As bankers and markets prepare for the inauguration of president Donald Trump, Timothy Massad, chairman of the Commodity Futures Trading Commission (CFTC), the lead regulator for the derivatives industry, has already made his own call on the future path of financial regulation.
Friday January 20 marks Trump’s first day in office and Massad’s last at the CFTC. He tendered his resignation at the start of January.
Timothy Massad, CFTC
Massad may have been a less aggressive character than his predecessor at the CFTC, Gary Gensler, who urged the Obama administration to introduce tough legislation to regulate the over-the-counter derivatives markets, then drove most of the swaps business onto central clearing, to bring transparency and greater oversight of market participants to trading on regulated platforms.
But Massad faithfully completed much of this and restored better relations with non-US regulators, especially those in Europe and the UK, that had privately accused Gensler’s CFTC of over-reach.
Massad who served as assistant secretary for financial stability at the Department of the Treasury and oversaw the Troubled Asset Relief Program (Tarp), took over at the CFTC in July 2014.
He expanded mandatory clearing of interest-rate swaps, saw through margin rules for uncleared swaps, introduced new capital requirements for swap dealers and, perhaps most importantly, early in 2016 resolved longstanding issues over mutual recognition and oversight of clearing houses with former European commissioner Jonathan Hill.
When dealers complained of an unlevel regulatory playing field, the CFTC took important steps with European and UK regulators to harmonize bilateral margin requirements.
When the industry complained that post-crisis derivatives regulation had not actually made the system safer but simply shifted the centre of systemic risk from the banks to the central clearers, Massad introduced stress tests on important clearing houses in the US and overseas. The CFTC released its first findings last November.
In a lecture at the London School of Economics, just days before Trump’s inauguration, Massad explained his resignation as the standard formality to be expected of an Obama appointee. He declined to speculate about the path of financial regulation under president Trump, even as bank stocks continue to rally and expectations spread of a repeal of Dodd-Frank or the abandonment of large parts of it as the likely next step after repeal of Obamacare by a populist administration hostile to government interference in markets.
But he offered some advice, especially on reform of the derivatives markets, which, particularly through credit derivatives, were the key agent that spread and magnified the damage from poor sub-prime mortgage underwriting into a threat to the entire global banking system.
“My belief is that to repeal or dismantle the reforms we have implemented would be a major mistake,” says Massad. “These reforms have made the financial system more resilient, which contributes to a strong economy. Their repeal would not contribute to improving the economic conditions that might have given rise to populist discontent expressed in recent elections.”
Will a protectionist US administration and the growing backlash against globalization now prevent close cooperation between US regulators and their peers in developed and emerging markets?
“I certainly hope not,” Massad says, “because I believe it is necessary to address the concerns about economic opportunity and growth that may have been expressed in these recent votes.”
He suggests: “If we enter a period when there is less international cooperation in regulating the global financial system, or worse, regulatory competition, that is likely to increase the risk of financial instability, which can in turn lead to another crisis that causes the type of suffering we saw last time.”
Massad also points out that the many and often contradictory calls for financial deregulation from Republicans don’t promise an easy path forward.
“There have been calls to raise capital and leverage requirements on banks in return for simplifying certain regulation. There have been calls to eliminate or ease the restrictions of the Volcker Rule – which restricts trading by banks – but at the same time some calls for reinstating the Glass-Steagall Act, which requires a separation between commercial and investment banking.”
Regulation for growth
Now, as investors and analysts try to trace the likely outline for the coming roll back in regulation of banks and financial markets, some question the whole basis of Republican hostility to regulation: that it has impeded economic recovery.
Since 2010 the US economy has been adding jobs at the rate of 2.4 million a year while the S&P500 has enjoyed annual average gains of 10.1%. House prices have recovered. Unemployment has halved to a state that seems near full employment.
Stephen Gallagher, chief US economist at Société Générale, says: “Deregulation can be positive for growth but is difficult to quantify.”
He pointedly notes: “The ability to determine the benefits of deregulation are clouded by the difficulty of determining what restraint these regulatory elements posed.”
Gallagher suggests that, unlike with Obamacare, outright repeal of Dodd-Frank is unlikely. Rather he groups the Trump team’s wish lists for regulatory pullback into three buckets: relief on Basel Committee standards for the strongest US banks with high leverage ratios, capital adequacy, asset quality, management accountability, liquidity and sensitivity to market risk metrics; new limitations on financial regulators such as the CFTC, SEC, Federal Reserve and the Consumer Financial Protection Bureau; and the repeal of specific individual reforms such as the Volcker Rule.
If that last happens, will owners of bank equity welcome a return to proprietary trading and a move away from banks’ recently adopted client-centric business models? The returns from banking may be lower now, but so too are the chances of sudden collapse.
“Exempting some banks from specific regulations – both domestic regulation and global standards – can be risky,” Gallagher points out. Opponents of regulation may suggest lighter burdens only for the most well-capitalized and highest-rated banks, but “how do we measure and rate financial institutions, without benchmarks and regulatory controls?”Good question.