RegTech Intelligence

Chipping away at Dodd-Frank: speculation subsides as US Treasury releases reform recommendations

On 12 June 2017, the US Treasury released the first in what will be a series of financial regulatory reports in accordance with Executive Order 13772 signed by President Trump.  The publishing of “A Financial System That Creates Economic Opportunities – Banks and Credit Unions” now gives us a better understanding of what the future of the Dodd-Frank Act looks like.  As noted in our previous article, Trump had set the bar high vowing to “do a big number” on the current financial regulations, but the report strikes, in some respects, as a modest route relative to the rhetoric.

The highly anticipated report, which nearly reaches the 150-page mark, suggests over 100 changes to American financial regulation.  Notably, Treasury Secretary, Steven Mnuchin, commented that 80% of the changes suggested within the report can be implemented purely through regulators – leaving a small portion up to the discretion of Congress.  The lack of congressional approval required to apply many of these reforms makes it likely that substantial changes to the banking system are on the horizon.

Within the plethora of regulatory recommendations made by the White House, consequential changes include reforming the Volcker Rule, specifically its compliance burden and market-making restrictions, as well as changes to the capital regime that would both eliminate a lot of the financial sector’s regulatory complexities but leave the banking industry vulnerable to risk-taking bankers.  Lastly, another polarising amendment concerns simplifying the capital regime, in which its requirements have proved to become more complex as the years pass.

The Volcker Rule

Section 619 of Dodd-Frank, known as the “Volcker Rule” is a prominent section within the Act, so it is no surprise that close attention is placed on amending it within the Treasury report.  In summary, the Rule tightens regulations on insured depository institutions – such as savings banks, commercial banks or credit unions –  by restricting them from engaging in proprietary trading, investing in hedge funds or private equity funds.  While the Volcker Rule came in necessary to rail in the speculative activities of banks that contributed to the 2008 crash, many argue it has important flaws.  Specifically, critics comment on the extensive scope of banks under compliance while also arguing that it restricts legitimate market-making from taking place.

The Treasury report tackles these issues but, while it recommends a series of amendments to this Rule, it does not call for its full repeal as many had expected.  The report does agree with the Volcker Rule in its main principle that banks protected by a federal safety net should not engage in speculative trading for their own account.  However, it recommends major amendments to market-making restrictions as well as the compliance regime banking systems are subjected to.

Provide increased flexibility for market-making

Market-making has been a contentious topic due to the difficulty of differentiating between a proprietary trading or market-making strategy.  Banks have complained that the Volcker Rule inhibits their ability to undertake the legitimate market-making functions needed to ensure a healthy level of liquidity, while others warn that weakening the Volcker Rule would encourage banks to engage in proprietary trading under the auspices of market-making.

The report sets out a position in support of loosening propriety trading restrictions.

The report suggests that regulators should allow banks additional flexibility to adjust what they deem as a reasonable amount of market-making inventory.  Furthermore, it recommends giving banks the ability to opt-out of the “reasonably expected near term demand” or RENTD requirement if the bank is completely hedged against “all significant risks arising from its inventory of that instrument”.

Reduce the burdens of the Volcker Rule’s compliance regime

Underlying the Volcker Rule’s proprietary trading restriction is a compliance programme created to ensure complete concurrence with its laws.  The Treasury put forward recommendations to reform the culture of compliance, coining it the “compliance burden” and strives to eliminate many aspects that critics of the Volcker Rule believe are unnecessarily draining of capital and resources.

The Treasury report tackles the spread of compliance within all big banks – currently “enhanced” compliance programmes are in place for all banking entities with over $50 billion in total consolidated assets.  The report recommends this only applies for those banking entities with at least $10 billion in trading assets and liabilities on a consolidated basis.  Furthermore it suggests that the five agencies responsible for implementing the Volcker Rule should re-evaluate the metrics that the larger firms are required to collect and eliminate metrics “unnecessary for effective supervision”.

Simplifying the capital regime

Regulatory reforms under Dodd-Frank have been criticised for being overly complex and bound by too many requirements, stressing that the “continual ratcheting up of capital requirements is not a costless means of making the banking system safer”.  This has led many to call for a simpler capital regime, which, according to the Treasury report, will be reformed by “reducing unnecessary burdens of certain regulations”.

Currently, the “Collins Amendment” to the Dodd-Frank Act has required US financial institutions that operate internationally to comply with Basel III’s risk-based capital regime.  This has required large, financial institutions that operate internationally to comply with both standard and “advanced” approaches to measure their risk-weighted assets using models, data, and methodologies developed by each organisation (after being approved by the federal banking agencies).  Other US banking organisations use the “standardised” approach as the primary way to measure their risk-weighted assets, with risk weights established by the agencies.  The logic behind this is that a comprehensive set of regulatory reform measures improves risk management and governance as well as banks’ transparency and disclosures.

On the other hand, many have argued that the growing complexity of these capital requirements has been counterproductive, making it harder for regulators to predict and absorb an impending financial crisis.  Since 1988, the Basel Capital Accord revisions have nearly twenty folded in content, expanding from 30 to 616 pages by the 2010 Basel III revisions.  Furthermore, the report notes that, compared internationally, the United States has higher standards to meet than their Basel counterparts, making these banks globally less competitive.

The Treasury report proposes that regulators reduce their reliance on the advanced approaches for risk weighted assets in an effort to simplify and apply the standardised approach to a greater extent.  The report, however, also suggests that the regulators introduce into the standardised approach greater risk sensitivity in the measurement of derivatives and securities lending exposures.



The Treasury report has provided us with insight on what was mass speculation surrounding the future of Dodd-Frank, but further certainty into the direction of this legislation is still needed.  The report is far less impactful than what was proposed by Trump during his campaign, but significant reforms are very likely to slip through Congress and be enacted thanks to regulatory bodies.

With financial regulatory relief looming on the horizon for Wall Street, this report comes as music to American banking ears, who feel as if they have been drowning in regulatory red tape since Dodd-Frank was put into action in 2010.  While it would be relief for banks, it is also important to note that, once again, considerable time and resources will have to be spent changing the banking system to comply with the views of a new administration.

All in all, bringing an end to speculation about the future of Dodd-Frank and providing concrete changes, it looks like the reins that are holding risk-loving bankers back may be loosened.

JWG will be following the development of reforms to Dodd-Frank and will publish further articles when additional information is released.  To receive these updates and all the latest financial regulation, you can subscribe to our newsletter and follow us on Twitter and LinkedIn.


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