DODD-FRANK 

ACT

The Dodd-Frank Wall Street Reform Act is a law that regulates the financial markets and protects

consumers. Its eight components help prevent a repeat of the 2008 financial crisis.

It is the most comprehensive financial reform since the Glass-Steagall Act. Glass-Steagall regulated
banks after the 1929 stock market crash.

(The Glass-Steagall Act is a law that prevented banks from using depositors' funds for risky
investments, such as the stock market. It was also known as the Banking Act of 1933. It gave power to
the Federal Reserve to regulate retail banks. It also prohibited bank sales of securities)

The Gramm-Leach-Bliley Act repealed it in 1999. That allowed banks to once again invest depositors'
funds in unregulated derivatives. This deregulation helped cause the 2008 financial crisis. 

The Dodd-Frank Act is named after the two Congressmen -Senator Chris Dodd introduced it March
15, 2010. On May 20, it passed the Senate. U.S. Representative Barney Frank revised it in the House,
which approved it June 30. On July 21, 2010, President Obama signed the Act into law.

1. Oversees Wall Street. The Financial Stability Oversight Council identifies risks that affect the entire
financial industry. It also oversees financial firms other than banks, like hedge funds. It recommends
that the Federal Reserve supervise any that gets too big. The Fed will ask the company to increase
its reserve requirement. That prevents a firm from becoming too big to fail, like the American
International Group Inc. 

Trump administration wants to prevent the Fed from supervising large firms.

2. Stops Banks from Gambling with Depositors' Money.

 The Volcker Rule bans banks from using or owning hedge funds for their own profit. It prohibits
them from using their depositors' funds to trade on their own accounts. Banks can use hedge funds
on behalf of their customers only.

Current Status -On June 13, 2017, U.S. Treasury Secretary Steve Mnuchin proposes changes to
the Volcker Rule. It seeks to exempt banks with less than $10 billion in assets from the Rule.

Dodd-Frank gave banks seven years to get out of the hedge fund business. They could keep any funds
that are less than 3 percent of revenue.
3. Regulates Risky Derivatives. Dodd-Frank requires that the most dangerous derivatives, like credit
default swaps, be regulated. This task falls to the Securities and Exchange Commission  or the
Commodity Futures Trading Commission.A clearinghouse, similar to the stock exchange, must be set
up. That ensures the derivative trades are transacted in public. Dodd-Frank left it up to the regulators
to determine the best way to create the clearinghouse.

4. Brings Hedge Fund Trades Into the Light.  When hedge funds and other financial advisers aren’t
regulated, the underlying assets of derivatives are hidden. One of the causes of the 2008 financial
crisis was that no one knew what was in the derivatives. This meant no one knew how to price them.
That's why the Fed thought the subprime mortgage crisis would remain within the housing industry.

Dodd-Frank requires all Hedge funds must provide data about their trades and portfolios so the SEC
can assess overall market risk.

5. Oversees Credit Rating Agencies. Dodd-Frank created an Office of Credit Ratings at the SEC. It
regulates credit-rating agencies like Moody's and Standard & Poor's. Many blame the agencies for
overrating some bundles of derivatives and mortgage-backed securities. Investors trusted these
agencies and didn't realize the debt was in danger of not being repaid. The SEC can require agencies
to submit their methodologies for review. It can deregister an agency that gives faulty ratings.

6. Regulates Credit Cards, Loans and Mortgages. The Consumer Financial Protection

Bureau consolidated the functions of many different agencies. It oversees credit reporting agencies
and credit and debit cards. It also oversees payday and consumer loans, except for auto loans from
dealers. The CFPB regulates credit fees, including credit, debit, mortgage underwriting and bank fees.
It protects homeowners by requiring they understand risky mortgage loans. It also requires banks to
verify borrower's income, credit history and job status. The CFPB is under the U.S. Treasury
Department.

Trump's plan would restructure the bureau as a multi-member commission. It would also allow the
president to remove the bureau’s director for any cause.  It would switch its funding from the
Federal Reserve to Congress. 

7. Increases Supervision of Insurance Companies.  Dodd-Frank created a new Federal Insurance

Office under the Treasury Department.  It identifies insurance companies that create a risk for the
entire system, like AIG did. It also gathers information about the insurance industry. It makes sure
affordable insurance is available to minorities and other underserved communities.

Trump's executive order may relax oversight on three big insurance companies, including AIG. 
8. Reforms the Federal Reserve. Dodd-Frank gave the Government Accountability Office new powers.
Even though the Fed worked with the Treasury during the financial crisis, the GAO audited the Fed's
emergency loans made during the crisis. It can review future emergency loans when needed. The
Treasury Department must approve any new emergency loans. That applies to single entities,
like Bear Stearns or AIG.  The Fed made public the names of banks that received these loans or TARP
funds.

