John D. Wright, of Wells Fargo & Company, just finished giving his thoughts about the Dodd-Frank Act’s new “abusive” standard. Section 1031 of the Dodd-Frank Act vests the newly created Bureau of Consumer Financial Protection with the authority to take enforcement action against banks and other covered entities from engaging in unfair, deceptive or abusive practices. Mr. Wright highlighted § 1031(d), which defines the abusive standard, claiming that the standard introduces “radically new concepts regarding the customer’s understanding of banking products, the customer’s suitability for a banking product, and the bank’s duty to act in the interests of the consumer.”
Mr. Wright pointed out that a lack of clarity in the statute’s language and guidance from regulators makes for muddy waters for large banks future interactions with customers. First, the wording of § 1031(d)(2)(A) seems to require banks to determine each customer’s “financial literacy” to a previously unknown degree. Furthermore, banks will require further clarification as to whether the standard the Bureau will apply is that of a reasonable consumer or a particular consumer. Second, § 1031(d)(2)(B) may require that a bank determine whether a particular customer is suitable for a financial product, regardless of whether there was clear and conspicuous disclosure of product terms, even if the customer understands it. Finally, § 1031(d)(2)(C) may create a legal duty to act in their customers best interest, beyond their normal trust or investment advisory settings.
For more, please view Mr. Wright’s paper here.
(click here to see the full abstract of Mr. Eric Finseth’s presentation at the Symposium) While Silicon Valley tech companies and VC firms did not have any clear hand in contributing to the recent financial crisis, several new regulations may nonetheless present new burdens on their industry. While exemptions were written throughout most of the Dodd Frank act to prevent VC firms from the obligations imposed on other financial institutions, some “collateral damage” has unfortunately manifested itself (in preventing relatively small companies from financing themselves through the “friends and family” channel).
(click here to see the full abstract of Mrs. Mary Dent’s presentation at the Symposium) Many individuals in D.C. focus on the importance of growth and innovation to fuel the continued growth of the national economy. Despite this rhetoric, legal regulation have historically (inadvertently) hampered the flow of capital into high growth industries through legislation that fails to recognize its effects on these industries. Regulations implemented in response to dramatic events in the economy have been a source of these inhibitory regulations, and Dodd-Frank is no exception. Mrs. Dent presents three policy recommendations that would correct these regulatory inefficiencies and facilitate the flow of capital necessary to fuel the high growth industries that underlie the future of the U.S. economy.
(click here to see the full abstract of Mr. Mark Perlow’s presentation at the Symposium) The financial crisis demonstrated clearly that money market funds present certain systemic risks when they “break the buck.” Before the crisis there were already a number of regulations in place for money market funds, on matters such the ratings of investments that money market funds can invest in, disclosure of investments, and net asset value per share ratios (among others). In response to the financial crisis, new regulations have been passed or are being proposed to mitigate the risks of runs on these funds in the future. Mr. Perlow notes that money market funds provide a socially useful alternative to the banking system (particularly for certain, essential financing purposes and maturity transformation in the market) which may warrant caution in future regulation.
(click here to see the full abstract of Mr. Erik Gerding’s presentation at the Symposium) Hedging provides financial institutions with an important tool for spreading risk and consequently provides greater liquidity for the market (at least in certain asset classes). However, the money multiplier effect that results from chains of credit default swaps, when combined with the use of leverage, can create conditions that facilitate asset bubbles. Recognizing these conditions is essential to properly identifying and correcting and smoothing out future “boom-and-bust” cycles in the financial markets.
Nancy Wallace from the Haas School of Business followed her fellow Haas colleague with a talk on the evolution of residential mortgage recording and tracking and the legal implications of MERS.
Some Key Highlights:
- Residential Mortgage Recording and Tracking has Diverged: while so-called “Shoebox” technology continue to be used to record and track property interest transfers (property sales) at county-level recording offices, the MERS system has supplanted the old technology and now comprises over 60% of the recording/tracking market.
- Chain of Title and Chain of Mortgage (Promissory Note) Separated Under MERS: the MERS system has detached the dual-recording/tracking of both property title and mortgage, which has significant complications for determining property ownership and mortgage liability.
- Transfer Language in Pooling-Servicing Agreement (PSA): the property transfer language MERS-tracked PSAs use stock MERS language that some courts have not given full recognition.
- Why does this matter: participants in the market for mortgage-backed securities may suffer significant financial losses if the validity of MERS transfers cannot be upheld.
A complete description of the presentation can be found here.
We’re blogging live from today’s Dodd-Frank Symposium!
Dwight Jaffee from the Haas School of Business kicked off the first set of Securitization and Governance panel presentations with a talk on Bank Regulation and Mortgage Market Reform.Key Highlights from the presentation:
- Moral Hazard in Securitization is wrong: Jaffee says that the hoopla over securitization causing the mortgage bubble and financial crisis is misplaced and the 5% risk-retention requirement will do nothing but restrict fundamental value of securitization, which is to spread out and segment risks.
- The private market can fully replace the GSEs: Jaffee thinks the proposals to wind down the GSE are generally a good thing and believes that the private market is more than capable of meeting the credit demand the GSEs currently now provide. Citing Europe, which Jaffee says has similar rates of homeownership as the U.S., Jaffee says that the GSEs have had minimal if any impact on spurring additional homeownership.
