Gauging the “Trump Factor”

What impact will the election of Donald Trump have on the regulatory landscape for foreign exchange? Galen Stops reports

In recent years, regulation has been a key theme for the FX industry, despite the fact that this market has been directly addressed by very little regulation since the financial crisis.

But in 2017 there will be one figure that will loom large in any discussion involving the regulation of the financial services industry, with that of course being Donald Trump, the next President of the USA.

Trump’s campaign included talk of repealing the Dodd-Frank Act. He recently said that for every new piece of regulation introduced, he would abolish two to make way for it and his “America first” campaign message has led to speculation about how his administration will approach the often thorny problem of harmonising and implementing cross border regulations.

So what is likely to be the realistic impact of a Trump administration for FX market participants?

Gabriel Rosenberg, a partner at Davis Polk, claims that the transition to a Trump Presidency is unlikely to result in any major changes to the regulations that are most important to the FX market, namely the derivatives provisions in Title VII of the Dodd-Frank Act.

“I think that the Title VII derivatives regulations are generally understood at the high statutory level by the market to be necessary post the financial crisis, it’s more the way in which it’s been implemented that’s been problematic for many people,” he says.

This is consistent with the views expressed by a number of other sources, including a compliance officer at one international bank who says that although his firm is bracing itself for some significant roll-backs to Dodd-Frank, they don’t expect to see much change to the Title VII provisions.

But while FX might not be directly impacted by a Trump administration, once again there could be significant indirect impacts. For example, Rosenberg said that overall he does expect major changes to financial regulation under Trump, citing the Consumer Financial Protection Bureau and possibly the Volcker Rule as two examples of areas that could be subject to change in the coming years.

Now the repeal of the Volcker Rule in particular could be interesting because that would enable banks to prop trade again.

Or as the head of one proprietary trading firm (half) joked recently: “If they get rid of the Volcker Rule under Trump, I’m definitely going to go and work in a bank. I’d rather trade with their money than mine!”

Whether or not banks that have in many cases shifted their whole business structure more towards an agency model for FX would have the appetite to build up prop desks again is open for conjecture, but the potential revenue available from such desks would surely be a major temptation.

The reality is though that a full repeal of the Volcker Rule appears uncertain.

Rosenberg notes that to repeal the rule there would need to be a statutory change that would have to go through Congress. This is likely to happen, given that Republicans control the House, but he predicted that it could run into trouble in the Senate, where although the Republicans also hold a majority, they would need Democratic support to get over the voting threshold that exists there.

“That statutory change, for the Volcker Rule in particular, would potentially be subject to a filibuster in the Senate by the Democrats and so I think there’s likely to be some kind of compromise on a roll-back of the Volcker Rule, but maybe not a full repeal,” he explains.

Similarly, Matthew Kulkin, a partner at Steptoe & Johnson, observes: “The Volcker Rule could be repealed, but that would be a pretty drastic policy shift if it happened.”

He adds: “A possible compromise would be to preserve a prohibition from proprietary trading and fund investments for the largest banks, while reducing the burdens on smaller, less systemically important institutions.”

With regards to the chances of getting a statutory change to eliminate the Volcker Rule through the Senate, Kulkin also anticipates difficulties.

“If that happens, you’ll see Democratic Senators such as Elizabeth Warren and Chris Van Hollen, who is the Senator-elect for Maryland and is going to serve on the Banking and Agriculture Committee, lining up to protect Dodd-Frank,” he says.

Justin Slaughter, chief policy advisor and special counsel to CFTC Commissioner, Sharon Bowen, points out that there are numerous regulators involved in the Volcker Rule, including the semi-autonomous Federal Reserve, and therefore it can be more challenging to rollback this regulation compared to regulations that include FX, where there is one regulator – usually the CFTC – involved.

Therefore, he says that it will be much easier for the CFTC to alter or reduce some of the regulatory burdens on the FX market than it will be for politicians to roll back the Volcker Rule.

Personnel changes

This is why, rather than focusing on the speculation surrounding which bits of Dodd-Frank might be repealed, FX market participants might be better served by observing the changes of personnel occurring at the various regulatory bodies for signs of what to expect going forward.

“What’s really interesting is that for as much as legislators like Jeb Hensarling, Chair of the House Financial Services Committee, want to repeal Dodd-Frank and the Republicans now control Congress and the White House, the reality is that a fair amount of the action is going to be at the agencies. They have the ability to make changes to regulations in a relatively short period of time,” says Kulkin.

One of the key changes in this regard is that Timothy Massad is stepping down as chairman of the Commodity Futures Trading Commission (CFTC) once Trump is sworn into office.

As the only Republican commissioner currently at the CFTC, Christopher Giancarlo will almost certainly be named as acting chairman of the Commission, but market sources indicate that he is also the favourite to be handed the position on a full-time basis.

This is significant for a number of reasons. Firstly, Giancarlo has been critical of the March 1 implementation deadline for the variation margin rules that are coming into effect next year.

In a speech in London during December, he commented: “Unfortunately, regulators imposed an unrealistic deadline on the marketplace and seem intent on sticking to that deadline regardless of the effect on the health of the market and market participants.

