House Financial Services Committee
Capital Markets, Securities, and Investment Subcommittee
“Examining the Impact of the Volcker Rule on the Markets, Businesses, Investors, and Job Creators”
Wednesday, March 29, 2017
Key Topics & Takeaways
- Fed Staff Report: Ranking Member Maloney presented data on the Volcker Rule from the Federal Reserve’s staff report that measured value-at-risk (VaR), which displayed the steady risk levels on banks’ trading desk since its implementation. She added that banks are no longer making their money through “inappropriate proprietary trading.”
- Volcker Rule Repeal: Many of the panelists and Members of Congress supported a full repeal of the Volcker Rule.
- Liquidity: Regarding liquidity levels, Kruszewski explained that there has been a “fire hose” running one-way for four years where there has been a “tremendous” amount of liquidity coming into the financial system through the issuance of corporate debt, and that markets need to be able to function when the liquidity “runs the other way.”
- Regulatory Oversight: Rep. Brad Sherman (D-Calif.) noted that Dodd Frank gave enforcement powers to five different regulatory agencies, each with primary oversight over a different segment of the financial industry, and asked if regulators are enforcing the Volcker Rule differently or if they have coordinated with each other. Kruszewski replied that the regulators “do the best they can,” but that they each have different views and mandates. He continued that due to the agencies having different interpretations and enforcements, it is a “race to the bottom” to take the most conservative view point.
- David Blass, General Counsel, Investment Company Institute
- Marc Jarsulic, Vice President, Economic Policy, Center for American Progress
- Ronald J. Kruszewski, Chairman and Chief Executive Officer, Stifel Financial Corp., on behalf of Securities Industry and Financial Markets Association
- Thomas Quaadman, Vice President, U.S. Chamber of Commerce
- Professor Charles K. Whitehead, Myron C. Taylor Alumni Professor of Business Law, Director, Law, Technology and Entrepreneurship Program, Cornell University
In his opening statement, Subcommittee Chairman Bill Huizenga (R-Mich.) marked the hearing as the Subcommittee’s opportunity to examine the impact of the Volcker Rule on the U.S. capital markets broadly, including its impact on the liquidity and functionality of the fixed income and securitization markets, the ability of U.S. and international businesses to finance their operations, U.S. competitiveness, and job creation. Huizenga described the “real-world implications” of the Volcker Rule as higher borrowing costs for job creators, smaller investment returns, and less overall economic activity due to regulations. He also described the Volcker Rule as a “solution in search of a problem.”
Subcommittee Ranking Member Carolyn Maloney (D-N.Y.) affirmed her strong support for the Volcker Rule, and said “it stands for an important principle that banks should not gamble with their customers’ money, especially when that money is backed by a taxpayer guarantee.” Ranking Member Maloney presented data on the Volcker Rule from the Federal Reserve’s staff report that measured value-at-risk (VaR), which displayed the steady risk levels on banks’ trading desk since its implementation. She added that banks are no longer making their money through “inappropriate proprietary trading.”
Subcommittee Vice Chairman Randy Hultgren (R-Ill.) reflected on the “mixed feelings” amongst Republicans and Democrats when the Volcker Rule was initially debated in Congress in 2010, and attributed it to policy makers understanding that proprietary trading did not cause the financial crisis. Hultgren added that Volcker Rule’s compliance burdens community banks, that have proven to regulators that they were never engaged in activity related to the rule.
David Blass, General Counsel, Investment Company Institute
In his testimony, Blass confirmed ICI’s support of the Subcommittee examination of the Volcker rule and its impact on the U.S. capital markets, specifically liquidity in the fixed income markets. Blass stated that the Volcker Rule was not intended to apply to ordinary stock and bond mutual funds, exchange traded funds (ETFs), and other investment funds registered under the Investment Company Act of 1940, as it provides regulation framework to protect investors. He addressed three major concerns for ICI and its members. First, that the five agencies implementing the Volcker Rule “failed” to provide a complete carve-out for registered funds, resulting in registered funds being treated as “bank entities.” Second, he voiced concern over the competitive inequalities between U.S. and foreign firms. Lastly, Blass stated that the Volcker Rule has disrupted the market for certain securities in which registered funds invest.
