Well it looks like the day may have finally come. After years of more and more regulations being heaped on the U.S. banks the Treasury announced in June plans to ease, or a least revisit, a number of the Dodd Frank rules. Most of the proposed changes will not require the approval of Congress, which makes it even more likely that many of these changes will happen (unlike the Financial Choice Act which will likely not get passed by the Senate). The upshot is that the Treasury is putting the brakes on any new regulation and is taking a significant look at what needs to be changed in the existing regulations.
Now that Fed Governor Daniel Turrullo is gone and bank-friendly folks are at the reins in the Treasury department the road has been cleared for this kind of action. Many have been calling for a time-out to evaluate the effects of the now seven year old Dodd Frank regulations. It only makes sense to take some time to do a review to see what is and what is not working. This type of discussion has been difficult with the extreme partisanship in Washington and lingering populist anger with Wall Street. That said, there have been many unintended consequences from the financial regulations and some recalibration needs to be considered. The Treasury proposal should be encouraging for the major banks. It gives them some hope that they won’t have to deal with any new regulations and what they already have to deal with may get dialed back.
What does all this mean for prime brokers and hedge funds?
The Treasury proposal contains changes to two regulations that will be a positive for prime brokers: the Supplementary Leverage Ratio (SLR) and High Quality Liquid Assets (HQLA). Specifically the proposal addresses some of the inefficiencies of the SLR and broadens the definition of HQLA to more closely align with that of the foreign banks.
The change to the SLR would provide the prime brokers with more balance sheet capacity. The U.S. banks are already well above the leverage thresholds and these changes will only increase this buffer. The SLR changes and their impact on prime broker balance sheets may also lessen the balance sheet scarcity especially in a crisis. The change to the HQLA definition won’t directly impact the primes but it may reduce the internal liquidity charges allocated to their business.
That said, in the end these changes are incremental and it will take a while for whatever changes are made to flow through the hedge fund financing food chain. Therefore status quo will probably be maintained for the foreseeable future. The primes and the hedge funds have reached a steady state in terms of managing the balance sheet and client returns. In the end the current counterparty risks brought on by regulation probably won’t be eased much for two reasons. First as mentioned earlier, these changes will take time. Second, the banks will be slow to make any big changes to their capital and liquidity management process knowing that a change in the political winds could reverse what the treasury is proposing to roll back.
In the end I will paraphrase the legendary Barton Biggs who once said in reference to tough times “…the news doesn’t have to be good it just needs to be less bad.” The Treasury proposal news is less bad for the banks.