A draft of the proposal on the Volcker rule, set to be unveiled by the Federal Deposit Insurance Corporation this week, was leaked on the Internet. According to the draft, the rule will restrict FDIC members from profiting through proprietary trading, as expected, and would also require banks to bulk up compliance programs and record-keeping for trading units.

In the "confidential" staff draft published by American Banker's Website on Wednesday, the bank regulator revealed its requirement for all member firms to establish a compliance program for their trading units.

A note sent out by law firm Davis Polk said that although the leaked draft describes a proposal that would require banking entities to create and maintain robust compliance programs. However, no compliance appendices were included in the draft.

“Compliance programs and record-keeping must also be in place and effective on this date [July 21, 2012],” Davis Polk said in a statement. General requirements for the compliance program to be established under the rule include basic internal policies and procedures, controls, testing, training, and recordkeeping elements. Smaller institutions are allowed to establish a less-complex compliance program that meets the minimum compliance standards.

Although the general definition remains broad, the FDIC did describe in detail allowed activities under the rule, said Davis Polk memo. The FDIC summed up its definition of proprietary trading as “If short–term principal trading is not excluded from the scope and is not a permitted activity, it is prohibited.”

Some of the permissible activities include bona fide market making or simultaneous buy and sell positions on a regular or continuous basis, activities that are designed only to meet near-term client, customer, and counter-party demand, and reasonable inventory and block positioning.

The rule further outlines that primary revenues for members' trading units must be designed to come from fees, commissions, and marginal gains from the bid/ask price differential and not attributable to changes in value or hedging of covered financial positions. The entity must be registered as a securities dealer unless its exempt from registration.

Meanwhile, these trading units must have in place reasonably designed written compliance policies, procedures, and controls. The compliance program “must be subject to independent testing and consistent with regulations on market-making principles,” it said in the draft.

Activities are considered as proprietary trading if

·         Unit takes excessive risk than is required to provide intermediary services to clients

·         Unit primarily generates revenues from price movements rather than customer revenues

·         Unit shows no consistent profitability or demonstrates high earnings volatility

·         Does not transact through a trading system that interacts with order of others

·         Unit routinely pays rather than earns fees, commissions, or spreads

·         Uses compensation incentives for employees to reward proprietary risk taking

·         Does not include but asks about possibility of using numerical thresholds

In addition, the rule also said that compensation arrangements for workers in the trading units must be designed not to encourage proprietary risk taking. The rule also outlined permitted hedging activity banks are allowed to take.

Deadline for comments to the rule is Dec. 16, 2011, and the proposed rule will take effect on July 21, 2012. The FDIC had earlier scheduled an Oct. 11 meeting to consider the proposed rule.