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Disassembly of Dodd-Frank won’t be easy

"Regulatory spaghetti' touches many areas; law has its fans and opponents

Christopher Dodd
Former Sen. Christopher J. Dodd: ‘Efforts to repeal (Dodd-Frank) are ludicrous on its face. . . . The next crisis — and we certainly will have one — we’re going to have far more difficulties putting that back in the bottle.”

President-elect Donald J. Trump's campaign pledge to dismantle the Dodd-Frank Wall Street Reform and Consumer Protection Act might have struck a chord among voters, but the politics of repealing or replacing it won't be simple.

“Anybody who tells you they know what's going to happen with Dodd-Frank is making it up. If you ask 100 legislators what they dislike about Dodd-Frank, you might get 100 different answers,” said Thomas Vartanian, partner and chairman of the financial institutions practice at Dechert LLP in Washington. He describes Dodd-Frank as “regulatory spaghetti” thrown at all financial institutions after the financial crisis of 2008.

The 2010 act launched a sweeping overhaul of the U.S. financial regulatory system. Given the crisis' roots in mortgage financing risks, a central piece is the Volcker rule, which restricts U.S. banks from making certain kinds of investments and from engaging in short-term proprietary trading.

Among other things, Dodd-Frank also created a multiagency Financial Stability Oversight Council to evaluate systemic risk, and added several corporate governance measures, such as more oversight on executive compensation. For asset managers, the act required centralized clearing of standard over-the-counter interest-rate and credit-default swaps, more transparency into asset-backed securities and reduced reliance on credit rating agencies.

Given the time and money spent on understanding and complying with Dodd-Frank, many in the regulated communities are reluctant to face the unknown.

The law has many supporters as well as detractors, at least for parts of it.

New opportunities

For Jonathan Grabel, chief investment officer for the $14.5 billion New Mexico Public Employees Retirement Association, Santa Fe, tighter banking rules created investment opportunities. “If banks are not lending as much as they had historically, there is a need for other parties to provide direct loans to smaller companies,” Mr. Grabel said.

“I think the regulatory environment that we are in now has created tremendous investment opportunities for long-term pools of capital like PERA in the direct lending space,” including a recent commitment up to $200 million to a direct lending fund managed by credit manager Tennenbaum Capital Partners LLC.

Restrictions on banks doing proprietary trading have been good for other asset managers.

“In general, the Volcker rule taking prop trading out has created better opportunities for the strategies we invest in and the managers we use to implement those strategies,” said Ray Nolte, chief investment officer at SkyBridge Capital LLC, New York, which manages $12.4 billion in hedge funds of funds, mostly for institutional investors.

Yet while the act took away banks' bargaining advantages, it also took away their role as a shock absorber to market moves in times of turmoil, Mr. Nolte said. “The unintended consequence is to actually heighten the volatility. I think it's created more noise along the way,” he said.

For large investors like members of the Council of Institutional Investors in Washington, which represents $3 trillion in combined assets, Dodd-Frank improved corporate governance, said Deputy Director Amy Borrus. Requiring companies to hold say-on-pay votes at least every three years “really was a catalyst for robust engagement between companies and shareholders. It's caused (compensation) committees to be more thoughtful about compensation and performance,” she said.

“If you are an activist equity manager trying to get companies to restructure, it definitely gives you more clout with fewer dollars,” said Mr. Nolte.

“Investors, led by the New York City pension funds, embraced private ordering in earnest, and now close to 300 companies have proxy-access bylaws,” said Ms. Borrus.

For Rick Fleming, investor advocate at the Securities and Exchange Commission, Dodd-Frank was all about investors, who, according to the Financial Crisis Inquiry Commission, lost $11 trillion in household wealth, including retirement accounts and savings, between 2008 and January 2011.

Mr. Fleming, whose post was created by Dodd-Frank along with the investor advisory committee, said in a recent speech that the new office “reflects a recognition that investors were underrepresented at the SEC in the years leading up to the financial crisis.” He is a fan of the swaps rules, more asset-backed securities disclosure and credit risk retention rules requiring issuers to have skin in the game. He also would like to see more curbs on credit rating agencies.

Dodd-Frank swaps rules are valuable, said Jim Allen, head of capital markets policy for the CFA Institute in Charlottesville, Va. With business conduct standards bringing more transparency, “you have a better sense that somebody's watching to make sure that things aren't getting out of whack. It has given investors a better sense of pricing, and it's been reasonably better for issuers as well,” said Mr. Allen, who also thinks less reliance on credit agencies forces companies and investors to do their own due diligence.

Regulatory overreach

J.W. Verret, senior affiliated scholar with the Mercatus Center at George Mason University, which promotes market-oriented ideas, and former chief economist for the House Financial Services Committee from 2013 through 2015, said the biggest downside to Dodd-Frank was its central theme of empowering independent regulators.

“That has always worried me because it is not consistent with the separation of powers principles at the heart of our constitutional arrangement,” he said.

One example of regulatory excess he notes is how two paragraphs on the Volcker rule became a 2,000-page regulation, while many of the corporate governance provisions distract from the SEC's core mission and could be handled by investors themselves. As for the systemically important financial institution designation of asset managers, Mr. Verret noted they are “heavily regulated” under the Investment Company Act of 1940.

“The SEC can regulate asset managers without the assistance of banking regulators and other members of FSOC,” he said.

What's ahead?

The bill's co-author, former Sen. Christopher J. Dodd, minces few words when talk turns to repeal.

“Efforts to repeal it are ludicrous on its face,” he told a recent gathering of actuaries in Washington. “The crisis was no accident; it was an outdated regulatory environment. The next crisis — and we certainly will have one — we're going to have far more difficulties putting that back in the bottle.”

Dechert's Mr. Vartanian, a former banking regulator, thinks the first order of business will be installing a new secretary of the Treasury to sign off on appointments to regulating agencies such as the SEC, Dodd-Frank's main enforcer.

After that, one of the first orders of reform he and others expect will be revisiting the costs and benefits of the law, and its effect on the economy.

“The change of administrations will clearly change the analysis of the formula. The hardest task you have as a policymaker is balancing the need for safety and soundness and the need for the market” to grow, said Mr. Vartanian.

“There's a lot of ways that the new administration could affect Dodd-Frank without full repeal,” said Todd Cipperman, CEO of Cipperman Compliance Services LLC, Wayne, Pa., who said the compliance requirement for private fund managers will not go away because institutional investors ask for it. He cautions that if federal regulators are told to back off, “then you may see a more active FINRA or state regulators and a lot more private litigation to enforce securities laws. The reality is, it's never going to get simpler.”

Full-scale repeal wouldn't sit well with Mr. Trump's populist supporters, argued SEC investor advocate Mr. Fleming, who hopes “that the new crop of policymakers will simply remember the people who put them here ... The protection of investors must serve as the first principle guiding our financial regulations.”

Neil Simon, legislative director for the Investment Adviser Association in Washington, thinks the incoming administration has higher priorities, such as infrastructure spending “and they're going to want to get some wins. Given the nature of the process, nothing is going to happen quickly,” he said.

Arleen Jacobius contributed to this story.

This article originally appeared in the November 28, 2016 print issue as, "Disassembly of Dodd-Frank won't be easy".