What Financial Reform Means for ETFs | ETF Trends

Legislation for financial reform is finally coming to a head, with the most recent draft of the bill expected to have enough support to become law. Financial exchange traded funds (ETFs) initially reacted negatively. Whether that’s just an initial shock or the beginning of trouble remains to be seen.

According to Damien Paletta of The Wall Street Journal, it took 20-plus hours of haggling to hammer out legislation that is expected to transform the way the financial industry is regulated.

In short, the bill calls for tougher regulation of large financial companies, mainly through two provisions that will impact big banks:

  • The Volcker rule, which will prohibit banks from making risky bets with their own funds.
  • Restrictions on federally-insured banks on trading derivatives. They will also have to be traded on regulated exchanges. [Derivatives-Based ETFs Await SEC Decision.]
  • Shareholders would have the right to vote on executive pay packages, and the Fed will set standards for risky pay.
  • Lenders will have to get proof that a borrower can pay a mortgage.
  • The Federal Reserve can break apart large companies that they feel pose a threat to the financial system. [Where the Healthy Banks Are: Emerging Markets.]
  • The government can charge fees – up to $19 billion – to large banks and hedge funds to help cover the cost of the new legislation. The government will also have the power to seize and dismantle faltering companies, something it did not have the power to do against Bear Stearns, Lehman Brothers and AIG (NYSE: AIG).

The legislation’s impact could hit large banks the hardest, at least in the short-term, while they process the law and change how they operate. Many believe that the days of rapid growth for big banks may be over, while tighter controls will be more favorable for regional and community banks that generally shy away from risky bets and won’t be broken apart by the government. [Why Some Are Bullish Despite Financial Reform.]

If this plays out as many believe it might, some ETFs that could be negatively impacted include:

  • iShares Dow Jones U.S. Financial Sector Index Fund (NYSEArca: IYF)
  • Vanguard Financials ETF (NYSEArca: VFH)
  • Financial Select Sector SPDR (NYSEArca: XLF)
  • WisdomTree International Financial Sector Fund (NYSEArca: DRF)
  • iShares S&P Global Financials Sector Index Fund (NYSEArca: IXG)

ETFs that may see a more positive impact include:

  • First Trust NASDAQ ABA Community Bank (NASDAQ: QABA)
  • SPDR KBW Regional Bank (NYSEArca: KRE)
  • iShares Dow Jones U.S. Regional Banks (NYSEArca: IAT)

For more stories about big banks and the financial sector, visit our financial category.

Sumin Kim contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.