Changes in Trump's Plan

1. The Treasury report -It would reduce the requirement for bank  stress tests from annually to
every two years.
2. It suggested modernizing the Community Reinvestment Act. That law requires banks to lend
based on a household's income regardless of what neighborhood it is in. Before the Act,
banks would "redline" entire neighborhoods as too risky. That meant they would refuse
mortgages even to high-income households within that neighborhood.
3. The report proposes exempting banks that have enough capital from other Dodd-Frank
regulations. This is meant to help small banks.

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Investment Advisers Act of 1940'

A piece of legislation passed in 1940 that, among other things, defined the role and responsibilities of
an investment advisor/adviser. The Investment Advisers Act of 1940 was largely drafted as a response
to the stock market crash 11 years earlier, as well as the subsequent depression. The Act originated
from a report on investment trusts and investment companies that the Securities and Exchange
Commission (SEC) prepared for Congress in 1935. The SEC report warned of the dangers posed by
certain investment counselors and advocated the regulation of those who provided investment
advice. Based on this recommendation, Congress began work on the bill that eventually became the
Investment Advisers Act of 1940.

A subsequent amendment to the act further stipulated that individuals designated as investment

advisors with more than $25 million under management are required to register with the SEC; lower,
and advisors only have to register with their state. The act also states the liability of investment
advisors have and provides guidelines regarding the fees and commissions they can collect.

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Foreign Bank Enhanced Prudential Standards (FBEPS)
In December 2012, the Federal Reserve published a notice of proposed rulemaking (NPR) describing
how the Enhanced Prudential Standards (EPS) under the Dodd-Frank Act would be applied to foreign
banking organizations (FBOs).

The NPR compels larger FBOs with material US operations to establish an Intermediate Holding
Company (IHC) for virtually all of their US subsidiaries. US branches and agencies of FBOs would
remain outside of the IHC structure but would nevertheless have to comply with enhanced liquidity
requirements.

Enhanced prudential standards (EPS)

The approval of the enhanced prudential standards represents a significant step on the part of the
Fed toward improving the framework for supervising and regulating large financial institutions, both
domestic and foreign. It addresses the risks that large financial institutions could pose to the financial
stability of the United States.

The proposed rule for domestic and foreign institutions offers new risk governance requirements,
including the establishment of a board of directors risk committee. Requirements reflect the view
that boards of directors should be more engaged and involved in risk management and oversight.

Focus on ensuring stronger oversight of and transparency around risk management across all U.S.
operations, including a requirement for having a U.S. Risk Committee of the Board and U.S. Chief Risk
Officer.

Comprehensive Capital Analysis and Review (CCAR)

Comprehensive Capital Analysis and Review (CCAR) is a United States regulatory framework
introduced by the Federal Reserve in order to assess, regulate, and supervise large banks and
financial institutions - collectively referred to in the framework as Bank Holding Companies (BHCs).
The assessment is conducted annually and consists of two related programs:

 Comprehensive Capital Analysis and Review

 Dodd-Frank Act supervisory stress testing

The capital plans rule applies to BHCs with assets greater than $50 billion.
The core part of the program assesses whether:
  BHCs possess adequate capital.
 The capital structure is stable given various stress-test scenarios.
 Planned capital distributions, such as dividends and share repurchases, are viable and
acceptable in relation to regulatory minimum capital requirements.
The assessment is performed on both qualitative and quantitative bases. The Federal Reserve may
order banks to suspend their planned capital distributions to shareholders until the target capital
balance is restored.

BCBS 239
In the financial crisis of 2008 was that banks’ information technology (IT) and data architectures were
truly inadequate to support the broad management of financial risks. In January 2013, the Basel
Committee of Banking Supervision (BCBS) introduced guiding principles – BCBS 239: Principles for
Effective Risk Data Aggregation and Risk Reporting –   to strengthen a bank’s risk data aggregation
capabilities and internal risk reporting practices, and, in turn, enhance its risk management and
decision-making processes.
The Principles cover four closely related topics:
1. Overarching governance and infrastructure
 Governance
 Data architecture and IT infrastructure

2. Risk data aggregation capabilities

 Accuracy and Integrity
 Completeness
 Timeliness
 Adaptability

3. Risk reporting practices

 Accuracy
 Comprehensiveness
 Clarity
 Frequency
 Distribution

4. Supervisory review, tools and cooperation

BASEL 2 & 3
The basic structure of Basel III remains unchanged with three mutually reinforcing pillars.
Pillar 1 : Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs) :
Maintaining capital calculated through credit, market and operational risk areas.
Pillar 2 :  Supervisory Review Process : Regulating tools and frameworks for dealing with peripheral
risks that banks face.
Pillar 3: Market Discipline :   Increasing the disclosures that banks must provide to increase the
transparency of banks

What are the Major Changes Proposed in Basel III over earlier Accords i.e. Basel I and Basel II?
(a) Better Capital Quality :   One of the key elements of Basel 3 is the introduction of  much stricter
definition of capital.  Better quality capital means the higher loss-absorbing capacity.   This in turn  will
mean that banks will be stronger, allowing them to better withstand periods of stress.

