Volcker Rule set for approval vote – concern on Wall Street and abroad

The Volcker Rule is a part of the banking reforms being brought about in the U.S under the 2010 Dodd-Frank Act. Its central aim is to prevent U.S banks from making certain speculative investments that are of no benefit to their clients. Derivative trading, read ‘speculative investments’, is an activity that has come under much scrutiny following the post-2007 financial crises as it was an activity widely blamed for, if not causing then certainly exacerbating, the issues. Losses of US$6bn at JP Morgan on derivatives trading in 2012, it is felt, would have been avoided had the Volker Rule been in place.

Commercial banks refer to the proposed Volcker Rule as a ban on proprietary trading, meaning that they can’t use deposits to trade on their own accounts. Indeed, the rules covered by the Volcker Rule will break up the existing business practices of banks in the U.S and reduce conflicts of interest between the banks and their clients by separating up the differing business practices they undertake. Banks were seen to have accumulated excessive risk ahead of the financial crises and these proposed rules will break down the financial sector into a transparent and easily regulated environment.

Paul Volcker was elected chair of the President’s Economic Recovery Board in February 2009 and it is his vision that has resulted in his name being lent to this rule. His view is that a commercial banking system plays a major role in financial stability. The populist view of ‘bankers’ playing high stakes in derivatives markets, designed to mitigate risk but actually doing the exact opposite, is shared by Volcker in this regard. U.S president Barack Obama agrees, too.

The latest draft of the proposal is to be voted on this week, although the banks are facing a slightly softer proposal than they first feared, in that it does not explicitly ban hedging activities, so long as the circumstances are right. Banks will, however, be faced with extra regulatory burden in evaluating their hedging and risk mitigation techniques and activities, meaning that they can hedge for risk mitigation purposes, but they will be required to show why this is.

It is expected that there will be legal challenges and intensified lobbying from U.S banks ahead of any implementation of the Volcker Rule, as they seek to have it watered-down to much more favourable terms for themselves or, better still from their viewpoint, have it abolished. As with most financial reforms the world over in the wake of the financial crises, the banks feel that the rules will be too tough and the myriad critics of the banks feel that the rules will be too soft.

There is also strong overseas opposition to the Volcker Rule and it represents another arm of the Dodd-Frank Act that could impact upon activity outside of the U.S, particularly in this instance, in the mutual fund space. Regulators from Europe, Canada and Japan are keen to have some of the wording changed since the Volcker Rule also aims to severely restrict the involvement of U.S banks in ‘covered funds’. In its current guise, the rule sees a covered fund as anything not governed by U.S laws, meaning that non-U.S mutual fund structures such as European Ucits, Canadian mutual funds and Japanese investment trusts would be treated the same as hedge funds under the rules. This would mean that foreign arms of U.S banks would not be able to have direct involvement in such funds outside of the U.S.

There are assessments under way at the U.S Federal Reserve as to whether or not implementation of the Volker Rule should be postponed until July 2015 – with a raft of other mandates being implemented under the Dodd-Frank Act, it is viewed that the U.S regulatory agencies responsible for oversight of the new rules will need time to readjust their sights. It would also give the banks and foreign governments, more time to get their lobbying done…

Tags: Volcker RuleDodd FrankHedge Fundsmutual fundsbanksRegulationderivatives