Bloomberg News

Volcker Rule Gaps May Leave Banks Uncertain About Trading Bans

October 12, 2011

Oct. 12 (Bloomberg) -- More than a year after they began crafting the Dodd-Frank Act’s ban on proprietary trading by U.S. banks, regulators published the so-called Volcker rule while acknowledging that hundreds of questions remain unanswered.

The proposed rule, written by four regulatory agencies and issued for public comment yesterday, would ban banks from trading for their own accounts. Banks would be allowed to make short-term trades for hedging or market-making while facing limits on investments in hedge funds and private equity funds.

Within the rule’s 298 pages, regulators seek feedback instead of offering precise definitions for many of the banned activities, which may leave financial firms unsure about how to prepare for the final adoption of the rule next year.

“There aren’t bright lines on many questions and that will make it difficult for banks to put in place their compliance regime,” said Kim Olson, a principal at Deloitte & Touche LLP, who formerly worked at the bank supervision department in the Federal Reserve Bank of New York.

The rule, named for former Federal Reserve Chairman Paul Volcker, was included in last year’s regulatory overhaul to rein in risky trading that helped fuel the 2008 credit crisis. The Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency worked with the Securities and Exchange Commission, which is to vote on the rule today. The Commodity Futures Trading Commission is also due to vote on the regulation.

In their proposal, regulators said it was difficult to define permitted activities because that “often involves subtle distinctions that are difficult both to describe comprehensively within regulation and to evaluate in practice.”

‘More Clarity’

Still, regulators will have to make the language more precise before a final rule goes into effect July 21, 2012, because the proposal includes substantial compliance requirements for banks, said Thomas Pax, head of the bank regulatory practice at the Clifford Chance law firm in New York.

“There’s got to be a lot more clarity put around the exceptions for the permissible activities in order for the compliance programs to make any sense at all,” Pax said in an interview.

At the same time, the rule should not be defined too narrowly, said Rob Toomey, managing director of the Securities Industry and Financial Markets Association.

“Our concern is that the narrowness then translates into an overall loss of liquidity in the market, which then leads into harming capital formation and general credit availability,” he said.

‘Close the Loop’

David Konrad, a bank analyst at KBW Inc., said it “feels like there’s enough maneuverability here” to allow banks to continue providing liquidity and executing trades for clients.

For their part, consumer advocates said they were wary of flexibility and want a final regulation that spells out exactly what banks can and cannot do.

“What you see over and over in this rule is a good principle in concept, and a step toward executing that principle,” said Marcus Stanley, policy director at Americans for Financial Reform, a coalition of consumer groups. “And then they won’t close the loop by being clear about, ‘You cannot do this.’”

The board of the FDIC voted 3-0 yesterday to seek comments on the proposal through January 13. The Fed also said it would accept feedback through that date.

Banks’ fixed-income desks could see revenue fall as much as 25 percent under provisions included in a draft circulated last week, brokerage analyst Brad Hintz said in an Oct. 10 note. Moody’s Investors Service said the rule would be “credit negative” for bondholders of Bank of America Corp., Citigroup Inc., Goldman Sachs, JPMorgan and Morgan Stanley, “all of which have substantial market-making operations.”

Foreign Banks

The impact on U.S. banks could be magnified because they will lose business to their foreign competitors, analysts said.

Foreign banks would be covered by the rule if they have U.S.-based staff involved in the restricted trades, according to the proposal. Foreign firms will be able to continue to engage in proprietary trading overseas.

“My greatest concern is the lack of competitive equality for U.S. banks competing abroad,” Ernest Patrikas, a partner at law firm White & Case LLC and a former general counsel at the Federal Reserve Bank of New York, said in an interview.

Anticipation of the rule has already had an impact. JPMorgan Chase & Co. and Goldman Sachs Group Inc., among others, have been winding down their proprietary trading desks.

Since regulators will eventually provide more guidance, financial firms should be cautious about moving too quickly, said Joseph Vitale, a partner at Schulte Roth & Zabel LLP.

‘Too Far’

“My advice to banks has been, ‘Don’t do anything you can’t undo because you don’t want to go too far in cuts if you don’t have to,’” Vitale said.

Stanley, of Americans for Financial Reform, said the proposal could have helped mitigate the financial system’s meltdown if it had been in place prior to 2008.

“Certainly there are parts of this rule that would have given regulators the power to crack down on things that were happening before the crisis,” Stanley said. “But they’re also so vague that they wouldn’t have forced the regulators to act.”

--With assistance from Michael Moore in New York and Phil Mattingly in Washington. Editors: Lawrence Roberts, Maura Reynolds

To contact the reporters on this story: Meera Louis in washington at; Clea Benson in Washington at

To contact the editor responsible for this story: Lawrence Roberts at

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