Tred Talks: US deregulation under Trump
21 March 2017
Tred McIntire, formerly head of Goldman Sachs Agency Lending and a member of the RMA executive committee, gives his thoughts on how Donald Trump’s presidency will come to bear on regulation of financial services
Image: Shutterstock
Despite losing the presidential election by more than 2.9 million votes, Donald Trump won the electoral college riding a wave of populist sentiment. After hitting an election night air pocket (the Dow Jones Industrial Average was down 827 points), the Dow has surged 14 percent (as of 9 March) since the election, and the Financial Sector ETF (XLF) is up 24 percent. The headlines have been full of optimistic Trump sentiment around the financial sector:
• "With SEC head’s resignation, field clears for Trump to cut back regulations" (Washington Post, November 2016)
• "Trump vows to dismantle Dodd-Frank disaster" (New York Times, January 2017)
• "Trump moves to roll back Obama-era financial regulations" (New York Times, February 2017)
• "Top Federal Reserve official resigns as bank deregulation looms" (Reuters, February 2017)
• "Trump’s man for the SEC: Time to ease regulation" (Wall Street Journal, February 2017)
• "Trump told Mnuchin he wants deregulation done in six months" (CNBC, March 2017)
What has happened to date?
Since the election, Trump has taken steps to begin the process of softening regulation of the financial sector, and this has resulted in certain high profile resignations and emboldened others to 'follow his lead':
• 14 November: A week after the election, Securities and Exchange Commission (SEC) chair Mary Jo White announced her intent to resign on 20 January, the day of Trump’s inauguration. Jay Clayton, a Sullivan & Cromwell lawyer who has represented Wall Street, is Trump’s pick to replace White.
• 30 January: Trump issues Executive Order on Reducing Regulation and Controlling Regulatory Costs. The order states that "for every one new regulation issued, at least two prior regulations be identified for elimination".
• 31 January: Republican Patrick McHenry, vice chair of the House financial services committee, sent a letter to Federal Reserve chair Janet Yellen criticising the Fed’s “negotiating international regulatory standards for financial institutions” and participating “in international forums such as the Financial Stability Board, the Basel Committee on Banking and Supervision”. He went on to say: “It is incumbent upon all regulators to support the US economy, and scrutinise international agreements that are killing American jobs.”
• 3 February: Trump issues Executive Order on Core Principles for Regulating the US Financial System. Highlights include calls for more rigorous regulatory impact analysis; advancing American interests in international financial regulatory negotiations and meetings; making regulation efficient, effective, and appropriately tailored; restoring public accountability within federal financial regulatory agencies and rationalising the federal financial regulatory framework. It also directs the secretary of the Treasury to report back to the president within 120 days.
• 10 February: Federal Reserve governor Dan Tarullo, a vocal advocate for bank regulation, announces plans to retire on 5 April. Known by some as the “alpha dog of financial regulators”, Tarullo was the Fed governor who assumed responsibility for heading regulation (a post created by Dodd-Frank), even though he was never formally confirmed for it. David Nason, a former General Electric executive and Treasury official under Hank Paulson, was expected to be nominated to replace Tarullo, however, he recently withdrew his name from consideration.
• 13 February: Steve Mnuchin, former Goldman Sachs partner, confirmed as Treasury secretary.
• 24 February: Trump issues Executive Order on Enforcing Regulatory Reform Agenda. The order requires federal agencies to appoint a regulatory reform officer. In signing the order, Trump said: “We’re going to put the regulation industry out of work and out of business.”
What are the possibilities?
Given this backdrop of executive orders, public statements and personnel changes, what are the likely possibilities?
Dodd-Frank rollback: A wholesale roll-back of Dodd-Frank in 2017 is highly unlikely with only a 52 to 48 margin in the Senate. However, depending on what happens this year, the numbers in the Senate could shift in favour of a clear Republican mandate in 2018 with 16 Democratic seats up for election.
Short of a full repeal, it is possible that certain elements of Dodd-Frank could be softened. For instance, the comprehensive capital analysis and review (CCAR) framework could be modified to reduce constraints on banks in regard to dividends and share repurchases. Secretary Mnuchin has also promised to ‘kill’ parts of the law, including the Volcker rule.
Single counterparty credit limits (SCCL): The limits are contained in Section 165(e) of Dodd-Frank. They are designed to limit the amount of net credit exposure that large banks, also known as systemically important financial institutions (SIFI, which are defined as greater than $50 billion of assets), to one another.
SIFIs may have net credit exposure of no more than 25 percent of regulatory capital to other SIFIs. The top tier, largest banks, known as G-SIFIs are subject to even more restrictive limits on their exposure to one another (no more than 10 percent). Although Dodd-Frank was originally passed in 2010, a definitive timetable for implementation has not yet been set.
