Financial Services in 2013 and Beyond: Adapting to the New Regulatory Climate

The following comes to us from Charles M. Horn, a partner at Morrison & Foerster LLP. 

The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act,” or “Dodd-Frank”) in 2010 was a watershed moment in the history of U.S. financial services regulation. As we move through 2013 with many key regulatory actions still hanging in the balance, it has become apparent that Dodd-Frank has catalyzed fundamental changes in the financial regulatory environment, and that banking organizations and other regulated firms will need to understand and respond to these changes in order to manage the new environment.

How can a financial institution doing business in the United States respond to the regulatory changes resulting from the Dodd-Frank Act and adapt to the increasing intensity of financial agency supervision and regulation? Our goal in asking this question is to propose a conceptual framework for operating in the new financial regulatory environment, along with a series of concrete suggestions that will assist financial firms in planning for and responding constructively to the new environment.

In the time since Dodd-Frank’s enactment, two broad regulatory phenomena have become apparent: (i) the supervisory climate has changed, involving more extensive and intrusive examination and regulation, and (ii) many of the regulatory changes that presumably were limited to systemically important organizations are flowing down to nearly all banks,2 regardless of size. Accordingly, all segments of the banking industry will need to understand the evolving climate and prepare for new regulatory standards.

Changing rules and principles will, of course, affect different banks in different ways. At least four different private sector constituencies have specific and significant interests at stake. Large U.S. banks and large foreign banks with U.S. operations, namely, those with $50 billion or more in consolidated assets, face the most substantial changes, including new prudential standards, capital and liquidity requirements, potential restrictions on activities, and several testing and planning obligations. Mid-size banks, those with between $10 and $50 billion in assets, are subject to several of the same requirements, including stress testing and capital planning. Community banks, those below the $10 billion threshold, are likely to encounter new requirements seemingly designed only for the largest banks but that nevertheless flow down to them in some form, such as capital and liquidity planning. Finally, nonbank financial institutions that have been designated as systemically important financial institutions (“nonbank SIFIs”) by the Financial Stability Oversight Council (the “Council”) will need to comply with banking-based requirements to which they may be unaccustomed.

Dodd-Frank has also created a fifth constituency—the regulators themselves. They have received new powers, but they also must take on the unenviable task of turning the Dodd-Frank principles into meaningful and enforceable regulations. Their discretion to promulgate rules is limited; much of Dodd-Frank is devoted to telling the regulators what to do and preventing the agencies from setting the “wrong” regulatory priorities. Given their limited resources, the agencies remain in the middle of their work—a major hindrance to banks attempting to develop compliance programs while not knowing key provisions of the new requirements.

As we discuss in greater depth in this paper, a number of broad duties are emerging from the legislation and regulatory efforts to implement the statute, including obligations to:
• Review and strengthen the governance structure.
• Conduct more intensive capital and liquidity planning.
• Engage in more stringent risk management planning and testing.
• Conduct a business risk/retention analysis.
• Review the adequacy of the enterprise risk management structure
• Ensure that resources are available to the organization to help execute the tasks.
• Respond proactively to regulatory climate change.

Dodd-Frank is a work in progress, and the future decisions of the regulators will affect many of the conclusions we draw in this discussion. Still, regulatory actions to date—formal and informal—are shaping the new regulatory climate in several distinct ways.

The full article, which was originally published on May 7, 2013, can be accessed here.