Financial Deregulation Under Trump

Basel May Not Go Away as Fast as Banks Believe

By Jeb Beckwith and Sanjay Sharma, Ph.D.

“We don’t want to [reform] in an unregulated way. We want to do it in a smart, regulated way.” – Gary Cohn, White House National Economic Council Director & Former President, Goldman Sachs & Co.¹

Friday’s Presidential Executive Order² and Memorandum³ kick off the Trump Administration’s ambitious plans for financial deregulation. Notably absent from these documents is any direct mention of the FRTB or other Basel initiatives. A careful reading of Trump’s new Core Principals, in the context of previous publications, leads us to conclude that the FRTB and the Basel Framework will persist for most banks.

Friday’s Presidential Executive Order⁴ on financial deregulation aligns with previous statements and documents published by candidate Trump as well as the Republicans in Congress. WSJ analysis, published only days after the election entitled “We will Dismantle Dodd-Frank”⁵, laid out a plan for fundamental reform based on detailed position papers from candidate Trump⁶ as well as even more detailed draft legislation from the House Financial Services Committee known as the Financial Choice Act (FCA)⁷. Friday’s headlines⁸ miss the fact that President’s Trump’s proposed financial reforms, while well telegraphed, do not directly target rules already promulgated by the Basel Committee on Bank Supervision (BCBS)⁹ and agreed to by the Board of Governors of the Federal Reserve system (BGFRS).

In our view, these reforms will be substantial, but will not materially impact BCBS initiatives, including the Fundamental Review of the Trading Book (FRTB). The Trump Administration seeks to attack financial deregulation through three mechanisms: Executive Orders and Memoranda, Legislation and Appointments. These reforms will be significant, but most of these changes are directed at regulation specific to the United States and not part of international frameworks. Table 1 summarize the changes we expect to see.

Table 1

Financial Deregulation: What Stays and What Goes
Major Overhaul or Repeal	Tools of Change	Limited Change Expected10
Dept. of Labor (DOL) rules	Changes via Executive Order or Memorandum	NA
Consumer Finance Protection Bureau (CFPB)	Changes of Legislation – Dodd-Frank Amendment (DFA)	NA
DFA, Title II (including Systemically Important Financial Institutions or SIFIs)
DFA, FSOC
DFA, CCAR
DFA, Volker Rule
Basel “Opt-Out” for Community Banks (10% test)	Changes through combination of Legislation and Appointments made over more extended periods of time	Basel III, IV for most banks
Federal Reserve System (FRS), Initiative to bring the Federal Reserve System (FRS) under the Congressional Appropriation Process will be resisted		Fundamental Review of the Trading Book (FRTB) for most banks
FRS, various new restrictions through Title VII of FCA11
FRS, various new notice and consultation requirements for new BCBS initiatives not already agreed

Presidential Executive Order – February 4th, 2017

President Trump outlined six Core Principles for Financial Regulation and directed the Treasury Secretary to consult with all FSOC¹² members and to issue a report within 120 days describing all laws, treaties, regulations, guidance, reporting, recordkeeping requirements, and other government policies that would inhibit regulation according to the Core Principles.

President Trump’s Core Principles for Financial Deregulation

Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth Prevent taxpayer-funded bailouts Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry Enable American companies to be competitive with foreign firms in domestic and foreign markets Advance American interests in international financial regulatory negotiations and meetings Restore public accountability within Federal financial regulatory agencies and rationalize the Federal financial regulatory framework

Actual changes may take time to implement depending on what this study finds. Trump’s Treasury Secretary and most FSOC¹³ heads have yet to be confirmed. These confirmations are a prerequisite for orchestrating and executing any rule changes. Past statements imply that the Trump Administration will use the FCA as a blueprint for implementing financial reform.

Executive Memorandum – February 4th, 2017

President Trump also issued an Executive Memorandum on February 4^th directing the Department of Labor (DOL) to examine their Fiduciary Duty Rule and to repeal it if it is found to reduce investor access or increase investor costs. It should be noted that this rule change does not require consent beyond the DOL.

Legislation: Deconstructing the Financial Choice Act (FCA) – HR 5983

FCA is the 513 page blueprint for financial reform. Despite recent headlines, the FCA does not seek to replace the DFA in its entirety. Rather, the Republican Congress seeks to replace certain aspects of DFA and other legislation which it considers to be most limiting to growth or which fosters the potential for tax-payer funded bailouts of large financial institutions.

Importantly, only the smallest community banks are expected to meet the 10% leverage test required under the FCA to opt-out of Basel capital and liquidity rules.¹⁶

Here is an outline of how the FCA is constructed.

