The year 2017 for banking will be remembered for President Donald J. Trump and the Republican-controlled Congress taking steps to either repeal or dismantle various aspect of the Dodd-Frank Act; the continuing story of the ability of the Financial Stability Oversight Council to designate non-bank companies as significantly important financial institutions (SIFIs); steps taken by the Office of the Comptroller of the Currency to bring financial technology under federal supervision; and changes to leadership at the Consumer Financial Protection Bureau and the other banking agencies.
This Strategic Perspectives will examine these developments and provide a glimpse into the issues that may arise in 2018.
1. Regulatory reform.
At both ends of Pennsylvania Avenue, there were a number of initiatives that sought to roll back or repeal various provisions of the Dodd-Frank Act.
Executive action. Within two weeks of his inauguration, the president made good on his promise to "do a big number" on the Dodd-Frank Act by signing an Executive Order on Feb. 3, 2017, that directed the Secretary of the Treasury to report back in 120 days on what rules promote or inhibit the administration’s priorities.
"Core Principles." The administration’s priorities, enunciated in Executive Order 13772, were based on seven Core Principles:
- empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
- prevent taxpayer-funded bailouts;
- foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
- enable American companies to be competitive with foreign firms in domestic and foreign markets;
- advance American interests in international financial regulatory negotiations and meetings;
- make regulation efficient, effective, and appropriately tailored; and
- restore public accountability within federal financial regulatory agencies and rationalize the federal financial regulatory framework.
The first report released by the Treasury Department in connection with the mandate set forth in Executive Order 13772 was entitled A Financial System That Creates Economic Opportunities: Banks and Credit Unions." The report’s findings and recommendations addressed changes brought about with the enactment of the Dodd-Frank Act and identified significant areas for reform in order to conform to the Core Principles.
The report also noted that given the breadth of the financial system and the unique regulatory regime governing each segment, the Treasury Department found it necessary to divide its review of the financial system into a series of reports. Subsequent reports in connection with the Executive Order 13772 review were to focus on markets, liquidity, central clearing, financial products, asset management, insurance, and innovation.
Among other things, the report called for a number of actions to be taken by the regulators or Congress. For example, the report said that a "sensible rebalancing of regulatory principles... can better align the financial system to serve consumers and businesses in order to support their economic objectives and drive economic growth."
Regarding specific recommendations, the report called for:
- "substantial amendment" to the Volcker Rule to promote liquid and vibrant markets;
- Congress and the regulatory agencies to undertake a holistic analysis of the cumulative impact of the regulatory environment, targeting the Community Reinvestment Act as one particular statute that needs to be modernized;
- right-sizing financial regulation and removing unnecessary regulatory duplication and overlap by providing: explicit, appropriately risk-sensitive capital standards; supervised stress-testing appropriately tailored based on banking organizations’ complexity; and actionable living wills for the largest systemically-important banks; and
- a "significant restructuring" of the Consumer Financial Protection Bureau.
SIFI and OLA review. In addition to the regulatory review based on the Core Principles, the president took other executive action that addressed the ability of FSOC to designate non-bank financial institutions as systemically important financial institutions (SIFIs) and the bank regulators to exercise the orderly liquidation authority (OLA) found in Title II of the Dodd-Frank Act.
The orderly liquidation authority found in the Dodd Frank Act authorizes financial regulators to wind down a large, complex financial institution that is failing and dismantle it in a way that is less harmful and disruptive than taxpayer bailouts or bankruptcy. The Presidential Memorandum on the orderly liquidation authority provided that the Treasury Department conduct an analysis to ensure that the OLA does not encourage excess risk-taking, moral hazard, and exposure to taxpayers. The Treasury Secretary noted that the OLA could be used in an emergency.
The designation of non-bank firms, such as insurance companies, allows FSOC to monitor the risks posed by nonbank financial companies and to address these risks through enhanced supervision and stricter rules. The Presidential Memorandum affecting the designation of non-bank SIFIs called for a 180-day review to ensure that the SIFI designation is "a fair and transparent process."
In November, the Treasury Department issued its report on FSOC’s SIFI designation process and provided recommendations on ways to improve FSOC’s processes for nonbank financial companies and financial market utility (FMU) designations. The report identified five policy goals that should be achieved by FSOC’s designation processes: leveraging the expertise of primary financial regulatory agencies; promoting market discipline; maintaining a level playing field among firms; appropriately tailoring regulations to minimize burdens; and ensuring FSOC’s designation analyses are rigorous, clear, and transparent.
