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Banks Get Respite as Regulators Okay Volcker-Rule Tailoring

Priti Dhanuka

Wall Street banks seem to be in a win-a-win situation, currently, on easing out of the Volcker Rule under the Trump administration. On Tuesday, the revamped rule was approved by two of the five U.S. regulators, under which related regulatory requirements have been simplified, providing more flexibility to banks on their restricted trading activities.

The rule will be effective Jan 1, 2020 for banks, with a compliance date of Jan 1, 2021.

Volcker Rule – A Brief Recap

The Volcker Rule prohibits banks or insured depository institutions from conducting proprietary trading, i.e. the practice of financial firms investing to pocket profits rather than buying or selling securities to meet customers’ demands. Also, it barred these companies from acquiring or retaining ownership interests in hedge funds or private equity funds.

The Volcker Rule had drawn widespread criticism at its very inception. Banks, including JPMorgan Chase JPM, Goldman Sachs GS and Morgan Stanley MS, have been complaining of its complexity and claimed the rule to be vague. Further, in 2017, the U.S. Chamber of Commerce put forth its views over the negative impacts of the rule on liquidity and that the costs associated with it outweigh benefits.

Recent Developments

The Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corp (FDIC) have given the green light, while approval from the Federal Reserve, the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) are anticipated in the coming weeks soon.

“One of the post-crisis reforms that has been most challenging to implement for regulators and industry is the Volcker Rule,” said FDIC chairman Jelena McWilliams. “Distinguishing between what qualifies as proprietary trading and what does not has proven to be extremely difficult,” McWilliams noted.

“Meanwhile, banks that do relatively little trading are required to go through substantial compliance exercises to ensure that activities that have long been considered traditional banking activities do not run afoul of the Volcker Rule,” further mentioned the FDIC chairman.

In July 2018, the FDIC, OCC, Federal Reserve Board, SEC and CFTC unanimously published proposed amendments aimed at simplifying and improving the Volcker Rule that prevents banks from engaging in certain types of speculative investments, with a view to curb their risk-taking abilities.

Key Changes under the Final Rule

Depending on the size of a bank's trading assets and liabilities, the rule’s compliance measures will be tailored, with the strictest requirements for the ones with high levels of trading activities. Notably, banks with minimum $20 billion in trading assets will be facing stringent requirements, while companies with trading assets between $1 billion and $10 billion will benefit from the reduced compliance requirements. Finally, financial firms with trading assets lower than $1 billion will be subject to the lowest level of compliance requirements.

Also, a proprietary trading ban has been eased, which prevents banks from making short-term investments using their own capital.

Furthermore, regulators have allowed banks to determine their own risk limits for underwriting activities and market making. Nevertheless, the companies, with significant trading assets and liabilities, will still be required to have a comprehensive internal compliance program.

Moreover, the final rule removes the assumption that positions held by lenders for less than 60 days are proprietary trades. It would even discard some parts of a test that determines whether or not a trade is proprietary, and replace it with a new criteria based on how the bank accounts for the trades.

Banks will also be freed from the elaborate documentation requirements for hedging activities under certain conditions. The revamped rule also simplifies trading activity-related information to be provided to the agencies.

Remarkably, foreign banks stand to benefit greatly from a major change in the rule. Under the existing rule, foreign banks are allowed to engage in proprietary trading only if it occurs outside the United States. However, per the final rule, the exemption will expand to trades initiated outside the country but should go through a U.S. branch or affiliate or is financed by one.

Will Rolling Back of the Rule be a Boon for Banks?

The final rule is anticipated to have a positive impact on the safety and soundness of the financial system, and greatly reduce fixed costs for the financial institutions. Additionally, these banks can now freely engage in hedging activities in limits they consider risk-free that might help them counter risk in other parts of their businesses.

Moreover, the changes in the Volcker Rule might help improve lending as banks will likely benefit from better liquidity positions.

Nonetheless, easing of regulations might leave behind some loopholes that banks seek to exploit. Therefore, the regulators are expected to strictly keep supervising banks’ activities, and maintain them on the right track to avoid another crisis.

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