How the Financial Choice Act Works
	Description	Impact
I	Opt-Out Capital Option	Allows banks to apply for Qualifying Banking Organization (QBO) status IF: Total Leverage Ratio14 > 10% CAMELS15 of 1 or 2 for all group depositories Election made for all depositories and holding companies within the group simultaneously QBO’s shall be exempt from: All other capital or liquidity requirements Any Financial Stability or Living Will reporting Limitations of mergers or acquisitions Use of RWA is NOT allowed Expected to be applicable only for smallest banks16
II	Ending “Too Big to Fail”	Dramatically eases CCAR tests and exempts QBO’s Dramatically reduces the powers of FSOC17 Repeals the Fed’s Orderly Liquidation Authority (OLA) found in Title II of the DFA Replaces the OLA framework with a new Financial Institution Bankruptcy framework Eliminates the use of government guarantees (except FDIC deposit guarantees) Repeals the use of systemic risk determination, the exchange stabilization fund Eliminates the Financial Market Utility designation
III	Replace CFPB	Replaces the CFPB with a new Consumer Financial Opportunity Commission (CFOC) CFOC governance is a commission structure which congressional budget oversight and Presidential reporting of commissioners
IV	Capital Markets Reforms	SEC Reforms Repeal of DOL Fiduciary Rules18 Repeal of Risk Retention requirements for commercial mortgages Repeal of many Private Equity reporting requirements CFTC Reforms, including swap dealer registration rules and harmonization of OTC derivatives rules Other reforms including the use of risk based measures for NRSRO’s and many section repeals
V	Insurance Regulation	a. Repeals the Federal Insurance Office
VI	Reforms in the Oversight of Regulators Other Than the Fed	Require Cost-Benefit Analysis for each proposed regulation New requirements for Notices of Proposed and Final Rulemaking including 90-day comment period between each Congressional Review procedures established for all rules with Congressional Approval required for Major Rules Bringing Federal agencies under the annual Congressional appropriations process Establishing rules for participation in International regulatory bodies such as the BCBS, the BIS, and IOSCO
VII	Fed Oversight Reforms	Bringing the non-monetary wing of the Federal Reserve System under the Congressional appropriations process Creating a new Centennial Monetary Commission to reexamine the FRS’s “Dual Mandate” and whether changes need to be made Strengthens various reporting requirements including compensation disclosures
VIII	Penalty Reforms	Increases monetary penalties levied against financial institutions
IX	Repeal of Volcker Rule	Repeals Volcker Rule restrictions on proprietary trading and private equity
X-XI	Reforms Aimed at Small Business	Various reforms aimed at reducing regulatory burdens for small businesses

Note that neither the FCA, the Executive Order, nor the Presidential Memorandum on Fiduciary Duty Rule¹⁹ have any direct mention of Basel III, Basel IV or the FRTB other than FCA Title I. Congress has already granted the BGFRS with broad powers to create implementing legislation for international rules and these powers have not been rescinded within the FCA.

Executive Branch and the Federal Reserve System Appointments

Financial regulation in the U.S. is governed by a complex network of agencies, bureaus and governmental authorities. Sitting atop it all is the Federal Reserve System (FRS) and governing the FRS is its 7-member board. The BGFRS represents the U.S. at most international bank regulatory organizations including the Bank for International Settlements (BIS), the BCBS, and the Financial Stability Board (FSB).

Unlike cabinet or agency appointments in the Executive Branch, the FRS’s governance is independent. No member of the BGFRS can be removed by Presidential Order alone and no members’ term expires prior to February 1st, 2020.²⁰ Of the 7-member board, the Trump Administration does have the power to nominate 2 new individuals to vacant board seats, including the Vice-Chair for Supervision.Trump can also elect to change the Chair (currently held by Janet Yellen) and Vice-Chair (currently held by Stanley Fischer) in 2018, but only from within the existing members of the BGFRS and only with Senate confirmation. While there is speculation that Ms. Yellen, Mr. Fischer and a third governor, Daniel Tarullo, may retire early²¹, there is no legal mandate for them to do so. We do not expect that the governors who spent years creating the Basel framework will easily now step aside to see it undone

Conclusion

Unlike many parts of the DFA, CFPB, Volker and other U.S. focused reform initiatives, we fully expect that rules promulgated by the BCBS under BGFRS guidance will be implemented on a timely basis for most banks. In particular, this includes the Fundamental Review of the Trading Book (FRTB) which is the first BCBS rule to contain specific
dates for local rule making and implementation.

While we do expect an opt-out provision for Basel capital and liquidity standards to prevail in the U.S. and possibly other parts of the world, we believe such a provision will be directed onlyto the smallest, community banks.