June 13, 2017
Nearly four months after Donald Trump signed an executive order calling for a review of Wall Street regulations, the administration has laid out part one of its plans for reforming the system in a detailed report released by the Treasury Department late Monday.
Some of the more notable proposals in the highly-anticipated report – the first in a series that will detail the administration’s thinking on how it plans to proceed with paring back post-crisis regulations in the financial services industry – include: adjusting the annual stress tests, easing trading rules (i.e., gutting the Volcker Rule), and paring back the power of the watchdogs – like the Consumer Financial Protection Bureau.
The Treasury said its plan was designed to spur lending and job growth by making regulation ‘more efficient’ and less burdensome, according to Bloomberg although in reality it simply caters to the “requests” of Wall Street, which has been limited in its activities since Dodd-Frank, most notanly prop trading, although in most cases banks, like Goldman, have found simply loopholes around the Volcker Rule. Also of note, “unlike the bill passed last week by House Republicans, the report consistently calls for most Obama-era rules to be dialed back, not scrapped.”
In a st
atement released along with the report, Treasury Secretary Steven Mnuchin said that while the administration backs congressional efforts to roll back Dodd-Frank, the report focuses on actions that can be taken without involving Congress. In fact, between 70 and 80% of its recommended reforms can be made unilaterally through federal agencies’ independent rulemaking authorities.
As expected, Democrats were quick to criticize the plan with Ohio Senator Sherrod Brown, the ranking member of the Senate Banking Committee, claiming that the reforms would gut the Consumer Financial Protection Bureau, the centerpiece of Dodd-Frank. The report is extremely critical of the fledgling agency, accusing it of being “unaccountable” and possessing “unduly broad regulatory powers.” To rein in the bureau, the Treasury report calls for the president to be able to fire its director for any reason, not just for cause as is now the case, as Bloomberg noted.
Meanwhile, representatives of the banking industry expressed their support for the report’s findings.
“Today’s Treasury report is an important step to refine financial regulations to ensure that they are supporting — not inhibiting — economic expansion,” said ABA President and CEO Rob Nichols. “We applaud Secretary Steven Mnuchin for recognizing that we need regulatory reform to boost economic growth, and we expect this report will serve as a catalyst in that effort.”
As Bloomberg adds, some of the most unpopular regulations that the report asks to re-do, such as the Volcker Rule ban on banks’ proprietary trading, were put together by five different agencies. It was not immediately clear which bank was supervising them.
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In any case, just because the administration has found a way to bypass Congress doesn’t necessarily mean that the reforms will be swiftly implemented. Some of the report’s most ambitious recommendations – such as reforming the Volcker Rule ban on proprietary trading – will require the cooperation of numerous separate federal agencies, as Bloomberg noted.
On the Volcker Rule, Treasury outlined several ways that regulators and Congress should consider weakening it, Bloomberg reported. Banks with less than $10 billion in assets should be exempted altogether, the report argued. It also said all lenders should have more leeway to trade and that restrictions on banks’ investing in private-equity and hedge funds should be loosened.
In other words, a return to the way Wall Street was before the financial crisis.
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And since it was mostly Goldman who was behind the report, here is Goldman’s take on the key changes:
US Treasury report proposes regulatory changes for US banks
The US Treasury released its report on the US financial system, titled A Financial System That Creates Economic Opportunities, which proposes sweeping changes to the US regulatory framework with the aim of achieving regulation consistent with the ‘Core Principles’ in President Trump’s Executive Order 13772. We note that proposals in the report do not represent policy actions and are preliminary in nature, particularly given the US Treasury is not an agency tasked with rulemaking. As we highlighted in our report of March 7, 2017, The regulatory reform agenda: Bank regulation through a growth lens, there are different thresholds for changing: 1) regulatory interpretations; 2) regulations as implemented by the regulatory agencies (e.g., the Fed, and the FDIC); and 3) Congressional legislation. Changes in the Treasury’s report would span all three.
