Financial Regulatory Reform: Regulators Have Faced Challenges Finalizing Key Reforms and Unaddressed Areas Pose Potential Risks
Published: 2013-01-23T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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 enterprisesFannie Mae and Freddie Macthat 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 systems 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.
section_title: What GAO Recommends
paragraphs: 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.

section_title: Letter
paragraphs: The 2007-2009 financial crisis threatened the stability of the U.S. financial  system and the health of the U.S. economy. Many households suffered  as a result of falling asset prices, tightening credit, and increasing  unemployment. In response to the crisis, the federal government took  unprecedented steps—providing hundreds of billions of dollars of capital  and over a trillion dollars of emergency assistance to financial  institutions—to stem the unraveling of the financial services sector and  restore order to the credit markets. Although many factors likely  contributed to the crisis and the relative role of these factors is subject to  debate, gaps and weaknesses in the supervision and regulation of the  U.S. financial system generally played an important role. In 2009, we  designated reforming the financial regulatory system as a high-risk area  and also identified characteristics that should be reflected in any new  regulatory system.
Pub. L. No. 111-203, 124 Stat. 1376 (2010). controversy or debate. For example, no consensus exists on the extent to  which the act will help to reduce the likelihood and severity of future  financial crises. In addition, some market observers have raised concerns  about the pace of reform, with some suggesting that reform is occurring  too slowly and others arguing that it is moving too quickly.
We prepared this report under the authority of the Comptroller General to  conduct work on GAO’s initiative to assist Congress with its oversight  responsibilities. Specifically, this report examines the (1) 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 objectives, we synthesized GAO’s body of  work on Dodd-Frank Act reforms and other financial regulatory reform  efforts and challenges. We also reviewed and analyzed government,  academic, and other studies on Dodd-Frank Act reforms and  implementation. To examine regulators’ efforts to implement the  provisions of the Dodd-Frank Act, we focused on eight major reform  areas: capital requirements; resolution of financial institutions; proprietary  trading; derivatives; consumer protection; mortgage reforms; expanded  regulation of institutions and products; and investor protection. We also  obtained and analyzed information from a database maintained by the  law firm Davis Polk and Wardwell that identified provisions of the Dodd  Frank Act that require and authorize regulators to take actions, and tracks  the status of regulators’ efforts to implement these provisions. We then  used various sources and assumptions to compile a list of provisions  requiring actions by regulators, including discussing provisions with  agency officials who are responsible for implementation of the majority of  these efforts. We focused our analysis on provisions that required  rulemakings and other key actions, but excluded other requirements,  such as those to publish studies. In addition, we used our professional  judgment to categorize the information from the law firm and financial  regulators. Using different sources, assumptions, and judgments in  compiling the list of provisions requiring rulemakings and other key  actions could result in different totals, and therefore the information we  provide should not be taken as a definitive count of all actions required by  the act.
We also interviewed officials from seven federal financial regulators— Board of Governors of the Federal Reserve System (Federal Reserve),  Bureau of Consumer Financial Protection—also known as the Consumer  Financial Protection Bureau (CFPB), Commodity Futures Trading  Commission (CFTC), Federal Deposit Insurance Corporation (FDIC),  Federal Housing Finance Agency (FHFA), Office of the Comptroller of the  Currency (OCC), and Securities and Exchange Commission (SEC), as  well as staff from the Financial Stability Oversight Council (FSOC) about  their implementation of various Dodd-Frank reforms, challenges they are  facing, and areas that continue to pose risk. In addition, we interviewed  industry and consumer groups about these issues and obtained the views  of market observers and experts who have written about various Dodd- Frank Act reforms. Appendix I contains additional information on our  scope and methodology.
We conducted this performance audit from June 2012 to January 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: The financial regulatory framework in the United States was built over the  last 150 years, largely in response to crises and significant market  developments. As a result, the regulatory system is complex and  fragmented. For some time, we have reported that the U.S. financial  regulatory system has not kept pace with major developments in financial  markets and products in recent decades. Although the Dodd-Frank Act  has brought additional changes, the U.S. financial regulatory structure  largely remains the same.
The U.S. financial regulatory structure is a complex system of multiple  federal and state regulators as well as self-regulatory organizations  (SRO). In the banking industry, the specific regulatory configuration  depends on the type of charter the depository institution chooses. Charter  types for depository institutions include commercial banks, savings  associations, and credit unions. These charters may be obtained at the  state or federal level. The prudential regulators—all of which generally  may issue regulations and take enforcement actions against industry  participants within their jurisdiction—are identified in table 1.
In addition, as will be discussed, the Dodd-Frank Act created CFPB as an  independent bureau in the Federal Reserve System that is responsible for  regulating the offering and provision of consumer financial products and  services under federal consumer financial laws. Under the Dodd-Frank  Act, certain authority vested in the prudential regulators and other  regulators was transferred to CFPB on July 21, 2011.
The securities and futures industries are regulated under a combination of  self-regulation (subject to oversight by the appropriate federal regulator)  and direct oversight by SEC and CFTC, respectively. SEC oversees the  securities industry’s SROs, and the securities industry as a whole, and is  responsible for administering federal securities laws and developing  regulations for the industry. SEC’s overall mission includes protecting  investors; maintaining fair, orderly, and efficient markets; and facilitating  capital formation. CFTC oversees the futures industry and its SROs.  Under the Dodd-Frank Act, CFTC also has extensive responsibilities for  the regulation of swaps and certain entities involved in the swaps  markets, and SEC has comparable authority for markets in security- based swaps. CFTC and SEC have responsibility for administering  federal legislation and developing comprehensive regulations to protect  the public from fraud and manipulation, insure the financial integrity of  markets, and help to foster better risk management, among other things.  Further, state regulators oversee the insurance industry and contribute to  the oversight of banks and securities as well.
Certain housing market participants, including the housing finance  government-sponsored enterprises—Fannie Mae and Freddie Mac (the  enterprises)—and the Federal Home Loan Bank System, are supervised  by FHFA. FHFA has authority to take enforcement actions against,  appoint itself conservator or receiver for, and resolve these enterprises.
section_title: Regulators Have Made Progress in Implementing Dodd- Frank Act Reforms, but Many Efforts Are Ongoing
paragraphs: 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. Other reforms seek to expand protections for consumers and  investors and expand oversight to entities that were less regulated. The  implementation of the reforms is largely being driven by the rulemakings  or other key actions of the various responsible financial regulators, and as  figure 1 shows, the status of the regulators’ implementation of these  reforms varies. As of December 2012, regulators had finalized rules for a  little less than half of the 236 required rulemakings and other key  rulemakings that we identified. The remaining required rulemakings and  other key rulemakings have not been finalized or have yet to be  proposed. Additionally, of the 236 provisions we identified, over two-thirds  (157) required regulators to take action by a specific date. Among the  provisions with deadlines that passed as of December 2012 (a total of  134 provisions), regulators had missed the act’s deadlines for the majority  (119, or 89 percent) of the provisions.
The recent crisis highlighted several sources of systemic risk, including  the potential for one financial firm’s distress to spill over into the broader  financial system and economy and for systemic risk to be generated and  propagated outside of the largest financial firms. This was due, in part, to  interconnections not only among firms but also among markets. 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. However, the  implementation of many of these reforms remains ongoing and the  effectiveness of some remains an open question.
The 2007-2009 financial crisis highlighted the lack of an agency or  mechanism responsible for monitoring and addressing risks across the  financial system and a shortage of timely information to facilitate this  oversight. To address these limitations, the Dodd-Frank Act created  FSOC to provide, for the first time, an entity charged with monitoring and  identifying risks to financial stability throughout the entire financial system.  The act also established OFR to serve FSOC, its member agencies, and  the public by improving the quality, transparency, and accessibility of  financial data and information; conducting and sponsoring research  related to financial stability; and promoting best practices in risk  management.