As for nonbank financial company designations, the Treasury Department recommended that FSOC prioritize its efforts to address risks to financial stability through a process that emphasizes an activities-based or industry-wide approach.
Regarding the designation of FMUs, the report recommended that FSOC add important enhancements to improve the analytical rigor, engagement, and transparency of the process, and to ensure that the designation process is individualized and appropriately tailored. Additionally, the report has recommended that FSOC continue to study key issues related to FMU operation, designation, and resolution. Finally, Treasury has recommended that FSOC consider incorporating cost-benefit analyses into its FMU evaluation process as well.
Legislative measures. At the end of 2017, there were two major legislative initiatives that sought to provide regulatory reform—H.R. 10, the Financial CHOICE Act of 2017 and the S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act.
The Financial CHOICE Act of 2017, which was introduced by House Financial Services Committee Chairman Jeb Hensarling (R-Texas), is based on the following key principles:
- taxpayer bailouts of financial institutions must end, and no company can remain too big to fail;
- both Wall Street and Washington must be held accountable;
- simplicity must replace complexity, because complexity can be gamed by the well-connected and abused by the Washington powerful;
- economic growth must be revitalized through competitive, transparent, and innovative capital markets;
- every American, regardless of circumstances, must have the opportunity to achieve financial independence;
- consumers must be vigorously protected from fraud and deception as well as the loss of economic liberty; and
- systemic risk must be managed in a market with profit and loss.
House Democrats dubbed the bill, the "Wrong Choice Act."
Following an early May 2017 Financial Services Committee mark up, the Financial CHOICE Act was passed by the House on June 8, 2017, by a 233 to 186 roll call vote.
The Senate’s regulatory relief initiative was introduced in November 2017 by Senate Banking Committee Chairman Mike Crapo (R-Idaho). The bill is a bipartisan measure which would raise the threshold for applying enhanced prudential standards to bank holding companies from $50 billion to $250 billion.
Other measures in the Senate bill would:
- provide that mortgage loans originated and retained in portfolio by an insured depository institution or an insured credit union with less than $10 billion in total consolidated assets will be deemed qualified mortgages under the Truth in Lending Act while maintaining consumer protections;
- require that the federal banking agencies establish a community bank leverage ratio of equity to average consolidated assets of not less than eight percent and not more than 10 percent. Banks with less than $10 billion in total consolidated assets that maintain tangible equity in an amount that exceeds the community bank leverage ratio will be deemed to be in compliance with capital and leverage requirements; and
- require credit bureaus to include in the file of a consumer fraud alerts for at least a year under certain circumstances, provide consumers one free freeze alert and one free unfreeze alert per year, and provide further protections for minors.
S. 2155 was reported out of the Senate Banking Committee on Dec. 5, 2017, and placed on the Senate Legislative Calendar under General Orders as Calendar No. 287.
2. CFPB at a turning point?
As the sixth year of the Consumer Financial Protection Bureau "serving consumers" comes to a close, its mission as envisioned in the Dodd-Frank Act possibly hangs in the balance given Republican control of Congress and the White House.
Although the CFPB issued two significant rulemaking initiatives, those actions were tempered by the actions taken by Congress and White House.
Arbitration rule. In July, the Bureau issued its final rule banning mandatory predispute arbitration clauses in consumer financial product contracts if those clauses prevent class actions. Arbitration clauses that apply only to individual actions must disclose that class actions are not covered. If a judge rules that a suit is not appropriate for class action treatment, an otherwise valid arbitration clause can be invoked.
As soon as the Arbitration Rule was released, Republicans in Congress vowed to repeal the final rule through use of the Congressional Review Act, which not only halts the regulation from taking effect, but it also bars federal agencies from enacting similar rules without congressional action.
Senator Tom Cotton (R-Ark) was first to voice his intent to rescind the Arbitration Rule stating, "The CFPB has gone rogue again, abusing its power in a particularly harmful way."
H. J. Res. 111 and S. J. Res. 47 were introduced in the House and Senate as the vehicles to repeal the Arbitration Rule.
Subsequently, H. J. Res. 111 was approved by the House and, narrowly, by the Senate with the president signing the bill on Nov. 1, 2017, thereby repealing the Arbitration Rule.
Payday loans. The other major initiative that the CFPB finalized was its regulations regulating short-term, small-dollar loans. The regulations will cover loans that require full or nearly full repayment at one time, such as payday loans, vehicle title loans, and deposit advance products. Some longer-term loans that have balloon payment features also are covered.
