Senators have voted through a compromise to the financial reform bill that would toughen up proposed limits on proprietary trading for deposit-taking banks in the US.
The bill was passed in one version by the House of Representatives in December 2009 and another version was passed by the Senate in May 2010.
Following the compromise the wording for a single bill was agreed by negotiators last night and it must now be passed by both chambers.
The compromise was put forward by senator Chris Dodd, one of the architects of the bill. It is essentially variation of the Volcker rule, originally proposed by former chairman of the Federal Reserve Paul Volcker, to ban deposit holding banks from engaging in proprietary trading or investing in hedge funds or private equity.
The text of the compromise offer, published prior to agreement, states that “Proprietary trading conducted by a banking entity or non-bank financial company” is only permitted “provided that the trading occurs solely outside of the United States and that the banking entity or non -bank financial company…is not directly or indirectly controlled by a banking entity or non-bank financial company… that is organised under the laws of the United States or of one or more states.”
However, the bill will contain exceptions that will, among other things, enable US banks to conduct trading activities in support of client business. Banks will still be permitted to buy and sell assets for; underwriting or market making activities “not to exceed the reasonably expected near term demands of clients, customers, or counterparties”; hedging against “aggregated positions, contracts, or other holdings”; investments in “small business investment companies” or “investments designed primarily to promote the public welfare”; or on behalf of regulated insurance company.
One legal source expressed concern around the draft’s use of the phrase ‘risk mitigation hedging activity’, saying “Most of us in the risk management side of the business think there is a difference between risk mitigation and hedging.”
Banks will also be able to buy and sell assets for the purpose of “organising and offering a private equity or hedge fund” where the bank provides bona fide trust, fiduciary, or investment advisory services or “the fund is organised and offered only in connection with the provision of bona fide trust, fiduciary, or investment advisory services”. No bank employee or director will be able to hold a position with the fund, the fund cannot appear to be part of the bank e.g. sharing the same name, and it must be clear that any losses to the fund will be held by investors and not the bank.
In addition to the restrictions on proprietary trading, the bill limits banks from investing more than 3% of their capital in either hedge funds or private equity firms.
Reacting to the bill, one source noted that outlawing banks’ prop desks would create a ‘”buyer’s market” as assets were sold off, adding that the net effect of removing trading firms from the market would be negative. At present, the bill commits to issuing a schedule for the sale of assets held by banks’ prop desks no later that six months beyond its final ratification.
The US department of the treasury secretary Tim Geithner said, “We commend Congress for completing their work within conference and bringing us this close to enacting meaningful financial reform. Tonight, due to the President’s leadership and Congress’ resolve, the finish line is in sight… We urge Congress to carry the momentum forward and move swiftly towards final passage.”