The voting members of FSOC include the Secretary of the Treasury and the heads of  CFPB, CFTC, FDIC, Federal Reserve, FHFA, National Credit Union Administration, OCC,  SEC, and an independent voting member with insurance expertise. The nonvoting  members include the director of the Federal Insurance Office, the director of OFR, and a  state banking supervisor, a state insurance commissioner, and a state securities  commissioner. on regulating proprietary trading, contingent capital, and concentration  limits on large financial companies. FSOC has also issued two annual  reports addressing market and regulatory developments across the  financial system. In addition, FSOC voluntarily issued rulemakings  explaining the processes and criteria that it will follow in designating  financial market utilities—entities that provide critical services to the  markets such as clearinghouses that process trading information and  facilitate payments associated with trades—as systemically important and  nonbank financial companies for supervision by the Federal Reserve.
OFR—created by the act to support FSOC, its member agencies,  Congress, and the public by improving financial data and conducting  research related to financial stability—has taken a number of steps to help   For example, in July 2012 OFR released its first annual  fulfill its mission. report, which assessed the state of the U.S. financial system.also begun a process to assemble an inventory of data that FSOC member  agencies obtain, which OFR staff described as a first step toward  standardizing data, reducing duplication, and eventually lowering costs for  industry and regulators. OFR has also collaborated with industry, foreign  government entities, and international bodies in efforts to create a legal  entity identifier (LEI), which OFR describes as an emerging global standard  that will enable regulators and companies around the world to quickly and  accurately identify parties to financial transactions. Additionally, OFR has  initiated a working paper series in which OFR researchers often collaborate  with outside academics. Three papers have been published, including one  that catalogs systemic risk monitoring systems and another that describes  ways to improve risk management at financial institutions. Several more  papers will be published in the coming months.
OFR has  Although the creation of FSOC and OFR could assist the U.S. regulatory  system in identifying systemic threats, they will have to overcome various  challenges to help ensure that these reforms achieve their intended  goals. First, FSOC’s key missions—to identify risks to financial stability  and respond to emerging threats—are inherently challenging. For  example, key indicators, such as market prices, often do not reflect these  risks; such threats do not develop in precisely the same way in  successive crises; financial innovations are not well understood; and  according to experts, effectively monitoring and mitigating systemic risk is  a very large and procedurally complex undertaking. Additionally, actions  to preemptively mitigate threats may appear unnecessary or too costly at  the time they are proposed or taken. Second, FSOC’s effectiveness  hinges to a large extent on collaboration among its many members,  almost all of whom come from federal and state agencies with their own  specific statutory missions. In testifying before Congress on Dodd-Frank  rulemakings, the chairperson of FSOC recognized this challenge, noting  that coordination in the rulemaking process was hard because the act left  in place a financial system with a complex set of independent agencies  with overlapping jurisdictions and different responsibilities. Third, OFR  faces the challenge of trying to build a world-class research organization  from the ground up while meeting shorter-term goals and responsibilities.  Those researchers who supported the creation of OFR have suggested  that it will take many years for the new entity to provide the insights that  will ultimately be expected of it.
In addition, in a September 2012 report, we concluded that the ability of  FSOC and OFR to fundamentally change the way the federal government  monitored threats to financial stability remains to be seen. The  uncertainty partly stemmed from the newness of the entities, as both were  continuing to develop needed management structures. But we also noted  that limits in FSOC’s and OFR’s transparency contributed to questions  about their effectiveness. We made 10 recommendations to FSOC and  OFR to strengthen their accountability and transparency. These include  FSOC and OFR clarifying their monitoring responsibilities to better ensure  that the monitoring and analysis of the financial system are  comprehensive and not unnecessarily duplicative, and FSOC  systematically sharing key financial risk indicators among member  agencies to assist in identifying potential threats for further monitoring or  analysis. In responding to the recommendations in this report, Treasury  emphasized the progress that FSOC and OFR have made since their  creation, including preparing rules and guidance, promoting transparency  and accountability by testifying before Congress, providing information to  oversight bodies, and making information available on websites. Treasury  also stated that officials would carefully consider the report’s findings and  recommendations, and would share them with the council for their review  and consideration.
The recent financial crisis revealed weaknesses in the existing regulatory  framework for overseeing financial institutions. For example, although  large, interconnected financial firms were subject to some form of federal  supervision and regulation, the oversight proved inadequate and  inconsistent. The crisis also showed that regulators did not require  financial firms to hold sufficient capital to cover their trading and other  losses or plan for a scenario in which liquidity was sharply curtailed.
To address these shortcomings, the Dodd-Frank Act requires the Federal  Reserve to supervise and develop enhanced capital and prudential  standards for bank holding companies, including foreign banking  organizations, with $50 billion or more in consolidated assets and  nonbank financial companies designated by FSOC for supervision by the  Federal Reserve. The act also requires the Federal Reserve to establish  a regulatory framework for the early remediation of financial weaknesses  for these companies. The act requires the enhanced prudential standards  to be more stringent than standards applicable to other bank holding  companies and financial firms that do not present similar risks to U.S.  financial stability. The act further requires the enhanced standards to  increase in stringency based on the risk characteristics of each firm. In  general, the Federal Reserve has authority to tailor the application of the  prudential standards, including differentiating among companies on an  individual basis or by category.
Some key actions to implement these reforms have not been completed.  The Federal Reserve has issued proposed and final rules implementing  certain elements of these requirements. In January 2012, the Federal  Reserve proposed regulations on enhanced prudential standards and  early remediation requirements for U.S. bank holding companies with  total consolidated assets of $50 billion or more and U.S. nonbank  financial companies supervised by the Federal Reserve. These proposed  regulations included risk-based capital and leverage requirements,  liquidity requirements, single-counterparty credit limits, overall risk  management and risk committee requirements, stress test requirements,  early remediation requirements, and debt-to-equity ratio requirements for  companies that FSOC has determined pose a grave threat to financial  stability. In October 2012, the Federal Reserve issued a final rule  implementing the supervisory and company-run stress test requirements  included in the December 2011 proposal. Federal Reserve issued proposed regulations that would implement the  enhanced prudential standards and early remediation requirements  required to be established by the Dodd-Frank Act for foreign banking  organizations and foreign nonbank financial companies supervised by the  Federal Reserve. According to the Federal Reserve, the proposed  standards for foreign banking organizations are broadly consistent with  the standards proposed for large U.S. bank holding companies and U.S.  nonbank financial companies.
As required by the act, FDIC and OCC also issued rules in October 2012 mandating  stress testing by the institutions they supervise with assets of over $10 billion.
In addition to the enhanced prudential standards for certain U.S. bank  holding companies and identified U.S. nonbank financial companies,  under the act, the regulators are also required to establish minimum  leverage and risk-based capital requirements, on a consolidated basis,   that apply to insured depository institutions, bank and thrift holding  companies, and systemically important nonbank financial companies. In  June 2012, OCC, the Federal Reserve, and FDIC proposed  comprehensive revisions to their regulatory capital framework through  three concurrent notices of proposed rulemaking. The proposals would  revise the agencies’ current capital rules to incorporate changes made by  the Basel Committee on Banking Supervision—a body that sets  international standards for bank capital and liquidity—to the Basel capital  framework consistent with relevant provisions of the Dodd-Frank Act.  According to the regulators, the reforms contained in the rule would,  among other things, improve the resilience of the banking sector in times  of stress. The proposed rules, which were published in August 2012,  include an extended comment period that ended in October 2012. 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 agencies  received thousands of comment letters from the public, including banking  organizations of all sizes, trade groups, academics, public interest  advocates, and private individuals, through the comment period.  According to testimony before Congress given by the Federal Reserve’s  banking supervision director, the breadth of the proposed changes has  raised concerns among many industry participants that a January 2013  implementation date for the rules would not provide sufficient time for  them to understand the rules or make necessary system changes. As a  result, the banking agencies announced in November 2012 that they did  not expect to finalize the proposal by January 2013—as expected in the  Basel Agreement.