(b) Capital Conservation Buffer:    Another key feature of Basel iii is that now banks will be required
to hold a capital conservation buffer of 2.5%.  The aim of  asking to build conservation buffer is to
ensure that banks maintain a cushion of capital that can be used to absorb losses during periods of
financial and economic stress.

(c) Countercyclical Buffer:   This is also one of the key elements of Basel III.   The countercyclical
buffer has been introducted with the objective to increase capital requirements in good times and
decrease the same  in bad times.  The buffer will slow banking activity when it overheats and will
encourage lending when times are tough i.e. in bad times.  The buffer will range from 0% to 2.5%,
consisting of common equity or other fully loss-absorbing capital.

(d) Minimum Common Equity and Tier 1 Capital Requirements :   The minimum requirement for
common equity, the highest form of loss-absorbing capital, has been raised under Basel III from  2%
to 4.5% of total risk-weighted assets.  The overall Tier 1 capital requirement, consisting of not only
common equity but also other qualifying financial instruments, will also increase from the current
minimum of 4% to 6%.   Although the minimum total capital requirement will remain at the current
8% level, yet the required total capital will increase to 10.5% when combined with the conservation
buffer.

(e) Leverage Ratio:     A review of the financial crisis of 2008 has indicted  that the value of many
assets fell quicker than assumed from historical experience.   Thus, now Basel III rules include a
leverage ratio to serve as a safety net.  A leverage ratio is the relative amount of capital to total assets
(not risk-weighted).   This aims to put a cap on swelling of leverage in the banking sector on a global
basis.   3%  leverage ratio of Tier 1 will be tested before a mandatory leverage ratio is introduced in
January 2018.
(f) Liquidity Ratios:  Under Basel III, a framework for liquidity risk management will be created. A new
Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be introduced in 2015 and
2018, respectively.

(g) Systemically Important Financial Institutions (SIFI) : As part of the macro-prudential framework,
systemically important banks will be expected to have loss-absorbing capability beyond the Basel III
requirements. Options for implementation include capital surcharges, contingent capital and bail-in-
debt.

Comparison of Capital Requirements under Basel II and Basel III :

Requirements Under Basel II Under Basel III

Minimum Ratio of Total Capital To RWAs 8% 10.50%
Minimum Ratio of Common Equity to RWAs 2% 4.50% to 7.00%
Tier I capital to RWAs 4% 6.00%
Core Tier I capital to RWAs 2% 5.00%
Capital Conservation Buffers to RWAs None 2.50%
Leverage Ratio None 3.00%
Countercyclical Buffer None 0% to 2.50%
Minimum Liquidity Coverage Ratio None TBD (2015)
Minimum Net Stable Funding Ratio None TBD (2018)
Systemically important Financial Institutions Charge None TBD (2011)
Basel 3 Ratios

1. Common Equity Tier 1 (CET1) ratio of 4.5% -

2. Leverage ratio

3. Liquidity requirements

Net stable funding ratio (NSFR)- read from MBM slides

Basel 3.5 – Fundamental review of the trading book

The main objectives of this review are to address outstanding issues such as the boundary between
banking and trading books, and to improve the capitalization of credit risk and market liquidity risk in
the trading book.

Differences between banking book and trading book

1. Assets that are held for trading are put in the trading book, assets that are held to maturity
are held in the banking book
2. Assets in the trading book are marked-to-market daily, assets in the banking book are held
at historic cost
3. The value-at-risk for assets in the trading book is calculated at a 99% confidence level based
on a 10-day time horizon. The value-at-risk for assets in the banking book are calculated at a
99.9% confidence level on a one-year horizon.

Some of the main changes are the replacement of the Value at Risk Measure (VaR) by Expected
Shortfall (ES) [is a risk measure used in the field of financial risk measurement to evaluate the market risk or
credit risk of a portfolio. The "expected shortfall at q% level" is the expected return on the portfolio in the
worst % of cases] , the categorization of trading book positions by different liquidity horizons and
supervisory approval for internal models on trading desk level instead of bank wide level.
Mifid II

A revamped version of the Markets in Financial Instruments Directive, or Mifid II, is designed
to offer greater protection for investors and inject more transparency into all asset classes:
from equities to fixed income, exchange traded funds and foreign exchange.
When will it start?
From January 3, one of the EU’s most ambitious, yet controversial, packages of financial
reforms will be rolled out.

