When the Dodd-Frank Act passed in 2010, an urgency existed to enact its many provisions. The market had nearly collapsed and there was little (if any) regulation of the financial instruments that caused the crisis to occur.
The original law called for some provisions to be enacted in 180 days, considered breakneck speed by most government agencies. But, none of that actually happened.
It has taken many years to slowly and steadily pass the rules laid out by Dodd-Frank. Other regulators, the industry, and legislators strongly pushed back, and some provisions were gradually weakened by exemptions and exceptions such as the Volcker Rule.
Dodd-Frank’s latest development came just last month, when the Securities and Exchange Commission (SEC) announced it established its first security-based swap data repository as part of its enaction of Regulation SBSR. The regulation requires public dissemination of transaction, volume, and pricing information of security-based swaps.
“The environment that existed, brought on by Dodd-Frank, no longer exists. What was implemented seemed like it was good enough for a long time.”
Amy Lynch, Founder and President, FrontLine Compliance
A decade later, how many other of the law’s provisions are still unfinished? And of those, are they mostly inconsequential, representing a routine buttoning up of loopholes and implementing of lessons learned?
Fifty-six of the 67 mandatory rulemaking provisions contained in the original Dodd-Frank Act have been enacted, leaving 11 remaining.
Of those 11, eight were proposed but languished for various reasons. In 2015 and 2016, four rules on executive compensation were put forward but haven’t budged since.
Two Dodd-Frank rules—one to create stress tests for nonbanking financial institutions and another to set new reporting requirements for short sales—were never proposed. A third non-proposed rule orders some minor changes to the Office of the Investor Advocate.
Why haven’t these rules been promulgated?
“The environment that existed, brought on by Dodd-Frank, no longer exists,” said Amy Lynch, founder and president of FrontLine Compliance and a former SEC regulator with the Office of Compliance Inspections and Examinations. “What was implemented seemed like it was good enough for a long time.”
Lene Powell, senior legal analyst, securities with Wolters Kluwer Legal & Regulatory U.S., said additional factors include the challenge of coordinating with other federal agencies and regulators and the lack of an accountability mechanism to ensure the last regulations are pulled across the finish line.
“Add to that competing priorities; or that some parts of these rules are packaged with other rules; or significant industry opposition or wide divergence of thought on what ought to be done among industry, advocates, and investors,” Powell said.
All eyes on Gensler
In May 26 testimony before the House Committee on Appropriations, new SEC Chair Gary Gensler laid out the agency’s 2021-22 budget priorities. Those included new rules for initial public offerings (IPOs), special purpose acquisition companies (SPACs), private funds, crypto assets, FinTech, and data analytics.
Among other initiatives, Gensler mentioned rules for security-based swaps, which has three Dodd-Frank rules still in the process of being approved. He also discussed Regulation Best Interest (Reg BI), new disclosure rules for public companies on the financial impact of climate change and human capital, and the transition from the London Interbank Offered Rate (LIBOR) to an alternative rate.
Needless to say, the SEC’s slate is full. But it should be noted, Powell said, that when Gensler led the Commodity Futures Trading Commission (CFTC) from 2009-14, he prioritized bringing the Dodd-Frank’s related rules to final action.
“They were like a machine, turning out rulemaking. They were pushing them out like gangbusters,” she said. “The CFTC under Gensler completed nearly all of its rulemaking responsibilities in regard to Dodd-Frank.”
Pillars enacted included the central clearing of swaps, establishing trading platforms known as swap execution facilities, and creating repositories to record swaps data.
Indeed, CFTC Commissioner Dan Berkovitz gave a speech Tuesday in which he stated the agency completed all of its mandated Dodd-Frank rulemaking last year.
Gensler might apply that drive to bring Dodd-Frank rules across the finish line with the SEC as he did with the CFTC. He indicated as much during his confirmation hearing.
Let’s take a closer look at the 11 Dodd-Frank rules still in wait-and-see mode and examine some current market trends that could make their enaction more or less likely under Gensler.
“I will work with fellow commissioners, SEC staff and counterparts at other financial regulators to complete all rulemakings directed by Congress. … I will consult with my counterparts to move forward on the joint mandates given to us by statute to issue a rule addressing compensation plans that encourage excessive risk in our financial system.”