During the recent crisis, the federal government took unprecedented  actions to address the financial difficulties of several large financial firms,  including making equity investments in some firms or placing others in  government-administered conservatorships. The Dodd-Frank Act  provides a new option for resolving failing financial firms whose disorderly  resolution would have serious adverse effects on U.S. financial stability  by creating a process under which FDIC has the authority to liquidate  large financial firms, including nonbanks, outside of the bankruptcy  process—called the Orderly Liquidation Authority (OLA). Under this  authority, FDIC may be appointed receiver for a financial firm if the  Treasury Secretary determines that the firm’s failure threatens U.S.  financial stability. SIFIs also must formulate and submit to the Federal  Reserve, FSOC, and FDIC resolution plans (or “living wills”) that detail  how they could be resolved in the event of material financial distress or  failure.
Progress has been made to implement the reforms related to resolving  large, complex financial companies. For instance, FDIC finalized several  rules to implement OLA. 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. However, work  remains to be completed in other important areas. Rules that either  remain in proposed form or have not yet been proposed include those  that establish a program to guarantee obligations of solvent depository  institutions and their holding companies and affiliates during times of  severe economic stress, and implement OLA for broker-dealers. In  addition, regulators have not yet completed their reviews of the large  bank holding companies’ resolution plans.
Although many market observers expect that these resolution reforms will  help mitigate threats to the financial system posed by the failure of a SIFI  or other large, complex, interconnected financial firm, some questions  about their potential effectiveness have been raised. Some observers  noted that OLA is new and untested, and its effectiveness in reducing  risky behavior by institutions will depend on the extent to which market  participants believe that FDIC will use OLA to make an institution’s  creditors and shareholders bear losses of any SIFI failure. Furthermore,  others questioned whether FDIC has sufficient capacity to use OLA to  handle multiple SIFI failures and thus prevent further systemic disruption.  Others have raised concerns over whether any FDIC-imposed losses on  some creditors of a failed firm could threaten the soundness of other  important financial institutions or how FDIC would handle the non-U.S.  subsidiaries of a failed firm.
Experts also expressed mixed views on the usefulness of the living wills.  One market expert expressed doubt that these living wills would prove  useful for resolving a complex firm’s failure, but was more optimistic that  the documents could serve to encourage regulators to make such firms  simplify their organizational structures and become more transparent.  Experts further noted that resolution plans may provide regulators with  critical information about a firm’s organizational structure that could aid  the resolution process or motivate SIFIs to simplify their structures and  this simplification could help facilitate resolution. However, other experts  commented that although resolution plans may assist regulators in  gaining a better understanding of SIFI structures and activities, the plans  may not be useful guides during an actual liquidation—in part because  the plans could become outdated or because the plans may not be  helpful during a crisis. Resolution plans also may provide limited benefits  in simplifying firm structures, in part because tax, jurisdictional, and other  considerations may outweigh the benefits of simplification.
FSOC has found that over-the-counter (OTC) derivatives, particularly  credit default swaps, generally were a factor in the propagation of risks  during the recent crisis because of their complexity and opacity, which  contributed to excessive risk taking, a lack of clarity about the ultimate  distribution of risks, and a loss in market confidence. Although some  standardized swaps, such as certain interest rate swaps, have been  cleared through clearinghouses—which stand between counterparties in  assuming the risk of counterparty default—credit default swaps and most  other swaps traditionally have been traded in the OTC market where  holders of derivatives contracts bear the risk of counterparty default.  Title VII of the Dodd-Frank Act establishes a new regulatory framework  for swaps to reduce risk, increase transparency, and promote market  integrity in swaps markets by, among other things, moving trading to  exchanges (or similar trading platforms), requiring that many trades are to  be centrally cleared, and providing for greater public dissemination of  trading information. To implement the act’s reforms, SEC is responsible  for any security-based swaps, SEC and CFTC are jointly responsible for  mixed swaps, and CFTC is responsible for all other types of swaps.
Progress has been made in implementing derivatives reforms. CFTC  officials noted that swap reform has involved multiple rulemakings  including rules, such as defining swaps, registering dealers and reporting  to CFTC on the size of positions in swaps held by such dealers. The  swaps definition rules are in place and effective, and dealer registration is  ongoing. As of April 2012, rules requiring dealers to publicly report their  swaps positions to CFTC were final, and in December 2012 the CFTC  Chairman testified that CFTC had finalized approximately 80 percent of  Dodd-Frank swaps rules. However, the rules that will specify how much  margin—funds posted with a clearinghouse that can serve to absorb  losses as the value of the swaps position changes—and how much  capital a swaps dealer must hold to absorb losses on its swaps remain  incomplete.
Because swaps are globally traded, the regulatory developments in  overseas markets also have affected implementation of the swaps  reforms. Although many other jurisdictions have been developing new  regulatory regimes, the United States has been one of the first  jurisdictions to have enacted legislation in this area. The Financial  Stability Board (FSB)—which is an organization of representatives of  national authorities responsible for financial stability that has been  established to coordinate and promote the implementation of effective  regulatory, supervisory, and other financial sector policies—reported to  the Group of Twenty leaders in October 2012 that regulatory uncertainty  remains the largest impediment to timely implementation of swaps  regulatory reforms across countries. FSB urged continued discussions  to identify and address any conflicts in rules affecting cross-border  activities. According to SEC staff, SEC and CFTC have been active  participants in these ongoing discussions. In some cases, international  bodies have requested the delay of some derivatives-related regulations  because of the importance of coordination. For example, CFTC officials  noted that one of the reasons their Commission voted to reopen the  comment period for the swaps capital and margin requirement rule was to  allow European regulators to complete similar rules, potentially by early  2013.
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. Some experts have  stated that the ability of banking entities to use federally insured deposits  to seek profits for their own accounts provides incentives for them to take  on excessive risks. In particular, academics have noted that commercial  banks benefit from government-insured deposits that subsidize their  funding and thus do not bear the full risks of their proprietary activities.  We previously reported that proprietary trading provided revenues but  also produced large losses for some financial institutions during the  recent crisis. However, others dispute that proprietary trading creates  significant risks. For example, one market observer questioned the role of  proprietary trading in the crisis—noting that losses by banks came from  holdings of mortgage-related securities and not their proprietary trading  activities. In addition, he noted that banks have expertise and add value  in conducting trading activities and that such trading is likely not more  risky than lending.
To address potential risks of proprietary activities, the act generally  prohibits proprietary trading by insured depository institutions and their  affiliates and restricts the extent to which these companies can sponsor  or invest in hedge and private equity funds. Regulators have taken some  steps to implement this reform. For instance, the Federal Reserve issued  the final rule and subsequent policy statement on the time frame for the  effective dates (beginning in July 2014 unless extended by the Federal  Reserve) after which banking entities must fully conform their activities  and investments with these requirements. FSOC also issued a study  recommending the types of monitoring metrics that regulators could use  to help ensure compliance. In addition, the regulators responsible for  issuing a rule specifying how affected institutions must comply—the  Federal Reserve, FDIC, OCC, SEC, and CFTC—issued proposed rules in  November 2011 and February 2012. The proposed rules have generated debate and interest from thousands of commenters, and some  in Congress have called for a repeal of the law or delay of its  implementation, and others have called for regulators to issue a revised  proposal. As of November 2012, staff from some of the regulators  responsible for preparing the rules related to proprietary trading and fund  investment restrictions told us that they were considering the public  comments and next steps, but could not estimate when the next action  would occur. In our 2011 report on proprietary trading, we recommended  that regulators collect and review more comprehensive information on the  nature and volume of activities potentially covered by the act.
subsections: section_title: Reforms to Address Consumer and Investor Protection and Other Areas Have Begun but Remain Incomplete
paragraphs: Regulators have also been implementing Dodd-Frank Act reforms to  improve protections for consumers and investors. In addition to creating a  new regulatory body—CFPB—that will consolidate certain rulemaking,  supervision, and enforcement authorities relating to various consumer  financial laws, including many of those relating to mortgage lending, the  act also included changes to securitization practices to better protect  investors. In addition, the act expands regulatory oversight of credit rating  agencies and advisers of private funds.