- Mortgage Contracts will Default to Safe, Low Risk Terms: Jaffee argues that in the absence of GSEs in housing market, the lack of conforming loan standards would nonetheless push borrowers toward the safest, least risky loan terms (i.e., the market would correct itself and move away from costly terms like prepayment penalties.
For a full read of Dwight Jaffee’s ideas, see his working paper on mortgage market reform.
The SEC recently proposed a rule that would require greater disclosure of performance-based compensation structures for broker-dealers and investment advisers at companies that manage greater than $1 billion in assets. In addition, the rule would enable SEC regulators to prohibit compensation schemes that it believes promote inappropriate risk-taking and regulators may even require partial deferral of incentive-based compensation for up to three years (for companies managing greater than $50 billion in assets).
This rule is just one of many that the SEC, in collaboration with various other regulatory agencies, has been empowered to implement under the Dodd-Frank Act in order to correct incentive structures which many believe contributed to the recent financial collapse. Many financial institutions (and non-financial institutions, for that matter) pay their employees and executives based on their individual, as well as on the company’s, performance in a given period of time. These compensation structures enable firms to overcome various principal-agent problems that may otherwise exist between shareholders and company executives (as well as between company executives and lower-level employees). The problem with this scheme is that it incentivizes individuals to take risks, particularly risks that pay off in the short term, as the employees stand to benefit tremendously if the risks pay off and yet are not faced with the prospect of personally losing the money that is invested if the risks don’t pay off. The result of this incentive structure is that broker-dealers and investment advisors may end of taking excessive risks, in pursuit of the high yields that fuel their own personal compensation.
Under Loan Originator Compensation and Steering rules issued by the Federal Reserve, new restrictions on loan originator compensation and steering practices will go into effect on April 1, 2011. The new rules amend Regulation Z, Federal Reserve rules for implementing provisions of the Truth in Lending Act (TILA), and are consistent with the § 129 TILA provisions in the Dodd-Frank Act (15 U.S.C. 1639(l)(2)). In particular, the new rules have three major prohibitions:
- Loan originators compensation must be based on the principal loan amount and cannot be based on any other loan terms or condition, such APR or interest rate. These new restrictions effectively end the practice of loan originators receiving yield-spread premium compensation from lenders. (more…)
The SEC to define “swap execution facilities”With the enactment of the Dodd-Frank Act, a new type of regulated marketplace was created known as “swap execution facilities” (“SEFs”) for which the Act established a comprehensive regulatory framework that would require swaps to be executed either on an exchange or on a SEF. The SEFs are defined under Dodd-Frank as a “trading system or platform in which multiple participants have the ability to execute or trade security-based swaps by accepting bids and offers made by multiple participants in the facility or system.” SEFs are a new category of markets, regulated by the Commission, where security-based swaps can be traded.
The SEC, recently, voted unanimously to propose rules defining SEFs and establishing their registration requirements. In a statement by SEC Chairman, Mary L. Schapiro, she explained that the four-part proposal would: 1. Provide a definition for a security-based swap execution facility – outlining what types of markets would meet the definition; 2. Address what it means for a security-based swap to be “made available to trade” on a SEF or an exchange; 3. Implement the 14 core principles detailed in Dodd-Frank (listed below); and 4. Establish a registration process for SEFs that would provide comprehensive information for the Commission to evaluate applications for registration.
The SEFs would be required to:
- Comply with the core principles and any requirement the Commission may impose.
- Establish and enforce rules governing, among other things, the terms and conditions of security-based swaps traded on their markets; any limitation on access to the facility; trading, trade processing and participation; and the operation of the facility.
- Permit trading only in security-based swaps that are not readily susceptible to manipulation.
- Establish rules for entering, executing and processing trades and to monitor trading to prevent manipulation, price distortion, and disruptions through surveillance, including real-time trade monitoring and trade reconstructions.
- Have systems to capture information necessary to carry out its regulatory responsibilities and share the collected information with the Commission upon request.
- Have rules and procedures to ensure the financial integrity of security-based swaps entered on or through the facility, including the clearance and settlement of security-based swaps.
- Have rules allowing it to exercise emergency authority, in consultation with the Commission, including the authority to suspend or curtail trading or liquidate or transfer open positions in any security-based swap.
- Make public post-trade information (including price, trading volume, and other trading data) in a timely manner to the extent prescribed by the Commission.
- Maintain records of activity relating to the facility’s business, including a complete audit, for a period of five years and to report such information to the Commission, upon request.
- Not take any action that imposes any material anticompetitive burden on trading or clearing.
- Have rules designed to minimize and resolve conflicts of interest.
- Have sufficient financial, operational, and managerial resources to conduct its operations and fulfill its regulatory responsibilities.
- Establish a risk analysis and oversight program to identify and minimize sources of operational risk and to establish emergency procedures, backup facilities, and a disaster recovery plan, and to maintain such efforts, including through periodic tests of such resources.
- Have a chief compliance officer that performs certain duties relating to the oversight and compliance monitoring of the security-based SEF and that submits annual compliance and financial reports to the Commission.
The SEC has already engaged in several rulemakings related to the derivatives market which include: defining security-based swap terms, establishing reporting rules, rules on data repositories, fraud prevention, swap conflict, and reporting of pre-enactment security-based swaps. Public comments on this recent proposal should be sent to the Commission by April 4, 2011.