Volcker Rule Will Raise Risk, Costs for U.S. Financial System, Critics Say
Representatives for the world’s largest banks said a U.S. proposal to ban proprietary trading would increase risk, raise costs for investors and be vulnerable to legal challenge.
Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. and Bank of America Corp. (BAC), alongside foreign banks and governments, were set to file letters today in opposition to the Volcker rule, a proposal made under the 2010 Dodd-Frank Act that seeks to limit risky trading at banks that receive federal assistance.
“The proposal will severely limit banking entities’ ability to hedge their own risk, thereby increasing rather than decreasing the risk to banking entities and the financial system,” the Clearing House Association, American Bankers Association, Securities Industry and Financial Markets Association, and Financial Services Roundtable said in joint 173-page letter.
The rule named for former Fed Chairman Paul Volcker, who championed it as an adviser to President Barack Obama, would seek to ban banks from proprietary trading while allowing them to continue short-term trades for hedging or market-making. It also would limit banks’ investments in private-equity and hedge funds.
The proposal is one of the most contentious provisions of Dodd-Frank, the regulatory overhaul enacted in 2010 that requires the ban on proprietary trading to be in place by July 21. A 298-page proposal released by U.S. regulators in October included more than 1,300 questions for affected banks to consider during the comment period, which closes today.
Volcker himself weighed in to defend his namesake rule, arguing the proposal is “not at all likely” to have an effect on liquidity and that bankers’ arguments that U.S. competitiveness would suffer are “superficial at best.”
“Losses within large trading positions were in fact a contributing factor for some of our most systemically important institutions, and proprietary trading is not an essential commercial bank service that justifies taxpayer support,” Volcker wrote.
Series of Exemptions
The proposal included a series of exemptions for permissible market-making trading, underwriting and hedging transactions. Lawmakers exempted market-making from the rule, along with certain forms of hedging and underwriting, because of concerns that a broad ban on proprietary trading could bring some U.S. and world markets to a halt.
SIFMA, which represents large financial institutions including Goldman Sachs, Bank of America, and Blackrock, argued in its letter that rule, as proposed, wouldn’t pass judicial scrutiny in part because regulators have “fallen far short” of conducting a cost-benefit analysis.
In their letter, the bank lobbying associations said the cost-benefit analysis in the Volcker rule didn’t meet the standards set in a court case overturning a Securities and Exchange Commission rule last year. The letter referenced the Business Roundtable’s victory against the SEC, which overturned the so-called proxy access rule designed to let shareholders put their own candidates on corporate ballots. The U.S. Court of Appeals in Washington agreed with the U.S. Chamber of Commerce and Business Roundtable.
Banks that make markets may pass on higher fees to their investors if the rule restricts their revenue from holding large, or block, positions as inventory, according to Janet McGinness, senior vice president at NYSE Euronext.
“In facilitating the ability of the customer to quickly sell such a large block of stock, the market maker may hold in inventory that portion of the purchase shares that it cannot resell without driving down the price of the stock,” McGinness said in a letter to regulators. The proposal may lead traders to set higher fees because of restrictions on how long inventory can be held, she said.
Douglas Sheline, senior vice president and assistant treasurer of M&T Bank Corp. (MTB), said the proposed rule would impose a harsh burden on regional banks. Banks like his would be required to “develop and implement, in extremely short order, compliance, internal controls, record keeping and reporting regimes simply to ‘prove a negative’ -- that we are not engaged in impermissible proprietary trading,” Sheline said in a letter. The Volcker threshold for banks with average trading assets could be raised from the current $1 billion to $5 billion or higher and still capture “at least 98% of total average trading assets and over 97% of total trading liabilities.”
The U.S. Chamber of Commerce argued that the proposed rule would restrict credit for small businesses or result in higher costs for basic financing. “Small businesses will have to forgo business opportunities altogether due to the increased capital costs and diminished access” to credit, David Hirschmann, president and CEO of the Chamber of Commerce, wrote in a letter.
Officials from Canada, Japan, the United Kingdom, and the European Banking Federation have sent letters to the U.S. Treasury Department and other regulators saying the measure would harm global liquidity and international cooperation. G-20 leaders have not endorsed the rule.
Regulators should “limit the scope of the rule only to the territory of the United States,” European Union Financial- Services Commissioner Michel Barnier said in a letter to regulators. “Moreover, the current exemption for non-U.S. banks as well as for activities outside of the U.S. would appear very restrictive.”
Six Canadian bankers and the Canadian government said the Volcker rule’s inclusion of Canadian securities in the proprietary trading ban would violate the North American Free Trade Agreement that guarantees that banks be allowed to trade equally in both U.S. and Canadian debt obligations.
“Failure to exclude Canadian public funds will undermine years of cooperation between U.S. and Canadian regulators as demonstrated by NAFTA provisions and by efforts to carefully adapt the U.S. securities laws to the realities of the growing economic and business integration of Canada and the United States,” wrote the Bank of Montreal, the Bank of Nova Scotia, Canadian Imperial Bank of Canada, Royal Bank of Canada and the Toronto-Dominion Bank. (TD)