An overhaul is on its way of the Dodd-Frank law in the US. Swaran Patnaik assesses the potential impact it may bring.
Donald Trump has passed many controversial executive orders since taking office, but one that undoubtedly will have the biggest impact on financial services is the review of the Dodd-Frank Act, first introduced to ensure there would never be another 2008-style meltdown.
The US president insisted: “We expect to be cutting a lot out of Dodd-Frank, because frankly I have so many people, friends of mine, that have nice businesses and they can’t borrow money.” The announcement saw the banks’ share prices rise instantly, with Barclays up 3.4% and Goldman Sachs up by more than 4% when trading closed for the day on 3 February.
The US Treasury secretary will report on whether Dodd-Frank meets Trump’s core principles for regulation, including enabling US companies to be competitive with foreign firms and advancing American interests in international financial regulatory negotiations. This competition between the US, EU and UK could lead to a race to the bottom as each regime weakens its prudential controls to support its banks and lending.
If Dodd-Frank is considerably dismantled, the US could get creative again with fancy financial instruments, and encourage more investors to turn their eyes and funds to the US. As senator Elizabeth Warren pointed out: “The Wall Street bankers and lobbyists whose greed and recklessness nearly destroyed this country may be toasting each other with champagne.”
Key areas of the Dodd-Frank Act likely to be affected include the repealing of the Consumer Financial Protection Bureau (CFPB), amendments to the Volcker Rule, and revisions to the regulatory requirements for advisers.
The CFPB was created to protect consumers and has returned over $11bn to the victims of payday lenders, loan sharks and excessive overdraft fees. It has also successfully uncovered the major issues at Wells Fargo, which led to a fine of $100m. But some argue it has overregulated entities, such as credit card providers and mortgage lenders, preventing growth. A large-scale amendment is expected.
The Volcker Rule seeks to put a firewall between a bank’s consumer operations and its risky trading activities. For years countries like Japan, Canada and the UK have argued against this and saw reduced liquidity in their bond markets as US banks reduced their activities, including in overseas markets.
While the fiduciary rule for financial advisers, much maligned by Wall Street, requires advisers to put the interests of their clients ahead of their own, it especially protects retirees from conflicts by stockbrokers. With the rule gone, it will be the stockbrokers who are protected.
UK banks with a strong US presence in the US will undoubtedly benefit from any deregulation, increasing their ability to lend and potentially create more jobs. Similarly, if the Volcker Rule is amended, this could improve liquidity in the markets and provide new growth avenues for banks and investors with interests in the US. However, large-scale changes will undoubtedly jeopardise the co-ordinated international efforts, from the likes of the Financial Stability Board and Basel Committee, in areas like setting capital rules, which finally appear to be bedding in after years of struggle. Even the European Central Bank was apprehensive about the US proposals, with its president Mario Draghi insisting Dodd-Frank has led to a stronger financial services industry.
Other critical regulations involving derivatives, such as the European Market Infrastructure Regulation and Central Counterparties, are works in progress and require help from all G20 members to prevent instability in the markets. The UK must watch the deregulation moves in the US carefully and increase it co-operation with the US government to point out possible negative impacts on the international economy. The UK should also carefully consider reforming its own regulations, without compromising market stability, while at the same time ensuring its own firms are not in a disadvantageous position to its US cousins.