Volcker Rule Opponents Make Eleventh-Hour Pitch for Changes

Federal regulators hope to begin reviewing a final version of the Volcker Rule—the Dodd-Frank Act requirement that would put prohibitions on proprietary trading by banks—any day now and issue it to the public in mid-December, but don't hold your breath.

As it begins to look like regulators from a group of agencies responsible for completing the rule could miss that deadline, like many others deadlines they have missed since Dodd-Frank was signed into law in July 2010, opponents of the rule are making a last-ditch effort for changes and alternatives.

These post-comment period Hail Mary passes by those who fear the Volcker rule could put a serious dent in bank profits come as discord continues among regulators over how strict or comprehensive to make the rule. Gary Gensler, the Commodity Futures Trading Commission chairman who supports a strong Volcker Rule, said in early November that he expects the CFTC—one of six regulators that must approve the Dodd-Frank Act provision—to take a vote in December. But as that time approaches, Gensler is not as confident in that timeline. He recently fretted that unless the document is in the hands of the CFTC soon, its review will be crunched for time.

Mary Jo White, chairman of the Securities and Exchange Commission—which must also approve the rule— appeared skeptical that it would be finished this year. “I don't want to be pinned down,” she told those attending a securities industry conference in New York last week. Would it be ready by the end of the year? “Maybe,” she said.

Back to the Drawing Board?

Opponents of the Volcker Rule are hoping to take advantage of another potential delay and re-inject themselves into the rulemaking process. The U.S. Chamber of Commerce, for example, is requesting that the Volcker Rule be re-proposed and sent back out for public comment before it is finalized. “This is the only way to ensure a meaningful opportunity for comment on what must certainly be a substantially altered rule,” it wrote in a letter to regulators last week.

According to the Chamber, the Volcker Rule takes the wrong approach to solving the problem. “We understand the intent, but our concern has always been that the rule is probably unworkable,” says Tom Quaadman, vice president of the Chamber's Center for Capital Markets Competitiveness. “The better way to achieve that intent is through the use of higher capital requirements. If institutions decide they want to engage in proprietary trading, fine, but then they should also have to face higher capital and liquidity requirements.”

The Chamber argues there are also deficiencies with the existing cost-benefit analysis. And the proposed rule and likely the final version, it maintains, fail to take into consideration adverse impacts on the ability of companies to raise capital; forces commercial companies that own banks to build and maintain compliance programs, even though they have never engaged in proprietary trading; and creates ambiguity as to what is permissible market making and underwriting.

“They are now trying to get this rule done as quickly as possible, but regulators haven't even thought through the consequences of it,” Quaadman says, adding that some issues arose after the comment period closed, another reason he wants regulators to re-propose the rule.

The Federal Reserve finalized its definition of “activities that are financial in nature” for designating non-banks as “Systemically Important Financial Institutions,” subjecting them to added scrutiny, capital requirements, and liquidity demands in April 2013—nearly 14 months after the comment period on the Volcker Rule proposal closed, he says. Those affected may have failed to comment initially because they did not think they would be included.

“The regulators specifically deferred consideration of how Dodd-Frank would apply to non-banks because, at the time, the Financial Stability Oversight Council had not yet finalized the designation criteria, nor had it designated any non-banks,” Quaadman says.

Even some of the regulators themselves are calling for more deliberation before the rule is finalized. Newly appointed SEC Commissioner Michael Piwowar, one of two Republicans on the Commission, for example, has demanded that the rule be re-proposed or he says he will vote against it.

“If institutions decide they want to engage in proprietary trading, fine, but then they should also have to face higher capital and liquidity requirements.”

—Tom Quaadman,

VP, Center for Capital Markets Competitiveness,

U.S. Chamber of Commerce

Keep It Simple

Other opponents say the rule, as it is currently proposed is overly complex. “They've been over-thinking it. It really is a simple notion, but they are turning it into something way too complex and very hard to enforce,” says William Isaac, a former chairman of the Federal Deposit Insurance Corporation and founder of the regulatory consulting firm The Secura Group, now a part of FTI Consulting.

Large banks have the staff, resources, and cash-on-hand to comply with most of what the Volcker Rule throws at them, Isaac says, but smaller banks may find the new requirements insurmountable. His solution is to streamline the rule, simplify it, and eliminate ambiguities. The rule, as he envisions it, could be summarized on just one sheet of paper, not the more than 800 pages the final rule will likely span.