Marc Jarsulic, Vice President, Economic Policy, Center for American Progress
Jarsulic used his testimony to highlight the importance of the Volcker Rule and argued it has not triggered deterioration of liquidity in the corporate bond market. Jarsulic noted critics of the Volcker Rule have forecasted dire consequences for the corporate bond market including declining liquidity and harm to the functioning of the capital markets, but these negative effects have not materialized. Jarsulic concluded that the departure of large banks from proprietary trading has not had a quantifiable effect on corporate bond market liquidity, liquidity risk, or the ability of corporations to raise funds in the capital markets. He stated that bond markets are operating “as well as, if not better than, they were in the pre-crisis period.”
Ronald J. Kruszewski, Chairman and Chief Executive Officer, Stifel Financial Corp., on behalf of Securities Industry and Financial Markets Association
In his testimony, Kruszewski discussed how the ban on proprietary trading has done little to reduce systemic risk. Kruszewski affirmed that he did “not believe that the best way to regulate risk, systemic, or otherwise, is by inhibiting trading or traditional market making, which provides liquidity and depth to our capital markets, but rather through capital and liquidity rules addressing the balance sheet of our financial institutions.” On the compliance regime for the Volcker Rule, he noted that the shared governance by five separate agencies has resulted in an “utter lack of guidance.” He noted his belief that the Volcker Rule makes capital markets less liquid which increases the cost of capital for clients, specifically smaller companies, who are the major contributors to job-creation. Kruszewski called for a repeal of the Volcker Rule, and failing that, modifications to the rule toreverse the language that assumes all trades are proprietary unless proven otherwise and eliminating the reasonably expected near-term demand (RENT D) requirement.
Thomas Quaadman, Vice President, U.S. Chamber of Commerce
In his testimony, Quaadman referenced the Chamber’s proposal for higher capital standards as an alternative to achieve the intent of the Volcker Rule (more financial stability) but without the regulatory complexity that can harm growth. Quaadman reflected on initial worries in February 2010 when the rule was introduced, adding that “it would be difficult to delineate market making and underwriting from proprietary trading.” He called the Volcker Rule “the poster child of why good economic analysis is necessary for rulemaking,” as no economic analysis was completed or shared with the public. Quaadman and the Chamber recommended a repeal or four modification recommendations: 1) Conduct an economic analysis; 2) Conduct an analysis of major regulatory initiatives since the financial crisis; 3) Regulators should report to Congress; and 4) Congress and the Administration should ensure that banking regulators conduct an economic analysis.
Professor Charles K. Whitehead, Myron C. Taylor Alumni Professor of Business Law, Director, Law, Technology and Entrepreneurship Program, Cornell University
In his testimony, Whitehead voiced his support for repealing the Volcker Rule and stated that the initial goal was to minimize risky trading activities by banks and their affiliates. Professor Whitehead added that the proponents for the rule were more interested in separating commercial banking from investment banking, specifically proprietary trading and principal investing. He stated that changes in the market spurred by the Volcker Rule continue to expose banks to the risks it was intended to minimize.
Questions and Answers
Federal Reserve Staff Report
Huizenga asked Whitehead to expand on the conclusions in the Federal Reserve’s staff report, entitled “The Volcker Rule and Market-Making in Times of Stress.” Whitehead replied that the report’s focus is on relative liquidity, and that they made low investment grade bonds a baseline of how liquid the market for those bonds was both before and after the Volcker Rule. The Fed staff report found a “substantial” impact in this class of low investment grade bonds that was concerning.
