Last year was a busy one for financial regulators. Their rulemaking schedules were packed, and the impact of Dodd-Frank began to emerge from the resulting web of new regulations. Dodd-Frank abstractions even created painful realities for entities that had thought they were safely beyond the law's reach. The limits of Dodd-Frank's "solutions" began to emerge. The flurry of regulatory actions that marked the year's end gives a glimpse of the busy year that has passed and a sense of what is coming in 2014.
The Commodity Futures Trading Commission finished off 2013 by bidding farewell to its chairman, who touted the CFTC's "over 170 Dodd-Frank actions-nearly one a week since it was signed into law." During the last couple weeks, the agency rushed out an all-too-familiar series of eleventh hour staff letters to provide temporary relief from an implementation schedule that has proved difficult for both the agency and the industry to keep up with. These letters are merely the latest pieces of a fractured and opaque regulatory regime that may result in markets that are a lot more complicated and less able to serve Main Street companies than the much maligned over-the-counter derivatives markets they are replacing.
Chairman Gensler's farewell remarks included thanks to his foreign counterparts. His gratitude rings hollow in the face of the CFTC's aggressive extraterritorial regulatory reach. The most recent manifestation was the agency's December 20th ostensibly generous determination to allow certain foreign entities in specified jurisdictions to satisfy some, but not all, of the CFTC's rules through compliance with their home country rules. The real harm will be domestic as this piecemeal, rule-by-rule approach encourages foreign firms to stay as far away from US customers and markets as they can, rather than trying to figure out whether and how each of the many US rules applies to their activities.
On December 10, ignoring calls for a reproposal of the Volcker Rule, the financial regulators joined together to finalize this much-heralded effort to keep the big banks in line. By year's end, regulators faced an emergency lawsuit prompted by its anticipated effect on community banks. Volcker's prohibition on certain investments by banks may require community banks to get rid of their pooled holdings of the securities of other banks. Although the provision does not take effect until 2015, it may force the banks holding these securities in their investment portfolios to recognize losses immediately. Regulators are scrambling to rethink how the rule should apply to these securities. In the meantime, community bankers are left worrying about whether a Dodd-Frank rule that was supposed to be about the big banks may be yet another obstacle to the ability of small banks to survive.
On December 23, the Federal Reserve proposed a long-overdue rule related to its emergency lending powers that it used to bail out AIG. Dodd-Frank pared back those powers, and the Fed is only allowed to lend through broad-based programs that are not designed to prop up failing institutions. The Fed's proposal, however, still allows aid to flow to failing companies, as long as they are not yet in formal bankruptcy or resolution proceedings. Under the new Fed rules, a firm like AIG-which was found by potential industry lenders to be insolvent just before the Fed's infusion of money-would still be eligible for rescue as part of a broader program.
The year-end news was not all bad. On December 18, the SEC made progress on JOBS Act implementation by proposing a rule that would make it easier for small companies to raise capital. On December 27, the SEC took another step-albeit only a partial one-toward eliminating regulatory mandates to rely on credit ratings. These mandates made bad calls by credit rating agencies mandatory inputs in financial industry decision-making leading up to the financial crisis.
The financial regulators have a lot more in store for us in the new year. One of the things we are sure to learn is that financial regulation reaches far beyond Wall Street. Rules designed to transform banks, investment managers, and broker-dealers have follow-on effects on the businesses and consumers that rely on them to meet their financial needs. As we learn this lesson in 2014, it will help to remind us that the primary objective of financial regulation is not to mete out punishments to financial institutions, but to make our capital markets work better.