As with the Bureau’s Arbitration Rule, Congress has taken the first step to nullify the payday lending rules pursuant to the Congressional Review Act. In early December, a bipartisan group of House members introduced H.J. Res. 122. Rep. Dennis Ross (R-Fla), the chief sponsor of the joint resolution, noted, "short-term, small dollar credit is essential to nearly 12 million American consumers who have difficulty qualifying for many other types of credit." Ross, along with the other co-sponsors—Reps. Alcee Hastings (D-Fla), Tom Graves (R-Ga), Henry Cueller (D-Texas), Steve Stivers (R-Ohio), and Collin Peterson (D-Minn)—also emphasized that all 50 states, the District of Columbia, and all Native American tribes already regulate short-term loans covered.
Who’s in charge? Although the CFPB may have both of its two big rulemaking initiatives nullified by Congress, the biggest change to the Bureau’s mission is just beginning to be played out in a federal court following the resignation of Richard Cordray as CFPB Director.
As Cordray was departing, Leandra English was named as Deputy Director, thereby setting into motion the CFPB succession provisions found in the Dodd-Frank Act. At the same time, the president, acting under the provisions of the Federal Vacancies Reform Act (FVRA), named Office of Budget and Management Director Mick Mulvaney as the Bureau’s acting director. Mulvaney had at one time called the CFPB a "sick, sad" joke.
With competing leadership, English sued Mulvaney and the president seeking a temporary restraining order and other relief. That effort was rebuffed by the U.S. District Court for the District of Columbia. English then amended her complaint seeking a preliminary injunction claiming, among other things, that Mulvaney’s appointment by Trump violates the Dodd-Frank Act’s mandatory succession plan and independence requirement, as well as the Separation of Powers and the Appointments clause of the U.S. Constitution. In response to English’s amended complaint, Mulvaney argued that English failed to demonstrate a substantial likelihood that she would prevail on her claim that, as deputy director, she automatically succeeded Cordray. He further contended that English had not established that, absent a preliminary injunction, she would be irreparably harmed. In her latest reply brief, English argued that the Dodd-Frank Act supplies "a clear answer" to the question on which the merits of the case turn. She added, even if Dodd-Frank’s succession statute were interpreted as being permissive rather than mandatory,the President’s selection of Mulvaney would still be impermissible because: (1) It flouts Congress’s design in creating the CFPB as an "independent bureau;" and (2) The FVRA, by its terms, does not apply to the appointment of "any member" of a multi-member board that "governs an independent establishment or Government corporation," and the CFPB Director, as an automatic Federal Deposit Insurance Corporation board member, is such a member.
A coalition of 17 state attorneys general wrote the president indicating that they would continue enforcing consumer protection laws regardless of the status of CFPB leadership. In a letter to the president, the attorneys general stated, "If incoming CFPB leadership prevents the agency’s professional staff from aggressively pursuing consumer abuse and financial misconduct, we will redouble our efforts at the state level to root out such misconduct and hold those responsible to account"
Beside the court dispute over who heads up the CFPB, the question of whether the Bureau’s leadership structure is constitutional is still pending before the U.S. Court of Appeals for the District of Columbia Circuit. In May, the full court heard oral arguments (audio file) in PHH Corporation v. CFPB. Among the issues in the appeal, the full court was asked to determine whether the CFPB’s structure as an independent agency with a single director violated the Constitution’s separation of powers requirements.
A different direction. Regardless of the outcomes in the English and PHH cases, it has been observed that the CFPB "is undergoing its first ideological swing in leadership" and the "new leadership should be expected to take the Bureau in a different direction." These observations were provided by Makada Henry-Nickie and Aaron Klein of the Brookings Institution. The authors also noted that "to characterize every change in policy as unprecedented or problematic—this would be a slippery trajectory." Henry-Nickie and Klein added, "It could be reasonably argued that Mulvaney’s changes may offer new policy tools that prove effective at improving consumer choice and enhancing competition, while combating abusive and predatory banking practices."
3. Fintech
The year 2017 saw the Office of the Comptroller of the Currency continue its push to allow financial technology companies, or fintech, the opportunity to apply for special purpose national bank charters.
