Goldman Sachs, Morgan Stanley Say Volcker Rule on Trading May Raise Risks
Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS), the two Wall Street banks most reliant on trading, warned U.S. regulators that a proposed ban on proprietary trading could make the financial system more risky and curtail services for clients.
The New York-based banks, along with competitors Bank of America Corp., Citigroup Inc. (C) and JPMorgan Chase & Co., are pushing to limit the reach of the Volcker rule, a ban on proprietary trading included in the 2010 Dodd-Frank Act. A draft of the rule, which takes effect in July, was released by U.S. regulators in October.
“Without substantial revisions, the proposed rule will define permitted market making-related, underwriting and hedging activities so narrowly that it will significantly limit our ability to help our clients,” John F.W. Rogers, Goldman Sach’s chief of staff, said in a comment letter.
“Although one of the key aims of Dodd-Frank was to promote greater stability in financial markets, we are concerned that the proposed rule could inadvertently increase systemic risk,” he added. If the rule makes hedging more expensive, “banking entities’ clients and customers will be forced to hold more risk on their own books.”
The Federal Reserve, Securities and Exchange Commission and other financial regulators received thousands of comments letters by the Feb. 13 deadline. A number of the world’s largest banks questioned whether regulators took into account how they conduct business.
“There appears to be a real misconception about how principal market makers generate revenues,” Colm Kelleher, who runs Morgan Stanley’s trading business, and Chief Operating Officer Jim Rosenthal, wrote in the firm’s comment letter. “The proposal should be revised to reflect the realities.”
Morgan Stanley generated about 44 percent of its revenue last year from trading. In the letter, the bank officers argued that the proposed rule fails to adequately distinguish between permitted market making and prohibited proprietary trading, and they objected to a provision requiring market makers to generate most of their revenue from commissions, fees and bid-ask spreads.
The proposed rule has a “narrow view” of market-making, underwriting and hedging activities that is based on liquid exchange-traded U.S. markets, Goldman Sachs’s Rogers said. The rule doesn’t account for trading that is currently conducted in less liquid or over-the-counter markets.
“The proposed rule’s rigid application of an agency-based, exchange-traded equities paradigm threatens to reduce liquidity in these markets,” Rogers said.
The rule may hurt banks’ ability to underwrite corporate bonds by restricting their ability to hold bonds as inventory during a bond issuance, which could then increase costs for issuers, according to the letter.
The two men responsible for the provision’s inclusion in the Dodd-Frank Act -- Democratic Senators Carl Levin of Michigan and Jeff Merkley of Oregon -- urged regulators to be more forceful in implementing the rule.
“The Volcker rule demands Wall Street change its culture,” Merkley and Levin wrote in their own comment letter.
The two senators insisted that the rule is not as complicated as the banks maintain.
“If a firm is holding onto a position in a way that principally profits from price changes in the instrument and it is being held for a period that indicates the holding was not a long-term investment or the extension of credit, then that should be considered prohibited proprietary trading,” the senators wrote.
Conflicts of Interest
Levin and Merkley also pushed for a more detailed account of bank activities that may be banned by regulators as well as an explicit ban on conflicts of interest. Levin has cited the ban as a response to a Senate investigation he oversaw into the financial crisis that faulted Goldman Sachs’ trading practices.
Goldman Sachs, which accounted for 60 percent of its revenue through trading in 2011, has already shuttered its standalone proprietary trading desk. No matter how the final version of the Volcker rule comes out, Rogers said Goldman Sachs recognizes that Wall Street is in a time of change.
“We are not arguing that the line between permitted activities and prohibited proprietary trading be drawn in such a way as to permit all activities in which we have historically engaged,” Rogers wrote.
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