What Regulation Will Mean for Financial Sector ETFs

by: Tom Lydon

The Obama administration has been saying that it will provide better financial regulation, and the U.S. Senate made some progress by passing two amendments aimed at obviating another copious taxpayer bailout of Wall Street. Big banks and related financial exchange traded funds wait on when the bills will become law.

The Senate voted an overwhelming 93 to 5 for a plan to set up a new government protocol for seizing and dismantling large financial firms that are in distress, ending the “too big to fail” possibility, as stated on CNBC. Analysts expect the bill to be enacted into law in a matter of weeks, but Republicans, Wall Street and banking interests have worked to weaken and delay legislation.

The Federal Deposit Insurance Corp. will be able to manage an “orderly liquidation” process for troubled firms that would pose a risk to the banking system if they were on the brink of collapse. Additionally, the Senate approved an amendment specifying that taxpayer money cannot be used to bail out troubled firms.

Overhauling financial regulation could also improve oversight of complex derivatives transactions through greater transparency, which could prove to be a boon for financial clearinghouses and exchange operations like the Chicago Mercantile Exchange (NASDAQ:CME), the InterContinental Exchange (NYSE:ICE) and LCH.Clearnet, reports Robert O’Harrow Jr. for The Washington Post.

The Wall Street Transparency and Accountability Act will lessen risks by restructuring how major banks trade derivatives and by requiring most derivative contracts to be cleared by a clearinghouse. The legislation may also have derivatives traded through exchanges.

Derivatives are used as a risk-management, or hedging, tool. The agreements are between two parties that relies on something occurring in the future, like the performance of an underlying asset including commodities, equities or bonds. Derivatives have become more complex and exotic over the years, and the risks only increased.

If “too big to fail” is done away with, could derivatives and other highly risky bets go the way of the dodo bird?

  • Vanguard Financials ETF (NYSEARCA:VFH)
  • Financial Select Sector SPDR (NYSEARCA:XLF)
  • Regional Bank HOLDRS (NYSEARCA:RKH)
  • iShares DJ US Financial Sector (NYSEARCA:IYF)

Max Chen contributed to this article.