Published October 11, 2011
U.S. regulators unveiled a ban on Wall Street banks' trading for their own profit, but the long-awaited Volcker rule proposal was so complex that banks blasted it as unworkable and consumer groups dismissed it as too weak.
The rule, required by last year's Dodd-Frank financial oversight law, is aimed at avoiding a repeat of the 2007-2009 financial crisis by curbing excessive risk-taking.
It has been difficult for the government to craft a rule that reins in Wall Street while protecting the trades that big banks execute on behalf of clients.
Regulators are giving the public until Jan. 13, 2012, to comment. That is more time than expected, and could result in more pressure to change elements of the rule.
``The proposal is written so that everybody has to lobby on it -- it is not straight forward,'' MF Global policy analyst Jaret Seiberg said.
The proposal includes more than 350 questions that regulators want interested parties to weigh in on, particularly on how the government should write exemptions that allow banks to still make markets for their customers and hedge risk in their portfolios.
``Only in today's regulatory climate could such a simple idea become so complex, generating a rule whose preamble alone is 215 pages, with 381 footnotes to boot,'' American Bankers Association Chief Executive Frank Keating said in a statement.
``How can banks comply with a rule that complicated, and how can regulators effectively administer it in a way that doesn't make it harder for banks to serve their customers and further weaken the broader economy?'' he asked.
On the other side of the issue, the consumer coalition Americans for Financial Reform said regulators warped a simple ban into a weak crackdown that is weighted toward preserving banks' flexibility.
``Unfortunately, the proposal issued today falls well short of what the Volcker Rule could and should achieve,'' AFR said.
The Federal Reserve and other bank regulators acknowledged in the proposal that it will be challenging for the government to identify ``proprietary trading'' that will be banned under the rule due, by law, to go into effect on July 21, 2012.
The proposal said drawing the line between prohibited and permitted trading ``often involves subtle distinctions that are difficult both to describe comprehensively within regulation and to evaluate in practice.''
The rule is expected to have the most impact on large banks such as Goldman Sachs <GS.N>, Morgan Stanley <MS.N> and JPMorgan Chase <JPM.N>, and could trim billions of dollars in annual revenues.
In a separate meeting of U.S. regulators Tuesday, the Financial Stability Oversight Council proposed using a $50 billion asset test as it reviews which non-bank financial firms are large enough to warrant additional oversight.
LONG RULE, COMPLEX ISSUES
The Volcker rule, named for former Fed Chairman Paul Volcker who championed the measure, aims to prevent banks from making risky trades by prohibiting short-term trading for their own profit in securities, derivatives and other financial products.
It will also prohibit banks from investing in, or sponsoring, hedge funds or private equity funds.
The idea behind the rule is to prevent banks that enjoy some sort of government safety net, such as deposit insurance on customer accounts or access to Fed money, from using that backstop to make money for themselves.
Industry groups have argued for broad exemptions for trades done to make markets for customers, and for trades used to hedge against certain risks in the banks' portfolios.
The proposal includes both types of exemptions, but it is difficult to determine how they will work in practice.
``There are enough vague descriptions that you can be bearish or bullish'' about the impact on banks, said bank analyst David Konrad of Keefe, Bruyette & Woods.
At a minimum, the proposed rule would increase costs and discourage firms from making markets in securities, said Dwight Smith, a partner at Morrison & Foerster LLP, a law firm which works with investment banks.
``It calls for some very precise management of that business and some very detailed record-keeping,'' said Smith. ``It becomes very cumbersome.''
The impact of the proposed rule will likely be discussed with investors as banks host quarterly earnings calls starting Thursday with JPMorgan.
Some analysts have said the proposed rule could severely hit fixed-income trading for Wall Street brokers, resulting in 25 percent less in revenues.
Regulators Tuesday acknowledged that controversy has surrounded the Volcker rule from the outset.
``The proposed rule has been noted as long, the issues are complex, so I think we made the right decision in allowing the full 90 days for comment,'' said John Walsh, acting director of the Office of the Comptroller of the Currency, which oversees the nation's largest banks.
Walsh spoke at a meeting of the Federal Deposit Insurance Corp board which agreed Tuesday to put the proposal out for comment. The Securities and Exchange Commission is due to discuss the Volcker rule proposal at a meeting Wednesday. The Commodity Futures Trading Commission has yet to announce how it will proceed.
The proposal released by bank regulators on Tuesday is largely similar to a draft of the rule leaked last week that received a mixed reaction from industry groups.
The Securities Industry and Financial Markets Association, for instance, raised concerns about whether the exemption for market-making trades is too narrow.
Randy Snook, a SIFMA executive vice president, said Tuesday that financial firms need to be able to provide capital and liquidity to markets. ``There is a real legitimate concern here that everything gets cast as prop trading. This isn't just about speculative activity, in our mind,'' Snook said.
Charles Whitehead, a professor at Cornell Law School and a former investment bank lawyer, said the draft offers a potentially unworkable maze of tests to distinguish proprietary trading from market-making transactions.
``We may create a real spider web of regulations that will be costly for the firms and almost impossible for the regulators to monitor,'' Whitehead said.