US Financial Services Policies Shift to Rules, Regulations, and Executive Actions

Transcript:

Drew Carrington: Hello and welcome. My name's Drew Carrington, Head of Institutional DC here at Franklin Templeton. I'm hosting this discussion today on behalf of the Franklin Templeton Institute. I'm joined today by Dean Sackett from Polaris Capital, Dan Murphy and Andy Lewin from the BGR Group, all of Washington, DC.

We're here today to talk about the implications of the 2022 midterm elections. And Dean, I'll start with you.

Dean Sackett: Thanks, Drew. So, what's the difference between 51-49? In and a 50-50 Senate, the Vice President casts the tie breaking vote, but there's a power sharing agreement. So, committee ratios are equal. Committee budgets are equal. Committee staff is equal. So now that the Democrats have a true majority in the Senate, 51-49, they're really in charge and can be more aggressive. So, what does this mean for some policies?

I think with the House Republicans in charge, you're going to see a lot more oversight. And it's not just going to be on some of these high-profile, kind of cultural issues. It's going to be in our space also. So, ESG [Environmental, Social and Governance] investing—something that's ubiquitous throughout the industry--that's in the sights of a lot of Republicans.

And the idea is, are you investing on behalf of your retail investors or are you investing to promote social goals? So, if we're dealing with impact investing, where that is the true purpose, I don't think there's a problem if that's clearly advertised. The issues Republicans have revolve more around influencing policies at corporations without investor knowledge, and not taking into account, first and foremost, investor returns.

So, we're going to see a lot of that. The Senate Banking Committee issued a report on going after the Big Three, as they said it, asset managers. And basically, their hypothesis is passive investors are influencing corporate policy with other people's money. If they overly influence banks, they should probably be regulated as bank holding companies. And oh, by the way, let's include the INDEX Act, which basically says the mutual fund would not vote the proxies. The individual investors would, which would be a very burdensome deal indeed. Tax policy—probably no tax increases coming out of the House.

Drew Carrington: Thanks, Dean. Andy, turning to you for a second. Let's talk a little bit more in detail about what Dean alluded to, the 51-49 Democratic control of the Senate. What does that mean for in particular that the committee leadership and the likelihood that we see movement on legislation out of the Senate? And anything else we ought to think about-the differences between 51-49 and what we had over the last two years of 50-50?

Andy Lewin: Yeah. Thank you, Drew. And thanks for having us. I agree with what Dean said about the power sharing agreement going away now that the Senate is 51-49. I think the Senate Banking Committee, in fact, circulated a memo outlining its likely agenda for the next two years. And cryptocurrency and digital assets will be at the top of the agenda for the Senate Banking Committee, as well a focus on housing.

I think digital assets and crypto is something we can get into a little bit more. I expect a heavy focus from the Senate and the House on both. I will note one thing in the area of ESG—I think because Democrats maintain control of the Senate and Republicans took the House majority, we will see a push against ESG-investment practices, particularly from the Big Three, but other asset managers as well, from the House side, from House Republicans.

And I think we'll see some counterprogramming, actually, from Senate Democrats. I think we'll see Senate Democrats pushing back against some of what we'll hear out of the House. And we'll see Senate Democrats trying to hold financial institutions and asset managers and others to any NetZero emissions pledges that they've made. We've already seen some of this pushback from the Comptroller in New York City, for example, and from Democratic states like California. So, I think we'll see the Senate Democrats use their authority to push back a little bit against some of the ESG focus from Republicans.

In many ways, it's a sort of a blessing and a curse to have divided government. I think fewer bad things happen to business when you have divided government and you certainly have less spending going out. But the downside, of course, is that it's sometimes tough to reach bipartisan agreement between the House and the Senate. Something that we can get into a little bit, Drew, is how difficult that will be, in particular, on the debt ceiling, where you're going to absolutely have to have bipartisan agreement between the House, the Senate, and the White House. And that's going to be a real challenge.

Drew Carrington: What's going on in Senate HELP [U.S. Senate Committee on Health, Education, Labor & Pensions]?

Andy Lewin: In Senate HELP, you've got new leadership of the committee and you're going to see, I think, a pretty heavy focus continuing, Drew, on retirement policy, but also certainly on the healthcare aspect of that committee's jurisdiction. It's that committee, as we know, has focused a bit on retirement policy.

But we've already heard rumblings that these committees are going to be focused on SECURE 3.0, possibly next year. So, we'll just have to see.

Drew Carrington: Dan let's talk a little bit about what's going on in the House.

Dan Murphy: Sure. Thanks, Drew. And thanks for the opportunity to talk to you and your listeners. On the election, we're now post midterm election. The biggest winners, of course, are President Biden. We talked about a red tsunami or red wave, which never occurred. Clearly, President Biden had a very strong midterm election. Certainly, Senator Schumer being reelected as the majority leader. I agree with the comments of my colleagues here about ESG. I think that will be a very heavy focus by the Republican majority, especially in the relevant committees—House Financial Services being one.

But I also would invite your listeners to pay attention to the states. Of course, in big, significant red states like Texas, Florida, Missouri, and others, they've put a very big focus on ESG. West Virginia, of course…And then on the other side of the aisle, the big blue states: New York, California, and Illinois, of course, have a very different viewpoint on ESG. And what ends up happening to asset managers and others that care about the markets is they get sort of whipsawed between the two. And it's a tough position to be in. But navigating that for asset managers is going to be a full-time job over the next couple of years.

Drew Carrington: Thank you. Hey, Andy, switching back to you for a second, how does the Democratic leadership feel about that on the Senate side?

