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Volcker Rule is Finalised but Regulators Remain Divided

On Tuesday December 10 five US Federal agencies issued the final rules for implementing section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, or as it is more popularly known, the Volcker Rule.

The final rules prohibit insured depository institutions and companies affiliated with insured depository institutions (banking entities) from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account. The final rules also impose limits on banking entities’ investments in, and other relationships with, hedge funds or private equity funds.

Like the Dodd-Frank Act, the final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, insurance company activities, and organising and offering hedge funds or private equity funds. 

The final rules also clarify that certain activities are not prohibited, including acting as agent, broker, or custodian.

The compliance requirements under the final rules vary based on the size of the banking entity and the scope of activities conducted. Banking entities with significant trading operations will be required to establish a detailed compliance program and their CEOs will be required to attest that the program is reasonably designed to achieve compliance with the final rule. 

Independent testing and analysis of an institution’s compliance program will also be required. The final rules reduce the burden on smaller, less-complex institutions by limiting their compliance and reporting requirements. Additionally, a banking entity that does not engage in covered trading activities will not need to establish a compliance program.

Banking organisations covered by section 619 will be required to fully conform their activities and investments by July 21, 2015.

“The final rule faithfully and strongly implements the statutory prohibitions on proprietary trading by US banks and their affiliates and the limitations on the ability of such entities to sponsor or invest in hedge funds or private equity funds – called “covered funds” in the rule,” says Mary Jo White, chair of the US Securities and Exchange Commission. “The deliberative process leading to today’s joint rule has been informed by a careful balancing throughout the final rule of the various prudential, economic, and other factors considered over the last three years.”

Commodities and Futures Trading Commission chair Gary Gensler is also in support of the finalised rule. “It achieves the important balance, as directed by Congress, of prohibiting banking entities from proprietary trading while at the same time allowing banking entities to engage in permitted activities, including market making and risk mitigating hedging,” he says.

However, not everyone at these two Commissions shared this opinion.

“From the very beginning, the Volcker Rule has been a solution in search of a problem, a common situation throughout the Dodd-Frank Act,” argues SEC Commissioner Daniel Gallagher, who also warns that the rule in its current form has the potential to “destroy the market-making system central to the liquidity and proper functioning of our capital markets”.

His fellow SEC Commissioner Michael Piwowar is also critical of the final rule.

He argued that the agencies involved in the rulemaking had failed to comply with the legal obligations associated with such a process, that they had failed to conduct the necessary economic or regulatory analysis of the impact of the rules and that consequently the Volcker Rule should be re-proposed.

“Common sense, as well as good government, dictates that, at a minimum, an agency knows what is in the rule and have a basic understanding of the potential impact the rule will have.  Unfortunately, the Volcker Rule being adopted today fails to meet both those fundamental principles,” he said.

At the CFTC Commissioner Scott O’Malia voiced his dissent against the rule, stating, “I cannot support a rulemaking that undermines the regulatory process, nor clearly delineates the Commission’s new jurisdiction and enforcement authority under section 13 of the Bank Holding Company Act of 1956 (“BHC Act”) and fails to include procedures that afford due process to market participants.”

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