The following is a speech given at the recent AICGS Symposium “Fueling the Recovery: The Role of Capital Markets and Banks” in Frankfurt, Germany by Roger Blissett, Managing Director for U.S. Strategy at RBC Capital Markets and Chairman of the Institute of International Bankers. The Symposium featured two panel discussions focused on analyzing the impacts of economic and financial policies in Germany and the United States in order to increase cooperation and understanding in the transatlantic relationship. Mr. Ludwig was a member of the second panel, “The Changing Banking Sector: What Kind of Banks Do We Need?” during which panelists discussed the changing banking industry, evolving banking regulations, and differences between the U.S. and European banking climates.
Good afternoon. It’s a pleasure and fitting to join you in Frankfurt this afternoon for this panel. Given this city’s history as a hub of commerce and finance in continental Europe, I can’t think of a better place to host a discussion of the kind of policies that banks need post the recent financial crisis. I want to thank Dr. Jackson Janes for inviting me to participate on this panel. Notwithstanding the complicated and evolving topic we will discuss today, it is a welcome break from the ongoing partisan political battles that absorb Washington, D.C. these days. In addition to my day job as Managing Director for U.S. Strategy at RBC Capital Markets, I also serve as Chairman of the Institute of International Bankers, a trade association with offices in New York and Washington that advocates on behalf of internationally headquartered banking organizations operating in the United States. The IIB represents banking organizations from over 35 countries around the world, representing a crosssection of OECD and emerging economies.
Given Alexander’s Policy report on funding the recovery and the prior panel discussion, my remarks will focus on the role of the U.S. operations of Foreign Banking Organizations (FBOs), post the Dodd Frank Act (DFA). As I think a number of you in the audience know, many voices within and without the U.S. today view the U.S. as a major exporter of financial regulation around the globe, particularly through the extraterritorial application of certain provisions of the Dodd-Frank Act, which was signed into law in 2010 and is still in the process of being implemented by the various regulatory agencies.
Since the IIB’s annual conference in March, there has been a great deal of discussion about the strategic direction of the U.S. operations of FBOs. This discussion has accelerated since submissions of the last wave of resolution plans in December, 2013 and in anticipation of submitting implementation plans pursuant to the new prudential standards included in FBO 165 of DFA. I hope to provide a brief review of where things stand.
But before doing so, let me set the context of where this all started. As all of us here today remember the trauma from the Financial Crisis of 2008. It was the scariest time I have witnessed over my twenty-seven year career on Wall Street, notwithstanding having started my career days before the stock market crash of October, 1987. For instance, estimates of aggregate job loss in OECD countries range from the beginning of the crisis in 2008 at 34 million to 42.1 million in 2010. From the time, the first tremors of the crisis were felt in the U.S. in the summer of 2007 to its peak in 2008, when $34.4 trillion in wealth was destroyed. For perspective, based on an article written by C.K. Liu at the Roosevelt Institute,this amount of lost wealth is more than the 2008 annual gross domestic product of the U.S., the European Union and Japan combined. Further, according to the U.S. Treasury Department in the U.S. alone household wealth declined by $19.2
Against this backdrop, the U.S. was the first to Act with President Obama signing the Dodd Frank Act into law on July 21, 2010. Implementation of the Act however has been has been precipitous in some areas and painfully slow in others. According to Davis Polk, as of its June, 2014 progress report, of the required 398 rulemakings required by DFA 208 have been finalized, representing 52.3%.
While the entire Act has changed the paradigm of financial regulation in the U.S., the most relevant sections followed the principles of the G-20 Communiqué and speak to:
• Financial stability,
• Orderly resolution of systemically important financial institutions,
• Transparency and accountability, specifically requiring a new trading and reporting framework for derivatives,
• Prohibitions on proprietary trading,
• New minimum capital, liquidity and leverage requirements, and
• Finally, the establishment of a new consolidated consumer protection
Needless to say that is a very cursory and rudimentary summary of the main areas. With that background, the most recent development under Title I, the Financial Stability mandate under DFA, occurred earlier this year – on February 18th to be precise – when the Federal Reserve Board issued its final rule on the application of enhanced prudential standards to foreign banking organizations (FBOs), specifically under Section 165 of the Dodd-Frank Act.
The reach of this rule is dramatic. Approximately 100 foreign banking organizations will be touched in some way by these rules, and 15 to 20 of those FBOs will be forced to re-structure their non-branch U.S. operations under an intermediate holding company, or IHC, which will be subject to U.S. bank capital requirements comparable to those applied to U.S. bank holding companies. This requirement to trap capital at the IHC level has gotten the attention of both foreign and domestic supervisors. At The Institute of International Bankers annual conference in March, SEC Commissioner Dan Gallagher took direct aim at the Fed’s IHC requirement and the inappropriate application of bank capital rules to foreign-owned broker-dealers in the U.S. Commissioner Gallagher said the Fed rule could have “a profound impact on the SEC-regulated subsidiaries of large foreign banks, one that would ripple through our capital markets as a whole.”
The final rule is being processed, but we’ve already seen reports in the press about how some large European banks are rethinking their U.S. strategies and taking steps to shrink their U.S. balance sheets. Those and other reports suggest that the most likely areas to be cut are in the repo and securities lending businesses. One potentially destabilizing consequence of the Fed’s rule is that the business could migrate to the less-regulated shadow banking system. Or, the gap could be filled by U.S.-owned broker-dealers, increasing concentration risk.
While I realize that encouraging the growth and access of capital markets to SMEs is a key priority of the ECB, it will be critical that this initiative is pursued on the basis of not disadvantaging the regulated banking sector. I look forward to commenting more on this during the course of the panel.
Let me stop there and I hope we can delve into other regulatory reform areas such as Volcker, OTC Derivatives Regulation and Section 716 Swaps “push out” requirements. I also anticipate our conversation related to how the financial sector will evolve as a result of global regulatory reform.