Andy Lewin: The Senate Democrats will largely be aligned with President Biden in the White House, which will give them extra leverage in negotiations on a range of issues with the House. So, from government spending to the farm bill, which needs to be reauthorized as it comes up every five years, to the debt limit, I think Senate Democrats will be fairly closely aligned with President Biden and the White House.

So, this is on the debt limit. I would note quickly that this is a dynamic that we've seen before. In 2011, we had a Democratic president, a Democratic Senate, and a brand-new House majority held by the Republicans. That's where we are now. The debt ceiling will need to be raised again. I think we all remember the debt crisis of 2011 and how challenging that was, and the financial and macroeconomic impacts that that the lead up to the debt crisis had.

And that was a situation where we clearly did not default on our debt. But just the drama leading up to it had an impact on the financial markets and on the economy. And I hope that we don't see that again in 2023, but that may that may realistically be where we are.

Drew Carrington: Thanks. So, one last question for each of each of you and this affects all aspects of our business. The regulatory environment has been incredibly active, sort of, across the board—the SEC, the Department of Labor, Consumer Financial Protection Bureau—is just an amazing amount of activity that affects our business, the way we interact with our customers, and their advisors.

Does the divided government mean that we get an even more activist set of regulatory agencies, or is the House able to tap the brakes on those agencies? How should we think about the pace of regulatory change in the next two years going forward?

Dan, why don't you start?

Dan Murphy: I would. Having served in government, helped run a federal agency, I've also served in the White House—when you come out of a midterm election like this and you enter into a divided government, I think it's clear that the House Republicans will spend a lot of time exercising their oversight responsibilities. I don't want to say in divided government, nothing can get done because things can get done, but it requires bipartisan agreement.

So, what you will see, to answer your specific question, is the Biden administration and the various departments from Department of Labor, Department of Treasury, the SEC, and other relevant agencies, will exercise their maximum authority and probably some Republicans would argue, exceed that maximum authority. They will try to get as much done as they can by rulemaking, executive orders, etc. The House will try to push back. It's probably the “Lawyers Employment Act.” You'll see lawsuits trying to slow down the administration. But to answer your specific question, I would look for a lot more agency activity to make up for the potential lack of activity in Congress.

Drew Carrington: Dean, did you want to add any color on that?

Dean Sackett: I agree with Dan: full speed ahead on the regulatory front and probably through executive action too, which is becoming increasingly common over the past few presidents. So, the Republicans will conduct oversight, bring chairs up to testify, and ask them questions. But in the end, if they have the authority, as Dan said, they're going to move forward. And maybe if they don't, they're going to move forward and try to implement the policies of their president.

Drew Carrington: All right, Andy, I don't know if you had anything you wanted to add on, in particular, how the Democratic Senate might view some of that activity on the regulatory side.

Andy Lewin: Sure. Well, the Democratic Senate will largely agree with the Biden regulators. Where they may disagree is in some Democratic senators actually wanting the regulators to go further and to move faster than they're already going. I would flag just a few things real quickly, including a potential rollback of some 2019 guidance at FSOC, the Financial Stability Oversight Council, which was created, of course, out of Dodd-Frank as a systemic risk regulator where all the regulators coordinate their activities as they pertain to systemic risk.

This would allow FSOC to more easily designate non-banks as SIFIs, as systemically important, and this could apply to hedge funds. It could certainly apply to asset managers. It could make it a little bit easier for FSOC in the future to designate crypto exchanges and others as systemically important, which subjects all of these entities to greater regulation and regulatory requirements.

So, of course, the SEC already has a number of rules that will likely be finalized in 2023, including rules pertaining to crypto, to cyber notification, certainly to climate disclosure. So, for the regulators we care about, it will be full speed ahead. I agree with Dean and Dan.

Drew Carrington: All right. Thanks. I thought that might be the case. It's certainly the environment has turned into one where we have to pay a lot closer attention to the changes on the legislative and regulatory side as we think about how we serve our clients, how we invest portfolios, how we respond to these kinds of regulatory situations.

So, any closing remarks? Dan let's start with you.

Dan Murphy: Those that want to be successful in Washington in the next two years need to find a bipartisan path to create the solutions that they want for their businesses. One-party rule is over for the next two years, and it requires both parties to want to work together to provide those solutions.

Drew Carrington: Andy?

Andy Lewin: Continue paying very close attention to the regulatory space which will be active in 2023 and likely even more active in 2024 in what could be the last year of the Biden administration.

Drew Carrington: Thanks. Dean?

Dean Sackett: SECURE 2.0 enhances the voluntary employer provided retirement system, enhance the ability of employers, especially small employers, to offer plans, help low-income employees save and plans of auto enrollment. So, you automatically get enrolled in your plan. Auto escalation year over year. You increase your contributions. You know, the investor is always in charge and could elect not to do that and it pushes RMDs—required minimum distributions—out so allowing people to save their money longer if they need to.

And I think there'll be opportunities to see alternative investments to retail considered. The accredited investor bill to help broaden those who can invest in certain products. So, I think that's going to be an opportunity to air some new ideas in the capital formation space.

Drew Carrington: All right. Thank you all for your comments today, and thanks everyone for joining. Please visit the Franklin Templeton Institute's website for more distinct insights, research, and their practical applications on areas of exploration like those we discussed today.

Host: And thank you for listening to this episode of Talking Markets with Franklin Templeton. If you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about anywhere else you get your podcasts. And we hope you’ll join us next time, when we uncover more insights from our on the ground investment professionals.

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