Mr. Barragate is one of the Co-heads of the firm's Financial Institutions Litigation and Regulation Practice.
This interview primarily addresses provisions of the Dodd-Frank Act that affect nonfinancial corporations.
The following Q&A provides general information and should not be used or taken as legal advice for specific situations, which depend on the evaluation of the precise factual circumstances. The views expressed by the speaker are not necessarily the views of Jones Day.
Editor: Please tell us about yourself and the financial institutions litigation and regulation practice that you lead at Jones Day.
Barragate: I am one of the co-heads of our Financial Institutions Litigation and Regulation practice. This practice area concentrates on providing comprehensive representation to financial institutions in connection with litigation, regulatory matters, and transactional and M&A-related work. My particular practice focuses on traditional commercial lending, bank regulatory and transactional matters.
Editor: You have written at length about the Dodd-Frank Act. Would you tell our readers why non-financial institutions should pay attention to this law?
Barragate: It is critical that non-financial insitutions spend time making sure they understand the Dodd-Frank Act because it reaches far beyond financial reform. Our firm wrote a white paper for our clients emphasizing this fact and encouraging traditional public and private corporations to make sure they understand the ways in which Dodd-Frank will impact their business. There are quite a number of provisions that apply to non-financial corporations, and corporations need to be aware of them.
Editor: The new law delegates a great deal of authority to regulatory agencies. For example, there are 240 rulemaking tasks that are to be done by 11 rulemaking bodies. How long will it take before all of these many regulations become effective?
Barragate: A large percentage of this legislation and its effects have been delegated to the rulemaking authority, and the regulations will roll out over the next two years or so.
Editor: So, for the next two years, how are companies that will be affected by these regulations currently expected to plan their future business strategies for growth and profitability?
Barragate: It is imperative that corporations establish a procedure, either internally through the use of outside counsel or other advisors, to follow the rulemaking, particularly for those areas that are most relevant to them. They must ensure that they are keeping on top of those rules as they are adopted. For example, recently the SEC published its rules relating to the proxy access and other shareholder rights provisions that are very important for non-bank corporations.
Editor: How can corporations influence the development of the regulations that are most relevant to them?
Barragate: The corporations need to identify any particular areas that are critical to their businesses and decide if they want to become involved in the rulemaking process. If there is something of particular importance to a corporation, it almost always has the ability to submit comment letters or participate in the rule-making process in a way in which the corporation usually can have some influence.
Editor: How will the creation of a public market for derivatives impact non-financial corporations, such as agricultural businesses, transportation or utilities?
Barragate: If you are a corporation that is a user of "plain vanilla" derivatives (e.g., an interest rate swap or foreign currency exchange contract), then this process will probably become simpler and, hopefully, less expensive because these types of derivatives will be traded on an exchange. This will make these types of transactions much more efficient. If you are a user of derivatives that involve something more complex, such as some of the energy derivatives or credit default swaps, these will most likely not be traded on exchanges and will have to be privately negotiated. These types of derivatives will continue to become more complicated, and it will require more attention and time from third-party professionals like lawyers.
Editor: Will access to capital be constrained by the new regulatory strictures on lenders? If so, how will nonfinancial corporations be affected by this?
Barragate: The provisions in Dodd-Frank that directly apply to financial institutions will, in turn, have a significant impact on the dealings between these financial institutions and the corporations that are their customers. Most bankers agree that, at least in the near term, the regulations are likely to make less capital available because of the increased capital requirements that are in the Act. If you combine those with the new Basel III rules that have been proposed, banks will have to hold more capital, which means that they will have less money available for loans, and credit will be constrained. In addition, there is going to be a period of uncertainty as banks look at having to dispose of certain lines of businesses, such as their private equity and hedge fund investments, due to the Volcker Rule. These institutions will also need to figure out what to do with their derivatives businesses because they may have to dispose of them or transfer them to affiliated non-bank entities. This all takes time, attention and money away from traditional lending. Overall, it is probably going to make less capital available in the short term.
Editor: How do the new "orderly liquidation" proceedings change the playing field for companies in distress? What is the scope of the potentially affected entities?
Barragate: The "orderly liquidation" provisions address the claims of creditors to banks and are structured in a way to attempt to avoid the "too-big-to-fail" problem, i.e., certain entities were considered too big to fail because of the impact this could have on the financial markets, so they were rescued by the federal government and allowed to continue to operate. These rescues were done for the benefit of the overall economic system, but they also had the side effect of saving creditors of those financial institutions. In an effort to avoid repeating this, the "orderly liquidation" provisions were created. Essentially, they provide that if a financial institution is determined to pose systemic risk to the financial system, it must be liquidated. It can never be rehabilitated and allowed to continue to operate. Congress has established a priority schedule to determine the repayment of creditors' claims. The risk to non-financial corporations is if they become creditors of a bank, because they own the bank's bonds or are a counterparty to a derivatives contract with that bank. In the liquidation proceeding, the priority of who gets paid what, when and how is a little different than in a traditional bankruptcy. In a traditional bankruptcy, you start with secured creditors and work your way down the hierarchy of creditors. In the liquidation proceeding, under certain circumstances, the government can have priority over other creditors, depending on whether or not it loaned money to the bank to help wind it down. So this new structure creates a lot of uncertainty for creditors to a financial institution, which in turn will raise the cost of raising money for banks.
Editor: In other words, once you increase the risk, the rate goes up.
Barragate: Correct, and it is likely to also diminish the pool of investors who are interested in making investments in banks. This will decrease the amount of capital available to banks, which in turn makes credit more expensive.
Editor: What is the impact of Dodd-Frank on corporate governance?
Barragate: Dodd-Frank includes certain investor protection provisions that apply to all corporations and not just banks. These include the proxy access rules and the say-on-pay provisions. These provisions give shareholders significantly increased rights relating to public companies. These do not necessarily have anything to do with banks or the financial crisis. Nonetheless, these provisions ended up in the Act, and they certainly will impact the governance of publicly traded companies.
Editor: If there is a Republican Congress after the November election, do you think it might try to repeal selected provisions of Dodd-Frank?
Barragate: I don't think so. First of all, even if you have a Republican majority in Congress, this alone would not give them enough votes to undo Dodd-Frank. They would have to have a majority sufficient enough to override a filibuster by the Democrats, which would be almost impossible to do. Despite the fact that the vote was clearly down party lines, I don't believe that that vote actually reflects what Republicans truly feel about the financial reform bill. If you went through it, piece by piece, there are many provisions that they would agree with - indeed, many of them participated in making them.
Editor: How much do you think that Dodd-Frank will discourage foreign investment in the U.S.?
Barragate: I don't think it is going to discourage it at all. I think that it creates a lot more opportunities for foreign investors, particularly for investors from countries like China whose banking system withstood the financial crisis very well. China's economy is in a different position, and many of its financial institutions have expressed an interest in making additional investments in the United States. This is a very good opportunity for foreign investors because so many U.S. banks will be preoccupied with complying with Dodd-Frank that they will have little capital to devote to additional investments.