started in the financial crisis is another significant issue that will confront regulators. Dodd-Frank’s progressive regulatory tax based on the size of an institution may need some recalibration. So too may regulatory policies that have discouraged “private capital” from investing in failed and healthy banks, “bail yourself out” plans regulators are developing for large banks, and Dodd-Frank’s systemic stability restrictions on acquisitions among large financial institutions are data points which investors are now well aware of.

The future path of the Financial Stability Oversight Council (FSOC) may also be up for grabs. There have been no designations since December 2014, and the FSOC is currently seeking to validate its effort to designate MetLife as a systemically important financial institution (“SIFI”) in a federal court of appeals.

The continuing impact of Dodd-Frank and the effect of technology on the development of financial products will also be prominent issues. Front and center are: how enhanced prudential regulation impacts larger banks; the future of the Volcker Rule and the extent to which the repeal of Glass-Steagall will be revisited; whether capital and liquidity requirements are at the right levels; the creation and uses of stress tests; increasing prudential regulation of non-bank financial firms; and the opportunities and threats posed by fintech companies, such as marketplace lenders. Housing finance policy and the role of the GSEs will continue to be the elephant in the room, one that is now eight years old and getting harder to ignore.

Some issues are not easily parsed based simply on partisan politics. For example, will a perceived end to “too-big-to-fail” institutions actually drive different and more reliable regulatory results in the next crisis? Will regulators be willing to close the largest non-bank financial companies if they are in severe financial distress and appoint the FDIC as receiver? Will living wills solve multi-jurisdictional disputes and create enough global agreement to avoid conflicts among nations over the remains of failed multi-national institutions? Only the handling of the next crisis will reveal the answers to these questions.

Finally, the courts may have an important influence on future regulation. Lawsuits challenging regulatory actions have and will continue to be important balancing factors. Among them are cases challenging the designation of MetLife as a SIFI, the validity of the terms of the preferred stock instrument held by the Treasury in Fannie and Freddie, and the structure and authority of agencies like the CFPB and Federal Housing Finance Agency. Cases like these are often canaries in the regulatory coal mine, signaling when the increasing level of regulation may becoming economically stifling.

With this backdrop, I believe that the new Administration will evaluate whether the current financial regulatory system is effective and efficient, understanding the overriding importance of keeping institutions as safe and sound as possible.
In that regard, all laws and agency rule-making should include standardized, rigorous cost benefit analyses to empirically demonstrate that the costs that they will create are reasonable when compared to their overall impact on safety and soundness and the corresponding benefits to the public. Additionally, given the velocity of change in the financial services business, regulators should construct a system in which no regulation sits on the books for more than five years without its continued existence being challenged and legitimized. Similarly, no new rule should be adopted without also including a built-in obsolescence date.
Moving forward, financial executives deserve a clear and consistent picture of government policies so that they can steer a course to profitability over a longer term. Dodd-Frank utterly failed to provide such a vision. Similarly, effective regulation should better incorporate state-of-the-art real-time electronic monitoring, moving toward a methodology that can value financial assets and liabilities each and every day.
The purpose and goals of the FSOC should be reevaluated. After five years, the FSOC has designated four nonbank financial companies as SIFIs, but only two remain as such. If the FSOC continues in some form, its time might be better spent focusing less on a few SIFI designations and more on developing comprehensive data and effective early warning mechanisms that can provide regulators with the opportunity to take remedial actions before the next crisis unfolds. That would indeed be a welcome change.
Finally, too many agencies are often involved in regulating financial institutions, particularly when it comes to enforcement. The Federal Reserve Board, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., Securities and Exchange Commission, Treasury Department, Commodity Futures Trading Commission, Consumer Financial Protection Bureau Department, and 50 state banking, securities and consumer protection agencies and attorneys general may all assert jurisdiction with regard to the same facts at the same time, not to mention federal and state criminal prosecutors. While strong regulation of financial institutions is necessary, regulatory piling-on is counterproductive and costly to the consumers and shareholders who will ultimately pay the bills.

Thomas Vartanian is currently the Chairman of the Financial Institutions practice residenced in the Washington D.C. office of the international law firm of Dechert LLP. He is a former General Counsel and senior trial attorney respectively at two different federal banking agencies.