As US regulators continue to rollout the Dodd-Frank Wall Street Reform and Consumer Protection Act, a few in the industry liken the process to the popular quote attributed to 19th century Prussian statesman Otto von Bismarck: “Laws are like sausages. It is best not to see them made.”
Although the intention of the US Congress was to reform the US financial markets, experts say the legislation falls short due to its omnibus nature.
“During the Great Depression, Congress took a systematic approach to regulating the market with The Securities Act of 1930, The Securities and Exchange Act of 1934 and the Trust Indenture Act of 1939,” says James Angel, associate professor at Georgetown University’s McDonough School of Business and member of exchange operator Direct Edge’s board of directors. “These systematic market overhauls lasted for over 50 years.”
Within the 2,319 pages of the Act exists approximately 400 specific mandates for rule-making agencies, with 100 of those falling to the US Securities and Exchange Commission (SEC).
During a recent speech to a regional meeting of the Securities Industry and Financial Markets Association (SIFMA), SEC commissioner Gallagher stated the regulator had just approved two final rules under Title XV that require companies to disclose their relationship with Congolese conflict minerals as well as resource payments made by US listed oil, gas and mining companies.
Neither of which had anything to do with the 2008 financial crisis or its aftermath and is not part of the SEC’s threefold mandate to protect investors, maintain fair, orderly and efficient market and facilitate capital formation.
“The transparency on conflict minerals is an example of what has gone wrong with US financial regulations,” says Angel. “This time around the the US Congress decided to use an omnibus bill to overhaul the financial markets and by the time it finished writing the bill, there were things in there like the Volcker rule and rules on regulating conflict minerals and no one knows where they came from.”
Stopping the horrific abuses in the Congo is important, but selecting the proper tools to achieve the desired results is also important – US financial market regulators are not the right choice he adds. “This particular piece of Dodd-Frank isn’t going to work because it only applies to publicly traded companies and not to private companies that can operate in the dark.”
“If that’s one of the contributors to why it’s taking so long to implement Dodd-Frank, now I understand,” says Raj Mahajan, CEO of global market maker Allston Trading.
Timing is everything
Prior to the 2008 credit market implosion, the SEC completed the implementation of the far-reaching Regulation National Market Structure (NMS), which modernised the US cash equities markets.
As it prepared to gauge the impact of Reg NMS from market participants in a systematic way, the SEC went from a farsighted planner to a body reacting to numerous unforeseen issues and events.
“A lot of the things that have come up in the reaction to implementing in Dodd-Frank would have been addressed in the pre-flash crash work being done by the SEC,” says Peter Nabicht, executive vice president business development at Allston Trading. “It would be good to put aside some of the distractions and get back to how to make the markets better for investors, how to keep them fair and how to keep the ball rolling in that direction.”
The SEC is broadening its expertise and trying to develop its own internal “think tank” to address these issues, says David Easthope, research director at industry analyst firm Celent. “The SEC is continuing to try to bring in new experts and a different level of expertise to understand the markets they regulate better.”
While addressing Dodd-Frank rule making, the SEC has had time to launch a few major initiatives to improve the cash equities market performance and mitigate future flash crashes by establishing market-wide circuit breakers, rolling out mandatory pre-trade risk checks for clients using direct market access connections as well as developing a consolidated audit trail.
This summer, the SEC also approved a controversial NYSE Euronext pilot that would for the first time allow the exchange to segment retail and institutional order flow and allow the exchange operator to treat them differently.
No one knows if the SEC had more time and resources to study the proposed pilot it might have come to a different conclusion.
However, it is important to evaluate the far-reaching initiatives as much as possible according to Mahajan. “With any one of these changes in market structure, there will be unintended consequences and it is of critical importance to understand, with at least what is knowable, what those are.”
One suggestion Mahajan offers to reduce the outstanding pace and number of yet-to-be-established Dodd-Frank Act mandates is for market regulators and the industry armed with earlier lessons learned from Dodd-Frank to approach Congress and see if there might be alternatives that would satisfy Congress’s original legislative intent.
“Clearly if it take another four years to implement Dodd-Frank we are going to have vastly different capital markets landscape,” says Mahajan. “What we might have thought was the right answer in 2008 may not be the right answer in 2016.”