In 2016, the OCC laid the groundwork to allow fintech companies to apply for the special purpose national bank charters. This process began with the release of a white paper entitled "Supporting Responsible Innovation in the Federal Banking System: An OCC Perspective," discussing the principles that will guide the development of the agency’s framework for evaluating new and innovative financial products and services. The final action taken by the OCC at the end of 2016 was release of a paper, entitled "Exploring Special Purpose National Bank Charters for Fintech Companies," that discusses several important issues associated with the approval of a national bank charter.
OCC’s next step. To continue the process, the OCC proposed adding a supplement to its Licensing Manual. According to the OCC, the supplement would address the unique factors that must be considered in evaluating special purpose applications. Under the proposed supplement, a special purpose national bank would be defined as a national bank that either pays checks (or makes other similar transfers, such as using debit cards) or lends money. Accepting deposits will not be permitted, and the banks will not be covered by the Federal Deposit Insurance Corporation. The proposed supplement also provides that fintech companies that receive charters will be expected to meet the same safety and soundness and fairness standards that apply to all national banks. The proposed supplement offers details on how a fintech company’s compliance with those standards will be determined.
Challenges to OCC. With the issuance of the proposed Licensing Manual supplement, the OCC seemed to be on track to eventually issue a special purpose charter. However, the New York State Superintendent of Financial Services, Maria T. Vullo, and the Conference of State Bank Supervisors (CSBS) had other ideas. Both Vullo and the CSBS filed separate lawsuits challenging the OCC’s ability to issue the special purpose charter.
The CSBS was the first to challenge the OCC, calling the OCC’s plan "an unprecedented, unlawful expansion of the chartering authority given to it by Congress for national banks." The complaint alleged that the OCC claims the authority to create charters for a broad variety of nonbank financial services providers, regardless of whether they might be thought of as fintech companies, exceeding the agency’s authority under the National Bank Act.
In her lawsuit, Vullo alleged that "[t]he Fintech Charter Decision is lawless, ill-conceived, and destabilizing of financial markets that are properly and most effectively regulated by New York State." Vullo’s complaint also claimed that the fintech charter poses serious threats to New York consumers and businesses because the charter would include vast preemptive powers over state law. Ultimately, Vullo’s complaint was dismissed on standing and ripeness grounds since the OCC not reached a final decision on whether to grant special purpose charters to fintech companies.
4. Nonbank SIFIs no more?
The validity of FSOC’s ability to designate non-bank financial companies as SIFIs under the Dodd-Frank Act was left unresolved in 2017 despite the fact that the appellate court deciding the issue heard oral argument (audio file) in October 2016. A federal district court had ruled, in early 2016, that FSOC’s SIFI designation for MetLife, Inc., was arbitrary and capricious and that FSOC acted contrary to its published guidance without explaining, or even acknowledging, the deviation.
The case of MetLife, Inc. v. Financial Stability Oversight is still unresolved due in part to the change in presidential administrations and MetLife’s own insistence.
As previously mentioned, the Trump administration sought a review of FSOC’s SIFI designation process in April. Following that action, MetLife had filed a series of motions with the appellate court to hold the appeal in abeyance until the Treasury Department released its report claiming that the results of the SIFI designation review "may substantially illuminate this Court’s consideration of the issues on appeal." The appeals court ultimately granted MetLife’s various requests.
Once the Treasury Department’s SIFI report was released, MetLife filed a supplemental brief with court arguing that "[e]ach of the fatal deficiencies highlighted by the Treasury Report requires rescission of [MetLife’s SIFI designation]." The brief also noted that "there are also sharp policy conflicts between the Report and the government’s position in this appeal."
Given the "sharp policy conflicts between the Report and the government’s position in this appeal," it is conceivable that government could change its position and align its position with the findings of the Treasury Department’s report.
Although MetLife is still attempting to shed its SIFI designation, FSOC announced, in late September, that American International Group, Inc. (AIG), is no longer in financial distress and therefore not a threat to U.S. financial stability. As a result, FSOC rescinded AIG’s designation as a systemically important financial institution, and the company will not be subject to supervision by the Federal Reserve Board and enhanced prudential standards. FSOC approved the rescission of AIG’s designation by a six-to-three vote with one member being recused. Once the rescission was announced, the Treasury Department released a document detailing the views of the Council’s seven members regarding the rescission.
Following AIG’s rescission as a SIFI, the advocacy group Third Way noted that the rescission showed that the "SIFI designation process is working" and "Dodd-Frank always intended for SIFI designations to be a dynamic process that phases firms in and out as their situations change." Third Way also pointed that the SIFI process was not like the Eagles "Hotel California" in that you can leave.