Many bank and nonbank mortgage lenders weakened their underwriting  standards and made mortgage loans to homebuyers who could not afford  them or engaged in abusive lending practices before the crisis. After  many homeowners were unable to make their mortgage payments, many  of these mortgages went into default and led to widespread foreclosures.  To address these consumer financial protection failures, the act created  CFPB, among other reforms. Before the passage of the act, consumer  financial protection responsibilities were vested in multiple agencies  across the federal government. The creation of CFPB brought many of  the consumer financial protection rulemaking and other authorities of the  federal government into one agency, with the purpose of increasing  accountability for such responsibilities. The authority for many of these  responsibilities transferred to CFPB in July 2011, but staff told us that it  was not allowed to move forward with its full regulatory responsibilities  until the appointment of its director in January 2012. CFPB has issued  rules and begun taking enforcement actions, including obtaining refunds  for consumers and imposing penalties on certain credit card issuers for  practices that violated the law. For example, in January 2012, CFPB  issued rules, which were formally published in February 2012, to protect  consumers who send money electronically to foreign countries. In  January 2013, the CFPB issued two rules that established numerous  mortgage servicing requirements.
Although CFPB’s mission extends beyond the mortgage market, many of  its initial rulemaking efforts have focused on this market as the bureau  works to implement the act’s reforms. For example, the act prohibits a  creditor from making a residential mortgage loan unless the creditor  makes a reasonable and good faith determination based on verified and  documented information that, at the time the loan is made, the consumer  has a reasonable ability to repay the loan according to its terms. When  making that determination, the creditor must consider, among other  things, the consumer’s income and assets, debt obligations, and credit  history. The act created a presumption of compliance with the repayment  ability requirement when creditors make “qualified mortgages.” The  Federal Reserve issued a proposed rule in May 2011 that would  implement the act’s ability-to-repay and qualified mortgage provisions;  however, due to certain transfers of authority under the Dodd-Frank Act  CFPB has responsibility for finalizing the proposal. After seeking  additional public comments on new data and information related to this  proposal in June 2012, CFPB issued a final rule in January 2013 that  defines qualified mortgages using the criteria specified in the Dodd-Frank  Act.  This rule is to be effective in January 2014. Although intended to  encourage responsible lending, many market observers (including  consumer advocates and lenders) previously have expressed concern  that the rule, as proposed, could result in overly restrictive requirements  (such as debt service-to-income ratios) that would limit the availability of  mortgages to lower-income and minority borrowers. However, in a prior  report, we examined five of the nine qualified mortgage criteria specified  in the Dodd-Frank Act for which sufficient data were available and  generally found that, for each year from 2001 through 2010, most  mortgages would likely have individually met each specific criterion.
The act also attempts to improve investor protections through a variety of  reforms, including reforming securitization practices and requiring  additional disclosures. According to some market observers, institutions  that created mortgage-backed securities in the lead-up to the crisis  engaged in a number of practices that undermined the quality of their  securities, including not adequately monitoring the quality of the  underlying mortgages, because they did not bear the risk of significant  losses if those mortgages defaulted. To address this risk and protect  investors, the act imposes certain risk-retention obligations on securitizers  to retain an economic interest of no less than 5 percent of the credit risk  of any securitized asset (such as a residential mortgage) that they  created unless the asset meets criteria (to be defined by the regulators)  associated with a lower risk of default. Securitized mortgages that meet  the criteria are exempt from the risk-retention requirement and are  referred to as qualified residential mortgages. The act directs the Federal  Reserve, FDIC, OCC, SEC, FHFA, and the Department of Housing and  Urban Development (HUD) to jointly prescribe rules to implement these  requirements. The act also requires additional disclosures to be made to  investors about these asset-backed securities. Some market participants  have expressed concern that restrictive criteria for qualified residential  mortgages would subject some mortgages with relatively low default risks  to risk retention and make mortgage credit less affordable for many  borrowers, because the increased securitization costs would be passed  on to borrowers in the form of higher mortgage interest rates and fees.
However, FDIC officials have stated that risk retention should not result in  substantially higher interest rates for non qualified residential mortgage  borrowers and comes with the benefit of safer and sounder lending  practices. Additionally, rulemaking agencies have indicated that a more  restrictive definition could help ensure that a sufficient volume of non  qualified residential mortgages subject to risk retention would be available  for an active, liquid securitization market for such mortgages.
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. In January 2011, SEC published final rules that will require an  issuer to perform a due diligence analysis of the underlying assets and  disclose the results. However, other key reforms, such as the joint  rulemaking requirement to define a qualified residential mortgage as well  as the rulemaking requiring greater disclosure of information related to  the loans backing specific portions of an asset-backed security remain  incomplete.  These rules likely will have a significant impact on the  volume of private (non-enterprise) mortgage-backed securitizations. As a  result, the rules likely will affect competition in the housing finance  market, which is currently dominated by the enterprises. We discuss  reforming the enterprises later in the report.
As the financial crisis unfolded in 2007 and 2008, questions were raised  about the role that credit rating agencies played in the securitization of  high-risk mortgages into investment-grade securities, the accuracy of the  credit ratings assigned to these securities, and the integrity of these  ratings processes. Critics of credit rating agencies also pointed to the  conflict of interest created by the industry’s predominant compensation  model in which issuers of securities pay the rating agencies for their  ratings as a contributing factor to the poor quality of ratings. In response,  the Dodd-Frank Act mandated additional oversight over the credit rating  agencies that issued these ratings. For example, the act created an Office  of Credit Ratings within SEC, which is to provide oversight and enhanced  regulation of the credit rating agencies registered with SEC as Nationally  Recognized Statistical Rating Organizations. The act also requires that  SEC study, among other things, an alternative means for compensating  credit rating agencies that would create incentives for accurate ratings.  SEC issued its study on alternative means for compensating credit rating  agencies in December 2012. However, as of December 2012, SEC had  yet to issue key rules related to credit rating agencies, several of which  had statutory deadlines. For example, a rule preventing sales and  marketing considerations of credit rating agencies from influencing the  production of credit ratings and a rule that will require these entities to  submit annual internal control reports to SEC remain in proposed form.
Over the last decade, private funds—such as hedge funds and private  equity funds—proliferated but generally were less regulated, raising  questions about investor protection and systemic risk to financial markets.  To address this gap, the act expands regulatory oversight to hedge and  private equity funds by requiring the investment advisers to these funds to  register with SEC. 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. SEC has  completed all of its rulemaking requirements related to private fund  oversight. SEC and CFTC also issued a joint rule, in consultation with  FSOC, to establish the form and content of the reports required to be filed  with SEC and CFTC by investment advisers that are registered under  both the Investment Advisers Act of 1940 and the Commodity Exchange  Act. The completion of these rules helps to bring a largely unregulated  part of the financial markets under regulatory supervision.
section_title: Regulators Have Faced Various Challenges Implementing Reforms
paragraphs: A variety of challenges have affected regulators’ progress in executing  rulemaking requirements intended to implement the act’s reforms.  Regulators to whom we spoke indicated that the primary challenges  affecting the pace of implementing the act’s reforms include the number  and complexity of the rulemakings required and the time spent  coordinating with regulators and others. In addition, some regulators  identified additional challenges, including extensive industry involvement  through comment letters and litigation resulting from rulemakings,  concurrently starting up a new regulatory body and assuming oversight  responsibilities, and resource constraints.
subsections: section_title: Number and Complexity of Rulemakings Has Delayed the Implementation of Certain Reforms
paragraphs: The regulators identified the number and complexity of the required  rulemakings as a primary impediment to their implementation of financial  regulatory reforms. In particular, regulators were tasked with a large  volume of rulemakings and other key actions; in many cases, the act  mandated their completion in relatively short time frames compared to the  typical rulemaking process. For example, we identified more than 80  provisions of the act for which SEC is responsible for (solely or jointly)  developing rules or taking other key actions. As of December 2012, SEC  had proposed or finalized rulemakings for at least 70 of these provisions.  Similarly, we identified more than 50 provisions for which CFTC is  responsible for (solely or jointly) developing rules, all but one of which  CFTC had proposed or finalized. According to SEC and CFTC staff, this  represents a significant increase in their rulemaking agendas.
In many cases, the rulemakings also involved complex issues, such as  developing regulation for a previously unregulated market function.  Implementing such complex regulatory reforms through the rulemaking  process has resulted in delays, as the following examples illustrate.