SEC Chair Gary Gensler on completing implementation of Dodd-Frank
— Three rules are left to finalize on security-based swaps, which were partly blamed for the 2008 financial crisis. Dodd-Frank laid out 29 different rules on overseeing and regulating security-based swaps, which are derivative contracts traded between large institutions in order to manage risk. The law addressed what regulators and lawmakers criticized as a system lacking in transparency and oversight. Critics of the rules, however, said they were cumbersome and overly complex.
Passing rules on swaps requires coordination with the CFTC, and therefore, can be considered an area of emphasis and expertise for Gensler. As a result, he’s likely to push through in this area, which in addition to creating the first swap repository also sets new rules to wring out fraud and conflicts of interest in the swap market.
“The meat of all these rules is to provide an orderly manner to the swaps market that is transparent and disclosable,” Lynch said. Even when these rules are finalized, the complete implementation period could take a few years, she noted.
Lynch added one area of swaps regulation that may receive attention under Gensler is total return swaps, which are currently exempt from SEC regulation. Total return swaps were the financial instrument used by Archegos Capital Management that failed so spectacularly earlier this year and were criticized by Gensler and others for lacking transparency.
Creditors like Credit Suisse and SoftBank lost billions when the Archegos collapse forced them to sell their shares in certain stocks at huge losses. Those creditors might have been more careful and acted to address their risks, had they known the extent of their exposure if Archegos’ bets with total return swaps failed.
— One Dodd-Frank rule never proposed would reform the short sale market. Wild market swings fueled by short selling rose to prominence recently with the meme stocks craze, and Powell said reforming the market is a likely area of emphasis for Gensler. He spoke to Congress about the problems caused by lack of transparency around short sales.
Section 929X(a) on short sale reform would compel every institutional investment manager that affects a short sale of a security to also file a daily report with the SEC in any way the Commission determines. Such a rule would bring the United States closer in line with current mandates in the European Union and United Kingdom, according to a March story on securitiesfinancetimes.com.
While the industry publication called the rule “moribund,” it noted SEC Commissioner Allison Herren Lee recently expressed support for reviving it.
“I could definitely see short sale reform as part of the SEC’s regulatory priorities,” Powell said. “It got so much attention recently.”
— Another never proposed Dodd-Frank rule would place stress tests on nonbanking financial institutions. As nonbanking financial institutions were practically nonexistent when Dodd-Frank passed in 2010, the regulation could be considered ahead of its time and easy to dismiss as a problem in search of a solution.
But 11 years later, nonbanking financial institutions proliferate in the market and numerous FinTech companies are now pushing the envelope of what’s possible. At Compliance Week 2021, a panel of experts examining compliance in 2030 predicted regulators will be primarily consumed with promulgating new rules for the FinTech sector, which includes nonbanking institutions. Although 10 years old, Section 165 could provide the starting point for such regulations.
— Four Dodd-Frank rules are left to be implemented on executive compensation: pay vs. performance, recovery of executive compensation, and two rules regarding incentive-based compensation arrangements and the risks they pose to investors.
“The executive compensation rules are very controversial,” Lynch said, adding Wall Street is likely to strenuously oppose any move to resurrect these rules. “There’s no appetite in the industry for any of these executive compensation rules.”
In addition, finalizing the two rules on regulated incentive-based compensation arrangements will require coordination among six federal agencies, including the SEC, the Treasury, the Federal Reserve Bank, and three other banking regulators.
— One rule left to finalize on asset-backed securities deals with conflicts of interest. Powell noted Gensler signaled during his Senate confirmation that he would examine asset-backed security rules, including securitization of leveraged loans and loan portfolios. Several SEC rule proposals relating to asset-backed securities currently on hold could be drawn into a rulemaking package.
The financial services industry is vehemently opposed, for the primary reason that, if enacted, the rules would be complex and difficult to enforce, Lynch said.
— The final unfinished rule, never proposed, would mandate the Office of the Investor Advocate to establish procedures requiring a formal response to all recommendations submitted to the Commission by the investor advocate, within three months of the submission.