Dodd-Frank is not likely to be repealed, but the incoming US government has signalled big changes for the banking industry. Smaller players will get the most regulatory relief, but Wall Street will win in other ways. Danielle Myles reports. 

Trump scrabble

Opportunity is knocking for US banks, and from an unlikely source. Within three weeks of Donald Trump’s surprise victory in the 2016 presidential race, he and his posse of advisors had vowed to roll back the post-crisis regulatory overhaul known as the Dodd-Frank Act, chosen a former-investment banker as treasury secretary, and promised tax cuts and a $1000bn fiscal stimulus that will pave the way for interest rate hikes.

The ultimate goal is to lift economic growth above 3%, but these measures also promise a reprieve for the country’s most heavily scrutinised industry. Whether the incoming administration delivers on its ambitious plans is an open question, particularly given the president-elect’s penchant for unpredictability, but the markets are certainly allowing him the benefit of the doubt.

In the month following the election, shares of the five big US investment banks gained between 20% and 35% on the expectation of regulatory easing, a steeper yield curve, and more fee revenue from greater business activity.

The repeal red herring

Speaking with New York bankers, the reaction is more measured. They feel they are entering a period of uncertainty, but are cautiously optimistic that the Republicans’ clean sweep of control of the White House and both houses of Congress will bring some regulatory relief. What they are not expecting is a repeal of the 2300-page Dodd-Frank Act and the 22,000 pages of regulation it has spawned.

Wall Street’s view is shared by community banks. Richard Hunt, CEO of the Consumer Bankers Association (CBA), describes the election outcome as “a sigh of relief compared to what it could have been”. He says the CBA now has a clear goal: “To get to work and create good, common sense bipartisan legislation. No one is calling for a repeal of Dodd-Frank.”

The Trump transition website’s pledge to dismantle the statute is clearly being taken with a pinch of salt. “When people talk about ‘repeal’ and ‘dismantle’, it is short-hand for significant reform,” says Wayne Abernathy, executive vice president of financial institutions policy and regulatory affairs at the American Bankers Association (ABA). “And we are in the ‘significant reform’ camp.”

Mr Trump will see some success in ‘draining the swamp’ of US financial rules. But the biggest changes for banks will possibly not come from Congress, but the business gains that will flow from an improved economy and new leadership of the banking watchdogs. 

The new powerbrokers

The single biggest determinant of the new regulatory climate is the identity of those appointed to key posts: the treasury secretary, heads of the independent agencies, and on the legislative front, the chairs of Congress’s two financial services committees.

“The US regulatory agenda for financial services is highly dependent on the individuals sitting in the key seats. These are the types of issues that, unless you are in a crisis, the president typically doesn’t personally get involved in,” says Gene Ludwig, CEO of Promontory Financial Group and former chief of the Office of the Comptroller of the Currency (OCC).

Dodd-Frank gave the regulators a tremendous amount of discretion regarding oversight, and the ability to craft and change regulations, meaning they can shape the banking rulebook without any statutory changes. There was a view that because agency heads come and go, long-life staffers wield the biggest influence on regulators’ policies. Today this is not the case.

“The tone at the top matters. If the leadership of the SEC [Securities and Exchange Commission] or CFTC [Commodity Futures Trading Commission] isn’t interested in aggressively pursuing enforcement, or the Federal Reserve isn’t passing strict rules and interpretation, that will trickle down to the staff and will mean lighter touch regulation,” says Ian Katz, a policy analyst at Capital Alpha Partners.

Agency chairs and commissioners are nominated by the president and must be confirmed by a majority vote in the Senate (in which the Republicans have 52 of 100 seats). It means Mr Trump will be able to populate the US financial regulators with individuals who share his views. This will occur over the next 14 months. The terms of the SEC, OCC and Federal Deposit Insurance Corporation chairs expire in 2017, while Janet Yellen’s post as chief of the Federal Reserve, the US central bank, is up in early 2018. During campaigning, Mr Trump made clear he would not reappoint Ms Yellen, who recently warned against turning the clock back on improvements made by Dodd-Frank.

While the president cannot replace these individuals until their terms expire, an October court ruling in PHH Corporation v Consumer Financial Protection Bureau (CFPB) indicates he could replace Richard Cordray as chief of the retail banking watchdog – which is maligned by many Republicans – before his term expires in 2018. “This suggests the president now has the authority to remove the head of the CFPB for any reason,” says James Sivon, of counsel with Squire Patton Boggs, who represents financial institutions before Congress.

