The Volcker Rule: Implications for the US Corporate Bond Market

A December 2011 Oliver Wyman Study on the Volcker Rule and its implications for the U.S. corporate bond market.

Implementing the Volcker Rule restrictions on proprietary trading will be one of the most important, and most challenging, rulemaking responsibilities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).  The study estimates the impact of an overly restrictive implementation of the Volcker Rule statute on the U.S. corporate credit market – specifically U.S. corporate bonds. The analysis focuses on the U.S. corporate bond market as an example – the Volcker rule obviously covers other asset classes where liquidity provision by banks also has significant value to the economy as a whole.

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Excerpt

Executive Summary

• Oliver Wyman has estimated the impact of an overly restrictive implementation of the Volcker rule statute on the US corporate credit market – specifically US corporate bonds
• The corporate credit market is a critical source of funding for American businesses (with nearly $1 TN raised each year) and an essential element of a diversified investment strategy for US household investors, who hold approximately $3 TN in corporate debt across direct holdings, pensions, and mutual funds1
• An overly restrictive implementation of the Volcker rule (as proposed) would artificially limit banking entities’ ability to facilitate trading, hold inventory at levels sufficient to meet investor demand, and actively participate in the market to price assets efficiently – reducing liquidity across a wide spectrum of asset classes
• In the US corporate bond market, any meaningful reduction in liquidity could have significant effects:
  • Cost investors ~ $90 to 315 BN in mark-to-market loss of value on their existing holdings, as these assets become less liquid and therefore less valuable
  • Cost corporate issuers ~ $12 to 43 BN per annum in borrowing costs over time, as investors demand higher interest payments on the less liquid securities they hold
  • Cost investors an additional ~ $1 to 4 BN in annual transaction costs, as the level and depth of liquidity in the asset class is reduced.
• Our analysis focuses on the US corporate bond market as an example – the Volcker rule obviously covers other asset classes where liquidity provision by banks also has significant value to the economy as a whole