One of the major reform areas of the act requires that previously  unregulated OTC swaps be brought under the regulatory umbrella.  Regulators indicated this presented a unique set of challenges  because the swaps market is complex and involves a large number of  domestic and international participants. According to SEC staff, they  had to research and acquire expertise on a range of issues. To  acquire diverse perspectives and information, staff also held meetings  and roundtables with industry participants and other agencies and  foreign regulators before proposing the rules.
Regulators responsible for implementing the restrictions on  proprietary trading and hedge and private equity fund investing also  indicated that developing rules on these topics has been challenging  because of the knowledge they had to acquire and the multiple  perspectives and interests of market participants they had to consider.  The complexities of implementing the proprietary trading ban was  highlighted in the rule proposed in November 2011 and February  2012, which included more than 750 questions seeking input from  market participants to help inform regulators’ decision making.
In other cases, the complexity involved identifying and developing  new frameworks or standards for market participants. For example,  regulators must replace references to credit ratings in their regulations  (that is, to regulated entities’ use of or dependence on ratings) and  substitute alternative standards of creditworthiness. According to the  regulators, creating objective and consistent standards for  creditworthiness and defining such standards by regulation is difficult  and finding an alternative to the ratings these agencies produce  requires a thorough understanding of how the process has functioned  in capital markets. Additionally, replacing the credit ratings with an  alternative standard affects other regulations and policies that rely on  credit ratings. 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 the regulators have missed statutory deadlines to complete  rulemakings, regulators told us that some of the mandated time frames  were ambitious. For example, CFTC staff described the statutory  timetable as a challenge, noting that they were required to issue a  significant number of rules within the first year of the act’s passage.  According to some of the regulators with whom we spoke with, their staffs  have prioritized “getting it right” over meeting statutory deadlines, which  has resulted in missing a number of the act’s deadlines.
section_title: Although Coordination among Regulators Improves Rules, It Has Delayed Implementation of Some Reforms
paragraphs: Regulators’ progress in implementing the act’s reforms also has been  delayed because of the need to coordinate with other domestic and foreign  regulators. We identified 58 provisions in which the act specifically  mandates that regulators issue joint rules or consult with other federal  financial regulators during rulemakings or other key actions. In other cases,  reforms require regulators to implement rules that impact or are impacted  by the rulemakings of other regulators. For example, rules related to what  constitutes a “qualified residential mortgage” for securitizations have been  awaiting CFPB’s issuance of the rule on what constitutes a “qualified  mortgage” because the act stipulates that the definition of a “qualified  residential mortgage” cannot be broader than the definition of a “qualified  mortgage.”  CFPB issued the final “qualified mortgage” rule in January  2013.
According to many regulators with whom we spoke, coordination among  domestic regulators and between domestic and foreign regulators has  improved the quality of the rulemakings. For example, these efforts likely  have eliminated duplication and helped fill regulatory gaps to limit risks  migrating to unregulated markets, according to the regulators.  Nevertheless, coordination with other regulatory bodies lengthens the  time required to implement reform. To facilitate domestic coordination,  while financial regulators employed some formal communication  methods, they mostly used informal communications strategies and tools.  Regulators generally held formal interagency meetings early in the  rulemaking process, then held recurring meetings at different staff levels  and facilitated coordination through informal communications (e-mail,  telephone conversations, and one-on-one staff conversations). For  example, FDIC, OCC, and the Federal Reserve held a principal-level  meeting to discuss the major issues relating to development of risk-based  capital rules. Afterwards, the agencies formed an interagency working  group at the staff level that continues to work on these rules. In addition,  FSOC has established a framework for consultation when it is required to  be consulted or may make recommendations.
On the international level, U.S. regulators also have coordinated with  foreign regulators and with international standard-setting bodies. For  example, in December 2012, FDIC and the Bank of England issued a joint  paper that discusses their common view about how to resolve failures of  large financial institutions. Also, CFTC and SEC coordinated with securities  and futures regulators in other countries on various derivatives reform  provisions by participating in several international groups as well as  numerous conference calls and meetings. OFR staff have also  coordinated with international regulators and financial market participants  through the FSB to develop standards for a LEI that is intended to  accurately identify parties to financial transactions. OFR played a key role  leading work streams and working with other regulators and industry to  provide recommendations to the Group of Twenty to guide the governance,  development, and implementation of a global LEI system. During the  implementation phase, OFR is serving as a vice-chair on the LEI  Implementation Group and will continue to provide leadership and support  as this group works towards meeting the March 2013 target for launching  the LEI system.
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. Regulators stated that working  with other agencies—both domestically and internationally—can be  difficult for a variety of reasons. For example, each regulator has different  statutory authorities and obligations, jurisdictions, and missions. Each  regulator has unique expertise and experience with the financial products  or services it regulates and the supervisory structures of each agency are  different. These differences can make reaching consensus (for instance,  by aligning or reconciling regulations) difficult and time consuming. For  example, although CFTC and SEC reached consensus on the text for the  jointly issued swap entities rule, the regulators outlined different  approaches in certain parts of the rule due to their regulatory jurisdiction  over different products. In addition, regulators told us that they had to  allow extra time for other regulators to review draft rules, hold  discussions, and reach consensus.
section_title: Volume of Comments and Industry Challenges Also Have Affected Pace of Implementation
paragraphs: The volume of comments that regulators have received on some rules  also affected the pace of rule development. 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. According to these staff, the volume of comments  from market participants and consumer groups has presented challenges  for deciding the content of a final rule—as in the case of market  participants advocating opposing or disparate positions, which regulators  then needed to consider and perhaps reconcile. CFTC staff cited the  example of comments relating to the amount of business that could be  done before an entity would be required to register as a swaps dealer.  Suggested amounts for the de minimus exception ranged from the  millions to the billions of dollars. Although some comments regulators  received on rules were multiple versions of similar form letters, in other  cases the letters were unique and could be lengthy (more than 200  pages). OCC staff noted that the proprietary trading rule received more  than 400 nonform letters with substantive comments, some of which were  more than 100 pages each. The capital rules generated fewer comments,  but these letters were very lengthy and had to be carefully considered.  Regulator staff told us that high comment volume lengthens the  rulemaking process and requires more staff review and analyze because  each regulator is legally required to consider every comment it receives.
In addition, industry involvement, including filing legal challenges, has  delayed some regulatory efforts. According to one public interest  association, intense industry lobbying efforts and the threat of lawsuits  have been roadblocks to successful implementation of consumer  protection reforms. Also, an industry-sponsored study has criticized the  impending reforms, such as the ban on proprietary trading. In other  cases, legal challenges filed by the industry have affected the pace of  reforms. For example, in October 2011, CFTC approved a final rule on  position limits for futures, options, and swaps related to 28 physical  commodities, such as agricultural and energy products or metals, an  action that the agency believed the act mandated. However, in  September 2012, the United States District Court for the District of  Columbia overturned the final rule after finding that the agency did not  prove that the Dodd-Frank Act granted CFTC authority to issue the  regulations without first determining the regulation was “necessary” or  “appropriate” and therefore the regulations were vacated. CFTC  appealed the District Court’s decision in November 2012, but until the  appeal is completed CFTC’s requirements are not in effect for market  participants. In another example, in July 2011 the United States Court of  Appeals for the District of Columbia Circuit overturned SEC’s rule on  proxy access requirements on the basis that SEC had failed to perform  an adequate cost-benefit analysis of the rule’s impact. Although this rule  was not mandated by the Dodd-Frank Act, SEC staff told us that because  of this decision, they have been spending additional time on developing  cost-benefit analyses for the rules they must develop under the act, which  has lengthened the time needed for rulemaking.
section_title: Other Challenges to Reform Implementation Included Establishing New Entities
paragraphs: 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.  After the act was passed in July 2010, staff detailed from Treasury  offices and other federal agencies began hiring new staff and  establishing internal administrative procedures and structures.  Although rulemaking and other authorities relating to the consumer  financial laws transferred to CFPB in July 2011, the agency did not  have a director until January 2012. Until then, it was limited in its  ability to issue certain rules and conduct certain oversight of entities  other than banks. As of October 2012, the agency had about 1,000  staff and anticipates reaching approximately 1,300 staff sometime in  2013. While establishing regulatory operations, its staff also had to  develop various rulemakings required by the act. As noted previously,  CFPB had been working on a complex rule that would promote  responsible mortgage lending by requiring creditors to consider a  consumer’s repayment ability before making a residential mortgage  loan. CFPB staff acknowledged that establishing their agency,  conducting its operations, and developing various rulemakings has  been challenging and likely slowed progress in some areas.
