What's Left for Dodd-Frank Rulemaking?

By the time children celebrate their second birthday they have already begun walking and even running. The Dodd-Frank Act, however, turned two this month, but it's still crawling along.

As of mid-July, only one-third of the regulations it mandates have gone into effect, according to a status report by law firm Davis Polk & Wardwell. The Securities and Exchange Commission and Commodity Futures Trading Commission have missed more than 75 percent of their rulemaking deadlines; the CFTC has missed 88 percent.

As of July 18, 2012, a total of 221 rulemaking requirement deadlines have passed, 55.5 percent of the 398 total rulemaking requirements. Among them were 78.9 percent of the 280 rulemaking requirements with specified deadlines.

The slow pace can certainly be blamed, in part, on complexity. Legislation that started as 848 pages is now accompanied by nearly 9,000 pages of rules and regulations it has spawned.

Ted Kaufman, a former Democratic Senator for Delaware who now serves as chairman of the Congressional Oversight Panel, blames a full-court press by industry lobbyists to water down regulations for much of the problem with delays.

“People think, when you talk about Wall Street having all this money, that it is all about buying senators and campaigns,” Kaufman says. “It isn't. It's the public relations. It's the lobbying. They send wave after wave of really smart people into these regulatory agencies. The amount of deference that is paid to these Wall Street guys is absolutely and completely out of proportion.”

His view is backed by research released earlier this month by the Sunlight Foundation after the non-profit advocacy group analyzed financial regulatory agency meeting logs. Representatives of the top 20 banks and banking associations met with regulators from the Treasury Department, the Federal Reserve, and the Commodities Futures Trading Commission on average, a combined 12.5 times per week for the last two years, a total of 1,298 meetings. The same regulators only had 242 meetings (about 2.5 per week) with reform-oriented groups. (Due to concerns about data quality, the SEC and Federal Deposit Insurance Corporation were excluded from the review).

Others rules that have been delayed or are still in the proposal stage may also suffer from infighting among multiple federal agencies that must concur on the final rules. Delays can also be caused by concerns from agencies like the SEC that opponents could challenge the regulations in court if there are any flaws in the rulemaking process or that rulemaking could have unintended consequences if they are not completely thought through.

Volcker Rule

The July 21 deadline for implementation of the Volcker Rule, which would ban proprietary trading by commercial banks unless such trades were deemed a hedge, came and went.

“The compliance burden associated with ensuring that any continuing proprietary trading fits squarely within the exemptions is extraordinary,” says Stacie McGinn, a financial services regulatory lawyer and partner in the New York office of Simpson Thacher & Bartlett. “On the other hand, regulators have legitimate concerns that the final regulations do not have unintended consequences on world financial markets.”

While caution may be understandable, there is a big problem in that aspects of the Volcker Rule are mandated to go into effect whether or not a final rule is in place. Congress initially required the Volcker rule to take effect on July 21, 2012, on the date of the Dodd-Frank Act's second anniversary. The inability of regulators to issue a completed rule by that deadline, an impasse apparent months ago, led the Federal Reserve to tell banks in April that they will have an additional two years to conform to the restrictions on proprietary trading.

“The compliance burden associated with ensuring that any proprietary trading you are engaging in fits squarely within the exemptions is extraordinary.”

—Stacie McGinn,

Partner,

Simpson Thacher & Bartlett

This enforcement delay has also created uncertainty as banks and legal advisers have debated whether work to unwind proprietary investments should begin immediately, even without clear-cut definitions, or if institutions can continue with business as usual until they hear otherwise.

Defining what is a hedge and what is proprietary trading, and who is an end product user and who is not, is “sort of like putting socks on an octopus,” says Kevin Blakely, senior adviser for Deloitte & Touche's Governance, Risk, and Regulatory Strategies practice. “It is an ever-changing thing and it is not easy. I don't envy the regulators who are trying to implement this.”

SIFI DESIGNATIONS

Also on the horizon are requirements for what are deemed Systemically Important Financial Institutions (SIFIs).

The Dodd-Frank Act created two new agencies—the Office of Financial Research and the Financial Stability Oversight Council—to oversee SIFIs and minimize systemic risks. Among the requirements for SIFIs will be quarterly credit-exposure reports, mandated stress tests, increased capital buffers, the implementation of “living wills” and contingency plans that would be triggered upon a failure, and limits on counter-party credit exposures.

