Legislation would exempt banks from many prudential rules if they agree to hold more capital; retroactively repeals FSOC's SIFI designations and the FDIC's orderly liquidation regime; converts CFPB to commission, subjects Fed's supervisory actions to Congressional appropriations

In a speech at the Economic Club of New York on June 7, 2016, House Financial Services Committee Chairman Jeb Hensarling (R-TX) unveiled a sweeping new Republican proposal to repeal much of the 2010 Dodd-Frank financial reform law, replacing it with a series of alternative mechanisms intended to substitute market discipline for what Hensarling called burdensome regulations that have stifled growth. Chief among these is a principle in which banks that agree to hold substantially higher levels of capital and a higher "leverage ratio" would be exempted from many prudential rules imposed by the Federal Reserve after the financial crisis.

Hensarling's Financial CHOICE Act, which has little chance of being taken up in the Senate this year, is expected to be among the six broad policy proposals that House Republicans are releasing throughout this month as part of Speaker Paul Ryan's (R-WI) agenda-building project, "A Better Way." After the speech, Hensarling reportedly met with presumptive Republican presidential nominee Donald Trump to discuss the legislation.

Attached with this Alert please find the text of Hensarling's prepared remarks and an executive summary of the Financial CHOICE Act. Hensarling has said that legislative text for the bill will be released in the coming weeks.

Says Dodd-Frank has failed. Hensarling began his speech with a scathing critique of the Dodd-Frank Act. "Simply put, Dodd-Frank has failed," he said. "It's time for a new legislative paradigm in banking and capital markets. It's time to offer all Americans opportunities to raise their standards of living and achieve financial independence." He said that "those on the left who gave us Dodd-Frank believe in the principle that human nature is self-destructive and that people … are fundamentally ignorant. Therefore, when it comes to markets, they believe private businesses are essentially predatory in nature and people are hapless victims. Consequently, their solution to the financial crisis was to impose yet even more stifling government regulations." But Hensarling said that the 2008 financial crisis was not caused by deregulation but by "dumb regulation," such as affordable housing goals for Fannie Mae and Freddie Mac that led the housing GSEs to invest aggressively in risky subprime mortgages.

Hensarling described at length what he saw as problems caused by Dodd-Frank: "Big banks are bigger and the small banks are fewer," so even more banking assets are concentrated in the largest banks; the Act codified "Too Big to Fail" in the form of systemically important (SIFI) designations of banks and non-banks; and the prospect of taxpayer-funded bailouts during an "orderly liquidation" of a failing institution. Hensarling said federal guarantees of financial sector liabilities "have increased to a whopping 60% of total liabilities post-Dodd-Frank." He said the Volcker Rule, which prohibits banks from doing proprietary trading with taxpayer-insured funds or sponsoring certain private funds, and parts of the Basel Committee's capital rules together have led to "dramatic bond market illiquidity and volatility," which "could well be the source of the next financial panic." He said bank loans to small businesses have dropped and that consumers "have been hurt by the loss of free checking" and "higher interest rates on their credit cards."

Echoing a charge that Republicans have leveled for years, Hensarling said Dodd-Frank "represents a breathtaking, unconstitutional outsourcing of legislative powers to the executive branch" in the form of the new Consumer Financial Protection Bureau (CFPB) and the Financial Stability Oversight Council (FSOC), which he called "a super-group of regulators [that] can exert ultimate functional control over almost any large financial firm in our economy, and do so with utter disregard for due process."

The Financial CHOICE Act

Hensarling outlined the major features of the bill:

Opt out of rules in exchange for holding higher capital. Hensarling said that under Dodd-Frank, "capital standards that were already complex have become even more complex and controlling with the latest iteration of the Basel capital accords." He said his bill would "allow banks to opt-in to an alternative regime that replaces growth-strangling regulation with reliable accountability." In exchange for agreeing to hold significantly more capital in reserve, banks would be exempt from Basel Committee capital and liquidity requirements as implemented by U.S. regulators, would also "be able to make capital distributions freely"; could consummate transactions without being subject to challenge by regulators arguing that such deals would increase risk to the financial system; and would be free of a number of other regulations that pre-date Dodd-Frank. Banks would also not have to comply with Dodd-Frank's "heightened prudential standards" as implemented by the Federal Reserve.