The report is far reaching and discusses in detail a number of changes throughout the US regulatory regime. Below, we summarize key takeaways across areas where we think the proposed changes will be most impactful.
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Making CCAR biennial, changing thresholds
- The report suggests a wide variety of changes to the CCAR process, adjusting both the timing of the process and the asset thresholds, as well as eliminating the qualitative overlay. In our view, changes to the CCAR process would represent interpretation changes that have the lowest threshold for implementation.
- Adjust the minimum asset threshold for inclusion in the Dodd Frank Act Stress Test (D-FAST) from $10bn to $50bn and eliminate the qualitative CCAR process.
- For banks above $50bn in assets, the report suggests including a more risk sensitive test for determining whether a bank should be included based on the complexity of its business model. This suggests that banks near the $50bn threshold, such as DFS, CMA and ZION, might benefit most from this revised test.
- The Comprehensive Capital Analysis and Review (CCAR) process should be biennial, rather than yearly.
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Changes to the Supplementary Leverage Ratio (SLR)
To improve the functioning of capital markets, the Treasury recommends making substantive changes to the calculation of the SLR, through the exclusion of cash and cash equivalents from the denominator of the calculation. The proposal goes further than we had anticipated as it recommends excluding not only cash with central banks but also US Treasury securities, and initial margin for centrally cleared derivatives.
While we expect that these changes will only lead to a greater level of excess capital for one of our banks, MS – we expect it to add $2.5bn to its excess capital (3% of market cap) we believe that if this change were implemented, banks could start to make some structural changes to their balance sheets in order to reduce Tier 1 leverage ratios as well, which could free up some excess capital (Exhibits 2 & 3).
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Volcker: More exemptions, improved coordination and streamlined reporting
The report states that the Volcker Rule has “far overshot the mark” (p. 71) and has given rise to an “extraordinarily complex and burdensome” compliance regime. In our view, the proposed changes would have a far reaching impact on the structure and enforcement of the rule. However, we note that it is not clear how many of the proposed changes would require either an amendment to Dodd-Frank or an NPR or both.
The Treasury recommends that the amended Volcker rule should provide increased flexibility for market making. Including, giving banks more flexibility on managing inventory. The proposed changes also call for a simplification for the enforcement and compliance regime.
- Give banks flexibility to adjust their inventory levels.
- Agencies should ensure that interpretive guidance and enforcement is consistent and coordinated.
- Banks with <$10bn total assets should be exempt; banks with >$10bn in assets but <$1bn in trading assets and trading liabilities and whose trading assets and liabilities represent 10% or less of total assets should be exempt.
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Increasing the availability of credit
The report recommends fostering an environment conducive to increasing the availability of credit with a particular focus on residential mortgages, leverage loans and small business loans. Key highlights:
- Repeal or revise the resi mortgage risk retention rules;
- Encourage banks to rely on a robust set of metrics instead of a simply 6x leverage metric when making leveraged loans;
- Consider reassessing regulations concerning CRE lending to promote additional flexibility for situations where a loan has strong collateral;
- Consider adjusting the calibration of the SLR for small business loans.
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Other areas of focus
In addition, the Treasury also recommends revisiting calibration of capital and liquidity rules as well as the role of the CFPB.
- To ensure competitiveness with global regulatory standards, revisit calibration of a variety of capital and liquidity rules, including: the US G-SIB surcharge; the Federal Reserve’s Total Loss Absorbing Capacity (TLAC); The Federal Reserve’s minimum debt rule; and Calibration of the enhanced SLR (eSLR), which applies to US G-SIBs.
- Living will should be moved to a two-year standard.
- US Liquidity Coverage Ratio (LCR) should only be applied to US G-SIBs, and a less stringent standard should be applied to other internationally active BHCs.
- Curtailing the powers of the Consumer Financial Protection Bureau.
- Make the director of the CFPB removable at will by the President.
- Fund the CFPB through the annual congressional appropriations process to enable Congress to exercise greater oversight and control over how taxpayer dollars are spent.
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Full report below (pdf link):