Regulators Have Made Progress in Implementing Dodd- Frank Act Reforms, but Many Efforts Are Ongoing

Federal financial regulators are continuing to implement reforms pursuant  to the Dodd-Frank Act. A key goal of the act was to promote the stability  of the financial system, and the act puts forward a number of reforms to  achieve this goal, such as provisions related to identifying and addressing  systemic risk and enhancing supervision of large, complex financial  institutions. To better  monitor and contain the potential for such events to create systemic risk  and increase overall system stability, the act mandated various reforms  including creating FSOC and the Office of Financial Research (OFR);  establishing heightened prudential requirements for certain nonbank  financial companies and new capital standards for banks and bank  holding companies; establishing the Orderly Liquidation Authority (OLA)  to address failures of certain financial institutions; expanding the  regulation of the swaps market; and banning banking entities from  engaging in certain types of trading and investments. Some key actions to implement these reforms have not been completed. The  provisions in U.S. regulators’ implementation of these capital  requirements are intended to conform to these international standards  and are proposed to phase in over the next 10 years. The Federal Reserve and FDIC finalized and  made effective rules relating to resolution plans, and the large financial  institutions that were the first firms required to prepare such plans  submitted these to regulators as expected in July 2012. The role that proprietary trading—trading activities conducted by banking  entities for their own accounts as opposed to those of their clients— played in the recent crisis is a matter of debate. Regulators have taken some  steps to implement this reform. Although regulators have finalized some rules in this area, they have not  yet completed all of the rules that would implement the reforms described  above. However, as of December 2012, SEC had  yet to issue key rules related to credit rating agencies, several of which  had statutory deadlines. This would result in any such advisers that had not  previously registered to begin providing reports to SEC on their activities  and being subject to examinations by regulatory staff. Regulators Have Faced Various Challenges Implementing Reforms

A variety of challenges have affected regulators’ progress in executing  rulemaking requirements intended to implement the act’s reforms. Number and Complexity of Rulemakings Has Delayed the Implementation of Certain Reforms

The regulators identified the number and complexity of the required  rulemakings as a primary impediment to their implementation of financial  regulatory reforms. Because of the broad effects that removal of the  references to credit ratings would have, regulators stated that they  had to approach this task with great care to avoid unintended  consequences, which is why some of these rules have yet to be  finalized. Although Coordination among Regulators Improves Rules, It Has Delayed Implementation of Some Reforms

Regulators’ progress in implementing the act’s reforms also has been  delayed because of the need to coordinate with other domestic and foreign  regulators. Although the federal financial regulators have developed and fostered  several mechanisms to facilitate coordination and believe these efforts  have improved the quality of the rulemakings, several regulators said that  interagency coordination has increased the amount of time needed to  develop and finalize several rulemakings. For example, regulatory staff  told us that they had received more than 19,000 comment letters on the  proposed proprietary trading ban rules, further complicating the  rulemaking process. Other Challenges to Reform Implementation Included Establishing New Entities

The need to establish new regulatory bodies or offices mandated by the  act affected the pace of implementation of some reforms, as illustrated by  the following examples:
The staff responsible for establishing the new federal consumer  financial protection agency—CFPB—faced the challenge of  simultaneously forming its agency structure, initiating supervision and  oversight responsibilities, and creating rules mandated by the act. Looking forward, CFTC and SEC staff expressed concerns  about their ability to carry out rule enforcement. Various Areas Continue to Pose Risks, and Regulatory Actions to Mitigate These Risks Have Not Been Finalized or Implemented

Although the act addressed a number of weaknesses of the regulatory  system that were exposed by the recent or past financial crises, some  risks remain and others have emerged. In 2009, we reported on many of  the limitations in the U.S. financial regulatory system that the 2007-2009  crisis once again revealed. In our report, we offered a framework for evaluating  regulatory reform proposals that described characteristics that should be  reflected in any new regulatory system (see table 2). This framework can  serve as a useful lens for examining how weaknesses were addressed  through the act and where additional work remains. The creation of FSOC  could help to address the framework’s call for a systemwide focus on  risks. For example, if the new resolution  authority—OLA—is effective, it could reduce the potential for additional  taxpayer exposure arising from the failure of large financial institutions. Fannie Mae and Freddie Mac. The  group that represents mutual funds—the Investment Company Institute— issued a letter noting that SEC’s 2010 reforms improved the credit quality,  maturity, liquidity, and transparency of money market funds and arguing  that the additional changes contemplated by the SEC Chairman would  effectively put an end to money market funds as an investment vehicle,  which would harm investors and eliminate a funding source for many  businesses. However, market observers have raised concerns that key  areas—the tri-party repurchase (repo) market and swaps  clearinghouses—in which financial risks have been concentrated lack  adequate protections. However,  currently only two institutions provide credit to facilitate transactions in this  market. Although many of the Dodd-Frank Act’s reforms and these other regulatory  efforts seek to address risks arising from large institutions and other  concentrations of risk, some market observers noted that risks that could  have systemic implications could also arise from other sources. Appendix I: Objectives, Scope, and Methodology

Our objectives in this report were to examine what is known about the (1)  the overall status of U.S. financial regulatory reforms arising from the act,  (2) challenges affecting the implementation of these reforms, and (3)  areas that pose continued risk. To address our first two objectives, we synthesized GAO’s body of work  on the Dodd-Frank Wall Street Reform and Consumer Protection Act  (Dodd-Frank Act) reforms and other financial regulatory reform efforts and  challenges. We took several steps to determine the number of provisions requiring  regulators to issue rulemakings or take other key actions as well as the  status of regulators’ efforts to implement the provisions. During the course of our work, staff from several regulatory agencies  noted that the private law firm’s data we used as the initial source to  identify provisions of the Dodd-Frank Act that required rulemakings and  other key actions by regulators overstates the number of required actions. Financial Markets Regulation: Financial Crisis Highlights Need to Improve  Oversight of Leverage at Financial Institutions and across System.
Why GAO Did This Study

