Fed Backs Easing ‘Volcker Rule’ Bank Trading Restrictions

by Ike Obudulu Posted on May 31st, 2018

Washington, D.C., USA: The Federal Reserve Board on Wednesday approved sweeping changes to the ‘Volcker Rule’ trading restrictions which was imposed on banks as part of Dodd-Frank, the 2010 law crafted in response to the financial crisis two years earlier. The changes would “broadly simplify and tailor” the Volcker Rule without negatively affecting the safety of banks, according to a summary of the plan.

“The objective behind this proposal is straightforward: simplifying and tailoring the Volcker Rule in light of our experience with the rule in practice,” said Randal Quarles,  the Fed’s vice chairman of supervision and point man on bank regulation. “This is a goal that is shared among all five agencies and among policymakers at those agencies with many different backgrounds.”

The revisions aren’t just a rollback, Quarles said, calling them “the fruit of long and shared experience” and not “assumptions of a few recently appointed individuals.”

Quarles said the plan was a “best, first effort” at simplifying the rule, indicating that further tweaks may be coming.

“I view this proposal as an important milestone in comprehensive Volcker Rule reform, but not the completion of our work,” Quarles said.

The proposal would remove an assumption that positions held by lenders for fewer than 60 days are proprietary trades. And it would scrap a part of the test for determining whether a trade is proprietary, replacing it with new criteria based on how the bank accounts for the trades, according to the summary.

The plan also sets up a tiered system for compliance based on a bank’s trading assets and liabilities, with the most stringent requirements applying to companies with $10 billion or more, according to the summary.

Regulators are also proposing to make it easier to take advantage of exemptions, such as one that gives broad flexibility to execute trades that serve as hedges against potential losses. Banks now have to submit documentation to prove they are hedging, requirements they say are unreasonable.

The proposal broadens exemptions banks can seek for underwriting and market-making to permit activities “designed not to exceed reasonably expected near-term demand of clients, customers, or counterparties,” according to the summary. In a key shift from the current rule, the proposal will let banks set their own risk limits for market-making and underwriting activity. Regulators will be able to review the limits on an ongoing basis.

It also seeks to ease the impact of the rule on foreign banks’ operations outside the U.S.

The volcker rule, named for former Fed Chairman Paul Volcker, banned what’s known as proprietary trading – the practice of banks investing for their own benefit rather than buying or selling securities to fulfill requests from customers. It also restricted lenders’ ability to invest in hedge funds and private-equity firms.

The rule is meant to bar banks with federally-backed deposit insurance from suffering out-sized losses by restricting their ability to bet with their own capital. Financial firms have said the rule is unnecessarily complex and almost impossible to adhere to.

Fed governors voted 3-0 to seek comment on proposed changes, kicking off an administrative process aimed at significantly reducing compliance costs for financial firms.

“The objective behind this proposal is straightforward: simplifying and tailoring the Volcker Rule in light of our experience with the rule in practice,” said Randal Quarles, the Fed’s point man on bank regulation. “This is a goal that is shared among all five agencies and among policymakers at those agencies with many different backgrounds.”

The revisions aren’t just a rollback, Quarles said, calling them “the fruit of long and shared experience” and not “assumptions of a few recently appointed individuals.”

Volcker  weighed in, saying he welcomes efforts to simplify compliance with the rule he’s credited with championing as an adviser to then-President Barack Obama.

“What is critical is that simplification not undermine the core principle at stake — that taxpayer-supported banking groups, of any size, not participate in proprietary trading at odds with the basic public and customers’ interests,” Volcker said in a statement. “I trust the final rule will strongly maintain that position by, as intended, facilitating its practical application.”

While banks will likely welcome the changes, the revamp isn’t expected to trigger a return of proprietary trading or prompt lenders to rehire some of the high-flying traders who fled for hedge funds after the financial crisis. A full repeal of Volcker is seen as improbable, because it would require an act of Congress.

Over the next week, agencies including the Securities and Exchange Commission and the Federal Deposit Insurance Corp. are expected to join the Fed in proposing the changes. The proposal will be released for public comment, after which regulators will have to put it to a final vote before the changes can take effect.

Regulators generally give the public months to weigh in on their proposals to overhaul rules, and then must hold a second round of votes to make changes binding.

Volcker Rule, the controversial proprietary trading ban, enacted in the Dodd-Frank Act, proved to be one of the financial reform law’s most challenging provisions to implement, forcing five regulators to work together in a lengthy process that  frustrated everyone involved. While the concept of the provision is easy to understand – forcing commercial banks to stop taking risky bets with U.S. taxpayers’ funds – the specifics spurred confusion and discord.

Regulators’ first problem was each other. The law required the Federal Reserve (Central Bank),  Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) to work together to craft a final rule. But bridging the different missions and various views represented on some of the agencies’ boards into a coherent rule became a onerous task.

They  also faced two other major challenges: defining proprietary trading in a manner that was consistent with the law’s intent while still addressing ambiguities and unintended consequences; and addressing intervening events that  spurred increased scrutiny of the drafting of the rule.

The biggest battle over the Volcker Rule’s implementation centered around the exception for market making, which bankers view as absolutely vital to preserving market liquidity – including for bond markets and certain derivative markets. Many industry representatives said the regulators erred in their initial attempt at creating that carve out when they issued their initial proposal in October 2011.

But Congress was vague in how regulators were to create the exemption, leaving them to decide how detailed they needed to be in defining its scope, including how it applied to various asset classes.

The “Volcker Rule” finally went into effect on April 1, 2014, with banks’ full compliance required by July 21, 2015 — although the Federal Reserve has since set procedures for banks to request extended time to transition into full compliance for certain activities and investments.

The Volcker Rule prohibits banks from using their own accounts for short-term proprietary trading of securities, derivatives and commodity futures, as well as options on any of these instruments. The rule also bars banks, or insured depository institutions, from acquiring or retaining ownership interests in hedge funds or private equity funds, subject to certain exemptions.

Along with the Federal Reserve which voted today to ease “Volcker Rule” restrictions, the other four banking regulators – OCC, SEC, CFTC and FDIC must also approve any changes to the “Volcker Rule” for the changes to take effect.

The FDIC is expected to vote on Thursday.

Author

Ike Obudulu

Ike Obudulu

Versatile Certified Fraud Examiner, Chartered Accountant, Certified Internal Auditor with an MBA in Finance And Investments who has both worked for and consulted with some of the world's largest companies on main street and wall street in over 20 countries, Ike brings his extensive reporting and investigations experience to bear on his role as Chief Editor.
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