To:
"V.K.Durham" <v.k.durham@comcast.net>
Sent: Friday, December 13, 2013 11:08:26 AM
Subject: This will have a big impact on the big banksters
Sent: Friday, December 13, 2013 11:08:26 AM
Subject: This will have a big impact on the big banksters
After several years and 18,000 comments, yesterday regulators braved a “snow covered” Washington and voted to approve a final rule to prohibit banks from engaging in proprietary trading, known as the Volcker rule. As industry had feared, the Volcker rule will likely increase compliance burdens and complexity and, as a practical matter, narrow the scope of trading revenue generating activities for covered institutions. Given the phased implementation schedule for the new requirements, the impacts will not be fully felt until 2017.
Changes from the Proposed Rule
As
with the proposed rule, the final Volcker rule generally prohibits banking
entities from engaging in short-term proprietary trading of securities and
derivatives (including swaps, commodity futures, and options) for their own
account and bars them from having certain relationships with hedge funds or
private equity funds. However, there are numerous exemptions to this standard,
including for market making, underwriting, hedging, trading in government
obligations, and organizing and offering a hedge or private equity fund.
In
response to numerous comments and industry pressure, the final rule grants
broader exemptions for banks’ market-making activities. While the proposed rule
outlined seven standards that banks must satisfy to meet the definition, the
final rule provides that banks’ trading desks need to be “routinely” ready to
both “purchase and sell one or more types of financial instruments” in order to
qualify as “market making.” Furthermore, the rule states that trades qualifying
for the market-making exemption, like those qualifying for the underwriting
exemption, will not be allowed to surpass the “reasonably expected near-term
demands of clients” which would be assessed through historical demand and
consideration of market factors. The new rule mandates certain risk management
activities and procedures for permissible hedging activities of market-making
desks.
The
final rule delineates the scope of certain foreign funds and commodity pools
covered by the fund investment and sponsorship restrictions in a more limited
manner than under the proposed rule. The final rule does not restrict
investments in or sponsorship of certain entities like wholly-owned
subsidiaries, joint ventures, and acquisition vehicles. The final rule excludes
mutual funds and other registered investment companies, business development
companies, certain publicly offered foreign pooled investment vehicles, loan
securitizations, insurance company separate accounts, small business investment
companies, and public welfare investments.
While
the market-making exemption and private fund activity restrictions may have
been softened, much of the final rule builds on the proposed, imposing new and
stronger requirements on banks.
Among the
strengthened provisions are risk-mitigating hedging provisions that require
banks to analyze, test, and demonstrate to regulators that a hedge
“demonstrably reduces or otherwise significantly mitigates one or more
specific, identifiable risks of individual or aggregated positions of the
banking entity.” Banking entities will be required to support claims of exempt
hedging with analysis, including detailed correlation analysis, to monitor and
recalibrate as necessary hedging strategies on an ongoing basis and to
document, contemporaneously with the transaction, the hedging rationale for
certain transactions that present heightened risks. Based on public comments
from regulators, it appears the hedging language was tightened partly in
response to a $6.2 billion JPMorgan trading loss by the rogue trader known as
the “London Whale.”
Among
the most vocal in their concerns with the proposed rule was the small and
community banking industry, which feared that the compliance requirements
associated with the rule would push them out of the market in favor of the
large banks and financial institutions with greater capacity to handle the
increased compliance costs associated with conforming to the Volcker rule’s
standards. The response to these concerns was to allow smaller institutions
additional time to comply with select requirements. Regulators created a phased
compliance schedule in the final rule. The originally proposed effective date
of April 1, 2014 was extended until July 21, 2015. The rule also requires a number
of quantitative measurements, knows as “value-at-risk” calculations. The final
rule offers a phased approach for reporting estimates of risk, position limits,
profits, losses, and estimates of capacity for loss per day. Beginning June 20,
2014, entities with over $50 billion in consolidated trading assets and
liabilities will be required to report quantitative measurements. Those
entities with less than $50 billion, but at least $25 billion in assets would
be required to begin this reporting on April 30, 2016. Finally, banking
entities with at least $10 billion, but less than $25 billion, will not have to
begin this reporting until December 31, 2016.
Not
only must larger institutions worry about a shorter compliance period, but
their CEOs must annually attest in writing to compliance. These obligations,
while less onerous than rumored, still apply to institutions with more than $50
billion in assets.