There are also a number of vacant seats Mr Trump could move to fill any time from his January 20 inauguration. The CFTC and SEC are both short of two commissioners, and the Fed is without a vice-chair for supervision – a role created by Dodd-Frank that has never been filled. This is potentially one of the US’s most powerful financial regulatory jobs, having responsibility for regulatory and supervisory policy. It is expected to be top of the list for regulatory appointments, largely because it may displace some of the influence of Fed governor Daniel Tarullo, who is known for his tough stance on capital standards.

“I think the empty vice-chair at the Fed will be one of the first out the gate regarding financial regulatory structure. I expect the Trump administration to move quickly to fill that position,” says the CBA’s Mr Hunt.

Mr Mnuchin & Co

The one role Mr Trump has been able to fill is treasury secretary. His choice, Steven Mnuchin, worked as a trader at Goldman Sachs for 17 years and eventually headed its mortgage-backed bond trading desk. He left in 2002 to work in hedge funds, co-founded Dune Capital Management, which has financed several films including Avatar, and set up a retail bank called OneWest. Mr Mnuchin has a relatively low profile on Wall Street, but he is described as a hard-driving financial executive who does not seek the limelight.

His banking career does not make Mr Mnuchin an unusual pick for treasurer secretary (both Bill Clinton and George W Bush appointed ex-bankers to the role). Nor does it suggest he will seek to roll back Dodd-Frank. The fact Mr Mnuchin – who has donated to the Democrats, worked for hedge funds run by philanthropist George Soros and is considered a moderate – was selected over representative Jeb Hensarling, another top candidate for the role, is telling.

Mr Hensarling, who chairs the House Financial Services Committee, is one of Dodd-Frank’s biggest opponents and is championing a draft law called the Financial Choice Act that would essentially replace the post-crisis statute. “If Mr Hensarling was selected as treasury secretary it would have been about deregulation. With Mr Mnuchin [Mr Trump has] picked someone who will compromise,” says one banker, speaking on condition of anonymity. “That tells me that regulations will clearly go the other way, but it will be balanced.”

Bankers have expressed approval at such an appointment – a banking professional with business sense, not a bureaucrat without industry experience. They are encouraged by the parade of financial executives sited at Trump Tower in recent weeks including JPMorgan chairman Jamie Dimon (who it is understood was approached about the treasury role but said he was not interested), Goldman Sachs president Gary Cohn, who has been named director of the National Economic Council, and private equity investor Wilbur Ross, who has been chosen as commerce secretary.

Mr Mnuchin is expected to help select people to fill the top agency posts, along with ex-SEC commissioner Paul Atkins, the transition team’s adviser on financial policy. He is perceived as having a stronger deregulatory bent than Mr Mnuchin, being a vocal critic of Dodd-Frank and arguing against stiff fines for corporations when at the SEC.

Mr Atkins resisted efforts to proliferate regulation following the fraud scandal that led to Enron’s collapse in 2001. “He was the guy who was trying to drain the swamp when so many in the Bush administration were trying to fill it,” says JW Verret, a banking law professor at Antonin Scalia Law School and former chief economist for the House Financial Services Committee.

Attention will not fully turn to these posts until all cabinet positions are filled, although Mr Atkins himself is rumoured as a candidate for SEC chairman or the Federal Reserve vice-chair for supervision.

Dodd-Frank: what will change

Personalities aside, parts of Dodd-Frank will change, and identifying those parts comes down to two factors.

First, the revisions already in the pipeline. Mr Hensarling’s Choice Act lays out Republicans’ pre-Trump reform priorities and is considered by some as a ready-made answer to the changes sought by the president-elect. It would repeal certain aspects of Dodd-Frank and excuse banks from its supervisory regime and Basel III prudential standards if they hold more capital. Separately, some regulators have recognised the need to ease rules for smaller banks.

Second is whether the revisions can be made by (Trump-appointed) regulators or must go through Congress. Legislative amends to Dodd-Frank should be subjected to the filibuster process, which requires 60 votes to pass a bill. As the Republicans hold 52 seats in the Senate, these numbers are not guaranteed. Some speculate the bills could instead go through reconciliation – a legislative process intended for budget-related changes and which avoids a filibuster.