The creation of new offices in SEC also has affected the pace of that  agency’s rulemakings. More specifically, the Dodd-Frank Act required  the creation of five new offices in SEC—including an Office of Credit  Ratings. This office was established when SEC named its director in  June 2012. As a result, some activities were started by other SEC  divisions and offices—including finalizing rules for credit rating  agencies that require them to disclose the information and  assumptions used in ratings they issue—according to SEC officials.
OFR also has faced the challenge of trying to build a world-class  research organization from the ground up while meeting shorter-term  goals and responsibilities. For example, as a new, relatively unknown  entity OFR had to overcome a lack of name recognition as it has  sought to hire researchers and other staff. OFR officials told us that the  organization has been making steady progress to overcome this  challenge, and has attracted highly qualified researchers and others to  senior staff positions. The absence of a Senate-confirmed director for  the organization until January 2013 slowed the process. While  establishing itself, OFR also has been conducting work to further its  mission to provide ongoing support to FSOC and standardize the types  and format of data collected and reported by financial regulators.
According to some regulators, their efforts to fully implement the reforms  also have been delayed due to resource constraints their agencies face.  For example, the Dodd-Frank Act increased SEC’s and CFTC’s  responsibilities, including their rulemaking responsibilities. However,  according to SEC and CFTC staff, their agencies did not receive  commensurate increases in appropriations. As a result, staff from both  CFTC and SEC told us that attempting to finalize so many interrelated  and often complex rules with their existing staffing levels has been  challenging. CFTC staff told us that personnel responsible for some  rulemakings have had to do the work of more than one person, which  increases the potential for errors and delays that interrupt the normal flow  of rulemaking. Looking forward, CFTC and SEC staff expressed concerns  about their ability to carry out rule enforcement. To mitigate these  concerns, CFTC requested 305 additional full-time equivalent positions in  its 2013 budget request. Likewise, SEC requested an additional 196 full- time equivalent positions in its 2013 budget request.
section_title: Various Areas Continue to Pose Risks, and Regulatory Actions to Mitigate These Risks Have Not Been Finalized or Implemented
paragraphs: 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. For example, we noted that regulators had  struggled, and often failed, to mitigate the systemic risks posed by large  or interconnected financial conglomerates and to help ensure they  adequately manage their risks. Problems in financial markets also  resulted from the activities of less-regulated market participants—such as  nonbank mortgage lenders, hedge funds, and credit rating agencies— some of which played significant roles in the financial markets. In  addition, we noted that the increasing prevalence of new and more  complex investment products posed challenges for regulators, investors,  and consumers. 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.
In a number of ways, the act’s reforms—if implemented effectively—could  address many characteristics of our framework. For example, the  consistency of consumer protection could be increased through the  establishment of CFPB, which consolidated certain of the consumer  protection rulemaking, supervision, and enforcement authorities  possessed by seven different federal agencies. The creation of FSOC  could help to address the framework’s call for a systemwide focus on  risks. Other Dodd-Frank Act reforms also address additional areas on  which the framework touches. 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.  Furthermore, regulations that will expand disclosures about mortgage- backed securities and require issuers to retain a portion of the credit risk  of these securities could improve investor protection.
Nevertheless, some potential risks remain and others have emerged in  the years following the 2007-2009 crisis, including the following:  Regulatory structure. In the framework, we called for a more effective  and efficient regulatory system. Specifically, we noted several  characteristics of effective and efficient oversight, including eliminating  overlapping federal regulatory missions where appropriate, and  minimizing regulatory burden without sacrificing effective oversight. To  this end, the Dodd-Frank Act abolished the Office of Thrift Supervision,  transferring its functions to OCC, FDIC, and the Federal Reserve.  However, the act did not otherwise extensively consolidate the roles and  responsibilities of the financial regulators and created new entities, such  as OFR and CFPB. Consequently, multiple regulators may oversee  different components of the same large, complex financial institutions  while retaining their independence, differing approaches, and specific  statutory duties and authorities, including rulemaking and enforcement.
Given the fragmented regulatory structure, regulators must continue to  coordinate actions across multiple agencies and try to reconcile differing  approaches and authorities to better ensure effective oversight of large  financial firms. Without sufficient coordination, financial institutions could  seek to take advantage of variations in how agencies implement  regulatory responsibilities in order to be subject to less scrutiny. We have  previously noted the role that FSOC could play in promoting coordination  among its member agencies, including during the rulemaking process.  However, FSOC’s Chairperson has noted that he does not have the  authority to force agencies to coordinate, and neither he, nor FSOC as a  whole, can force agencies to adopt compatible policies and procedures.
Fannie Mae and Freddie Mac. Our 2009 framework emphasizes that  effective reform would minimize taxpayer exposure to financial risk,  particularly when market participants encounter financial difficulties.  However, the act did not address the futures of Fannie Mae and Freddie  Mac that together support the majority of single-family mortgage loans.  Given mounting losses, in September 2008 the enterprises were put into  conservatorship and provided access to federal assistance through Senior  Preferred Stock Purchase Agreements with the U.S. Treasury; together  they have received over $187 billion in federal assistance as of the end of  fiscal year 2012. Although recently the enterprises began earning profits  that are being returned to the U.S. Treasury, the act did not address the  existing taxpayer exposure from the enterprises or provide a road map to  mitigate potential future losses related to them.
In late 2008, a combination of government-led actions ensured the secondary mortgage  market kept functioning, including Treasury’s financial backstop of these enterprises’ debt  and mortgage-backed securities (MBS) holders; and MBS purchases by Treasury and the  Federal Reserve. infrastructure for the secondary mortgage market, gradually contracting  the enterprises’ dominant presence in the marketplace while simplifying  and shrinking their operations, and maintaining foreclosure prevention  activities and credit availability for both new and refinanced mortgages.
In August 2012, FHFA took two actions affecting the enterprises. First, to  encourage greater participation in housing markets by private firms,  FHFA directed the enterprises to raise the fees they charge lenders for  securitizing their mortgage loans to reduce the cost difference between  securitizations done by the enterprises and those done by private firms.  Second, FHFA, in conjunction with Treasury, revised the senior preferred  stock purchase agreements to have the enterprises pay dividends to the  U.S. Treasury based on their net worth (when positive) rather than a fixed  percentage of the outstanding senior preferred stock. Among other things,  this change should eliminate the need for the enterprises to borrow from  Treasury to pay such dividends. In October 2012, FHFA also sought  public comment on a proposal for developing a new mortgage  securitization platform to process payments and perform other functions  that could be used by multiple issuers that would replace the enterprises’  proprietary systems. Although such proposals and plans have been put  forward, as of December 2012, no definitive plan had been developed  and the enterprises remain in conservatorship, which places taxpayers at  continued risk. Furthermore, given the large role that the enterprises play  in the mortgage market, the future of mortgage lending depends, in part,  on how the enterprises are resolved. The Treasury and HUD plan  acknowledges that changes in the role of the enterprises will also require  changes in the activities of HUD’s mortgage insurance and guarantee  programs to ensure that the private market rather than the government  expands its market share.