Of course none of this can take effect until regulators decide exactly which financial companies will be categorized as SIFIs. McGinn says, however, that not a single non-bank institution has yet to be designated as a SIFI. ““The agencies have proposed how they would go about the determination process, but they haven't finalized those guidelines yet,” McGinn says. “They really haven't started the process of designating SIFIs.”

Executive Compensation

“Say-on-pay,” which requires publicly traded companies to submit executive compensation plans to a shareholder vote at least every three years is already in effect. But other compensation rules, including those pertaining to the “clawback” of executive compensation, the disclosure of hedging by executives or directors of company stock received as compensation, and the disclosure of the ratio of CEO pay to median employee pay remain unfinished.

DODD-FRANK RULEMAKING UPDATE

The following graph and statistics from Davis Polk explain what's happened in the world of Dodd-Frank rulemaking as of July 18, 2012:

As of July 18, 2012, a total of 221

Dodd-Frank rulemaking requirement

deadlines have passed. This is

55.5% of the 398 total rulemaking

requirements, and 78.9% of the 280

rulemaking requirements with

specified deadlines.

Of these 221 passed deadlines, 136

(61.5%) have been missed and 85

(38.5%) have been met with finalized

rules. Regulators have not yet

released proposals for 19 of the 136

missed rules.

Of the 398 total rulemaking

requirements, 123 (30.9%) have

been met with finalized rules and

rules have been proposed that

would meet 134 (33.7%) more.

Rules have not yet been proposed to

meet 141 (35.4%) rulemaking

requirements.

total fees.

Source: Davis Polk.

The Dodd-Frank requirement on CEO pay ratio will be particularly difficult to implement once the rule is finalized, says Blakely. “If you have 100,000 employees, you have to figure out who is that one person who represents the median, that half the people are above them, half are below them,” he says. Questions remain about who should be counted and what will count towards the compensation of those who should.

The complexity of compensation schemes for executives, with stock options, bonuses, and other provisions make such a direct comparison difficult and many companies “are not geared up to provide that sort of information,” he says.

Mortgage Lending Rules

Final rules and guidance that could have a tremendous effect on mortgage lenders are also still in the works. Blakely says forthcoming definitions and rules would impact “qualified mortgages” and “qualified residential mortgages.”

QRMs face new restrictions that stem from the loosened underwriting standards and securitization that exacerbated the financial meltdown of 2007 and 2008. Dodd-Frank tasks regulators with considering a potential requirement that banks must hold a certain portion of their mortgage securitization, currently set at a 5 percent exposure.

A QRM would get an exemption from this risk retention if it is guaranteed by the government or through Freddie Mac and Fannie Mae (as about 90 percent already are). A private label mortgage would have to meet certain underwriting criteria (such as a down-payment-to-debt ratio), but those guidelines have yet to be finalized. Both sides are anxiously awaiting CFPB guidance on these matters, although rules are not expected before the end of 2012.

“It has real implications on consumer credit ability,” Blakely says. “That is one of the reasons why the CFPB has not issued the final definition of what is a qualified mortgage and does it qualify under safe harbor or rebuttable presumption. If they make it too tough on the banks, they are going to get very conservative in how they underwrite mortgages.”

A few other pieces of unfinished business (though by no means all of what's left) still await regulators, including:

·         The SEC issuing long-awaited final rules regarding the use of “conflict minerals” and extraction payments. The Dodd-Frank Act calls for companies to disclose payments made to any foreign government for the extraction of oil and minerals and demand corporate disclosures relating to the use of so-called “conflict minerals” mined in Central Africa. The commission has scheduled a vote for Aug. 22.

·         The CFTC's is still finalizing final rules governing the cross-border application of swaps market reforms.

·         In June, the SEC opened the Office of Credit Ratings, a requirement of the Dodd-Frank Act intended to provide better oversight of the ratings agencies and conduct annual examinations. Still to come are related rules that establish professional standards for credit analysts, enhanced public disclosures about the performance of credit ratings, and the methodology behind them and protections against conflicts of interest.

“There is quite bit yet to come,” Blakely points out. “At least some of the really big stuff has been at addressed in some fashion.”

As for the pace of final rulemaking, he points out that, in past years, the financial industry might have faced a dozen or so new or amended regulations per year. That many can hit in just one week since the Dodd-Frank pipeline began. The relatively short time frames can be “overwhelming to the agencies" as they strike a balance between new rulemaking and the enforcement of those already on the books, he says.