Rep. Bruce Poliquin (R-Maine) also noted the Fed’s staff report that stated illiquidity of stress bonds has increased since the Volcker Rule, and asked if Kruszewski agrees with this, to which he said yes. Kruszewski continued that it equates to higher cost of capital for companies and the economy, higher interest rates, and less money for jobs in development.
Poliquin then asked if the conclusion by the Fed could pose systemic risk to the economy. Quaadman replied that it is “definitely causing a drag on growth.”
Volcker Rule Impacts
Huizenga asked how the Volcker Rule impacts the ability to make markets. Kruszewski replied that when his firm raises money for clients, they commit to make markets, and that there is a hindrance in the ability to make markets due to the rising cost of capital.
Maloney noted data she received from the Federal Reserve and asked if the Volcker Rule has caused banks to pull back from market making during periods of market stress. Jarsulic explained that it appears there is an “essentially stable” VaR across various measures, and that it is stable during shocks to the market. He continued that the data Maloney provided suggests the market making activity remained relatively stable during stressful periods.
Maloney then asked why it is important that most of the returns are from new positions rather than existing positions. Jarsulic replied that it suggests that there is a movement toward a real market making function where market makers try to run flat books and earn profits from fees and commissions.
Hultgren asked how the reductions in liquidity under the Volcker Rule impacts funds. Blass explained that in comparison to the market 10 years ago, today’s market has smaller transaction sizes and fewer block trades.
Rep. Ann Wagner (R-Mo.) stated that the rationale behind the Volcker Rule is that it would prevent Wall Street banks from proprietary trading, but that other institutions that do not engage in such trading have been impacted by the rule by having to prove they are not involved in proprietary trades. Quaadman replied that regional and community banks, overseas joint ventures, and non-financial businesses have to create Volcker Rule compliance programs, which leads to liquidity impacts on Main Street.
Rep. David Scott (D-Ga.) explained that one of the goals of the Volcker Rule is to de-risk the financial markets, but that they can never be fully de-risked because “it is not what is best for the average American,” adding that banks have to be able to make money. Jarsulic agreed that financial institutions are in the business of bearing risk, and that there is no attempt in the Volcker Rule or any other regulation to end that function. Kruszewski stated that to limit the risk of banks, do not let them make loans. He continued that the Volcker Rule limits his firm by raising the cost of capital for companies creating jobs.
Rep. Tom Emmer (R-Minn.) asked if the U.S. economy is experiencing impacts even though many regulations are still being implemented. Kruszewski replied with yes, adding that there are “a lot of rules that need to be re-looked at,” because if companies cannot raise capital, they cannot invest or create jobs.
Small and Medium Businesses
Hultgren asked why small businesses are experiencing negative impacts from the Volcker Rule. Kruszewski replied that for debt markets, liquidity is needed to efficiently price bonds, and that less liquidity due to the Volcker Rule means higher costs for smaller companies.
Rep. French Hill (R-Ark.) explained that he has heard from community banks that they have had to sell off profitable businesses and investments due to the Volcker Rule, and asked if the panelists have seen community banks divest at the holding company or bank level where they made a passive investment. “Absolutely,” replied Kruszewski. He continued that if Congress is going to modify the Volcker Rule, the covered rule needs to be looked at. Blass agreed, adding that the covered fund definition is “very confusing,” and that regulators “over included” when they targeted hedge fund activity.
Hultgren asked about the compliance challenges for companies like Stifel. Kruszewski explained that the Volcker Rule has a presumption that every trade is a proprietary trade unless proven differently. He continued that and that even if there is an intent to meet customer demand, if it is not accomplished in a certain timeframe, the firm is in violation of the Volcker Rule. Kruszewski added that this “significantly and materially” impacts their ability to make markets.
Hill asked if the Volcker Rule is too difficult to comply with due to being so complex. Kruszewski replied that any rule that tries to “get into the minds of a trader” is “simply not workable.”
