RPC Reg Spotlight November 30, 2011

 

Regulatory Action in the Spotlight:

 

The Volcker Rule

 

Adverse Effects:

 

  • Placing banks at a competitive disadvantage, internationally.
  • Market and regulatory uncertainty.

 

 

Response of the Obama Administration:

 

Pursuant to Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the Securities and Exchange Commission (SEC), the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board (FRB), and the Office of the Comptroller of the Currency (OCC) co-proposed the so-called Volcker Rule on October 12, 2011.  Named after former Fed Chairman Paul Volcker, the rule would prohibit bank entities from engaging in proprietary trading, where they trade for their own profit and not at the behest of clients.  It also limits banks' relationships with hedge funds and private equity funds to a three percent ownership limit in an attempt to isolate them from riskier parts of the financial market.  Systemically identified non-bank entities engaged in such activities would be subject to enhanced disclosure and reporting requirements.  Certain hedging, market-making, securitization, and risk management activities would be permitted.  The final Volcker Rule is scheduled to go into effect on July 21, 2012, with a seven-year compliance timeframe.  The Commodity Futures Trading Commission (CFTC) is crafting its own Volcker Rule language in respect to any entity of which it is the primary regulator.  Their proposed rule-making is expected to be published in the “near future”.

 

 

Impact on the United States:

 

Regulators offered up a rule spanning nearly 300-hundred pages and posing nearly 400 questions to the public on areas of the rule that they are still trying to figure out.  It appears that instead of defining prohibited activities, regulators are positioning themselves to define permissible activities.  Banks are left having to evaluate their activities and make a determination as to whether they fall within the rule.  This ambiguous scenario opens banks to regulatory uncertainty and possible legal action, in spite of best efforts to comply.   Furthermore, the paperwork burden is estimated at over 4.75 million hours for initial compliance, and over 1.83 million hours annually.  Compliance and capital costs were estimated by the OCC at $1 billion annually.

 

Under the rule, a “bank entity” includes any company under control of a firm that also controls a bank (a bank holding company).  Although the intent of the Volcker Rule is to prevent banks from using depositors’ FDIC-insured assets for trading purposes, prohibiting holding companies from trading on their house accounts, or participating robustly in hedge funds and private equity funds, it has the unintended consequence of limiting profitability and places them at a disadvantage to their international counterparts.  In an October 10, 2011 report, Moody’s Investor Service analyst Peter Nerby forecast, "The rule disadvantages the important core market-making franchises of the big U.S. banks and creates opportunities for unregulated competitors, such as high-frequency trading firms, and the non-U.S. operations of foreign banks".

 

 

In Closing:

 

The Volcker Rule impacts banks at a time when they are dealing with other provisions of Dodd-Frank and enhanced Basel III capital requirements.  Restrictions on firms' abilities to conduct market-making activity will discourage investment, limit credit availability and increase the cost of capital.   This will negatively influence economic growth and job creation.  When the rule was proposed, the FDIC, FRB, SEC and the OCC all signed on to the joint proposal, but the CFTC did not.  This leaves it to either sign on at a later date or issue its own take on how the rule should be implemented.  Either scenario creates further market and regulatory uncertainty to a rule already fraught with both.  

 

 

Relevant Legislation:

 

The House Financial Services Committee’s Capital Markets and Government Sponsored Enterprises Subcommittee and the Financial Institutions and Consumer Credit Subcommittee will hold a joint hearing on the proposed Volcker Rule on December 13, 2011.