While it isn’t an updated version of Glass-Steagall, the latest financial-services reform legislation — still in need of a few last Senate votes to pass (as of press time in mid-July) — is poised to have a variety of impacts on the large banks employing wirehouse advisors, as well as on broker-dealers.
“This is a tough law that will also have profound effects on the operations and cost structure of most financial services companies and financial markets,” said Securities Industry and Financial Markets Association (SIFMA) president and CEO Tim Ryan in a statement on June 25.
Still, Ryan added, “Much of this new law should help to restore and maintain confidence in U.S. financial markets…such as the establishment of a systemic risk regulator, resolution authority, and a new federal fiduciary standard for retail investors.”
Many analysts note that the initial reforms were much more sweeping than the final legislation. The industry ended up with more benign reforms, they say, though some firms should be hurt financially and otherwise as the required changes take place.
“Generally speaking, my impression is that overall the legislation is not going to be as restrictive as originally thought — for all firms, including the wirehouses,” said Fritz McCormick, a senior analyst with Aite Group, a Boston-based consultancy.
Wall Street analysts agree. “While we believe the final bill will be restrictive to earnings and constrain capital, the outcome could have been worse, with both derivative reform and trading restrictions eased somewhat in the final hours, though maybe not as much as some of the bigger banks would have hoped,” wrote Jason Goldberg, CFA, a large-cap bank analyst with Barclays Capital in New York in a June 28 report.
This doesn’t mean that carrying out required reforms will be a walk in the park for banks and other financial organizations: There are at least 350 new regulations and some 150 studies mandated in the 2,000-plus page conference report, according to the U.S. Chamber of Commerce.
“The new law could translate into anywhere from an estimated 15,000-20,000 pages of new rules by which firms will have to manage in the future,” explained Goldberg. “Much of the legislation is short on specifics, giving regulators power to either determine its impact or leave it open to interpretation and/or regulatory discretion; while many of the other changes won’t occur near-term, rather they will be phased in over a long period of time, giving banks time to adjust.”
The Senate and House conferees’ deal on fiduciary duty requires that the SEC take six months to study advisor and broker obligations toward retail customers. The SEC can then put brokers under the same fiduciary standard of care that applies to investment advisors, putting firms with retail-brokerage and wealth-management operations under new rules.
“Investment advisors will be dealing with this legislation for years to come,” said David Tittsworth, CEO of the Investment Advisers Association, in an e-mail interview with Investment Advisor. It remains to be seen “whether or not the bill represents a net ‘win’ or ‘loss’ for advisors and their clients,” he added.
Tittsworth also explained that the legislation may lead to new regulations “that could increase the complexity and burden of compliance for all advisory firms.”
“Raising the $25 million threshold to $100 million alone will result in a significant reduction in the number of SEC-registered investment advisors,” and “other critical questions, such as whether a [self-regulatory organization or] SRO is warranted, will be the subject of study and potential future action,” said Tittsworth.
The Financial Services Institute, according to CEO Dale Brown in a phone interview, has wanted to see “a new standard of care developed for all advisors in all client situations across all business models in the industry. The group now has “concerns about imposing the fiduciary duty and its unintended consequences on small investors.”
With the increased regulatory complexity, Brown explains, “small investors could be priced out of the reach of professional service and advice. That is not a good outcome.”
The broker-dealer community, he adds, isn’t intimidated by the concept of a fiduciary standard. “But the devil is in the proverbial details,” Brown said.
But broker-dealer Edward Jones, which classifies its 12,750 advisors as employees, is a bit more upbeat. “We believe the Dodd-Frank Act is a good effort toward putting important rules, regulations and guidelines in place to assure appropriate protections for the investing public and the proper functioning of the markets,” said Jim Weddle, a managing partner with Edward Jones in St. Louis, in a statement.
“We look forward to providing input, along with many other constituencies, as the SEC completes the prescribed study of the implications of a uniform standard of care, regardless of whether an individual is working with an adviser or a broker,” Weddle explained. “If properly defined and implemented, this legislation can assure (1) investor choice of pricing alternatives and (2) investor access to a full array of the products and services today’s financial services industry makes available.”
Wells Fargo, with some 15,000 advisors (most of whom are employees), is taking the shift toward a fiduciary standard for brokers in stride as well. “Wells Fargo Advisors believes that giving the SEC the authority to review fiduciary standards is the right decision. We will work closely with our regulators as they develop recommendations to harmonize the standard of care when providing advice to clients,” Wells Fargo said in a statement.
Financial advisors surveyed recently by the Aite Group believe the legislation could elevate the role of financial planning. When asked if a fiduciary standard will lead to the greater promotion of financial planning, the majority of planning-driven financial advisors, 56% of the 400 polled, said “yes.” Most advisors classified as planning challenged, 40%, said “don’t know,” though 38% said “yes.”
Trading and Derivatives
For large banks, such as J.P. Morgan, Goldman Sachs and Morgan Stanley, “The biggest impacts are on proprietary trading and derivatives,” said Chip Roame, head of the consulting firm Tiburon Strategic Advisors, in the Bay Area.
“Bank of America-Merrill Lynch and Wells Fargo will probably be most impacted by consumer-lending reforms on the banking side … not so much on the high-net-worth side,” Roame explained. “But, still, the banks are going to make less money, and then could try and gauge [advisors] more to keep up margins. Thus, these reforms could impact the private-client groups of these institutions, as well as J.P. Morgan.”
Barclays Capital concluded that the reforms would hurt big banks’ earnings via fee reductions, higher costs, new restrictions and tied-up capital.
However, for derivatives, interest rate and foreign-exchange swaps, the large banks won’t need to start up separate subsidiaries. Plus, for some credit-default swaps, commodities and equities, there will be a two-year phase-in for subsidiaries, Goldberg notes.
In terms of the Volcker Rule (aimed at restricting bank’s speculative investments), there will be a portion of private equity investments allowed, and banks can continue to hold inventory needed to facilitate client activity.
“We also don’t expect banks to stand still. We expect changes to existing products, new product innovation, and fee and cost adjustments,” wrote Goldberg.
These are among the reform “highlights” noted recently by Barclays Capital:
- Banks can continue to use derivatives to hedge their own risk, but other derivatives business must be conducted in separately capitalized subsidiaries of the holding company.
- Banks would be able to retain operations for interest-rate swaps, foreign-exchange swaps, and gold and silver swaps as well as credit derivatives relative to investment grade entities.
- Banks would be forced to push trading in agriculture, uncleared commodities, most metals, energy swaps, equities and non-cleared CDS to their affiliates.
- Certain types of proprietary trading are banned; this includes any account used for acquiring or taking positions in securities or other instruments principally for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short-term price movements).
- The Durbin amendment directs the Federal Reserve to set debit-card interchange fees that are “reasonable and proportional.”
- The bill creates a new Consumer Financial Protection Bureau (CFPB) housed under the Fed with authority to regulate all consumer financial products sold by banks.
- Federal regulators have new authority to seize and break up large troubled financial firms without taxpayer bailouts in cases where the firm’s collapse could destabilize the financial system.
- The total cost of the legislation is estimated to be roughly $19 billion.