The proposals are named after their creator, former Federal Reserve Chairman Paul Volcker. The 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 proposal was introduced after the House of Representatives passed its version of financial regulatory reform. The Senate chose to include the rule in their legislation as it was proposed by President Obama. A revised version of the rule was ultimately adopted by the Congress and was then signed into law on July 21, 2010 by President Obama as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
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 have a seven year timeframe to become compliant with the final regulations.
On October 11, 2011, the Federal Deposit Insurance Corporation (FDIC) proposed rules that would implement the statutory Volcker Rule. The rule was co-proposed by the U.S. Department of Treasury’s Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (FRB), FDIC and the Securities and Exchange Commission (SEC). Originally, regulators set January 13, 2012 as the deadline for public comment on the proposed rules. On December 23, 2011, the regulators extended the comment period until February 13, 2012.
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’s primary concern with the October 11th proposal is the potential negative impact on market liquidity. As proposed, the rule's narrowly-crafted exemption for permitted market making activity exceeds Congressional intent and overly prescriptive and burdensome compliance requirements could well depress the market making functions of banks and their affiliated broker-dealers as well as the asset management alternative fund business. Restrictions on the ability of firms to make markets will reduce market liquidity, discourage investment, limit credit availability and increase the cost of capital for companies. This will have the cumulative effect of stifling economic growth and job creation.
SIFMA believes the proposal appropriately raises important questions related to the costs and burdens of complying with certain aspects of the proposal and SIFMA appreciates the opportunity to work with regulators to ensure proper economic analysis is undertaken.