The so-called Volcker rule, which aims to ban prop trading by deposit-taking institutions in the US, could substantially reduce liquidity and cause significant mark-to-market loss of value for investors, according to a new report from research firm Oliver Wyman.
The report, commissioned by US-based sell-side trade body the Securities Industry and Financial Markets Association (SIFMA), found that investors would have to pay more to trade bonds that are now systematically less liquid, with a potential annual cost to investors of US$1 billion to US$4 billion.
“An overly restrictive implementation of the Volcker rule – as proposed – would artificially limit banking entities’ ability to facilitate trading, hold inventory at levels sufficient to meet investor demand, and actively participate in the market to price assets efficiently –reducing liquidity across a wide spectrum of asset classes,” the report said.
The study found that reductions in liquidity in the bond markets would create a number of problems and costs.
Oliver Wyman believed the cost to investors could range from US$90 billion to US$315 billion in mark-to-market loss of value on existing holdings, as fixed income assets became less liquid and therefore less valuable.
SIFMA added that a number of provisions of the Volcker rule risked constraining market liquidity, including artificial limits on size and duration of inventory and retained risk, restrictions on inter-dealer trading and active trading to price assets, a requirement to show consistent revenue and risk dynamics, and fragmented regulatory oversight and enforcement.
“Less liquid instruments or markets would likely be disproportionately affected,” the report said. “The impact of reduced liquidity will have a disproportionate impact on the value of bonds backed by, generally smaller, firms at the lower end of the credit spectrum.”
The Volcker rule, named after former Federal Reserve chairman Paul Volcker, is intended to restrict US banks’ proprietary trading activities and investments in private equity and hedge funds in order to reduce risk in the US banking system. The rule was introduced as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Other areas of contention among market participants include the rule’s definition of proprietary trading and its application to foreign entities.
According to US law firm Davis Polk, by the end of December, a total of 200 Dodd-Frank rulemaking requirement deadlines had passed – some 50% of the 400 total rulemaking requirements and 70% of the 286 rulemaking requirements with specified deadlines.
Of the deadlines which had passed, 149 (74.5%) were missed and only a quarter (51) had been met with finalised rules.
On 11 October, the Federal Deposit Insurance Corporation, Federal Reserve, Office of the Comptroller of the Currency and the Securities and Exchange Commission issued their joint proposal for the rule. Late December, the deadline for public comment on the joint proposition was put back a month to 13 February after lawmakers pleaded for more time.
The Commodity Futures Trading Commission (CFTC) has said its own proposal would be “consistent” with that of the present proposed rule.
“I would be hopeful that we would address ourselves to a proposal – possibly even in the first meeting of January – of the Volcker Rule,” CFTC chair Gary Gensler said late last month when asked when he expected the watchdog to release its own version of the rule.
The CFTC’s next meeting is tentatively scheduled for 11 January.