One of Wall Street’s favorite things about President Trump is his opposition to government regulation, of everything from coal mines to the health care industry. On Friday, Trump took his most significant step toward deregulation yet, starting the process of significantly scaling back the Dodd-Frank Act via executive order. And that could be very good news for financial stocks.
What is Dodd-Frank?
Passed in the wake of the 2008 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act aimed to prevent another financial crisis, and also created some new financial protections for consumers. The act placed leverage limits on major financial institutions, increased capital and liquidity requirements, and required banks to pass annual “stress tests.”
Dodd-Frank also limited proprietary trading by banks, made derivative trading more transparent by bringing it onto exchanges, and required financial institutions to retain at least 5% of the credit risk when they create new securitizations. It required credit rating agencies to register with the SEC and to separate their rating activities from their sales and marketing activities. It put structures in place for more orderly resolution of future financial crises, like a “resolution regime” for winding down failing firms.
New consumer protections put in place under Dodd-Frank include the creation of the Consumer Financial Protection Bureau (CFPB), the creation of awards for whistleblowers, and the application of a fiduciary standard to broker-dealers who provide personalized investment advice. The CFPB has toughened oversight of mortgage lending and credit cards, and led the investigation that uncovered the Wells Fargo fake account scandal last year.
Obama signed the Dodd-Frank Act in 2010.
The executive order Trump signed Friday directs the Treasury to review the Dodd-Frank Act and propose revisions. While we don’t know what parts of the rule will be rolled back, there are a few likely candidates:
- The Volcker Rule, which limits proprietary trading by banks (basically banks trading with their own money), was one of the most controversial parts of Dodd-Frank, and is one of the most likely to be repealed. Opponents say it reduces liquidity in various markets, like the junk bond market, by discouraging banks from making markets for those securities.
- Many lawmakers think the Financial Stability Oversight Council, an uber-regulator created by Dodd-Frank, should be more transparent, and less powerful.
- The Consumer Financial Protection Bureau has been a favorite target of Republicans, and could easily be weakened by reducing its budget or replacing its leader with someone more Wall Street-friendly.
Trump signed the executive order Friday.
Fiduciary Rule Delayed
Trump has also taken steps to delay the implementation of the fiduciary rule, which was passed last Spring but wasn’t scheduled to take effect until this April. The rule requires brokers and advisors who work with tax-advantaged retirement accounts to give advice that is in their clients’ best interests. They also have to avoid conflicts of interest, which would limit the use of commission-based compensation.
If Trump gets his way and the fiduciary rule is rescinded, retirement savers will have to be more vigilant about who they let near their retirement accounts. Merrill Lynch has already nixed commission-based retirement accounts in anticipation of the rule going into effect, and said they’ll stick to their plan even if regulations are loosened. But other brokerages, including Morgan Stanley and Wells Fargo, may keep some commission-based accounts and could lower standards for retirement advisors.
Opportunity for Investors in Financial Stocks
There is a silver lining for individual investors. If you own financial stocks in your retirement account (or elsewhere) this rollback could create big profits for you (in addition to your financial advisor).
Big banks like Goldman Sachs (GS), JPMorgan (JPM) and Citigroup (C) are expected to benefit from more freedom for their traders under new rules. They may also be able to offer more exotic products, keep less capital on hand or increase their dividends more quickly—all moves that could juice earnings and stock prices.
Small and mid-sized financial institutions may also benefit, especially if the Treasury moves to increase the threshold at which banks are deemed “systemically important.” Currently, banks with over $50 billion in assets can be slapped with the designation and subjected to increased oversight. Raising the bar would lower the regulatory burden for numerous publicly traded banks, including Zions Bancorp (ZION), SunTrust Banks (STI), Regions Financial (RF), KeyCorp (KEY) and Fifth Third Bancorp (FITB).
Insurance companies like Prudential (PRU) and American International Group (AIG) could also benefit, because they manage retirement accounts that are subject to the fiduciary rule.
Financial stocks rallied after Trump signed the order Friday, adding to their already significant gains since the election. But this is likely just the start of a major rally for financial stocks, which spent most of the past two years in a holding pattern.