Isaac, along with retired chairman and CEO of Wells Fargo bank Richard Kovacevich, continue to promote an alternative plan of limiting the amount of trading revenue as a percentage of the firm's total revenue. The minimal level could, for example, be set at 10 percent, protecting banks from failing by taking massive positions on their own account. Regulators would monitor trading activity and lower the cap for any bank that consistently loses money on trading positions until it addresses the problem.

The plan, says Isaac, would also eliminate the need to distinguish between proprietary trading and hedging. “Sometimes it's not clear which category your activity falls into,” Isaac says. “Are you trading to hedge or were you doing it as a profit-making exercise? The beauty of what we are suggesting is that it doesn't really matter which it is. You are limited to what percentage of your income can come from that source. If it begins to dominate your income statement, then you are doing something that was not intended. That's the only thing a regulator should really be concerned about”

The Bipartisan Policy Center, a Washington D.C. based think tank, offered its alternative in a report released in October by its Capital Markets Task Force. “As President Obama pushes regulators to complete the Volcker Rule by year's end, the complexity and lack of clarity of the regulations proposed by the agencies remain a work in progress,” says James Cox, one of the report's authors.

Under their plan, regulators would use metrics tailored to each asset class, financial product, and market to define what kinds of trading should be considered permissible. The goal is that the new regulations be crafted with “real-world experience.” They say the new regulations should be phased in with timing appropriate for each asset class.

LINCOLN AMENDMENT

The following excerpt from the Bipartisan Policy Institute's Financial Regulatory Reform Initiative suggests Volcker Rule alternatives and addresses views on the “Lincoln Amendment.”

Section 716 of the Dodd-Frank Act, also known as the Lincoln Amendment, or the “swaps push-out rule,” was, like the Volcker Rule, intended to protect taxpayer funds by prohibiting federal assistance from being given to entities engaged in swaps. The effect of this provision is that insured banks must “push out” their swaps business to nonbank affiliates that are not eligible for deposit insurance or access to the Federal Reserve's discount window.

Once the final regulations implementing the Volcker Rule have been issued, policymakers will be in a better position to assess whether the initial rationale for the Lincoln Amendment remains persuasive and, if so, how best to address those concerns. The Volcker Rule may well achieve the goals of Section 716 in a more comprehensive manner. Bank regulators already have permitted delays in complying with the Lincoln Amendment for up to two years past the July 2013 effective date as they continue to determine how it can be implemented while avoiding significant unintended consequences. Indeed, Chairman Volcker, Federal Reserve Chairman Ben Bernanke, and former FDIC Chairman Sheila Bair have all expressed concerns about the Lincoln Amendment.

Thus, the task force recommends a wait-and-see approach regarding the Lincoln Amendment until more experience can be gained from the Volcker Rule in the amended form the task force proposes. If Congress is satisfied with regulators' implementation of the Volcker Rule—as the task force believes they should be under its alternative proposal—then the Lincoln Amendment could be repealed without any negative effect on the safety and soundness of the U.S. financial system.

Source: Bipartisan Policy Center.

The Waiting Game

While critics look for one last chance to shape the rules, others are growing restless with the inability of regulators to get their act together. “They say it is coming out any minute, but it has been ‘coming out any minute' for the last four years,” says Kurt Schacht, managing director of the CFA Insitute's Standards and Financial Market Integrity Division. “You have to wonder how it could possibly even happen with six different regulators weighing in and every sort of lobbying organization in the world with any interest in derivatives and proprietary trading involved. It is almost an insurmountable task to come out with legislation that is precise and to the point.”

Manmeet Brar, a senior manager and business consultant at Sapient Global Markets, thinks a final rule could still come in December. He expects the final version will be more stringent than what banks pushed for, that it will offer no additional comment period, and that full compliance will be delayed until either January or July of 2015.

“This rule is 850 pages, and I've been told 600 of those additional pages are trying to fine tune what constitutes market making and what a legitimate hedge is under the rules,” Brar says. “The hope is—and I  highlight the word ‘hope'—that it will make things really black and white so entities will not be seen as prop traders even though they are market making and hedging.”

Otherwise, Brar worries, the final rule could be a catalyst for chaos. “Firms will go around making their own interpretations, and it is not going to be pretty,” he says.