Money market funds. The framework calls for improving the regulatory  system by ensuring a focus on risks that could affect the system as a  whole. However, one risk that continues to raise significant concerns is  the potential systemic risk posed by money market funds (MMF). MMFs  are mutual funds that seek to offer investors three primary features: return  of principal, liquidity, and a market-based rate of return. During the  financial crisis, runs on MMFs led to severe disruptions in the short-term  credit markets in which the funds played a significant role. After a number  of MMFs recorded significant decreases in the value of portfolio holdings  when the market for asset-backed commercial paper collapsed in the  summer and fall of 2007, these funds’ sponsors absorbed these losses.  However, in 2008, the sponsor of the Reserve Primary Fund did not  provide support for the relatively small losses incurred by this MMF, which  led to a general run of investors withdrawing their money from money  market funds, creating severe funding pressures for issuers of  commercial paper. The run was stopped by unprecedented interventions  by Treasury and the Federal Reserve to provide guarantees and liquidity  support to the industry.stated that the events of the financial crisis highlighted that the risks  posed by MMFs stem from flaws inherent in the structure of these funds  (such as valuation methods that make funds susceptible to runs and a  reliance on discretionary sponsor support for stability). She further stated  that she considers the structural reform of money market funds one of the  pieces of unfinished business from the financial crisis.
The former SEC Chairman—Mary Schapiro— In 2010, the Commission adopted the first round of reforms to boost the  resilience of MMF portfolios. For example, SEC required MMFs to hold  more highly liquid assets and to disclose their portfolio holdings monthly.  Some market observers contend these reforms are sufficient to address  any risk from these funds and that further reforms are unnecessary.  However, regulators and others continue to be concerned. According to a  paper issued by the International Monetary Fund, strengthening the  regulation of MMFs is critical especially because U.S. regulators are now  prohibited from using the types of emergency authorities they employed  in the recent crisis, such as the government-backed guarantees of MMFs’  obligations to shareholders that prevented further problems.
In June 2012, the SEC Chairman discussed the need for SEC to pursue  additional reforms, including potentially requiring funds to have a floating  net asset value per share or to maintain a capital buffer of assets to absorb  day-to-day fluctuations in the value of the funds’ portfolio securities. 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. In August 2012, a majority of the SEC commissioners  informed the SEC Chairman that they would not support a staff proposal to  reform the structure of money market funds without further study. In  September 2012, these commissioners posed several questions to SEC  staff regarding various aspects of money market funds, which were  addressed in a study issued in November 2012. However, as of  December 2012, no official agency action had occurred.
FSOC has urged SEC and other members to take certain actions to  address the risks posed by cash management vehicles similar to MMFs.  For instance, in July 2012 FSOC recommended that its members align  regulation of cash management vehicles within their regulatory jurisdiction  to limit the susceptibility of these vehicles to the risk of runs. Furthermore,  at a November 2012 meeting, FSOC—under its authority to recommend  that a primary financial regulatory agency apply new or heightened  standards or safeguards to financial activities or practices conducted by  bank holding companies or nonbank financial companies that create or  increase the risk of significant liquidity, credit, or other problems—issued  several proposed recommendations for reforming MMFs for a 60-day  public comment period. Similar to those proposed by the SEC  Chairman, these proposed alternatives for reform include requiring MMFs  to have a floating net asset value per share, maintain a buffer of assets of  up to 1 percent of net asset value to absorb day-to-day fluctuations in the  value of the funds’ portfolio securities and allow the funds to maintain a  stable net asset value.also noted that it was still preferable for the responsible regulator—SEC— to take the appropriate actions but absent such SEC actions, other  regulators might have to act. However, although FSOC can make such  recommendations and agencies must respond to such recommendations,  FSOC cannot require that such changes be implemented.
At the November meeting, the FSOC Chairman  Concentration of risks. The framework also calls for the U.S. regulatory  system to subject all activities posing risks to appropriate oversight and  protections. 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. The financial crisis revealed weaknesses in the design of the U.S. tri-party repo market, a funding mechanism used by  major broker-dealers to finance their inventories of securities. However,  currently only two institutions provide credit to facilitate transactions in this  market. According to the Federal Reserve Bank of New York, these  weaknesses could rapidly elevate and propagate systemic risk. For  instance, it became apparent during the crisis that the market’s  infrastructure to settle transactions had fundamental flaws that could lead  to serious instability during periods of market stress. In its 2012 Annual  Report, FSOC notes that the elimination of most intraday credit exposure  and the reform of collateral practices in this market continue to be areas  of intense focus for the council.
The resiliency of the tri-party repo market is important for a number of  reasons. First, the market serves as a tool for cash and liquidity  management and for short-term borrowing for a range of financial  intermediaries, including money market funds, insurance companies,  banks, and securities dealers, all of which play an important role in  supporting the savings and investment programs of households, small  businesses, and nonfinancial corporations. Second, the tri-party repo  market is currently the source of funding for some $1.8 trillion in securities  held by securities dealers and only two banks currently act as agents and  clearing organizations in the vast majority of tri-party repurchase  agreements. Managing the interdependency of financial products is an  important factor in reducing systemic risk and enhancing the stability of  the U.S. financial system.
Market participants and regulators have made some progress in  addressing the tri-party repo market shortcomings and enhancing  protections. For instance, the current tri-party repo market is smaller than at  its peak and generally funds higher-quality collateral than it did before the  crisis. However, certain vulnerabilities remain. According to testimony by a  Federal Reserve official, the reliance on discretionary intraday credit in the  tri-party settlement process poses difficult dilemmas for cash lenders,  borrowers, and clearing banks during periods of market stress, which could  result in securities dealers experiencing a sudden and acute loss of  funding. Furthermore, key stakeholders believe that not as much progress  has been made—or made as quickly—as warranted by the seriousness of  the risks this market poses. Consequently, a task force of market  participants that regulators convened issued a final report in February 2012  calling for a settlement process that relies less on extensions of credit. The  Federal Reserve also has acted to reduce the reliance of market  participants on this form of funding by encouraging market participants over  which it has direct authority to implement the task force recommendations  in a timely fashion. However, in congressional testimony, a Federal  Reserve official acknowledged continued work is needed to generate  additional solutions for reducing systemic risk.
Another source of concentrated financial risks arises from the activities of  clearinghouses for financial products, and some of the reforms of the act  could expand this risk. For instance, by requiring that most swaps be  cleared through clearinghouses rather than the OTC market, the act  attempts to reduce the vulnerability of the financial system to the failure of  one or a few of the major swap dealers by transferring credit risk from the  swap counterparties to the clearinghouse. However, some experts noted  this reform concentrates credit risk at the clearinghouses and, in effect,  creates a source of systemic risk. For example, a former regulatory  official told us that clearinghouses in the new swaps market will be “too  big to fail” and pose the same moral hazard problem as large financial  institutions because the Dodd-Frank Act includes a provision allowing the  Federal Reserve to assist certain clearinghouses. In addition, experts  commented that clearinghouses that become engaged in clearing less- standardized swaps could expose themselves to greater risks and more  complex risk-management challenges. Regulators have taken some  actions that could mitigate the risk posed by these clearinghouses. In July  2012, FSOC designated several clearinghouses as systemically important  financial market utilities, which will subject these entities to heightened  prudential oversight by the Federal Reserve.
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. For  example, one academic noted that during the crisis the activities of some  smaller institutions, such as those involved with asset-backed  securitizations, were not individually problematic but became so as  numerous institutions experienced losses, which, in turn, spread to affect  others due to the interconnectedness of the system. Such threats to  financial stability could stem from a large number of institutions that  encounter trouble with certain risky products or from soundness problems  that arise at a group of smaller institutions, such as regional banks. The act  includes some reforms that, if effectively implemented, could minimize such  threats, such as minimum capital standards for banks and FSOC’s ability to  monitor and respond to a broad range of threats. However, their  effectiveness will be greatly affected by how they are implemented and the  vigorousness of regulators’ oversight efforts.
Overall, the federal financial regulators have considerable work under  way to implement reforms that could improve the financial system in  many of the ways that our 2009 framework envisions. However, much  work remains to implement the Dodd-Frank Act reforms. As of December  2012, regulators had finalized a little less than half of the provisions we  identified as requiring rulemakings or other key actions. Moreover,  completing the rulemaking process does not mean that reforms are fully  implemented. Rather, it will take time—beyond the time spent on  finalizing the rulemakings—for regulators and industry to adopt the  reforms contained in the rulemakings, and even longer to determine  whether the reforms have had their intended outcomes.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to CFPB, CFTC, FDIC, the Federal  Reserve, FHFA, FSOC, OCC, OFR, and SEC for their review and  comment. The SEC Chairman provided written comments on our draft.  The Chairman’s letter notes that implementation of the Dodd-Frank Act  continues to be a major undertaking of SEC and other agencies. She also  describes progress SEC has made in issuing required rules and studies.  These comments are reprinted in appendix II.  We also obtained technical  comments from CFPB, FDIC, FSOC, OCC, OFR, and SEC, which we  have incorporated as appropriate.  The Federal Reserve, FHFA, and  CFTC did not provide comments.
