Today, a final version of the long-awaited Volcker Rule has been published by the five US agencies involved in its drafting. The rule as finalised is something of a victory for banks owing to multiple broad exemptions and an extension of the timeline. However, there are many questions still outstanding, and implementation will be a significant challenge for firms.
Firstly, the timing: The Fed has granted a one year delay for compliance with the headline proprietary trading ban, until 21 July 2015. However, reporting requirements will be phased in from June 2014, beginning with banks with $50 billion or more in assets and liabilities.
For the central requirements of the rule there are two main parts: the ban on proprietary trading and the ban on holding interests in or sponsoring certain funds (so-called ‘covered funds’).
The proprietary trading ban, which threatened to be extremely onerous, has been significantly watered down. There will be five main exemptions to it:
- Where banks underwrite issues of securities;
- Market-making: However, this obviously had to be capped in some way to prevent banks from profiting from their market-making activities. In order to prevent this, market-making using proprietary capital will be capped within ordinary market rates of supply and demand. To set this supply and demand, the rule expressly requires banks to conduct ‘demonstrable analysis of historical customer demand’, potentially increasing market data costs and record-keeping requirements;
- Hedging risks: However, to avoid the obvious loopholes this has to be done according to a pre-defined hedging strategy;
- Trading in public debt: Will this see a push towards more fixed income trading?
- ‘Foreign banking entities are permitted to engage in proprietary trading solely outside the US, following a risk-based approach’: This final exemption looks likely to suffer from some of the same issues as the CFTC’s rules in terms of identifying who exactly does pose a risk to US markets and reining in the extraterritorial implications of that policy.
The second part of the rule, relating to a ban on holding interests in or sponsoring ‘covered funds’, seems to be somewhat similar to the UK/EU’s two ring-fencing efforts (Vickers and Liikanen), splitting up retail banking from investment. The list of ‘covered funds’ is long, but already defined, including: foreign pension or public funds, acquisition vehicles and certain derivatives and asset-backed securities. US banks will have to divest themselves of their interests in these ventures, leading to a significant restructuring in the market.
On the face of it, it would appear that the parting shot of the Commissioner could have been a lot worse. This is, however, a summary of the headline changes, after an initial read of a story that has many more chapters to come. No doubt we will be wading through the detail and ‘known unknowns’ on this one for some time to come. The real battle will come next year as we attempt to interpret this rule and put standards in place across the globe.