The likely impact of SCCL as drafted would be to limit the capacity of agent lenders and principal borrowers to transact with one another. As much of the volume of securities lending business is concentrated among the top prime brokers and agent lenders, it may lead to a mix of potential responses: reduced borrowing and lending activity, shifting business to smaller less creditworthy counterparties, allocating more capital to the business, or increasing efforts to develop a viable central counterparty model for the US market.
On 4 March, the Fed released a proposed draft with comments due by 3 June. SCCL would seem to present a likely target for de-emphasis. Without active support and sponsorship within the regulatory community, it is possible that this element of Dodd-Frank may languish.
Net stable funding ratio (NSFR): NSFR was originally introduced in 2009 to address a perceived over-reliance by several banks on short-term wholesale funding. It effectively raises the overall cost of funding securities finance transactions and may reduce liquidity. Another potential effect is to encourage the insertion of a central counterparty into securities finance transactions. At this point, it is scheduled to be fully implemented by 1 January 2018.
In a comment letter sent to the Fed, OCC and the Federal Deposit Insurance Corporation last August, the Securities Industry and Financial Markets Association, the American Bar Association and several other industry organisations said that the NSFR is unnecessary due to “key reforms already enacted, including the liquidity coverage ratio”. Like SCCL, the NSFR would seem to fall within the scope of Trump’s executive orders and could clearly be de-emphasised.
Equities as collateral: SEC approval of the use of equities as collateral in securities lending transactions has been under review for nearly two years. After a flurry of activity and much enthusiasm in 2015, the proposal has been in limbo.
With only two SEC commissioners at the moment and some questions about whether the change needs the formal approval of the commission, a decision has not yet been taken. This would appear to be an ideal cause for the new SEC chairman nominee, Jay Clayton, to push forward.
In addition to the much-touted benefits of correlation between collateral and loaned assets, this would also put the US market on a more equal footing with non-US markets, an important Trump objective for all aspects of the economy.
In addition to approving brokers’ use of equities as collateral, the SEC’s investment management division must separately approve the acceptance of collateral by ’40 Act funds, and the Department of Labor would need to approve its use by Employee Retirement Income Security Act plans. At a minimum, these efforts are likely to receive positive support from the Trump administration.
Likely outcome
Trump has raised expectations for a significant easing of financial regulation, however, it remains to be seen how much he will be able to accomplish given the ambitious legislative agenda that he has proposed (ie, healthcare reform, a major tax overhaul and major changes in the federal budget).
Progress on deregulation (or at least at a slower pace) in the coming months seems likely in some respects:
• Equities as collateral: Probable in two to three months
• SCCL: Less likely to be implemented in short run
• NSFR: Less likely to move forward in short run
• Dodd-Frank rollback: Unlikely to change meaningfully before 2018 at the earliest
• CCAR: Possible ‘softening’ approach this year.
• "With SEC head’s resignation, field clears for Trump to cut back regulations" (Washington Post, November 2016)
• "Trump vows to dismantle Dodd-Frank disaster" (New York Times, January 2017)
• "Trump moves to roll back Obama-era financial regulations" (New York Times, February 2017)
• "Top Federal Reserve official resigns as bank deregulation looms" (Reuters, February 2017)
• "Trump’s man for the SEC: Time to ease regulation" (Wall Street Journal, February 2017)
• "Trump told Mnuchin he wants deregulation done in six months" (CNBC, March 2017)
What has happened to date?
Since the election, Trump has taken steps to begin the process of softening regulation of the financial sector, and this has resulted in certain high profile resignations and emboldened others to 'follow his lead':
• 14 November: A week after the election, Securities and Exchange Commission (SEC) chair Mary Jo White announced her intent to resign on 20 January, the day of Trump’s inauguration. Jay Clayton, a Sullivan & Cromwell lawyer who has represented Wall Street, is Trump’s pick to replace White.
• 30 January: Trump issues Executive Order on Reducing Regulation and Controlling Regulatory Costs. The order states that "for every one new regulation issued, at least two prior regulations be identified for elimination".
• 31 January: Republican Patrick McHenry, vice chair of the House financial services committee, sent a letter to Federal Reserve chair Janet Yellen criticising the Fed’s “negotiating international regulatory standards for financial institutions” and participating “in international forums such as the Financial Stability Board, the Basel Committee on Banking and Supervision”. He went on to say: “It is incumbent upon all regulators to support the US economy, and scrutinise international agreements that are killing American jobs.”
• 3 February: Trump issues Executive Order on Core Principles for Regulating the US Financial System. Highlights include calls for more rigorous regulatory impact analysis; advancing American interests in international financial regulatory negotiations and meetings; making regulation efficient, effective, and appropriately tailored; restoring public accountability within federal financial regulatory agencies and rationalising the federal financial regulatory framework. It also directs the secretary of the Treasury to report back to the president within 120 days.
