The proposals are named after their creator, former Federal Reserve Chairman Paul Volcker. Original proposals prohibited banks from trading on a proprietary basis – trading using the firm’s own funds – for purposes that are unrelated to serving clients. It also would have prohibited banks from owning, investing in or sponsoring a hedge fund or private equity fund. The rule would have also limited the size of financial institutions by market share.
The final Volcker Rule included in the Dodd-Frank Act prohibits banks from proprietary trading and restricted investment in hedge funds and private equity by commercial banks and their affiliates. Further, the Act directed the Federal Reserve to impose enhanced prudential requirements on systemically identified non-bank institutions engaged in such activities. Congress did exempt certain permitted activities of banks, their affiliates, and non-bank institutions identified as systemically important, such as market making, hedging, securitization, and risk management. The Rule also capped bank ownership in hedge funds and private equity funds at three percent. Institutions were given a seven year timeframe to become compliant with the final regulations.
On October 11, 2011, five agencies proposed rules that would implement the statutory Volcker Rule. Over 18,000 comment letters were received during the public comment period, which was opened and later extended from January 13, 2012 to February 13, 2012. Final Volcker Rule regulations were released and adopted by the agencies on December 10, 2013, which generally prohibit banking entities from:
- engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account.
- owning, sponsoring, or having certain relationships with hedge funds or private equity funds, referred to as ‘covered funds.’
Municipal securities are exempt from the Volcker Rule. They are defined as “a security that is a direct obligation of or issued by, or an obligation guaranteed as to principal or interest by, a State or any political subdivision thereof, or any agency or instrumentality of a State or any political subdivision thereof, or any municipal corporate instrumentality of one or more States or political subdivisions thereof.”
The final rules will become effective on April 1, 2014. The conformance period has been extended until July 21, 2015.
While pure proprietary trading for one’s own account is a limited activity for most banks, the ability to trade and take positions in securities has been an essential tool to making markets and ensuring those markets remain liquid. Although SIFMA does not believe that the Volcker Rule addresses the root causes of the financial crisis, we will work with regulators to ensure it is implemented in a way that does not inadvertently limit market making and, in turn, reduce liquidity which would increase volatility and risk in markets.
SIFMA is in the process of reviewing the final Volcker Rule regulations in detail with our members, many of whom have already been working to meet the spirit and purpose of the Rule by curtailing aspects of their proprietary trading activities and reducing positions in entities that are clearly a private equity or hedge fund. Our primary concern remains to be the potential negative impact of the Volcker Rule on market liquidity. An overly restrictive Rule will inflict serious harm on our nation’s economy and American savers, stifling economic growth and job creation. It is imperative that the final Volcker Rule does not unnecessarily restrict market making or a firm's ability to hedge risks in the effort to clearly define prohibited proprietary trading activities.