Agencies jostled over Volcker implementation

Pressure is mounting on US regulatory agencies to push through the so-called Volcker rule prohibition of prop trading as opposition continues unabated from industry.

Pressure is mounting on US regulatory agencies to push through the so-called Volcker rule prohibition of prop trading as opposition continues unabated from industry.

Last week, 22 Democratic senators signed a letter co-authored by Jeff Merkley (Oregon) and Carl Levin (Michigan), calling on the Securities Exchange Commission (SEC), the Commodity Futures Trading Commission, the Federal Reserve System and other regulators to quickly implement a strong Volcker without any loopholes.

“Conflict-ridden, high-risk trading activities played a central role in big banks’ accumulation of the failed toxic assets that … led to trillions of dollars of taxpayer-backed bailouts of the largest financial firms,” read the letter addressed to watchdog chiefs including Feb chairman Ben Bernanke and SEC chair Mary Shapiro.

The senators are concerned industry pressure is watering down the rule intended to prevent deposit-taking institutions from making speculative bets with retail client money.

For one, Merkley and Levin are keen the rule draws a clear distinction between speculative trading activities at traditional banks and other activities necessary for the banking system by “using objective data and observable markets”.

“The rule should be finalised this summer. The banks that will be directly impacted by the Volcker rule have already had nearly two years to realign their business to comply with the broad contours of the rule, and many have already taken steps to do so,” wrote the senators. “Please implement a clear, strong, and effective Volcker rule without delay.”

But industry pundits believe there is little chance of the agencies moving forward quickly on Volcker. The prop-trading ban is one of more than 200 reforms under the Dodd-Frank Wall Street Reform and Consumer Protection Act. According to law firm Davis Polk, as of today, 221 Dodd-Frank rulemaking requirement deadlines have passed – just over half (55.5%) the 398 total rule-making requirements, and 78.9% of the 280 rule-making requirements which have specified deadlines. But 148 (67%) of these deadlines have been missed and only a third (73) have been met with finalised rules.

Fire from all sides

And the 300-page Volcker rule’s implementation is one of the more contentious in Dodd-Frank, drawing fire from not just those banks directly under fire but a diverse range of industry players – from international governments worried about Volcker’s potential affect on sovereign bond liquidity, to mutual fund interest groups concerned about unintended consequences for funds and their advisers.

In a letter to federal agencies earlier this year, Paul Schott Stevens, president and CEO of buy-side lobby group the Investment Company Institute (ICI), warned regulators Volcker could do “serious harm to US financial markets”, including registered funds.

“The proposal would impede the organisation, sponsorship and normal activities of registered mutual funds,” said Schott Stevens, whose organisation is the national association for US investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts. “For example, by applying the Volcker rule’s hedge fund restrictions to many registered funds, contrary to Congressional intent.”

The ICI believes the rule needs to be revised to explicitly exclude all registered funds and ensure banking entities can continue to serve as authorised participants in funds such as ETFs.

The ICI warns that the proposal could also limit investment opportunities for registered funds and their shareholders.

“The narrow exemption in the proposed rule for trading outside of the United States could significantly limit US registered funds’ access to non-US counterparties,” said Schott Stevens. “To avoid this, any final rule should adhere closely to the approach taken under the SEC’s ‘Regulation S’, a regulation governing whether a securities offering takes place outside the United States.”

Schott Stevens warns that Volcker as it currently stands could deter banks from sponsoring asset-backed commercial papers (ABCP) and tender option bond (TOB) programs – activities Congress never meant to restrict.

“Any final rules should exempt ABCP and TOB programmes,” said Schott Stevens.

The Federal Reserve Board said last month banks would have two full years to conform to Volcker. Unless the board further extends the conformance period, deposit-taking institutions will have until 21 July, 2014. Previously, some banks were concerned they would need to begin compliance of the yet to be fully understood rules by the beginning of the enforcement period, 21 July, 2012.

The announcement was seen by many in the industry as a signal regulatory agencies were unlikely to produce a final rule by 21 July and would reassess their current rule proposals, which were heavily criticised when published earlier this year.