After weeks of deliberation, the U.S. Congress passed the final version of legislation for the first major overhaul of the nation’s financial system since the Great Depression, imposing more restrictions on Wall Street and banks having a dramatic effect on stocks and exchange traded funds (ETFs) which track the sector.
This final version will give the government new powers to break up companies that threaten the economy, create a new agency to guard consumers in their financial transactions and shine a light into shadow financial markets that escaped the oversight of regulators. To be more specific, the law will restrict banks from prop trading by limiting the amount an institution can invest in a hedge fund or private-equity fund to a maximum 3% of the bank’s capital. Companies most likely to be influenced by this regulation include big players like JP Morgan Chase (JPM), Goldman Sachs (GS), Bank of America (BAC), Wells Fargo (WFC) and Morgan Stanley (MS).
Another facet of a tighter leash on large financial companies comes from the comprehensive regulation to the over-the-counter (OTC) markets. With the new law, routine derivatives will have to be traded on exchanges or other electronic systems and routed through clearinghouses, which increases transaction costs. Additionally, banks who participate in derivatives trading are going to be required to turn their derivatives trading operations into affiliates.
A third artery of the new law includes an increase in the deposit-insurance fee paid by banks to the Federal Deposit Insurance Corporation (FDIC), eating away at cash that can be used to generate revenue. In addition to this increase, the new law requires banks that package loans to keep 5% of the credit risk on their balance sheet and allow regulators to exempt certain “low-risk” mortgages from this requirement.
Lastly, the new law revamps the credit-rating industry which allows investors to sue credit-rating firms for “knowing or reckless” failure and gives the Securities and Exchange Commission (SEC) the power to deregister a firm that gives too many bad ratings over time.
In a nutshell, the new law is expected to expand consumer protection and clamp down on lending practices and may be beneficial to the average consumer, however, it is likely to have a negative impact on revenue generation and the overall bottom line of the large financial institutions.
Some ETFs that are likely to be influenced by the new law include:
- Financial Select Sector SPDR (XLF), which boasts JP Morgan Chase , Bank of America and Wells Fargo as its top holdings.
- iShares Dow Jones US Financial Services (IYG), which includes Goldman Sachs and Citigroup in its top holdings.
- Vanguard Financials ETF (VFH), which gives ample exposure to the aforementioned firms as well as includes The Travelers Companies (TRV) and Aflac (AFL), which are expected to be impacted by the newly constructed Federal Insurance Office to monitor the insurance industry and give it two cents on ways to modernize insurance regulation.
When investing in these ETFs, it is important to consider the inherent risks that are involved. To help mitigate these risks, the use of an exit strategy which identifies specific price points at which downward price pressure is likely to be seen is important. Such a strategy can be found at www.SmartStops.net.
Disclosure: No Positions