The Dodd-Frank Wall Street Reform and Consumer Protection Act (henceforth, the “Dodd-Frank Act”), was signed into law by President Obama on Wednesday July 21, 2010. The Act spans over 2,300 pages and affects almost every aspect of the U.S. financial services industry. The objectives ascribed to the Act by its proponents in Congress and by the President include restoring public confidence in the financial system, preventing another financial crisis, and allowing any future asset bubble to be detected and deflated before another financial crisis ensues.
The Dodd-Frank Act effects a profound increase in regulation of the financial services industry. The Act gives U.S. governmental authorities more funding, more information and more power. In broad and significant areas, the Act endows regulators with wholly discretionary authority to write and interpret new rules.
The coming months and years will reveal the answers to important questions that will determine how effectively this increased regulatory presence will advance the Act’s objectives: Will talent and capital flow to pockets of finance that the new regulations do not reach? Will new financial products make the regulations irrelevant? Will the Act have unintended consequences on nonfinancial companies? Will U.S. firms lose business to foreign competitors? Will the regulations stifle innovation? Will the availability of credit be impaired by increased uncertainty and costs?
We examine the Dodd-Frank Act and the business implications expected to flow from it, based on the text approved by the House of Representatives. Some of the provisions might be changed by subsequent legislation implementing “technical corrections” based on amendments made in the Senate. Our analysis covers the following aspects of the Act:
Oversight and Systemic Risk. The Act gives regulators new resolution authority, creates a new council to monitor and address systemic risk, and changes the mandate of the Federal Reserve.
- Orderly Liquidation Authority. Regulators will receive new authority under the Act to take control of and liquidate troubled financial firms if their failure would pose a significant risk to the financial stability of the United States. We explore the types of financial companies subject to this authority, the elements of the systemic risk determination, and the mechanics and funding of the liquidation process.
- Key Measures to Address Systemic Risk. Under the Act, for the first time, the mitigation of systemic risk and the maintenance of system-wide financial stability will be regulatory objectives. Our analysis covers the powers of the new Financial Stability Oversight Council established to fulfill these objectives and their application to financial firms, including nonbank financial companies.
- Federal Reserve Emergency Credit. We describe the Act’s limitation of the Federal Reserve’s authority to extend credit in “unusual and exigent circumstances” to participants in facilities with broad-based eligibility.
Financial Institutions. The Act imposes significant new regulations on banking organizations. In addition, for the first time, the Act will allow the Federal Reserve to regulate companies other than banks — such as insurance companies and investment firms — if they predominantly engage in financial activities and are selected for regulation by the Council based on an evaluation of their balance sheets, funding sources, and other risk-based criteria. We explore the reach and scope of the new federal regulations, which will extend to the entire holding company structure of these “nonbank financial companies.” In this area, we consider the following impacts of the Act:
- Regulation of Banking Organizations. The Act effects numerous, significant changes in the regulation of banking organizations. We explore these changes, including creation of the Consumer Financial Protection Bureau, enhancement of supervision of large institutions and nonbank affiliates, and establishment of additional capital regulations.
- Volcker Rule. The “Volcker Rule” is embodied in the Act’s limitations on insured depositary institutions and their affiliates conducting “proprietary trading” and investing in hedge funds and private equity funds. We describe these limitations, as well as provisions of the Act that will force these institutions to move much of their derivatives activities to nonbank affiliates and to comply with new capital and support standards.
- Private Fund Investment Advisers. We describe the Act’s impacts on advisers to hedge funds and private equity funds, which include new requirements for registration, recordkeeping, and reporting, as well as the effect of the “Volcker Rule” on the ability of certain types of firms to sponsor or invest in hedge funds and private equity funds.
- Insurance Companies. The Act will potentially subject some of our largest and most well-respected insurance companies to designation as nonbank financial companies and oversight by the Federal Reserve for the first time. We explore these developments and the functions of the new Federal Insurance Office created by the Act to monitor the industry, along with related provisions designed to promote uniformity among the states in market regulation of specified types of insurance.
- Supervision of Payment, Clearing and Settlement. We describe the greater role that the Act assigns to the Federal Reserve in the supervision of systemically important financial market utilities and payment, clearing and settlement activities conducted by financial institutions.
Capital Markets. The Act brings significant changes to the rules that affect the process of financing business enterprises. We explore these changes in the following areas:
- Derivatives and Swaps Clearinghouses. The Act imposes a new regulatory regime on over-the-counter derivatives, which includes clearing, exchange trading and other requirements intended to increase transparency, liquidity and efficiency, and to decrease systemic risk. We describe the mechanisms established to satisfy these objectives and some of their anticipated effects on current market practices. We also evaluate the potential for the new regulations — coupled with new implementation and monitoring responsibilities placed on regulators — to produce market dislocations, increase the cost of certain swap transactions, and adversely affect certain types of investment funds and structured finance transactions.
- Securitization. Under the Act, issuers or originators of asset-backed securities generally will be required to retain at least five percent of the credit risk associated with the securitized assets. We describe these provisions of the Act and explore their potential impact on the securitization field.
- Credit Rating Agencies. Credit rating agencies will enter into an entirely new regime of regulation under the Act. We summarize the new substantive standards, disclosure obligations, and private litigation rules applicable to rating agencies.
- Investor Protection and Securities Enforcement. The Act enhances the SEC’s enforcement program and investor protection mission by establishing a new whistleblower bounty program, providing the SEC with new enforcement authority, and permitting the SEC to impose a “fiduciary duty” on broker-dealers that provide retail investment advice. We consider the implications of these changes and conclude that the Act will make the SEC a stronger and potentially more assertive agency.
Governance and Compensation. The Act authorizes the SEC to adopt rules giving nominating shareholders access to the company’s proxy. In addition, the Act requires enhanced disclosure of executive compensation and gives shareholders the right to a “say-on-pay” vote on executive compensation.
Consumers. A new governmental authority, the Bureau of Consumer Financial Protection, is endowed by the Act with broad power to regulate retail financial products and services. We describe the responsibility of the Bureau and offices within it to supervise and examine specified types of institutions and to establish and enforce rules related to consumer finance. We also describe the Act’s new prohibitions or restrictions on certain lending practices.
We have prepared a collection of commentaries, entitled The Dodd Frank Act: Commentary and Insights, which summarize and analyze the Dodd-Frank Act; they are available here.