The Dodd-Frank Act: when will we know if it's working?
Meg Tahyar
Davis Polk & Wardwell
New York
Meg Tahyar (Bio)
As the largest transformative change in US financial regulation since the Great Depression, aka the Dodd-Frank Act, enters its second year, the political, popular and media debate about it has, if anything, intensified.
There are many reasons for the continued controversy about its effectiveness. but prime among them is that the Act is not a cohesive whole. Instead, it covers at least a dozen unrelated areas of financial regulation. These many different silos means that there is a natural tendency for any one person to view the entire Act through the prism of his or her own particular business, legal or political silo.
In this respect, the Act is like the old fable of six blind men who were led up to an elephant and asked to describe it. The six men perceived the elephant to be a wall, a snake, a spear, a tree a fan or a rope. In some versions of the fable, a wise king resolves the dispute by explaining to the six men that each of them understood only a part and each of them is right. In other versions of the fable, the conflict is never resolved. Of course, in our times, we must also add to the tale, the fact that the different blind men each have different interests at stake both in perceiving and in reporting their perceptions and so resolution by a wise king is not going to be the way that the Dodd Frank tale ends.
Instead, we will have the cacophony of different interests analysing and describing different topics. My list of the topics that have gathered the most attention during the last year is as follows:
- Enhanced prudential regulation, including increased capital, of systemically important banks and non-banks and a resolution authority, all designed to mitigate or solve the moral hazard of too big to fail and the risk that taxpayer money might be used for a bailout.
- The outline of what will become an entirely new regulatory and market infrastructure for derivatives, focused on counterparty risk reduction and transparency.
- The creation of an entirely new regulatory agency for consumer financial products.
- Enhanced regulation of the investment advisors of hedge funds and private equity funds.
- Enhanced regulation of credit rating agencies and the diminished use of ratings in regulations.
- A whistleblower regulatory regime for violations of the US securities laws.
- The creation of a new standard of care for investment advisors.
- Changes in corporate governance including proxy access and more say on pay.
- Reform of standards and disclosure for mortgages, including a skin in the game requirement and changes to the asset-backed securities regulation.
- Enhanced disclosure of activities related to conflict minerals.
- Minor steps in the direction of some federal regulation of insurance.
- Enhanced regulation of the municipal securities market.
- Enhanced regulation of bank holding companies, including activities restrictions in the Volcker Rule and increased regulation of interaffiliate transactions.
A key insight from this list, which is surely incomplete, is that many of the key topics that Dodd-Frank has required regulators, financial institutions, companies and other stakeholders to spend their time on over the last year have no relationship with one another except, perhaps, in a very general sense which is useless for a real analysis of the policy benefit and cost.
There is no real relationship between increased disclosure on conflict materials, whistleblowing rules, the creation of a federal office of insurance, corporate governance across all listed companies, enhanced consumer regulation and increased registration of investment advisors of private equity and hedge funds. While there is, of course, a relationship among the many provisions related to the causes of the last financial crisis, which are designed to lower systemic risk in the system, there has so far been little thought to the interaction of these provisions, proposed or finalised, with one another.
It is helpful to keep in mind, therefore, that there is not one Dodd -Frank but many. As a result, in order to assess whether or not the Act has worked as intended or, whether those provisions not yet implemented will work, requires assessing each major severable topic of enhanced or new regulation individually against its costs and benefits and, for those that relate to one another, alongside the regulations with which each Dodd-Frank cone shares a common policy goal.
In most cases, it is too early to tell since the Act, despite its 880 pages, is largely a general blueprint for regulatory action over an extended period of transition and implementation rather than, as many imagined, a detailed set of prescriptions. The second year of Dodd-Frank – which is likely to see more court challenges to the regulations, more divided decisions by regulators and a greater emphasis on the economic costs and benefits of the regulations being put into place – will begin to set the stage for our ability to answer the question: Did Dodd-Frank work? It is likely, however, that the ultimate answer will be known for at least five years.