Regulators
also made changes to allow foreign trading of sovereign debt under more
circumstances than previously proposed. Earlier drafts of the Volcker rule had
drawn criticism from international regulators for its potential to reach
overseas banks’ activities and the sovereign debt market. To resolve these
concerns, the final Volcker rule adopts a territorial approach, exempting
trades outside the U.S., assuming “the trading decisions and principal risks of
the foreign banking entity occur and are held outside of the United States.”
The Regulators Voted
While
the day began with news that weather complications had forced the CFTC to
change its public meeting to a private vote, snow did not stop regulators from
voting to finalize the long-delayed Volcker rule.
The
Fed was the first regulator to formally announce it had approved the rule in a
unanimous vote to apply its provisions to the large bank and financial holding
companies under its jurisdiction. The FDIC also approved the rule in a
unanimous 5–0 vote. While Vice Chairman of the FDIC Thomas Hoenig expressed
reservations about the complexity of the rule, he agreed with the remainder of
the Board that the rule is a “necessary step in ensuring that the current
financial industry structure is less vulnerable.”
Although
the Fed and FDIC votes were uncontentious, much of the debate over the final
rule in weeks leading up to the vote appears to have been amongst CFTC and SEC
commissioners. In the end, the SEC voted 3–2 to approve the final rule, with
the Commission’s two Republicans, Michael Piwowar and Daniel Gallagher,
opposing.
The
CFTC followed the SEC, approving the rule in a 3–1 vote. While the vote was
private, CFTC Commissioner Scott O’Malia, who opposed the rule in its proposed
form, also voted down the final rule. In his dissenting statement, O’Malia
cited concerns that the rule does not adequately address the CFTC’s
jurisdiction and enforcement powers, adding that he cannot support a proposal
that had not been meaningfully vetted by the full Commission.
Comptroller
of the Currency Thomas Curry’s approval made the OCC the fifth and last agency
to approve. Notably, the OCC has also released a budgetary impact statement
under the Unfunded Mandates Reform Act of 1995. The release states that the OCC
has “determined that the final rule qualifies as a significant regulatory
action under the UMRA because its Federal mandates may result in expenditures
by the private sector in excess of $100 million or more.”
Stakeholders Respond
At the
release of the final rule, Senators Jeff Merkley (D-OR) and Carl Levin (D-MI),
the sponsors of the Volcker rule amendment to the Dodd-Frank Act, released a
statement reiterating the need for “a firewall between traditional banking and
hedge fund style gambling.” Though the lawmakers said they were still reviewing
the specifics of the rule, finalizing the proprietary trading ban was a “big
step” forward and that “hedging looks tougher, market-making looks simpler,
trader compensation remains appropriately structured, and CEOs are required to
set the tone at the top.”
Chairman
of the Senate Banking Committee Tim Johnson (D-SD) also praised the final rule,
saying it is a “milestone” in the progress toward full implementation of the
Dodd-Frank Act and that it will “help improve the integrity of our banking
system.”
After
reports late last week that the final Volcker rule would be a stronger version
of the proposed, industry groups expressed disappointment that regulators did
not re-propose the Volcker rule before finalization. The head of the Chamber of
Commerce’s Center for Capital Markets Competitiveness, David Hirshmann, warned
that the rule is the most complex of the “convoluted Dodd-Frank law” and that
it has the potential to shut out small business, raise the cost of capital, and
place the U.S. at a competitive disadvantage to the global economy. While not
as pessimistic as the Chamber, other industry groups, such as the Financial
Services Roundtable and Financial Services Forum have warned against the broad
economic implications of the rule. Rob Nichols, head of the Financial Services
Forum, expressed hope that regulators “implement it in a way that recognizes
the economic importance of hedging and market-making.”
Industry
backlash may be tempered by looser than expected market-making requirements and
the narrowing of the fund activities restrictions; however, it is still
conceivable that a legal challenge to the Volcker rule could be brought, just
as legal challenges to other Dodd-Frank related rulemaking efforts (e.g., the Fed’s Durbin
Amendment rules, the CFTC’s initial position limit rules, and the CFTC’s mutual
fund regulations) have proceeded with varying degrees of success. In the
interim, banks must now begin to plan their compliance programs for this much
anticipated legacy of Dodd-Frank.
Published In: Commercial Law & Contracts Updates, Finance & Banking Updates, International Law & Trade Updates, Securities Law Updates
