By HAL S. SCOTT and JOHN GULLIVER
Originally published by The Hill on December 12, 2016
On the campaign trail, President-elect Donald Trump said that he would “dismantle Dodd-Frank.” However, actually repealing and replacing the legislation would be a very heavy lift for his administration.
Democrats hold more than 40 seats in the Senate, so even with support from a Republican Congress, Senate Minority Leader Chuck Schumer (D-N.Y.) could block legislative change. Fortunately, the Trump administration can use the regulatory process to enhance the stability of the U.S. financial system and competitiveness of U.S. financial institutions.
This is because the agencies that regulate the financial system, which include the Federal Reserve Board, Securities and Exchange Commission (SEC), and Commodity Futures Trading Commission (CFTC), have substantial discretion to change how the Dodd-Frank Act is implemented and enforced. The Trump administration will ultimately determine the senior staff at these agencies, and those appointments will affect the regulatory agenda.
All of the financial regulatory agencies must carefully follow the requirements of the Administrative Procedure Act (APA) of 1946. If agencies do not follow the APA, then their actions can be subject to judicial challenge and invalidation.
The requirements of the APA depend on the agency action at hand. For example, agencies can immediately alter their enforcement priorities by amending related guidance, such as internal policies and manuals.
This could include guidance about the trading strategies that supervisors should be looking for when determining whether a bank has violated the Volcker rule’s restriction on short-term trading. This can make catching violations more or less likely.
When it comes to agency actions that target specific financial institutions, agencies can also quickly make changes. In 2013, for example, the Financial Stability Oversight Council (FSOC), which is chaired by the Treasury secretary and includes the heads of the financial regulatory agencies, designated American International Group (AIG) and Prudential Financial as systemically important financial institutions. As a result, these insurers are now subject to enhanced regulation and supervision by the Federal Reserve.
Under the Trump administration, the Treasury-led FSOC can promptly determine that in their view these entities do not pose systemic risk. This would remove the additional regulatory burden from AIG and Prudential. To comply with the APA, the FSOC must only publicly disclose a rational basis for doing so based on the risks posed by these insurers.
In other important instances, U.S. agencies have used “guidance” instead of rules to implement Dodd-Frank. For example, the CFTC used guidance to apply Dodd-Frank’s requirements for derivatives (which include credit default swaps and interest rate swaps) to foreign trading by U.S. financial institutions. The result is that under a Trump administration the CFTC could promptly rescind this guidance, so long as they again publicly disclosed a rational basis for doing so.
Finally, and most importantly, agencies can also change the formal rulemakings that impose Dodd-Frank’s most significant changes to the financial system. These rulemakings include regulations determining minimum capital and liquidity requirements for the largest banks, including stress tests. They also include the living will process that requires banks to explain precisely how they would fail without disrupting the broader financial system.
However, to change rulemakings in a legal manner, the agencies must follow a much more circumscribed process than for other agency actions. They must first propose a new rulemaking that explains how their interpretation of Dodd-Frank is consistent with the APA. They must provide the public with an opportunity for comment. The agencies must consider and then meaningfully respond to those comments when finalizing the rule.
Nonetheless, there are often multiple versions of a rule that would be consistent with Dodd-Frank, so agencies have wide latitude for change even when it comes to rulemakings. This could include changing the living will process to focus on ensuring that the critical functions of the largest banks would remain operational in a crisis, rather than attempting to predict how each and every subsidiary would be disposed of. In the areas of capital and liquidity, wholesale changes could also be made.
While legislative change that would make the U.S. financial system more competitive is certainly welcome, it will take time and require congressional approval. On the regulatory front, the Trump administration can make significant changes immediately.
Hal Scott is a professor of international financial systems at Harvard Law School and director of the Committee on Capital Markets Regulation. John Gulliver is the research director of the Committee on Capital Markets Regulation, where he develops policy reforms for financial markets.