Republicans have branded the so-called Volcker rule, banning prop trading by US deposit-taking institutions, too expensive and complex for market participants to implement and for regulators to enforce, favouring a re-proposal of the rule.
At a House Committee on Financial Services meeting, scheduled yesterday to review the rule, Republican representatives lambasted regulators for drafting a rule which was 300-pages long. The rule is also accompanied by 1,300 questions for public consideration which regulators said were aimed at helping participants understand which trades do – and do not – fall under the definition of prop trading.
“Making such distinctions will be difficult, if not impossible,” said Spencer Bachus, a Republican and chairman of the committee. “When we have to interpret people’s motive, we’re on thin ice.”
Republican Michael Grimm branded regulators appearing before the committee as “overzealous” bureaucrats who “found creative ways to make a terrible rule even worse”.
Regulators were repeatedly asked if they would consider re-proposing the rule.
“We’ve been willing to re-propose rules in the past,” responded Democrat Gary Gensler, commissioner of the Commodity Futures Trading Commission (CFTC).
But Representative Barney Frank, a Democrat for Massachusetts and one of the authors of the Dodd-Frank Wall Street Reform and Consumer Protection Act, defended the law as important for the nation’s financial stability, chastising Republican for stalling tactics.
“Delay is a stalking horse for opposition for most people,” said Frank, chastising Republicans. In November, Frank announced he would step down as the ranking member on the financial services committee at the end of this term.
Bad for the buy-side?
America’s largest fund manager told the committee the Volcker rule could dry up liquidity and make it harder for institutional investors to trade.
Bearing witness in front of the committee, Alex Marx, head of global bond trading at Fidelity Investments, warned that while Volcker did not apply directly to mutual fund managers that are not deposit-taking entities, the prop trading ban could have significant indirect effects on his firm's ability to manage funds and execute trades on behalf of shareholders.
“Funds, including those managed by Fidelity, collectively represent a significant portion of the investments made by the American public. These funds rely on the liquidity provided by banks and their affiliates as market makers,” said Marx. “Restrictions on the ability of banks and bank affiliates to provide crucial market making services to investors and to provide underwriting services to issuers of corporate and municipal securities should not jeopardise traditional sources of capital for issuers, investments for issuers, or liquidity for the market generally. Market illiquidity will result in price uncertainty, volatility, higher transaction costs and a reduced ability to access capital.”
But Daniel Tarullo, a governor of the Federal Reserve System, said the statute applies only to positions taken by a banking entity as principal for the purpose of making short-term profits.
“It does not apply to positions taken for long-term or investment purposes,” said Tarullo. “Moreover, the statute contains a number of exemptions, including for underwriting, market making-related activities, and risk-mitigating hedging activities.”
Other witnesses appearing before the joint hearing of the subcommittee on capital markets and government-sponsored enterprises, and the subcommittee on financial institutions and consumer credit, questioned the practicality of the ban to deliver Congress’s desired result.
“My core problem with the Volcker rule is that it seems to be trying to eliminate excessive investment risk at our core financial institutions without measuring either the level of investment risk or the capacity of the institutions to handle the risk, which would tell us whether the risk was excessive,” said Douglas Elliott, a fellow in economic studies at Washington-based nonprofit public policy think tank, the Brookings Institution. “Instead, the rule focuses on the intent of the investment rather than its risk characteristics.”
Last week the CFTC revealed its version of the Dodd-Frank Act’s prop trading rule, mirroring the joint rule proposed in October by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission. Representatives of all five regulators appeared before the committee.
Elliott said Volcker suffered from a question of relevance. “It is unclear to me why I care very much what the intent of the bank was. It’s the level of risk relative to the capacity to bear that risk which is of prime interest,” he said. “By focusing on intent, we are almost certain to miss large swathes of investments that are taken on with an acceptable intent, but still represent excessive risk.”
To Elliott, the question which had not been asked by the regulators and Congress was: “How does the Volcker rule impact the ability of non-financial companies to raise capital and mitigate risk and are we willing to live with the adverse impacts of the Volcker rule that will affect the competitiveness and the overall efficiency of the US economy?”
Recently, fears have been raised over the extraterritoriality of Volcker, which could apply to instruments and firms outside the US if they had US connections, presently loosely defined. Regulators have received letters from the Canadian government, which was troubled the rule’s specific mention of Canadian bonds could lead to a squeeze in liquidity in its markets. Japanese watchdog the Financial Services Agency has sent a similar letter to US regulators and the UK government had been in touch with US counterparts through the UK embassy in Washington to voice its own concerns.
Simon Johnson, the Ronald Kurtz professor of entrepreneurship at the Massachusetts Institute of Technology’s Sloan School of Management, said while bankers were expressing concerns Volcker would discriminate against ‘safe’ foreign sovereign debt, this was misleading.
“If a bank is holding sovereign debt as a classic long-term banking investment, then this is in the ‘banking book’ and hence not prohibited under the rule,” Johnson said at the afternoon session on Capitol Hill. “Similarly, if a bank is underwriting or market-making for sovereign debt, then this is also a permitted activity. The only restriction in question is whether a US banking entity can purely prop trade sovereign debt. Proprietary trading in foreign sovereign debt is inherently risky. This is exactly the kind of gambling that led to the recent demise of MF Global.”
According to Johnson, treating US treasuries differently under Volcker was appropriate because US government securities are the main instrument banks use as collateral for many transactions and asset-liability management.
The period for public consultation over the jointly-proposed rule was last month extended from 13 January to 13 February, while the CFTC’s version, handed down on 12 January, is presently undergoing a 60 day consultation period.