The Volcker Rule included in the Dodd-Frank Act prohibits banks from proprietary trading and restricts 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 underwriting. 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.
After an initial proposal in the Fall of 2011, final Volcker Rule regulations were released and adopted by the agencies on December 10, 2013. The rules 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.'
The Rule contains a number of significant asset class exemptions. In addition to an exemption for U.S. Treasury securities, municipal securities are exempt from the Volcker Rule. A municipal security is 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 became effective on April 1, 2014. A number of large banks subject to the Rule began tracking certain metrics in July 2014. Those firms began reporting these metrics in September 2014. All firms will be required to be fully compliant by July 21, 2015. Another group of firms will become subject to metrics reporting obligations in January 2016 with a final group subject later in 2016.
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 continue to 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.
Most firms, even prior to the publication of the final regulations eliminated their proprietary trading activities and reduced positions in entities that are clearly a private equity or hedge fund. Our primary concern with the implementation process is that there is limited negative impact on market liquidity and that overall compliance by the industry is efficient. SIFMA also looks to the multiple Volcker regulators to continue to develop a transparent process that will lead to consistent interpretation, supervision and enforcement of the Rule.