The 2007-2009 financial crisis resulted in unprecedented government actions to respond to the unfolding turmoil in the markets, including providing capital to many financial institutions and government conservatorship for others. Although many factors likely contributed to the crisis, gaps and weaknesses in the supervision and regulation of the U.S. financial system generally played an important role. In recognition of the need to improve the regulation of financial markets and institutions to minimize the potential for future crises, in 2009 GAO designated reform of the U.S. financial regulatory system as one of the high-risk issues facing the federal government. In July 2010, the Dodd-Frank Act directed regulators to implement reforms across a range of areas. To assess these efforts, GAO examined the (1) overall status of U.S. financial regulatory reforms arising from the act, (2) challenges affecting the implementation of the act, and (3) areas that pose continued risk.
GAO analyzed data from private and regulatory sources on the status of required rulemakings, synthesized GAO's body of work on Dodd-Frank Act reforms, and interviewed financial regulators and industry and consumer groups on the status of and challenges to implementing reforms.

What GAO Found

Implementation of financial regulatory reform is ongoing. Although regulators have made progress in implementing some key reforms required by the Dodd- Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), others remain incomplete. Moreover, the effectiveness of some implemented reforms, as illustrated below, remains to be seen.
The Financial Stability Oversight Council (FSOC) was established to, among other things, identify systemic threats, and it has taken steps to carry out its responsibilities. However, GAO recently made a number of recommendations to enhance the accountability and transparency of FSOC's decisions and activities and improve collaboration among its members.
Regulators have taken actions to implement some key reforms intended to reduce systemic risk. For example, FSOC developed--and is currently implementing--a process and criteria to determine whether certain nonbank financial institutions should be designated for supervision. But, to date, no such designations have been made. Although not directly required by the act, regulators have also proposed rules implementing international standards to enhance capital requirements for banks. These also are not yet final and their protections are proposed to phase in over the next 10 years.
Key aspects of new liquidation authorities and other reforms for resolving troubled financial firms have been implemented, with certain institutions having submitted required resolution plans--"living wills"-- that would guide their rapid and orderly resolution in a bankruptcy, if needed. However, market observers noted the effectiveness of these provisions would not be known until the first large failure.
Overall, GAO identified 236 provisions of the act that require regulators to issue rulemakings across nine key areas. As of December 2012, regulators had issued final rules for about 48 percent of these provisions; however, in some cases the dates by which affected entities had to comply with the rules had yet to be reached. Of the remaining provisions, regulators had proposed rules for about 29 percent, and rulemakings had not occurred for about 23 percent.
A variety of challenges affected regulators' progress in implementing the act's reforms. Regulators noted that completing rules has taken time because of the number and complexity of the issues, and because many rules are interconnected. For example, to implement the act's ban on proprietary trading-- trading activities conducted by financial institutions for their own accounts as opposed to those of their clients--the regulators issued draft rules that contained over 750 questions for the public's input and spurred over 19,000 comment letters. Further, regulators said that implementing the act's reforms requires a great deal of coordination at the domestic and international levels. Although regulators have established mechanisms to facilitate coordination and believe coordination efforts have improved the quality of the rulemakings, several regulators indicated that coordination increased the amount of time needed to finalize rulemakings. Finally, regulators noted that they have prioritized developing responsive, appropriate rules over meeting tight statutory deadlines. As a result, some important rules may take the longest to develop.
Although the act addressed a number of weaknesses of the regulatory system that were exposed by the recent financial crisis, some risks remain and others have emerged. In 2009, GAO established a framework for evaluating financial regulatory reform proposals; it outlines nine characteristics that should be reflected in any new regulatory system. This framework provides a useful lens through which to consider how weaknesses were addressed through the act and where additional work remains. For example, the creation of the Consumer Financial Protection Bureau could help to ensure broader and more consistent oversight of firms and issues affecting consumers. Additionally, the creation of FSOC could help to provide a systemwide view and identify potential threats before they create a disruption. In contrast:
The efficiency of the regulatory system was not materially changed as a large, fragmented regulatory structure with numerous regulators remains. This requires regulators to coordinate actions and try to reconcile or balance differing approaches to ensure that regulated entities are subject to appropriate scrutiny.
GAO and others have raised concerns about the failed housing government-sponsored enterprisesFannie Mae and Freddie Macthat have operated under federal conservatorships since 2008, and as of December 2012 have received $187 billion in federal assistance. Until their status is resolved, these entities continue to represent financial exposures for the federal government, a risk to taxpayers, and an impediment to the transition to a housing market that functions effectively without the current level of substantial federal support.
Although the act took steps to increase the regulatory systems focus on systemic threats, regulators have expressed concerns that the current structure of money market mutual funds may represent an unresolved risk. These funds provide short-term funding to many financial institutions but lack capital buffers and other protections that could reduce the likelihood of destabilizing runs on their holdings. However, some have questioned the need for additional recent reforms affecting these funds.
Certain credit risk concentrations also pose potential systemic implications, such as the failure of one of the two institutions that provide credit to facilitate transactions in the tri-party repurchase (repo) market that provides short-term funding to many institutions. While these concentrations of credit risks create potential threats to stability, some observers caution that threats also can emerge from other sources, such as from risky products or large numbers of failures among smaller institutions.
Although various proposals for action to address these risks have been put forward, definitive actions have yet to be taken to implement them.

What GAO Recommends

GAO is not making any new recommendations in this report, but has previously made over 25 recommendations to the federal financial regulators related to Dodd- Frank reforms implementation.