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Dodd-Frank’s Volcker Rule Released by Regulators for Comment

U.S. regulators requested public comment on Dodd-Frank Act restrictions that would ban banks from making short-term trades for their own accounts and prevent them from owning or sponsoring hedge funds and private-equity funds.

The so-called Volcker rule, released today by the Federal Reserve, the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency, is aimed at heading off risk-taking that helped fuel the 2008 credit crisis.

The language of the rule is little changed from drafts that have been leaking in recent weeks. It would ban banks from taking positions held for 60 days or less, exempt certain market-making activities, change the way traders involved in market-making are compensated and make senior bank executives responsible for compliance.

The board of the FDIC voted 3-0 today to seek comments on the proposal through January 13. The Federal Reserve also said it would accept feedback by that date.

Analysts say the rule, as proposed, could cut revenue and reduce market liquidity in the name of limiting risk. Banks including JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc. (GS) have been winding down their proprietary trading desks in anticipation.

Banks’ fixed-income desks could see revenue fall as much as 25 percent under provisions included in a draft circulated last week, brokerage analyst Brad Hintz said in a note yesterday. Moody’s Investors Service said the rule would be “credit negative” for bondholders of Bank of America Corp. (BAC), Citigroup Inc. (C), Goldman Sachs, JPMorgan and Morgan Stanley (MS), “all of which have substantial market-making operations.”

Risky Trades

The rule, named for former Federal Reserve Chairman Paul Volcker, was included in last year’s regulatory overhaul to rein in risky trading by firms whose customer deposits are federally insured. The Fed, FDIC and OCC worked jointly on the draft rule with the Securities and Exchange Commission. A final version is slated to take effect on July 21, 2012. The Commodity Futures Trading Commission is also due to vote on the regulation.

Regulators are grappling with a difficult task, said Kim Olson, a principal at Deloitte and Touche LLP in New York.

“The thing that has always been tricky about Volcker is how do you distinguish between what is permitted and potential proprietary trading that is not permitted?” she said in a telephone interview yesterday.

Exemptions

The proposal includes a series of exemptions for trades designed to hedge credit, interest rate or other specific risks. A bank could be free of the Volcker restrictions if it is hedging a specific position or a portfolio of risks across multiple trading desks.

Hedging trades would need to have a “reasonable,” not a full, correlation with the underlying risk. Banks could also win exemptions if they are hedging a risk they are “highly likely” to face in the future.

Traders involved in the transactions would have to be paid from fees and the spread of their transactions rather than the appreciation or profit from their positions.

Foreign banks would be covered by the rule if they have U.S.-based staff involved in the restricted trades, according to the proposal.

To contact the reporters on this story: Meera Louis in washington at mlouis1@bloomberg.net; Clea Benson in Washington at cbenson20@bloomberg.net

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net

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