We are sending copies of this report to CFPB, CFTC, FDIC, the Federal  Reserve, FHFA, FSOC, OCC, OFR, and SEC, interested congressional  committees, members, and others. This report will also be available at no  charge on our website at http://www.gao.gov.
Should you or your staff have questions concerning this report, please  contact me at (202) 512-8678 or clowersa@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found  on the last page of this report. Key contributors to this report are listed in  appendix II.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: 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 also reviewed and analyzed government, academic, and  other studies on Dodd-Frank Act reforms and implementation. To  examine regulators’ efforts to implement the provisions of the Dodd-Frank  Act, we focused on eight major reform areas: capital requirements;  resolution of financial institutions; proprietary trading; derivatives;  consumer protection; mortgage reforms; expanded regulation of  institutions and products; and investor protection. We also obtained and  analyzed information from a database maintained by the law firm Davis  Polk and Wardwell LLP that identified provisions of the Dodd Frank Act  that require or authorize regulators to take actions, and tracks the status  of regulators’ efforts to implement these provisions. We focused our  analysis on provisions that required rulemakings or other key actions, but  excluded other requirements, such as those to publish studies.
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. For example,  after we identified provisions that we believed required regulators to issue  rulemakings or take other key actions, we discussed these provisions with  staff from eight agencies that are responsible for implementation of the  majority of these efforts. In some cases, the law firm’s staff had identified  provisions in the act as requiring separate actions, but which regulators  saw as the same required action and had responded to the provisions by  issuing a single rule. In other cases, regulators acknowledged that the act  had called for separate actions but they had chosen to respond to these  provisions in a single rule. For purposes of our report, we counted a  provision as calling for a separate requirement if it appeared in our  professional judgment to be a distinct requirement, regardless of how an  agency combined or separated it for rulemaking purposes. In cases in  which multiple regulators were required to implement one provision, we  counted the provision as being finalized when at least one regulator had  finalized a rule, and we counted a rule as having been proposed when at  least one of the regulators had proposed a rule. Finally, our analysis  focused on regulators’ progress implementing rulemakings and taking  other key actions from the act’s passage through December 2012.  Using  different sources, assumptions, and judgments in compiling the list of  provisions could result in different totals, and therefore the information we  provide should not be taken as a definitive count of all actions required by  the act.
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.  This is because the database presents as separate requirements various  Dodd-Frank Act provisions that regulators may view as one requirement  with multiple elements and thus may be addressed through a single rule.  However, because we have used various additional sources, including  input from the relevant regulators, to compile the list of provisions  requiring regulatory action, we maintain that the total we present in this  report—which is significantly less than the total required actions reported  by the original source—has been compiled using reasonable methods  and treats requirements consistently across agencies.  Moreover, we  have disclosed the steps we took to compile the list of provisions and the  limitations of our analysis.
For our first two objectives, we also interviewed officials from seven  financial federal regulators—Board of Governors of the Federal Reserve  System (Federal Reserve), Bureau of Consumer Financial Protection  (CFPB), Commodity Futures Trading Commission (CFTC), Federal  Deposit Insurance Corporation (FDIC), Federal Housing Finance Agency  (FHFA), Office of the Comptroller of the Currency (OCC), and Securities  and Exchange Commission (SEC)—as well as staff from the Financial  Stability Oversight Council (FSOC) about their implementation of various  Dodd-Frank reforms, challenges they are facing, and areas that continue  to pose risk. In addition, we interviewed industry and consumer groups  about these same issues and obtained the views from market observers  and experts who have written about various Dodd-Frank Act reforms.
For the third objective, we compared key reforms (as identified for  objective one) of the act against GAO’s 2009 framework for evaluating  regulatory reform. We analyzed documentation and reports issued by  federal regulators, market participants and observers, GAO, and  congressional committees that identify areas of the U.S. financial system  that undermine its stability and were not addressed by recent reforms.  Finally, we interviewed regulatory officials, market participants, and  observers to obtain their viewpoints about what areas, issues, or products  could decrease the stability of the financial system that would benefit from  additional or enhanced reforms, and any progress taken by the regulators  to address these issues.
We conducted this performance audit from June 2012 to January 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Comments from the Securities and Exchange Commission
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Cody J. Goebel (Assistant  Director), Anne A. Akin, William R. Chatlos, Camille K. Jennings,  Waterankwa Kadzai, Jon D. Menaster, Marc W. Molino, Barbara M.  Roesmann, and Jessica M. Sandler made significant contributions to this  report.
section_title: Related GAO Products
paragraphs: Financial Regulatory Reform: Financial Crisis Losses and Potential  Impacts of the Dodd-Frank Act. GAO-13-180. Washington, D.C.:   January 16, 2013.
Dodd-Frank Act: Agencies’ Efforts to Analyze and Coordinate Their  Rules. GAO-13-101. Washington, D.C.: December 20, 2012.
Community Banks and Credit Unions: Impact of the Dodd-Frank Act  Depends Largely on Future Rule Makings. GAO-12-881. Washington,  D.C.: September 13, 2012.
Financial Stability: New Council and Research Office Should Strengthen  the Accountability and Transparency of Their Decisions. GAO-12-886.  Washington, D.C.: September 11, 2012.
Municipal Securities: Options for Improving Continuing Disclosure.   GAO-12-698. Washington, D.C.: July 19, 2012.
Bankruptcy: Agencies Continue Rulemakings for Clarifying Specific  Provisions of Orderly Liquidation Authority. GAO-12-735. Washington,  D.C.: July 12, 2012.
Credit Rating Agencies: Alternative Compensation Models for Nationally  Recognized Statistical Rating Organizations. GAO-12-240. Washington,  D.C.: January 18, 2012.
Bank Capital Requirements: Potential Effects of New Changes on Foreign  Holding Companies and U.S. Banks Abroad. GAO-12-235. Washington,  D.C.: January 17, 2012.
Dodd-Frank Act Regulations: Implementation Could Benefit from  Additional Analyses and Coordination. GAO-12-151. Washington, D.C.:  November 10, 2011.
Federal Reserve System: Opportunities Exist to Strengthen Policies and  Processes for Managing Emergency Assistance. GAO-11-696,  Washington, D.C.: July 21, 2011.
Bankruptcy: Complex Financial Institutions and International Coordination  Pose Challenges. GAO-11-707. Washington, D.C.: July 19, 2011.
Mortgage Reform: Potential Impacts in the Dodd-Frank Act on  Homebuyers and the Mortgage Market. GAO-11-656. Washington, D.C.:  July 19, 2011.
Dodd-Frank Act: Eleven Agencies’ Estimates of Resources for  Implementing Regulatory Reform. GAO-11-808T. Washington, D.C.:   July 14, 2011.
Proprietary Trading: Regulators Will Need More Comprehensive  Information to Fully Monitor Compliance with New Restrictions When  Implemented. GAO-11-529. Washington, D.C.: July 13, 2011.
Financial Assistance: Ongoing Challenges and Guiding Principles  Related to Government Assistance for Private Sector Companies.   GAO-10-719. Washington, D.C.: August 3, 2010.
Financial Markets Regulation: Financial Crisis Highlights Need to Improve  Oversight of Leverage at Financial Institutions and across System.   GAO-09-739. Washington, D.C.: July 22, 2009.
Systemic Risk: Regulatory Oversight and Recent Initiatives to Address  Risk Posed by Credit Default Swaps. GAO-09-397T. Washington, D.C.:  March 5, 2009.
Financial Regulation: A Framework for Crafting and Assessing Proposals  to Modernize the Outdated U.S. Financial Regulatory System.   GAO-09-216. Washington, D.C.: January 8, 2009.