Larry Thompson, DTCC Vice Chairman and General Counsel
Five years ago, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) was signed into law, dramatically altering the financial industry landscape. The law was designed to strengthen market safety and soundness and increase transparency to prevent the type of excessive risk-taking that nearly caused a meltdown of the global financial system in 2008. However, with more than 20 percent of rulemaking requirements yet to be proposed, along with the need to coordinate policymaking with jurisdictions around the world, implementation of Dodd-Frank remains ongoing.
Larry Thompson, DTCC Vice Chairman and General Counsel, has testified before the U.S. Congress multiple times regarding the Dodd-Frank Act, including most recently before the House Agriculture Committee during a Dodd-Frank Fifth Anniversary hearing. Thompson spoke with DTCC Connection to reflect on the legislation, current challenges and what lies ahead for Dodd-Frank’s next five years.
DC: Although rulemakings will continue in the coming years, what impact has implementation of Dodd-Frank had to date and what area(s) of the financial marketplace have been most impacted?
LT: The 2008 financial crisis exposed a number of glaring weaknesses in the financial system. Two of those market flaws – undercapitalized banks and the lack of regulation of the over-the-counter (OTC) derivatives – have been addressed by Dodd-Frank.
Dodd-Frank imposed stringent capital requirements on banks to help limit their reliance on debt. As a result, banks are better capitalized today and are more capable of withstanding severe shocks as a result of adverse economic conditions or market events. They also now undergo periodic tests of their capital adequacy, as required by Dodd-Frank.
How Has DTCC Responded to Dodd-Frank Mandates?
DTCC has undertaken key initiatives to assist the industry effectively and efficiently comply with Dodd-Frank mandates.
1. We applied for and received provisional registration from the Commodity Futures Trading Commission (CFTC) to operate a swap data repository (SDR) for OTC credit, equity, interest rate, foreign exchange and commodity derivatives in the U.S. The DTCC U.S. SDR began accepting trade data from clients on October 12, 2012 – the first day that financial institutions began trade reporting under Dodd-Frank. On December 31, 2012, DTCC was the first and only SDR to accept swap dealer regulatory reporting and publish real-time price information.
2. In collaboration with six founder banks, we launched Clarient Entity Hub, a financial industry solution designed to provide centralized services for all client data and documents needed to satisfy internal on-boarding and help firms meet broader related regulatory requirements including Know Your Customer (KYC), Foreign Account Tax Compliance Act (FATCA), European Market Infrastructure Regulation (EMIR) and Dodd-Frank.
3. DTCC-Euroclear, the joint venture between DTCC and Euroclear, leverages both companies expertise in collateral processing to help the industry address capital and operational challenges promulgated by new regulations, including Dodd-Frank.
Clearing of OTC derivatives is another sector of the market where Dodd-Frank has had an impact. Prior to the 2009 Group of 20 (G20) Pittsburgh Summit and new regulatory mandates stemming from Dodd-Frank, these complex instruments and their associated trading and clearing processes were lightly regulated and there was little, if any, transparency into the market. Dodd-Frank shined a spotlight on OTC derivatives by mandating central clearing and requiring reporting of all derivatives (cleared and non-cleared), which provides greater transparency into market participants’ trading activities and exposures.
As a result, the OTC derivatives market has undergone a dramatic transformation over the past several years and continues to evolve rapidly as market participants meet new mandates, including new regulatory requirements stemming from Dodd-Frank.
DC: Whenever laws as complex as Dodd-Frank are written and implemented, unintended consequences emerge. Where has that been most evident with Dodd-Frank?
LT: Having sufficient levels of capitalization has brought obvious benefits, but it has come at a cost – higher lending rates, a decrease in lending activity and the rise of shadow banking in which financial activity is occurring outside the system. However, regulators don’t have extensive information about the potential risks shadow banking present to the marketplace. It’s a different risk profile and as a result, regulators and the industry need to proceed carefully.
Transparency in the OTC derivatives market is another area that has not reached its full potential as set forth by the G20. As you know, the G20 goal set out a transparency mandate and as I stressed in my recent testimony before the House Agriculture Committee, there are three key obstacles:
- The lack of global coordination resulting from the regional approach to trade reporting regimes;
- The lack of global data standards; and
- Legal barriers to global data sharing among regulators.
DC: What challenges lie ahead for Dodd-Frank?
LT: Clearly, progress has been made, but more work remains to complete and effectively enact reform measures. It is my hope that as Dodd Frank measures continue to roll out, regulators will take time to review and assess rules already implemented.
For example, removing Dodd-Frank’s indemnification provisions would facilitate the sharing of information and collaboration among regulators to monitor risk. DTCC has been highly supportive of legislative efforts to remove these provisions as they pose a significant barrier to the ability of regulators to effectively utilize the transparency offered by SDRs. The good news is that the U.S. Senate and House of Representatives continue to focus on addressing these unintended consequences. Both Chambers have taken steps towards removing these provisions from the law and we are hopeful that a legislative fix with bicameral support can be achieved.
Another key challenge the industry faces is the lack of harmonization of new rules across jurisdictions, which could unravel the progress that has already been made in bringing transparency to the OTC derivatives market. Differences in data reporting standards and access, privacy laws and sharing requirements across jurisdictions only serve to complicate efforts and prevent data from being aggregated and converted into information that can be used to monitor risk.
Also, capitalization requirements continue to pose a challenge, particularly for small banks. The Fed has indicated that it is willing to consider some changes to the capital requirements to make it easier for smaller banks to compete. Specifically, the $50 billion in assets threshold established by Dodd-Frank for banks to come under stricter Fed supervision may be eased in some circumstances.