The U.S. House of Representatives is poised to vote as early as today on two significant tweaks to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The two measures, part of a package of changes incorporated into the Insurance Capital Standards Clarification Act of 2014, are small but important improvements and would represent the most significant effort so far to update the landmark financial reform bill. Although a package passed by the House would still need to be approved by the Senate to move to the president’s desk, both of these provisions enjoy bipartisan support. They could set the stage for a broader Dodd-Frank improvement package when the new Congress takes shape next year.
Avoiding One-Size-Fits-All Capital Rules
One change in the House legislation would provide the Federal Reserve with more flexibility to tailor capital requirements for insurance companies deemed systemically important financial institutions (SIFIs); under the current rules, insurance companies face the possibility of being shoehorned into capital rules designed for banks that have very different business models. Asking Congress to clarify the desirability, and the Federal Reserve’s flexibility, to effect such tailoring was one of the five key recommendations in the Bipartisan Policy Center’s (BPC) recently released report, Responding to Systemic Risk: Restoring the Balance.1
Dodd-Frank created a mechanism to bring systemically important nonbanks under the umbrella of federal financial regulation, specifically empowering the Federal Reserve to regulate these institutions. But the Fed’s supervisory practices were geared primarily toward banks, which have different business models than other financial institutions like insurers, asset managers, and consumer finance companies. As Responding to Systemic Risk noted, that means one-size-fits-all regulation may not be appropriate:
“While it is possible for nonbank companies to present the type of systemic risk that warrants designation as nonbank SIFIs, the risks presented by such institutions are likely to be different from the ones presented by predominantly banking organizations. As a result, the consolidated supervision of such institutions ought to be tailored to address those different risks.”2
To be sure, the original Dodd-Frank legislation made clear in several places that in developing prudential standards for nonbank SIFIs, the Federal Reserve may and shall take into account the ways nonbank SIFIs differ from banks.3 Indeed, Federal Reserve Chair Janet Yellen and Governor Daniel Tarullo agree that tailoring is prudent and that the Federal Reserve will tailor to the extent that it can.4
However, Section 171 of Dodd-Frank (the “Collins Amendment”) has been interpreted by the Federal Reserve as tying its hands with regard to setting capital leverage standards for nonbank SIFIs. Senator Collins herself has indicated that is not consistent with her intention to allow tailoring,5 and she supports this change.
The measure is timely given that the Financial Stability Oversight Council (FSOC) has designated three insurers (AIG, Prudential Financial, and most recently, MetLife6) as systemically important over the last two years. But the provision is limited in scope since it would only provide regulatory flexibility for insurance companies rather than for all non-bank financial institutions..
The Senate version of the bill (S. 2270) was introduced by Sens. Susan Collins (R-ME), Sherrod Brown (D-OH), and Mike Johanns (R-NE) and was passed by unanimous consent in June. Companion House legislation (H.R. 4510) has 204 co-sponsors (116 Republicans and 88 Democrats)7. BPC has consistently supported this legislation, testifying in support of it before the Senate Banking, Housing, and Urban Affairs Committee.
While BPC supports this legislative fix to the problem, we encourage Congress to think more broadly. The FSOC may designate other companies in different industries in the future and has already begun reviewing the asset management industry, which could result in further designations. Congress should address potential future problems with tailoring by clarifying the intent of Dodd-Frank for all nonbank SIFIs, not just for insurance companies.
Facilitating Compliance with the Volcker Rule
Another change in the House legislation would allow banks to avoid having to sell certain complex investments under fire-sale conditions as they work to comply with the Volcker Rule. A separate provision in the House bill would modify Volcker Rule regulations on the divestiture of collateralized loan obligations (CLOs). CLOs are securities backed by pools of business loans and are held by many financial institutions. The Volcker Rule prohibited banks from owning equity in CLOs and required that they divest themselves of CLOs they already own.
While restricting CLO ownership on a prospective basis has merit, requiring divestiture runs the risk of forcing banks to sell their CLO interests at a substantially reduced price since potential buyers know that banks have to sell. As BPCC’s Aaron Klein wrote, the result can be a fire-sale dynamic that “would create unnecessary losses at banks and produce windfall profits for those who demand to buy [CLOs] at below market rates.”8
The House bill would extend the divestiture period by two years, a move that has already been supported by regulators. The legislation also has strong bipartisan support, having been reported on a 53-3 vote by the House Financial Services Committee and passed by the full House via voice vote. That is why BPC believes the current measure represents a pragmatic fix to the Volcker Rule.
If the House and Senate are able to agree on a package of amendments to Dodd-Frank, it will be the first such package passed by Congress. Admittedly, these bills would not make major changes to existing law. However, for a Republican Party that has largely focused on repealing Dodd-Frank and a Democratic Party that has resisted any changes to the law, passage would mark the overcoming of significant psychological hurdles on both sides. These two changes incorporated in the legislation before the House are sensible improvements and should be enacted. We hope that it presages better odds of Congress passing a Dodd-Frank improvement package in 2015.
1 John C. Dugan, Peter R. Fisher, and Cantwell F. Muckenfuss III, “Responding to Systemic Risk: Restoring the Balance,” Bipartisan Policy Center, September 2014, pp. 53-8. Available at: https://bipartisanpolicy.org/sites/default/files/BPC%20Responding%20to%20Systemic%20Risk.pdf.
2 Dugan, Fisher, and Muckenfuss, Ibid., p. 53.
3 See, for example, Section 165 (b) (3) (A), Section 165 (a) (2) (A), and Section 115 (a) (2) (A).
4 See: Victoria Craig, “Janet Yellen Talks Disappointing Data, Weather on Capitol Hill,” Fox Business, February 27, 2014. Available at: http://www.foxbusiness.com/economy-policy/2014/02/27/janet-yellen-talks-dissapointing-data-weather-on-captiol-hill/. See also: Daniel K. Tarullo, “Final rules to implement the enhanced prudential standards of section 165 of the Dodd-Frank Act,” memorandum to the Board of Governors of the Federal Reserve System, February 7, 2014. Available at: http://www.federalreserve.gov/aboutthefed/boardmeetings/memo_20140218.pdf.
5 Susan Collins, “Finding the Right Capital Regulations for Insurers,” statement to the Subcommittee on Financial Institutions and Consumer Protection of the Senate Committee on Banking, Housing, and Urban Development, March 11, 2014. Available at: http://www.collins.senate.gov/public/index.cfm/press-releases?ContentRecord_id=02467e48-1aff-4085-91e8-ff0c3884ac67.
6 The FSOC voted on September 4 to designate MetLife as a SIFI but has not finalized its vote yet. MetLife has 30 days from the initial vote to appeal its decision on “arbitrary and capricious” grounds. The statutory language for the designation process can be found in Section 113 of the Dodd-Frank Act. See: http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/html/PLAW-111publ203.htm.
7 H.R. 4510’s lead sponsors are Reps. Gary Miller (R-CA) and Carolyn McCarthy (D-NY). The updated version of the legislation was introduced by Rep. Andy Barr (R-KY) and includes H.R. 4510 and three additional provisions, including Barr’s own bill, the Restoring Proven Financing for American Employers Act (H.R. 4167).
8 Aaron Klein, “Regulators Must Preempt Volcker Fire Sales,” American Banker, February 24, 2014. Available at: http://www.americanbanker.com/bankthink/regulators-must-preempt-volcker-fire-sales-1065770-1.html.