"To avail themselves of this exchange, many larger banks will have to raise significant additional equity Capital," Hensarling said. Banks would have to maintain at least a 10% leverage ratio and, at the time of the election, have a composite CAMELS rating of 1 or 2. Hensarling said the 10% leverage ratio was significantly higher than the 3% ratio required under the Basel III regime, or the 6% leverage ratio required for the largest "G-SIB" banks by U.S. regulators. "Collectively, we estimate that those U.S. banks currently identified by regulators as G-SIBs will need to raise several hundred billion dollars in new equity to qualify for regulatory relief in our plan, assuming their asset size remains constant," he said.

Hensarling added that the risk-weighting system used by the Basel rules is not effective because it is "far too complex, requiring millions of calculations to measure capital adequacy," and because it gives an advantage to the largest financial institutions "that have the resources to navigate its mind-numbing complexity."

Repeal of Title II orderly liquidation authority. Hensarling said the bill would repeal Dodd-Frank's Title II, which established a process managed by the FDIC in which large, failing institutions can be wound down and ultimately dismantled. He called orderly liquidation a regime "whereby government bureaucrats can exercise vast discretion to favor some creditors and impose losses on others." In its place the bill would create a new bankruptcy chapter for large financial firms, which would "provide certainty for stakeholders to understand how the firm will be treated based on centuries of well-settled legal precedent." The bill would also "prohibit the use of Treasury's Exchange Stabilization Fund to bail out a financial firm or its creditors, and impose significant, new and real constraints on the Federal Reserve's emergency lending authority."

Repeal of FSOC SIFI designations. The bill would repeal the FSOC's authority to designate SIFI non-banks going forward and retroactively repeal the Council's previous SIFI designations of AIG, Prudential and GE Capital.

Other changes. The Financial CHOICE Act would also:

Repeal the Volcker Rule and the "Durbin Amendment" to Dodd-Frank, which requires the Federal Reserve to limit the interchange fees that banks charge retailers for processing debit-card transactions.

Require every new every financial regulation to pass a rigorous cost-benefit test. Hensarling said this was a part of the REINS Act (HR 427), passed by the House in July 2015, which also requires that all "major" regulations be approved by Congress before they can take effect.

Place all the financial regulatory agencies on budget. The bill would subject the Federal Reserve's prudential regulatory and financial supervision activities to the congressional appropriations process, with an exception for the Fed's conduct of monetary policy, which would be left off-budget.

Convert the CFPB, the Office of Comptroller of the Currency and the Federal Housing Finance Agency into five-member bipartisan commissions.

Repeal the "Chevron doctrine" that requires the courts to give deference to financial regulatory agencies' interpretation of the law.

Impose "the toughest penalties in history" for financial fraud, self-dealing and deception. "We will double the cap for the most serious securities law violations and will allow for triple monetary fines when penalties are tied to illegal profits," Hensarling said. "We will give the SEC new authority to impose sanctions more closely linked to investor losses, and increase punishments even more for repeat offenders. We will increase the maximum criminal fines for both individuals and firms that engage in insider trading."

Ensure that disciplinary proceedings are public and that all fines imposed by regulatory agencies are sent to the Treasury for deficit reduction.

The bill includes a package of capital formation provisions that Hensarling said would: 1) exempt all asset classes except residential mortgages from Dodd-Frank's "risk retention" requirement; 2) expand the Sarbanes-Oxley 404(b) auditing exemption for smaller public companies, and 3) eliminate Dodd-Frank's mandatory disclosures for "extractive" industries such as mining and oil & gas companies, along with the Act's required disclosure of the pay ratio between the CEO and an average employee of a financial firm.

Hensarling said this section of the bill would also allow small businesses to better compensate their employees with ownership in the business; provide a voluntary exemption data reporting requirements; change the regulatory regime for Business Development Companies so that BDCs "can invest more in small and middle-market companies"; give the SEC authority to register venture exchanges; allow broker-dealers to issue research on exchange-traded funds; expand the SEC's definition of "accredited investor"; and allow startup firms to meet with angel investors without violating securities laws.

