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Fed Likely to Delay Slew of Critical Dodd-Frank Rules


WASHINGTON - Although Federal Reserve Board officials promised to unveil a long-awaited package of key Dodd-Frank rules by the end of the summer, the central bank is likely to need more time to complete them.

The rules, which implement Section 165 of the regulatory reform law, cover some of the biggest issues in financial services, including risk-based capital requirements, leverage, resolution planning and concentration limits.

To many, the set of rules are at the core of Dodd-Frank.

The proposals will detail how the Fed plans to regulate large, interconnected financial institutions, including non-banks, for the first time. They will also provide clarity on whether such firms will face an added capital surcharge and how regulators plan to unwind systemically important companies if they fail.

"This is absolutely the heart of Dodd-Frank; what should be the prudential standards [for] every element of supervision," said H. Rodgin Cohen, a partner at Sullivan & Cromwell.

The set of regulations-rumored to range between 1,000 to 2,000 pages-will lay out the new gold standard the industry will need to adhere to.

"It sets the tone for what the future regulatory posture is going to be for the Fed, plus the other agencies in terms of dealing with institutions," said Gil Schwartz, a partner with Schwartz & Ballen LLP and a former lawyer for the central bank. "It's critical because it will establish how companies are going to be able to grow and what limitations are going to be imposed upon them."

The scope alone explains why it is taking so long to get the rules out. For its part, the industry wants the central bank to take its time, fearing a rushed product could lead to unexpected consequences.

"If at the end of the day, the delay ends up meaning we end up getting a more thoughtful and nuanced approach to the rules, then I think the delay is worthwhile," said Satish Kini, who co-chairs the banking group at Debevoise & Plimpton LLP. "Because these issues are so important, so critical, people are willing to wait."

Experts anticipate the Fed will release the rules later this month, which would still keep it on track to tie up its rulemaking process by the end of the year. However, there are some that anticipate it could drift into early October.

But financial institutions are also hoping to see the rules soon, so they have greater clarity on what the regulations will be.

"Many institutions are already being pro-active, getting prepared for what the Fed's rules might mean, so they can be more focused on areas of weakness or gaps," said Sabeth Siddique, a director at Deloitte & Touche LLP and a former assistant director of banking supervision and regulation at the Federal Reserve Board.

The Section 165 rules are likely to be imposed at the same time regulators propose the Volcker Rule, which bans proprietary trading and limits investments in hedge funds, and the Financial Stability Oversight Council begins to offer more meaningful guidelines on what firms should be considered systemically important.

Topping that list will be what the Fed specifies when it comes to capital, liquidity and leverage rules, especially in light of the Basel III regulations.

There was some speculation the Fed could decide to go beyond the Basel III requirements, especially when it came to the capital surcharge, but those fears, at least for now, appear laid to rest.

In June, Fed Gov. Daniel Tarullo alarmed bankers when he suggested the surcharge could go as high as 7% ahead of talks with global regulators. Adding to banks' anxiety, Tarullo specified in that same speech that the special resolution regime and enhanced capital requirements under Dodd-Frank part of Sec. 165 would be viewed by the Fed as "complementary rather than as substitutes" to Basel III.

But observers have said they no longer expect the Fed to go beyond Basel III, and will just propose a capital surcharge of 2.5%, at least initially.

"Basel III is a very stringent standard for U.S. banks. It means almost a tripling of what the previous capital requirements were," Cohen said. "That's very substantial. I don't see a need at this point to go beyond. I'm not saying it should never happen, just not right now."

Siddique doesn't expect the Fed to promise the buffer won't go above 2.5%."They would say generally it would be in this range, but depending on the size, complexity of the institution, we would expect the institution to keep the appropriate level."

The other major issue of concern is how the Fed will regulate nonbank financial institutions deemed systemically important-a pressing issue for those that have never been supervised by the central bank.

To be sure, most observers expect the Fed to tread carefully in showing some flexibility, and not being too prescriptive across the board in its rule writing. But that's not to say the Fed won't get specific on who the rules will apply to and how.

"If they're too prescriptive it kind of puts certain institutions in a box," said Siddique. "They want to convey principles in a way that offers sufficient flexibility, enhances safety and soundness,."

Others, agreed, saying the last thing the industry wants is rigidity. "The Fed has a history of being reasonable in establishing procedures and establishing requirements," Schwartz said.

 

Donna Borak writes for American Banker.