Why is it being implemented?

The original Mifid was intended to be a cornerstone of EU efforts to create a single financial
market for the bloc that could rival the depth and dynamism of the US capital markets.

It mainly sought to end the monopoly of stock exchanges and drive down overall trading costs
for investors, and, in its small way, contribute to economic growth.
Its arrival in November 2007 coincided with the onset of the financial crisis and the subsequent
years exposed Mifid’s shortcomings in focusing on equities.
The review has more ambitious and structural aims: not only will it update existing rules to
keep up with technological developments but will tackle what global policymakers saw as
“under-regulated and opaque aspects of the financial system”. That included the vast off-
exchange markets, such as derivatives and bonds.

How far-reaching are the new rules?

The new rules cover virtually all aspects of trading within the EU. They reach across the
financial services industry, from banks to institutional investors, exchanges, brokers, hedge
funds and high-frequency traders.

If a fund manager wants to buy anything that has an underlying product listed in the EU —
such as an HSBC option in Hong Kong — it falls into Mifid’s scope, no matter where the asset
manager is based. Another instance would involve an EU-based investor purchasing shares in
Apple as the US group has a secondary listing in Germany.

Buried within Mifid is a regulatory desire to push more trading away from the phone and on to
electronic venues, which come with better audit and surveillance trails.
That will mean a wave of data, likely to be measured in petabytes. Institutions will have to
report more information about most trades immediately, including price and volume.

Trades will be timestamped, to 100 microseconds for some, while information in documents
for transaction reporting will stretch to more than 65 fields. It must be stored for a minimum
of five years for example, while banks and brokers will be forced to show customers that they
were offered the best available price for their trades.
IFRS 9
IFRS 9 is an International Financial Reporting Standard (IFRS) promulgated by the International
Accounting Standards Board (IASB). It addresses the accounting for financial instruments.
It contains three main topics:
 Classification and measurement of financial instruments
 Impairment of financial assets 
 Hedge accounting.
Other aspects of IAS 39 are scope, recognition, and derecognition of financial assets.
It will replace the earlier IFRS for financial instruments, IAS 39 when it becomes effective in 2018.
It is meant to respond to criticisms that IAS 39 is too complex, inconsistent with the way entities
manage their businesses and risks, and defers the recognition of credit losses on loans and
receivables until too late in the credit cycle.
The IFRS 9 model is simpler than IAS 39 but at a price—the added threat of volatility in profit and loss.
Whereas the default measurement under IAS 39 for non-trading assets is FVOCI, under IFRS 9 it’s
FVPL.

Asset backed Security & Mortgage backed security

An ABS is simply a pool of financial products that have an associated cash flow i.e. mortgages, auto
loans, credit cards, student loans, accounts receivable, etc… These financial products are securitized
by Wall Street ibanks and sold to investors in the form of Asset Backed Securities/Bonds.
ABS are typically shorter in duration than MBS and more challenging when it comes to predicting cash
flows. The primary difference between these two security types is the collateral upon which the
securitized asset is based.
A MBS (Mortgage Back Security which can be CMBS or RMBS) is simply a subset of ABS. Thousands of
mortgages are pooled together to form a single MBS. The principal and interest payments from the
homeowners flow into the MBS and are then paid out to investors. L2 dives pretty deep into MBS.
A CDO (Collateralized Debt Obligation) is a SIV (Structured Investment Vehicle) and is a portfolio of
ABS. CDOs are the financial products of doom we have been hearing so much about over the last 2
years with regard to the financial crisis. CDOs have seniority structures (tranches) that dictate which
groups of investors are paid first, second, etc…last. CDOs have come under fire because the ratings
agencies like S&P, Moody, etc… would rate a particular CDO AAA while its entire portfolio of ABS was
no higher than BBB.
CDS (Credit Default Swap). Simply put a CDS is an insurance policy against the default of a particular
debt. I would google this one if you want more info.
Market Surveillance

The prevention and investigation of abusive, manipulative or illegal trading practices in the securities
markets. Market surveillance helps to ensure orderly markets, where buyers and sellers are willing to
participate because they feel confident in the fairness and accuracy of transactions. Without market
surveillance, a market could become disorderly, which would discourage investment and
inhibit economic growth. Market surveillance can be provided by the private sector and/or the public
sector.

For example, NASDAQ OMX, a private-sector company, offers a market surveillance product called
SMARTS that assists individual exchanges as well as regulatory agencies and brokers in monitoring
trading activities across multiple markets and asset classes.

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