Volcker Rule
A proposal that bans banks from indulging in high risk speculative trading that endangers the deposits of average customers is being fiercely opposed by most banking institutions in the USA. The proposal which is on its way to its final draft is meeting with all kinds of resistance. The Volcker rule named after Paul Volcker, a former Federal Reserve chairman no less, who proposed a complete ban on proprietary trading by banks.
The ban of proprietary trading was not carried through, and banks are allowed to invest in hedge funds and private equity funds. The import of the rule is that while banks themselves were government insured against risk, to allow them to trade in high risk, high speculation instruments, sometimes against the best interests of its clients would result in systemic failure. An area of contention has been the method to differentiate between market making and speculation. This has not been easy to define and has resulted in some delay in the completion of the final draft. It is most likely that the proposal will have different methods for market making different types of securities. The team drafting the proposal currently has Treasury under secretary of domestic finance Mary. J. Miller heading it and lawyers from the Federal Reserve, SEC, FDIC, FTCC and OCC.
Given below are details from the Commodities Futures Trading Commission document regarding the prohibitions and restrictions of proprietary trading.
“Section 619 of the Dodd-Frank Act, among other things, generally prohibits two activities of banking entities.
- It prohibits federally insured depository institutions, bank holding companies, and their subsidiaries or affiliates (banking entities) from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity’s own account, subject to certain exemptions.
- It prohibits owning, sponsoring, or having certain relationships with a hedge fund or private equity fund, subject to certain exemptions.
Section 619 also prohibits banking entities from entering into any transaction or engaging in any activity that would:
- Involve or result in a material conflict of interest,
- Result in a material exposure to high-risk assets or high-risk trading strategies,
- Pose a threat to the safety and soundness of the banking entity,
- Pose a threat to the financial stability of the United States.
To implement Section 619, the Commission is considering a proposal that would clarify the scope of the section’s prohibitions and, consistent with statutory authority, provide certain exemptions.
The Commission’s proposal to implement Section 619 is substantively similar to the joint rule proposal issued by the Board of Governors of the Federal Reserve System (the Board); the Office of the Comptroller of the Currency, Treasury (OCC), the Federal Deposit Insurance Corporation (FDIC); and the Securities and Exchange Commission (SEC) in October of 2011 (the Joint Volcker Rule). The Commission’s proposal also includes several additional questions asking whether certain provisions of the Joint Volcker Rule are applicable to CFTC-regulated banking entities.