Trading a new Dodd-Frank Act

“The key elements of the Dodd-Frank Act in the cross hairs of President Trump (and his intentions towards these) are:

• The stress tests: relax them
• The Volker Rule: redefine (at least) the rule and permit banks to make speculative investments with deposit insured funds
• The Fiduciary Rule: enters into force this April and would stop the sale of high fee & commission products in the name of greater choice
  

Clearly, if you are in the banking and investment business such changes would mean more profit. At what cost is another matter.”

That excerpt comes from tomorrow’s edition of our research newsletter along with a specific trade idea close to execution. A trial accessing the research can be obtained here.

A broader concern in the discussion of Dodd-Frank is would such changes be, on balance, a good turn of policy? It is easy to see how they might not.

• For example, relaxing the stress tests is a step towards greater bank sector consolidation and thus increased too-big-to-fail risk. By what process might this occur? Well, should the threshold defining “systematically important financial institutions” (SIFIs) be raised it will promote M&A activity that creates larger entities that flirt with, but do not meet, SIFI status. Such new entities raise consolidation risk incrementally.

• Reinterpreting or abolishing the Volker Rule risks going all the way back to the mixing of commercial and investment bank activities that the Glass-Seagall Act abolished after the Great Depression. Glass-Seagall was specifically intended to create a firewall between customer deposits and bank speculation with those funds. Its systematic erosion in the name of “competitiveness” was a material factor in the 2007 to 2009 crisis.

• It is difficult to accept as serious an argument that suggests an incentivised salesmen sets out the case between a high commission product and a lower commission product evenhandedly. The contrary assumption has been seen before, very recently, in the subprime mortgage market. The Fiduciary Rule is due to take effect this April. A still birth would be a cause for concern.

There are usually ways existing regulatory legislation can be finessed for the greater good. With these three elements doing so requires great care.