Dodd-Frank At 4: Where Do We Go From Here?

Where do we go from here? As we mark another milestone in regulatory reform with the fourth anniversary of the enactment of the Dodd-Frank Act, it strikes us that although most studies required to be undertaken by the Act have been released and final rules have been promulgated addressing many of the most important regulatory measures, we are still living with a great deal of regulatory uncertainty and extraordinary regulatory complexity.

In this post we begin to provide a brief recap of the most significant Dodd-Frank Act related regulatory developments of the last year. In the complete publication, we continue this recap and also offer our thoughts on what’s left.

Regulatory Recap: United States

Substantial rulemaking progress was made in the last year (since July 2013) with many of the most important and most controversial Dodd-Frank Act related rules having been finalized. Below we begin to offer a quick recap of the most significant regulatory developments of the last year in the United States. In the complete publication, we continue this recap and also provide a review of the most significant developments in Europe.

Regulatory Capital Requirement

Just before the last anniversary of the enactment of the Dodd-Frank Act, in early July 2013, the Federal Reserve Board, the OCC, and the FDIC (collectively, the “Agencies”) approved the publication of the final regulatory capital rules (the “Regulatory Capital Rules,” or “Rules”). The Regulatory Capital Rules make major changes to the U.S. regulatory capital framework in an effort to strengthen the regulatory capital of U.S. banking organizations and bring the United States into compliance with the Basel Committee’s current international regulatory capital accord (“Basel III”). The Rules replace the Agencies’ general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules, as provided by the Rules’ transition provisions. In brief, the Rules:

• Revise the basic definitions and elements of regulatory capital. Consistent with Basel III, Tier 1 capital will consist of common equity Tier 1 capital and additional Tier 1 capital. Total Tier 1 capital, plus Tier 2 capital, will constitute total risk-based capital. The Rules require a number of capital adjustments, exclusions, and deductions (e.g., goodwill, other intangibles, and most deferred tax assets).
• Make substantial changes to the credit risk weightings for banking and trading book assets through the adoption of material elements of the Basel II standardized approach for credit risk weightings.
• Finalize changes made to the Basel capital framework in the aftermath of the financial crisis to large U.S. banking organizations subject to the advanced Basel II capital framework (the “advanced approach framework”).
• Adopt a new phased-in capital conservation buffer for all covered banking organizations equal to 2.5% of total risk-weighted assets, and for banking organizations subject to the advanced approach framework, the Rules adopt a macro-economic countercyclical capital buffer of up to 2.5% of total risk-weighted assets.
• Adopt a separate Tier 1 leverage capital requirement, measured as a ratio of Tier 1 capital, minus deductions, to average on-balance sheet assets. Banking organizations subject to the advanced approach framework will be subject to a new and separate supplementary leverage ratio.

The Rules became effective on January 1, 2014, with a mandatory compliance date of January 1, 2015, for banking organizations that are not subject to the advanced approaches framework. On that date, most banking organizations would be required to begin the transition to the full implementation of the new capital framework by 2018. For banking organizations subject to the advanced approaches framework, the effective date and compliance period, and the start of the transition period, was January 1, 2014. The Rules provide phase-in/phase-out periods for certain aspects, including minimum capital ratios, adjustments and deductions, non-qualifying capital instruments, capital conservation and countercyclical capital buffers, supplemental leverage ratio for advanced approaches banks, and changes to the PCA rules, which generally take effect by January 1, 2019.

Volcker Rule

The Final Rule

The final Volcker Rule was adopted more than two years after the proposed rule, and three and a half years after the Dodd-Frank Act was enacted. On December 13, 2013, the Federal Reserve, the FDIC, the OCC, the SEC, and the CFTC (together, the “Agencies”) adopted the final rule (the “Final Rule”) implementing Section 13 of the Bank Holding Company Act.

The Volcker Rule generally prohibits, subject to exceptions, banking entities—a broad term that includes banks, bank holding companies, foreign banks treated as bank holding companies, and their respective affiliates—from (i) engaging in proprietary trading and (ii) acquiring or retaining ownership interests in, or acting as sponsors to, certain hedge funds and private equity funds (“covered funds”). Certain trading and fund activity is expressly permitted—notably, underwriting activities, market-making related activities, and risk-mitigating hedging activities. In addition, the Volcker Rule has special application for foreign banking organizations (“FBOs”).

The Volcker Rule legislation covered the area with a broad brush, leaving many significant issues open to regulatory interpretation. The Final Rule is complex in scope and has elicited significant commentary and questions from the banking industry and the public at large. We address only certain selected topics from the Final Rule.

The complete publication is available here.