• 10 February: Federal Reserve governor Dan Tarullo, a vocal advocate for bank regulation, announces plans to retire on 5 April. Known by some as the “alpha dog of financial regulators”, Tarullo was the Fed governor who assumed responsibility for heading regulation (a post created by Dodd-Frank), even though he was never formally confirmed for it. David Nason, a former General Electric executive and Treasury official under Hank Paulson, was expected to be nominated to replace Tarullo, however, he recently withdrew his name from consideration.
• 13 February: Steve Mnuchin, former Goldman Sachs partner, confirmed as Treasury secretary.
• 24 February: Trump issues Executive Order on Enforcing Regulatory Reform Agenda. The order requires federal agencies to appoint a regulatory reform officer. In signing the order, Trump said: “We’re going to put the regulation industry out of work and out of business.”
What are the possibilities?
Given this backdrop of executive orders, public statements and personnel changes, what are the likely possibilities?
Dodd-Frank rollback: A wholesale roll-back of Dodd-Frank in 2017 is highly unlikely with only a 52 to 48 margin in the Senate. However, depending on what happens this year, the numbers in the Senate could shift in favour of a clear Republican mandate in 2018 with 16 Democratic seats up for election.
Short of a full repeal, it is possible that certain elements of Dodd-Frank could be softened. For instance, the comprehensive capital analysis and review (CCAR) framework could be modified to reduce constraints on banks in regard to dividends and share repurchases. Secretary Mnuchin has also promised to ‘kill’ parts of the law, including the Volcker rule.
Single counterparty credit limits (SCCL): The limits are contained in Section 165(e) of Dodd-Frank. They are designed to limit the amount of net credit exposure that large banks, also known as systemically important financial institutions (SIFI, which are defined as greater than $50 billion of assets), to one another.
SIFIs may have net credit exposure of no more than 25 percent of regulatory capital to other SIFIs. The top tier, largest banks, known as G-SIFIs are subject to even more restrictive limits on their exposure to one another (no more than 10 percent). Although Dodd-Frank was originally passed in 2010, a definitive timetable for implementation has not yet been set.
The likely impact of SCCL as drafted would be to limit the capacity of agent lenders and principal borrowers to transact with one another. As much of the volume of securities lending business is concentrated among the top prime brokers and agent lenders, it may lead to a mix of potential responses: reduced borrowing and lending activity, shifting business to smaller less creditworthy counterparties, allocating more capital to the business, or increasing efforts to develop a viable central counterparty model for the US market.
On 4 March, the Fed released a proposed draft with comments due by 3 June. SCCL would seem to present a likely target for de-emphasis. Without active support and sponsorship within the regulatory community, it is possible that this element of Dodd-Frank may languish.
Net stable funding ratio (NSFR): NSFR was originally introduced in 2009 to address a perceived over-reliance by several banks on short-term wholesale funding. It effectively raises the overall cost of funding securities finance transactions and may reduce liquidity. Another potential effect is to encourage the insertion of a central counterparty into securities finance transactions. At this point, it is scheduled to be fully implemented by 1 January 2018.
In a comment letter sent to the Fed, OCC and the Federal Deposit Insurance Corporation last August, the Securities Industry and Financial Markets Association, the American Bar Association and several other industry organisations said that the NSFR is unnecessary due to “key reforms already enacted, including the liquidity coverage ratio”. Like SCCL, the NSFR would seem to fall within the scope of Trump’s executive orders and could clearly be de-emphasised.
Equities as collateral: SEC approval of the use of equities as collateral in securities lending transactions has been under review for nearly two years. After a flurry of activity and much enthusiasm in 2015, the proposal has been in limbo.
With only two SEC commissioners at the moment and some questions about whether the change needs the formal approval of the commission, a decision has not yet been taken. This would appear to be an ideal cause for the new SEC chairman nominee, Jay Clayton, to push forward.
In addition to the much-touted benefits of correlation between collateral and loaned assets, this would also put the US market on a more equal footing with non-US markets, an important Trump objective for all aspects of the economy.
In addition to approving brokers’ use of equities as collateral, the SEC’s investment management division must separately approve the acceptance of collateral by ’40 Act funds, and the Department of Labor would need to approve its use by Employee Retirement Income Security Act plans. At a minimum, these efforts are likely to receive positive support from the Trump administration.
Likely outcome
Trump has raised expectations for a significant easing of financial regulation, however, it remains to be seen how much he will be able to accomplish given the ambitious legislative agenda that he has proposed (ie, healthcare reform, a major tax overhaul and major changes in the federal budget).
Progress on deregulation (or at least at a slower pace) in the coming months seems likely in some respects:
• Equities as collateral: Probable in two to three months
• SCCL: Less likely to be implemented in short run
• NSFR: Less likely to move forward in short run
• Dodd-Frank rollback: Unlikely to change meaningfully before 2018 at the earliest
• CCAR: Possible ‘softening’ approach this year.
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