A Message from Walt Lukken, President and CEO, FIA

A New Day in Washington

December 5, 2016

On Nov. 8, U.S. voters stunned the pundits and elected Donald Trump as the next President and reaffirmed Republican control of both houses of Congress. This outcome means that next year the Republican Party will control all three branches of the U.S. government, which almost certainly will lead to dramatic public policy changes. 

Exactly what those changes will be is difficult to say. As I pointed out in my most recent Insight column, every change of administration triggers a cascade of appointments across the executive branch. There are quite literally thousands of jobs that President Trump will need to fill, and it may take months before the people he nominates actually take office. 

Since the election I have been asked time and again what the change of administration means for our industry. It is difficult to make any predictions until the new administration takes office and begins setting out its policy priorities. Probably the only thing that is certain, at least in the short run, is change. 

Starting on Jan. 20, there will be a new leadership at the Commodity Futures Trading Commission. The chairman serves at the pleasure of the President, so the Democrats will hand over the gavel to Republicans on Inauguration Day. As I write this in November, Chris Giancarlo is the only Republican Commissioner at the CFTC, and it seems likely that he will be named acting chairman until President Trump finds a new chairman or permanently names Commissioner Giancarlo to this role. 

A similar transition will take place at the Securities and Exchange Commission and many other regulatory bodies across the government. This will put a whole range of pending regulatory initiatives on hold. We plan to continue engaging with the CFTC and other regulators on these initiatives, but we also need to prepare ourselves for significant changes in the policy environment. 

During the campaign Donald Trump made several comments about his views on financial regulation. He spoke about repealing Dodd-Frank, reducing the regulatory burden on the financial sector and restoring Glass-Steagall separations between commercial and investment banking. But he did not offer any detailed plans, and it is hard to know how these campaign promises will translate into actual policy. 

That said, I think there is one theme from the campaign that could lead to a noticeable change in the U.S. approach to financial regulation. Exit polls on the day of the election showed that economic issues ranked first in the minds of voters, and voters responded to Trump’s pledge to strengthen the U.S. economy. 

So I expect that the Trump administration's approach to regulation will aim for a different balance between stability and growth. Regulators have spent the last eight years working on a vast array of new rules to prevent the reoccurrence of the 2008 crisis, and I think it's fair to say that the financial system today is on a much more secure footing. The U.S. now has an opportunity to take stock of the progress that has been made, consider the economic impact of all these rules and tackle the adverse effects and unintended consequences that have emerged along the way. 

As we look for ways to grow the economy, the leverage ratio essentially limits the capacity of businesses to hedge risk in our markets.

Right at the top of my list is of course is the leverage ratio and specifically its impact on the clearing of derivatives. The Basel Committee intended the leverage ratio to serve as a backstop to risk-based capital requirements. That is a valid goal, but what no one seems to have realized is that the leverage ratio will work against another one of the G-20’s goals; namely, to bring more derivatives into central clearing. The leverage ratio has become a binding constraint on our industry’s capacity for clearing, and I worry that the regulators have unintentionally introduced a new source of systemic risk. 

Here’s why this is a problem that should trouble everyone. The resiliency of the central clearing system depends on having a certain number of clearing firms as the first layer of protection. The leverage ratio erodes this foundation, however, by making it drastically more expensive for clearing members to accept new customers. In fact, there is a real possibility that if and when the next crisis hits, customers of a failing clearing firm will be unable to find a new home. That would force the clearinghouses into a mass liquidation of hedged positions, making a bad situation worse. 

Having a healthy clearing system has other benefits as well. Keep in mind the contribution that derivatives markets make to the real economy by providing a tool for managing risk. Derivatives help businesses eliminate unwanted volatility. That allows them to focus on their core competencies, protect the future value of their production and allocate more capital to building the business. Think of a power company that wants to build a new generation plant, or a manufacturing company that wants to enter a new market overseas. The leverage ratio should be a safety and soundness backstop, not handcuffs on a businesses’ ability to serve its customers and support economic growth. 

Of course the leverage ratio is just one of the many policy issues that are now in play following the U.S. election. The new leadership in Washington has a rare opportunity to reconsider the entire regulatory framework for financial services. I wonder if the new administration might want to look across the Atlantic for inspiration and consider the "call for evidence" launched by Lord Hill, the former European Commissioner for financial services. The idea was to take a critical look at the massive increase in financial regulation with an eye to striking a better balance between preserving stability and enabling investment. As Lord Hill rightly said, the lack of growth is itself a threat to stability. 

As I said at the beginning of this column, the political landscape in the U.S. will change dramatically in the coming months. This comes on the heels of the Brexit vote this summer and the shifting regulatory landscape in Europe. We are eight years past the financial crisis and we should use this moment to reconsider the relationship between stability and growth. Let's capitalize on this opportunity by realigning regulation so that it more effectively supports sustainable growth and job creation.

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