5. Changes in leadership
At the beginning of 2017, before Trump was even inaugurated, there were calls to fire "King Richard" Cordray by Sens. Ben Sasse (R-Neb) and Mike Lee (R-Utah). After Trump’s inauguration, Rep. Jeb Hensarling also called on the president to fire Cordray. As already noted, Cordray left on his own accord.
Beside the changes being litigated at the CFPB, the three bank regulatory agencies—the OCC, Fed, and FDIC—are also in the process of having their leadership changed.
Fed changes. At the Fed, the president was given the opportunity to name a new Chairman, as well as other Fed Governors.
In early February, Daniel K. Tarullo announced that he was resigning as member of the Fed and would be leaving on or around April 5, 2017. In his resignation letter to the president, Tarullo stated, "It has been a great privilege to work with former Chairman Bernanke and Chair Yellen during such a challenging period for the nation’s economy and financial system"
The president nominated Randal Quarles of Colorado to be a member of the Fed for a term expiring Jan. 31, 2032, and to be vice chairman for supervision for a four-year term. The position of vice chairman for supervision was created by the Dodd-Frank Act. The vice chairman is responsible for developing policy recommendations regarding supervision and regulation for the Fed. Quarles was also nominated for the remainder of a 14-year term expiring in 2018, and for an additional 14-year term.
After much speculation in the media, the president nominated current Fed member Jerome H. Powell to become the next Fed Chairman. In an article appearing in the New York Times, it was noted that the president was "breaking precedent" since "[the] previous three Fed chairmen were reappointed, in each case by a president of the opposite political party."
The president also announced, on Nov. 29, 2017, his intention to nominate Marvin Goodfriend of Pennsylvania as a member of the Fed’s Board of Governors. The nomination would place Goodfriend on the Board of Governors for the remainder of a 14-year term expiring on Jan. 1, 2030.
Once current-Fed Chair Janet L. Yellen departs in early February 2018, Powell is confirmed as Chairman, and Goodfriend is confirmed as a Fed Governor, the president will still have the opportunity to name three new members to get the Board up to seven members if he so chooses. At least one of these nominees must have community banking experience.
New head at OCC. Joseph Otting was confirmed by the Senate to be the 31st Comptroller of the Currency. The 54-43 vote confirming Otting was along mostly party line, with only two Democrats voting in favor of confirmation. Otting was sworn-in as Comptroller of the Currency on Nov. 28, 2017. In his remarks after being sworn into office, Otting noted that "[j]ob creation and economic growth are part of the President’s agenda, and banks can support those goals by providing capital and financial services to the consumers, business, and communities they serve."
Changes at FDIC. Finally, the president announced that he will nominate Jelena McWilliams as the next Chairperson of the Federal Deposit Insurance Corporation. She would serve the remainder of a six-year term expiring July 15, 2019, according to the White House statement. McWilliams currently serves as Executive Vice President, Chief Legal Officer, and Corporate Secretary for Fifth Third Bank in Cincinnati, Ohio. Previously, she has worked in the United States Senate and at the Fed.
6. A look ahead
It would be somewhat remiss for a "year-in-review" not to say something about what lies ahead in 2018.
The Deloitte Center for Regulatory Strategy, Americas noted that most of the "challenges and uncertainties" from 2017, such as continuing lack of clarity over the final shape of post-crisis reforms, would probably remain in 2018. The report also noted that "[t]he consensus in the US is that there will be some meaningful adjustments to the Dodd-Frank Act, but no large-scale repeal or rewrite." The report added that, on a global scale, supervisors will be turning more attention to long-term structural issues, such as fintech and climate change. Addressing changes in senior leadership of many of the world’s leading regulatory bodies, the report noted that it "remains to be seen how far new leaders will uphold the key tenets of the international supervisory agenda of the last decade, particularly its emphasis on cross-border coordination, or whether supervisory priorities will tilt more toward promoting the competitiveness of individual jurisdictions."
Martin Neil Baily and Aaron Klein of the Brookings Institution noted in a report entitled "Biggest financial regulation stories of 2017, and what to watch in 2018" that "2017 mostly served to set up 2018 as the year of action." Baily and Klein added, "Dodd-Frank is here to stay. However, 2018 is likely to feature far more significant changes in implementation of Dodd-Frank as well as potentially its most major legislative changes. But if prior years are any guide, financial regulation can be as difficult to forecast as financial markets."
This article previously appeared in the Banking and Finance Law Daily.
