Yesterday, the long-awaited Volcker Rule (one of the hottest section of “Dodd-Frank Act”) got the final votes from five regulators – Federal Reserve, the Federal Deposit Insurance Corp, the Office of the Comptroller of the Currency, SEC and the Commodity Futures Trading Commission.
Since many US banks have such a big financial supermarket structure and they are involved in wide array of financial activities, the rule needs to be adopted by five U.S. agencies: three bank watchdogs (Federal Reserve, the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency) and two market regulators (SEC and CFTC).
This regulation is aimed at curbing the risk-taking behavior of investment banks. Going forward, the banks will not be able to make big trading bets with their own money . It would give a big jolt to many banks whose revenue model ,to a significant extent, is based on revenue from proprietary trading. Though, it is still to be seen how regulators would monitor the allowable trades(hedged trades and trades done as market-maker) and non-allowable trades(speculative trades done for own profits).
Some of provision under the final version of the rule have been made more harsher compared to its previous draft and some have been left as is.
The 2012 revelation of a multibillion-dollar trading loss at J P Morgan Chase & Co, (JPM) has dented the lobbying efforts of many banks to make the rule less stringent. In many ways , this rule is an attempt to modernize the Glass-Steagall firewall between commercial and investment banks for the 21st century. The aim here is, regular banks should engage in the lending activities critical to a strong economy, rather than gambling using their customers’ money.
Below are the important highlights of the rule:
- The rule applies only to those banks which have an access to the Federal Reserve’s discount window or other government agencies. Financial firms that do not have such access are not under purview of this rule.
- The deadline, by which banks have to fully comply with this new regulations, is July 2015 (Though, some legal challenges to this rule can further delay it).
- Banks can engage in market-making and can take on positions to help clients trade but their inventories should not exceed “the reasonably expected near-term demands of customers”.
- The speculative trades done under the veil of portfolio hedging will be penalized.
- Fat bonus culture would be passe now. Traders would not be rewarded for taking on undue risk.
- Fortunately or unfortunately, speculative activities on government bonds, which will now be permitted for foreign sovereign fixed-income instruments as well in addition to U.S. bonds, are not prohibited.
- The rule will apply to proprietary trading and fund activities by U.S. banking organizations regardless of where the trading or activities are conducted. However, for non-U.S. banking organizations, the Volcker Rule would apply only to proprietary trading and fund activities in the U.S., or such activities outside the U.S., if they involve the offering of securities to any U.S. resident.
- The rule requires chief executives to attest every year to regulators that the bank “has in place processes to establish, maintain, enforce, review, test and modify” a program to monitor compliance with the rule.
The approval on this rule comes at an unceremonious time for most of banks. Banks are already frightened by talk of fed tapering and consequent increases in jumps in interest rate (which would have a direct impact on their mortgage business). Poor recovery in Euro-zone countries and slowdown in Asian markets, are , on the other hand, limiting the growth prospects for the banks. Though the rule is aimed at strengthening the markets as a whole, some of its provisions are still vulnerable. It still allows those trades which had ruined some big banks such as :
- MF Global(as it still allows repo-to-maturity Euro debt trade)
- LTCM (High-frequency arbitrage trading on non-US government bond is still allowed).
- JP Morgan London-whale’s $6B loss (Portfolio hedging is still allowed).
This rule has potential to cause thousands of job cuts within the banks. But the good news is, it has given a another opportunity to the legal fraternity to make big bucks by helping banks comply with the rule and find the loopholes in it.