“As the variation margin deadline approaches, I call on my fellow regulators to determine the market’s readiness and help ease the transition as much as possible to ensure the orderly functioning of the marketplace.”

If he is acting chairman of the CFTC, Giancarlo might well be in a stronger position to ensure that this deadline is relaxed, giving firms subject to the requirement extra time to get all the necessary documentation in place.

In addition, Slaughter notes that “it’s probable that we’ll see a change to the SEF regime” if Giancarlo is named as the permanent Chairman of the CFTC.

He continues: “I think it sounds like one of the things he wants to do if he gets the full-time chairmanship is make an effort to streamline some of these regulations to reduce their complexity.”

For evidence of the changes that Giancarlo might be likely to propose for the SEF regime, market participants would probably be well-advised to review the whitepaper that he published last year regarding potential swaps market reforms that he would like to see implemented.

This could be good news for SEF operators, as Edward Brown, CEO of GTX SEF, makes clear.

“As a service provider, and certainly from a client perspective the one thing that we all crave is certainty and there’s definitely been a lack of that in recent years,” he says. “We want regulation that is thoughtful and purposeful and allows the markets to grow and for liquidity to flourish. At this point with the lack of certainty that we’ve had with respect to the regulation and timelines, it’s been a big challenge. So Ithink we would welcome any kind of roll back or streamlining or reduced complexity that would allow for the SEF environment to thrive.”

Tempered optimism

A number of market sources have also expressed optimism that under a Trump administration there’s going to be a broad change from policies being made with an eye towards systemic risk oversight and mitigation to more of a pro-jobs, pro-lending growth agenda. Realistically, some of this optimism will have to be tempered to a degree.

“The number one thing I’ll tell you as someone who has been in government for a number of years is that everything moves slower than you think at this point in the cycle,” says Slaughter.

He adds: “Eight years ago I was involved in a lot of conversations where people thought they were going to roll through with financial reform as a bill and then all the regulations within four years. Now, six-and-a-half years after Dodd-Frank was passed there are still many mandatory rules that aren’t finished because it just takes a very long time and the vagaries of the law in this space; the Administrative Procedure Act makes it difficult to just undo a rule making without significant data. If you don’t give a very clear cut evidentiary-based reason for why you’re undoing something, you open yourself up to legal challenges, and many of these cases are decided not at the Supreme Court but at the DC Circuit Court.”

In addition, there are still many unknown variables regarding the Trump administration’s approach to financial services regulation.

“There’s a lot that remains to be seen and the first question to ask is: who are the personnel who will be executing the plan? And that’s not clear yet. Once the personnel is in place, which will take a few months for the nomination, vetting and confirmation of each candidate, then we’ll start to see the policy initiatives begin to take shape.

“We’ve seen a couple of key financial services names announced by the Trump team, but we haven’t gotten to the senior staff at Treasury and we haven’t seen CFTC or SEC leaders yet, so there’s are a lot of blanks to still be filled in,” says Kulkin.

“There’s still a lot of unknowns at this point,” says the bank compliance officer. “Obviously we’re all keeping an eye on what’s happening and there’s been some speculation about different regulatory scenarios that could play out with the repeal of certain elements of Dodd-Frank. But we won’t be making any changes to our plans or business unless something definitive is announced.”

One group that might not be thrilled by the potential roll back of financial services regulation during the Trump Presidency is the European regulators. This is because the way that the financial services regulations are crafted in Europe could make it more difficult for them to be repealed.

The US clearly took the lead on drafting and implementing a regulatory response to the financial crisis with the Dodd-Frank Act, but in recent years Europe has been catching up.

However, Dodd-Frank outlines rules and goals and then in many cases leaves it to the individual regulatory agencies to the interpret and enforce the legislation. One recent example of this is the CFTC’s interpretation of the Dodd-Frank requirement to allow swaps execution “through any means of interstate commerce”, which generated complaints from market participants, and criticism from Commissioner Giancarlo, for being too prescriptive.

In contrast, European financial services regulations like Mifir and Mifid – which are broadly equivalent to Dodd-Frank – put the rules into law. Because these rules exist as laws all the way through the regulation, as opposed to an implementation of a law, it could make them harder to repeal.

Therefore, if the US starts to repeal or soften its stance to financial services regulation under Trump, Europe might be stuck out in front, unable to follow suit.

Trump’s decisions as president could have a major impact on financial services regulation, but in many cases it’s simply too early to accurately gauge which areas will be the biggest targets for his administration. Overall though, it seems likely that there will be a recalibration over the next couple of years, both at the agency and legislative levels, which will see the regulatory pendulum swing back towards a reduction of regulatory oversight.

Or as Rosenberg succinctly puts it: “The impact of the “Trump factor” on regulatory reform in general is likely to be enormous, but regarding FX trading and derivatives more specifically, there is unlikely to be much at the high congressional level, but perhaps some changes round the edges that will hopefully simplify some of the CFTC’s rules and perhaps offer some deadline relief.”

Galen Stops

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