The bill also includes more than two dozen provisions relaxing a number of regulatory requirements for community banks — such as the creation of an 18-month examination cycle, allowing exam reports to be released earlier, and allowing all mortgage loans issues by such banks to be considered "Qualified Mortgages" under new CFPB's ability-to-repay rules, as long as the bank holds such loans in portfolio.

Reaction

Maxine Waters (D-CA), ranking member on the House Financial Services Committee, called Hensarling's bill "a gift to nearly every special interest that the Financial Services Committee oversees. While the plan purports to get tough on bank crime, it gives Wall Street a 'get out of jail free' card by including legislation that would gut law enforcement's ability to prosecute financial fraud. It fakes a step in the right direction by requiring higher capital ratios at the largest banks, but immediately takes two steps backward by eliminating any oversight of the riskiest activities at banks and non-banks by dismantling the [FSOC] and subjecting bank regulators to the appropriations process. And it takes yet another shot at the Labor Department's much-needed conflict of interest rule, threatening Americans' hard-earned retirement savings."

Senate Banking Committee Ranking Member Sherrod Brown (D-OH) said, "While the American people want stronger oversight of Wall Street, Republicans time and again have sought to make life easier for mega-bankers and tougher for ordinary Americans. This latest proposal is more of the same. It underscores the collective amnesia of many in Congress and on Wall Street about how devastating the financial crisis was for an entire generation of working and middle-class Americans. We've made too much progress to let special interests and their congressional allies undermine reform and once again leave Americans exposed to the abusive lending and risky Wall Street gambling that almost destroyed our economy."

During his daily press briefing today, White House Press Secretary Josh Earnest said, "There should be no more confusion about which party is on the side of big banks and large financial interests on Wall Street … [Dodd-Frank reforms] essentially guarantee that taxpayers will not be on the hook for bailing out big banks if their risky bets go south. But if you tear it down like House Republicans say that they want to do, that will allow big banks to go back making risky bets and put taxpayers on the hook once again for bailing out those banks to prevent a second Great Depression. That doesn't make any sense … It's really hard for Republicans to make a case that it is at all in our economic interest to tear down the reforms that have already done a lot to make our economy stronger and more stable."

Senate Majority Leader Mitch McConnell (R-KY), in an interview today with Fox Business News, said, "I think it's important to set the predicate for what we will do if we are able to get the White House and begin to change that [Dodd-Frank] law. It was a terrible law. You know, it was sold as a Wall Street measure. It has really hit Main Street extremely hard … our system is kind of suffering from sclerosis as a result of Dodd-Frank. And of course, Jeb Hensarling is one of our brightest members. I haven't looked at what he's doing yet, but I'm sure it's the kind of thing that I would approve of. And of course, we would like to put on the desk of a president who would sign it … I think the Volcker Rule is very unpopular. Also, the CFPB has had a negative impact on our economy."

Former CFTC chairman Gary Gensler, an adviser to former secretary of state Hillary Clinton, a candidate for the Democratic nomination for president, said the Hensarling proposals are "ill-conceived … Hillary Clinton strongly opposes Chairman Hensarling and Donald Trump's efforts to gut critical reforms put in place to protect the public after the financial crisis. While Republicans attempt to roll back measures that protect consumers and curb excessive risk-taking on Wall Street, Hillary Clinton will fight to defend Dodd-Frank and go beyond it, with tough new rules, stronger enforcement and more accountability."

During a hearing today at the Senate Banking Committee, Sen. Elizabeth Warren (D-MA) said it was clear that Hensarling "and fellow Republicans think the poor Wall Street banks have suffered too much under the new rules and it's time for them to return to the good old days before the 2008 crisis, when these banks ran wild … " While "most Republicans in Congress are debating not whether to run away from Trump, but how far and how fast, Congressman Hensarling is sprinting toward Trump Tower," Warren said. "I get that Republicans want unity right now … but if unity means a marriage between Donald Trump's toxic racism and Jeb Hensarling's Wall Street giveaways, then I think they'd be better off with division. That is not what the American people are looking for and it's a path to ruin, both for our economic system and for our country."

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ATTACHMENTS

Hensarling speech

Executive summary