But Aaron Klein, a fellow at the Brookings Institution, thinks this unlikely. “There are some gimmicky things you can do to make changes appear to impact the budget, but financial regulation isn’t really one of them,” he says. In short, anything that can be made by the regulators is more guaranteed.

Volcker's days numbered?

Based on these criteria, there are four items most likely to change.

First, the Volcker Rule. Republicans have long-sought to pare back the ban on proprietary trading that is widely considered the most despised rule on Wall Street. Some regulators have suggested exempting small banks, while the Choice Act would kill it – an option supported by the ABA. “There hasn't yet been a case made for the value of the Volcker Rule. We have been working with the regulators to find ways to implement it in the least harmful way, and they have listened to us significantly. But in the end, it needs to be repealed,” says the ABA’s Mr Abernathy.

Sullivan & Cromwell senior chairman H Rodgin Cohen says while it would be difficult if not impossible to repeal all of Dodd-Frank, substantial changes are possible, and Volcker is among the lowest hanging fruit.

“[That’s] because it creates substantial regulatory burden and was not responsive to any of the actual causes of the financial crisis. What exactly will happen is still up in the air but I think an insufficient outcome would be that it doesn’t apply to banks under a certain size,” he says. “In the absence of a legislative solution, it could be implemented differently. There is a fair amount of interpretation regarding the proprietary trading definitions and some aspects of that could clearly be changed by the regulators.”

Indeed, banks’ biggest gripe is that the five agencies charged with overseeing the Volcker Rule have not agreed on firm parameters for how long securities can be held before they are classified as proprietary trading. Under Trump appointees it is expected the rule will be simplified and safe harbours expanded. This would include the exemption for market making, which would improve market liquidity.

Systemically unimportant?

The second item is the $50bn asset threshold that classifies banks as systemically important financial institutions (SIFIs), bringing them within the Fed’s strict oversight and tough prudential rules. Trade associations have lobbied for this statutory change for years. “You can’t find a single $50bn bank in the US that is systemically important, and even many others above that,” says Mr Abernathy.

Within Congress there is broad acceptance that $50bn is an arbitrary and relatively low number, but there is less agreement on how it will be amended. “I do think the odds favour moving the SIFI threshold from $50bn upwards. If I had to guess, I would say $500bn is likely, though it could be only as high as $250bn,” says Mr Ludwig.

Some suggest moving it to $250bn – a level already used by the Fed to tailor its rules between large and small SIFIs – with an off-ramp that allows banks with less than $500bn to request de-designation. Instead of asset size, the ABA wants criteria based on banks’ business activity, complexity and interconnectedness, similar to that used to designate non-bank SIFIs. The lower house of Congress passed a bill proposing this in early December.

CFPB and capital rule change

The third item is weakening the CFPB, the powerful consumer banking watchdog which is targeted by the Choice Act. “For the Republicans that are interested in financial regulation, this is almost their Obamacare – it’s what they despise most about what’s happened under the Obama administration,” says Mr Katz. Republicans believe that as a single-person directorship that is not subject to the same budget rules, the CFPB lacks accountability and has been able to impose excessive fines. They will push for it to be converted to a board structure and funded the same way as other regulators.

Fourth, capital rules and oversight are expected to be eased, because this can bypass Congress. “The Fed has substantial discretion over capital rules,” says Mr Cohen, one of Wall Street’s most influential lawyers, who was at the centre of attempts to save Lehman Brothers. “For example, one of the Basel requirements it has gold-plated is the supplemental capital requirements for GSIBs [global systemically important banks]. They must calculate this requirement under both the Basel and Fed’s methodology, and then apply the higher of the two. So that could be eliminated.”

The stress-testing regime, known as the Comprehensive Capital Analysis and Review, or CCAR, could also become more lenient. Issues such as these would fall to the vice-chair of supervision, an empty seat that Mr Trump is expected to swiftly fill.

Main Street versus Wall Street 

While lighter touch oversight will benefit banks of all sizes, the substantive changes are a clearer win for Main Street than Wall Street. They are consistent with Mr Mnuchin’s first public statements on financial regulation after his nomination.

