AFR In the News: Regulators Advance Volcker Rule
Ben Protess (DealBook/NYT)
October 11, 2011
Federal regulators on Tuesday took a much-anticipated step toward reining in risky trading on Wall Street, introducing a proposal that would prohibit federally insured banks from making certain types of bets with their own money.
John Walsh, a member of the F.D.I.C. board and head of the Office of the Comptroller of the Currency, said at an F.D.I.C. meeting on Tuesday that he was “delighted” regulators had reached an agreement on the proposed rule, “given the controversy that has surrounded this provision — how it addressed root causes of the financial crisis.”
Several other federal agencies must still vote on the proposal, which will be open for public comment until January. The Securities and Exchange Commission is scheduled to vote on Wednesday. And on Tuesday morning, ahead of the F.D.I.C.’s vote, the Federal Reserve released the proposed rule for public comment. A final version of the rule will take effect by July 2012.
“I expect the agencies will move in a careful and deliberative manner in the development of this important rule, and I look forward to the extensive public comments that I’m sure will follow,” Martin J. Gruenberg, acting chairman of the F.D.I.C., said during the meeting.
The flurry of activity kicked off what is sure to be a lengthy and contentious battle over the esoteric details of the Volcker rule. Much of the debate has already centered on controversial exemptions to the rule.
While the regulation prevents big banks from placing bets on many stocks, corporate bonds and derivatives, it exempted trading in government bonds and foreign currencies.
The rule also provides a path for getting around the ban, for instance, when banks hedge against losing money while carrying out a customer’s trade. Market-making and underwriting are exempt, too, though the line is often blurred between these pure client activities and proprietary bets.
Indeed, the Volcker rule highlights the fuzzy nature of proprietary trading. Most big banks like Goldman Sachs and Bank of America shut down their stand-alone proprietary trading desks once Dodd-Frank became law last year.
But proprietary bets often slip into client-focused activity. Banks, as part of routine market making, can buy securities from one customer with the intent of selling them to another client. The proposal on Tuesday attempted to draw the line between such legitimate market-making and proprietary trades, when a bank’s stake exists solely to benefit its own account.
The proposal, in defining market making, largely tracks the metric laid out in an earlier report by the Financial Stability Oversight Council. It also sketched out a framework for detecting proprietary trading, relying on a litany of calculations, including revenue figures. Regulators plan to scrutinize positions in a bank’s trading account, typically trades held for less than 60 days.
Wall Street has mounted a united front against the rule, saying it would eat into profits and constrain liquidity at a difficult time for the banking industry. Those concerns were echoed on Monday by Moody’s, which issued a report saying the current version of the Volcker rule would “diminish the flexibility and profitability of banks’ valuable market-making operations and place them at a competitive disadvantage to firms not constrained by the rule.”
Some Democratic lawmakers and consumer advocates, however, are pushing to close certain loopholes in the rules, particularly the broad exemption for hedging. Volcker rule proponents take issue with a plan to excuse hedging tied to “anticipatory” risk, rather than clear-and-present problems.
“Unfortunately, this initial proposal does not deliver on the promise of the Volcker Rule or the requirements of the statute,” said Marcus Stanley, policy director of American for Financial Reform, an advocacy group.
Each side also disagrees over how to enforce the rule. The proposal spells out an expansive internal control regime that banks must adopt, putting the onus on the industry to police its own trading. Under the rule, banks must turn over a battery of information to regulators, including nearly two-dozen metrics to gauge whether a bank is helping clients or trading for its own benefit.
For now, regulators stopped short of forcing bank C.E.O.s to certify the legitimacy of their compliance program. Instead, executives must only “review the effectiveness of the compliance program.” The proposal asked the public to comment on the the possibility of “C.E.O. attestation” and the use of data warehouses, where regulators could keep an eye on the trading.
The F.D.I.C. vote was somewhat anticlimactic, after a version of the rule was leaked to the media last week. The 205-page document outlined much of the regulatory minutiae surrounding the Volcker rule, with only minor changes appearing in the longer draft released Tuesday.
The proposal left many details to be developed in coming months. It posed hundreds of questions for the public and the financial industry to address, leaving the window open for significant changes.
“The vagueness of the proposal, and the hundreds of questions it includes, also demonstrate that we are still in the middle of this process,” said Mr. Stanley. “It’s important to use this opportunity to strengthen the rule – and to prevent Wall Street lobbyists from weakening it still further.”