Rep. Jim Himes (D-Conn.) asked Kruszewski for clarification on his opinion of RENT D. Kruszewski replied that from a business perspective, it cannot be implemented as he does not understand the concept.
Himes questioned whether any of the three largest banks would exist if they were not the recipients of the troubled asset relief program (TARP), to which Kruszewski replied that he did not know.
Himes asked if Federal Deposit Insurance Corporation (FDIC) insured institutions should be taking long-term proprietary bets, to which the panel did not respond. He then asked if the “real exercise” is to ensure depository institutions have enough near-term inventory to make markets. Kruszewski stressed that drawing the line between proprietary bets and market making like the Volcker Rule tries to do is “extremely difficult” and causes financial institutions to not make markets like they otherwise would, because each trade is considered proprietary.
Hill asked why Congress exempts U.S. obligations and those of states and municipalities from proprietary trading if proprietary trading truly provides no social good or value in creating liquidity and markets. Quaadman replied that it is a “good question,” and that if you look at the Volcker Rule, Basel III, and other rules, U.S. treasuries are always exempt.
Rep. Trey Hollingsworth (R-Ind.) spoke about short-term proprietary trading versus long-term, stating that the reality is that there is real long-term risk in loan books. Kruszewski replied that you can eliminate the risk by not making loans, but that “we need loans and good capital goals.”
Rep. Brad Sherman (D-Calif.) noted that the European Commission has a similar regulation to the Volcker Rule. Jarsulic replied that it suggests the risks posed by proprietary trading are recognized by Europe, as well as the impacts they have on the operation of the banking system.
Poliquin asked what other types of activities a company might be involved in that are riskier than proprietary trades. Kruszewski replied that his firm does not engage in proprietary trading, as it is not essential to their business model, and that he is not sure what other firms are doing to compensate.
DOL Fiduciary Rule
Wagner stressed that the April 10, 2017 applicability date of the Department of Labor’s (DOL) fiduciary rule is approaching, and asked what impact the lack of certainty around implementation has had on business and what the rule’s effect would be on customers. Kruszewski stated that there is “a lot of confusion” when it comes to the implementation date, and that both clients and the industry are “very confused” about how, if, and when the rule will be implemented. He continued that tens of thousands of investors will lose advice or have their costs raised significantly due to being moved into a fee-based account, which is a “very costly” consequence of the rule.
Wagner noted President Trump’s Executive Order on “Core Principles” and asked if the Volcker Rule promotes those principles. Quaadman replied that it does not, as it makes it harder to raise the capital needed for small businesses.
Optimal Levels of Liquidity
Himes asked how to know when there is optimal liquidity in a given market. Kruszewski replied that while the market will get to an optimal level, it will not be through regulation. Whitehead referred to the Fed’s staff report that tried to determine optimal market liquidity, adding that it is “hard to pinpoint a number.”
Regarding liquidity levels, Kruszewski explained that there has been a “fire hose” running one-way for four years where there has been a “tremendous” amount of liquidity coming into the financial system through the issuance of corporate debt, and that markets need to be able to function when the liquidity “runs the other way.”
Volcker Rule Oversight
Rep. Brad Sherman (D-Calif.) noted that Dodd Frank gave enforcement powers to five different regulatory agencies, each with primary oversight over a different segment of the financial industry, and asked if regulators are enforcing the Volcker Rule differently or if they have coordinated with each other. Kruszewski replied that the regulators “do the best they can,” but that they each have different views and mandates. He continued that due to the agencies having different interpretations and enforcements, it is a “race to the bottom” to take the most conservative view point.
Alternatives to the Volcker Rule
Rep. Thomas MacArthur (R-N.J.) stated that the emphasis should be on leverage ratios and capital requirements rather than the government trying to control “very fluid markets” that change day by day. He continued that while some believe there is an optimal level of liquidity, “if it exists, it does not exist for more than a moment,” and that it is “time to rethink” how to manage risk without “shutting down” the providers of liquidity.
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