Speaking with CNBC, and on behalf of commerce secretary Mr Ross, he said: “We have been in the business of regional banking and we understand what it is to make loans, and that is the engine of growth to small and medium-sized businesses. The number one problem with Dodd-Frank is that it is way too complicated and cuts back lending.” Mr Mnuchin’s emphasis on small banking activity aligns with the presidential transition website, which laments that the “big banks got bigger while community financial institutions have disappeared”. However, the prospect of reinstating the Glass-Steagall Act is given little credibility, despite Mr Trump’s campaign comments about breaking up universal banks.

Most on Wall Street are just grateful that the regulatory climate is not expected to be any tougher than it is today. “It feels like banks are probably at the furthest end of the regulatory pendulum, and may now start swinging back the other way,” says Tommy Mercein, global head of debt capital markets (DCM) at Credit Suisse.

However, generally speaking investment bankers do not want a wholesale rollback. As one muses: “It’s hard to put the genie back in the bottle, isn’t it?” Many investment banks have restructured and spent billions of dollars on compliance and IT systems, many of which they readily admit improve the industry’s long-term health and rein in pre-crisis behaviours. Some businesses from which they have withdrawn are now dominated by new players, often staffed by their former employees.

And while it is human nature to want fewer regulations, these considerations limit bigger banks’ desire for wholesale changes. “Now that a lot of the regulations are in place, I think the industry realises that stripping them out only to have them reimposed in a different shape or form, and against a new political environment with different attitudes, will... create costs,” says Mr Ludwig.

There is clearly appetite for the Volcker Rule to be weakened, but otherwise Wall Street banks are more focused on eliminating reporting and record-keeping obligations that create great expense without enhancing safety and soundness. One banker recalls when the revenue-generator to back-office worker ratio was 5:1. Today it is about 1:10. He is hoping the numbers will start to edge back in the other direction. One in-house counsel says his team is identifying the changes they want, and seeing if they align with the published opinions of sitting commissioners who, they believe, may be promoted to chairperson.

Industry makeover

Regulatory easing could reshape the US banking sector in other ways, however. Changes to the SIFI test are a case in point. "If the threshold is lifted from $50bn – most believe it will go up to $250bn but some say maybe up to $500bn – then we will see more bank mergers and acquisitions [M&A],” says Alejandro Przygoda, global head of financial institutions group (FIG) at Credit Suisse. “Since Dodd Frank, banks have been reluctant to cross the $50bn and $250bn thresholds as they didn’t want to sign up for more onerous oversight and regulations.”

After seven years of little activity, there is thought to be significant pent-up M&A demand. The size of deals depends on the degree of deregulation but Mr Przygoda says that in the longer term, the combination of lower regulations, a steep yield curve and strong dollar could drive large bank M&A.  

In the weeks after the election, numerous banks sold follow-on equity offerings, taking advantage of investor appetite for FIG. The trend is expected to continue into early 2017. With bank stocks rallying on the assumption of higher interest rates and fiscal policy and regulatory changes, more privately owned lenders are expected to go public. “Could we see several bank initial public offerings over the course of 2017? Absolutely,” says Douglas Adams, co-head of equity capital markets for the Americas at Citi.

Fiscal realities

For all the talk of stripping back Dodd-Frank, the biggest favour Mr Trump could do for the bank sector, particularly the bigger players, is deliver on his promises of fiscal expansion and GDP growth. Taken in isolation, a strong economy is significantly more important to bank success than regulatory relief.

DCM bankers confirm that yield-starved insurers are committed to long-dated fixed income, meaning infrastructure bonds are a viable option for helping to fund a $1000bn infrastructure plan. Slashing the 35% nominal corporate tax rate (among the highest in the world) would boost stock valuations and, in turn, equity capital market activity. It would also benefit banks directly.

“There is probably no industry that would profit more from a general corporate tax reduction than the banking industry. For many industrial, tech and commercial companies, they already pay well below the basic rate. But banks almost always pay in the 30s,” says Mr Cohen. “So if you bring the stated rate down to the low 20s, as an industry banks could be the biggest beneficiaries.”

Neither Mr Trump’s victory speech nor his plan for his first 100 days in office mention financial regulation, and any changes to supervision, regulations and legislation will have a long lead-time. Growth, tax cuts and fiscal expansion, on the other hand, have been reaffirmed time and time again as top priorities. Luckily for banks, it is these changes that could provide the bigger opportunity.


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