On May 30, the US Federal Reserve kicked off with a 60-day consultation to try and make the Volcker Rule work better for banks and the regulator. This is likely to be quite a challenging process as creating clear definitions around different types of trading, for example, is quite difficult.
What is happening?
The five US regulatory agencies in charge of overseeing the Volcker Rule are trying to figure out how to change it so it works more effectively without undermining its purpose. On May 30, the US Federal Reserve launched a 60-day public consultation to get feedback on some ideas and to pose an enormous number of questions, suggesting that significant technical revisions are in the pipeline.
In short, the Volcker Rule is a piece of US legislation that is part of the Dodd-Frank Act and is designed to stop commercial banks engaging in certain speculative trading activities. It bans commercial banks from doing proprietary trading and investing in hedge funds and private equity funds.
The rule reflects that many of the banks that got into trouble during the 2007-09 financial crisis were involved in risky proprietary trading and were exposed to high-risk funds. Although the rules’ intentions are quite clear, in practice its application is opaque, complex and expensive to comply with – thus it is much disliked by banks.
The consultation largely focuses on areas from trying to clearly define proprietary trading through to deciding on the reporting requirements that are appropriate for different types and sizes of bank.
Why is it happening?
In some quarters, the review of the Volcker Rule has been characterised as being part of the Trump administration’s plans to deregulate financial services and let banks off the leash to indulge in high-risk activities – and, therefore, pose a risk to financial stability.
This is not so. The global banks, in particular, will still be expected to stay away from proprietary trading. The regulators themselves have long recognised that the Volcker Rule has problems and even Paul Volcker (the former Federal Reserve chairman after whom the rule is named) welcomed efforts to simplify compliance providing it does not lead to taxpayer-supported banks being allowed to engage in proprietary trading.
Even regulatory hawk and former Federal Reserve governor Dan Tarullo supports reforming the Volcker Rule because it has damaged bank market-making activities.
And, if anything, it is an effort to remove grey areas between what the rules consider to be legitimate trading activities versus those that are high-risk proprietary trading. It also seeks to absolve smaller banking groups, which hardly do any trading, from its onerous reporting requirements.
What do bankers say?
The banks are naturally pleased that the Volcker Rule is being examined; for smaller banks and those less active in trading, it should mean lower reporting requirements.
Among the big changes the Federal Reserve is consulting on are: to tailor the rule to a bank’s trading assets and liabilities; to streamline reporting requirements; to change requirements around market underwriting and hedging interests in covered funds; and to limit the impact on trading activity of foreign banks conducting proprietary trading solely outside the US. Banks welcome much of this.
But proposals such as changing the definition of ‘trading account’ from being purpose-based to using an accounting treatment have raised some concerns with banks, which believe it potentially complicates rather than simplifies definitions.
Another issue to raise red flags is the idea of creating a ‘presumption of compliance’ with the underwriting and market-making exemptions for certain trading desks within certain internal risk limits. There are fears this could actually make reporting requirements even more onerous and complicated.
But these are points for discussion. At this stage the Fed is seeking feedback rather than looking to impose these requirements, so the industry has an opportunity to influence them. Also, the regulators genuinely want to make the Volcker Rule work better and ensure this is not just a Republican-led initiative.
Will it provide the incentives?
It is still too early to say whether regulators can tweak the rule enough so that it creates clear boundaries – between, for instance, market-making and more speculative forms of proprietary trading. In many cases, the Fed is simply asking a lot of questions, some 342 in all, and in areas such as dealing with private equity and hedge fund investments, it is mainly seeking industry ideas.
Indeed, the Fed will be spending considerable time sifting through the industry’s feedback, which can be expected to be substantial, and doubtless will need to continue a dialogue with the industry to eventually devise a reformulated Volcker Rule that works better for banks, as well as for the five agencies that administer it.
