On July 21, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The reforms , as envisaged in Act, will be in three broad categories : (a) Regulatory Oversight, (b) Dealing with big banks and (c) Prop Trading and derivatives.
The legislation seeks to introduce new measures to protect customers of banks and financial intermediaries, check the powers of big banks and cracks down on deceptive practices by credit card firms. The most important provision is the resolution authority under which federal regulators can seize any financial company whose failure threatens the financial system, and quickly pay off secured creditors while imposing losses on shareholders and unsecured creditors.
Though a secondary player in the crisis, derivatives are a perennial candidate for causing the next one because they add opacity and leverage to the financial system. Most derivatives that now trade dealer-to-dealer will be traded on public exchanges. That will lessen the risk that one dealer’s failure brings down others. An extreme proposal to stop banks trading derivatives has been mercifully scaled back. (The Volcker rule, limiting banks’ ability to trade on their own account, also seems likely to hurt Wall Street profits less than some feared.)
Significantly, this legislation also seeks to bring more accountability for the credit rating agencies. They may have to give their signed opinions on the prospectus in future. Statements made by a credit rating agency will attract liabilities in the same manner and to the same extent as the statements made by a registered public accounting firm or a securities analyst under the securities laws
However, it may be up to a year before a new Consumer Financial Protection Bureau is set up. It could be 18 months before the new regulations emerge to stop the banks from engaging in impermissible proprietary trading and investments in hedge funds.