U.S. banks pushed regulators to widen proposed restrictions on trading and hedge-fund ownership by foreign firms, then encouraged governments around the world to complain about the rule’s reach.
The two-pronged lobbying strategy resulted in foreign officials joining U.S. lenders to push back against the Volcker rule, named after former Federal Reserve Chairman Paul A. Volcker and incorporated in the 2010 Dodd-Frank Act.
“The criticism of foreign governments on behalf of their banks is helping U.S. banks fight the rule,” said Anat Admati, a professor of finance at Stanford University. “It also muddies the water, shifting the debate away from the main issue, which is reducing the risks banks impose on the economy.”
The Volcker rule seeks to prevent deposit-taking firms from making bets with their own capital or owning hedge funds. Last year, U.S. banks including JPMorgan Chase & Co. (JPM) and Morgan Stanley lobbied the Fed and other regulators to apply the regulation more broadly to companies based outside the U.S., according to four people with knowledge of the discussions who asked not to be identified because the talks were private.
In a December 2010 phone call, a lobbyist for JPMorgan told Fed officials the Volcker rule would create “a competitive disadvantage” for U.S. banks, according to a document posted on the agency’s website. Seven Morgan Stanley executives met with six Fed staff members last April to express similar concerns, another document said.
Banks and their lobbyists later sent position papers to the Washington embassies of foreign governments and met with officials to warn that sovereign-debt prices would suffer if U.S. banks are barred under the Volcker rule from buying other nations’ bonds for their trading accounts, three of the people said. That led to an outpouring of letters from Canadian, Japanese and European Union officials, as well as from dozens of non-U.S. lenders, urging regulators to overhaul the rule.
“The global reaction has been extraordinary,” said Karen Petrou, managing partner at Federal Financial Analytics, a Washington-based research firm. “If regulators don’t feel like they have enough flexibility to satisfy foreign governments’ demands, they could go back to Congress, which would open the whole rule to revisions.”
In recent months, as regulators sought comments on a 298- page proposal to implement the Volcker rule, the outcry from banks has swelled. Lobbyists have argued that the plan would reduce trading in bond markets and increase borrowing costs for investors and companies. One industry-funded study said the additional expense just for the corporate bond market could be as much as $360 billion.
Complaints from foreign nations and banks center on language in Dodd-Frank exempting U.S. Treasuries from the ban on proprietary trading because they’re deemed safe, as well as on the rule’s attempt to control activities outside the U.S.
The exemption for Treasuries didn’t arouse much opposition until two months ago, after U.S. banks began calling representatives of foreign governments in Washington, warning that sovereign-debt prices would suffer if they weren’t allowed to buy the bonds for their trading accounts, say lobbyists and regulators familiar with the talks.
Banks based outside the U.S. met with their home-country regulators and central bankers, briefing them about the dangers and unfairness of the proposed rules, the people say. Allen & Overy LLP, a law firm representing a dozen non-U.S. lenders, including Frankfurt-based Deutsche Bank AG (DBK) and HSBC Holdings Plc (HSBA) in London, said its lawyers, accompanied by bank executives, held meetings with the U.K. Treasury, the European Central Bank, Canada’s finance ministry and German regulators. The law firm wouldn’t say which banks participated at the meetings.
The Volcker rule’s extraterritorial reach didn’t become clear until after the Fed, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Securities and Exchange Commission published a draft proposal on Oct. 11. While the Dodd-Frank Act said that U.S. divisions of foreign banks would have to abide by the restrictions, the plan extended that to cover the activities of any bank with a connection to the U.S., even a single branch in one state, according to lawyers and bank executives.
“If you look at the proposed rule’s preamble, it’s clear that the U.S. regulators are trying to level the playing field between their banks and the outsiders,” said Douglas Landy, the New York-based head of the U.S. financial-services regulatory practice at Allen & Overy.
Even U.S. Senators Jeff Merkley of Oregon and Carl Levin of Michigan, who pushed Dodd-Frank’s Volcker rule provision through Congress, said in a Feb. 13 letter to regulators that the proposal goes beyond the bill’s original intent by seeking to prevent non-U.S. banks from owning stakes in private-equity or hedge funds offered to U.S. citizens.
U.S. banks and their lobbying groups held 21 meetings with Fed staff from September 2010 to October 2011 to discuss the Volcker rule, according to the central bank’s website.
The banks started calling on foreign governments and regulators after the draft proposal was released in October, with efforts intensifying in December. That culminated in a flurry of public statements in January and February from high- ranking officials, including Bank of Canada Governor Mark Carney and EU Financial Services Commissioner Michel Barnier.
Barnier, speaking at a conference in Washington today, said that it wasn’t “acceptable that U.S. rules have such a wide effect on other nations.” U.K. and Japanese finance ministers also weighed in today, saying that without an exemption from the rule, their governments’ borrowing costs would rise.
“At such a vulnerable time in the sovereign debt markets, it would be the wrong prescription,” U.K.’s George Osborne and Japan’s Jun Uzumi wrote in a Financial Times opinion article.
The response from foreign governments and banks “shows the veracity” of the argument U.S. banks have been making since the Volcker rule was proposed in 2009, said Randy Snook, executive vice president of the Securities Industry & Financial Markets Association, which represents the largest U.S. lenders.
“Banks serve a crucial role in government bond markets, and the regulation would restrict that,” Snook, who’s based in New York, said in an interview. “It doesn’t respect the market- making role, either, and would hurt these markets seriously.”
Snook declined to say whether banks had lobbied regulators to extend the Volcker rule’s reach. Spokesmen for Morgan Stanley (MS) and JPMorgan, both based in New York, as well as for the Fed, the FDIC, the OCC and the SEC declined to comment.
July 20 Deadline
The agencies, which are sifting through more than 300 comments on the proposal, face a July 20 deadline when the Volcker rule is scheduled to go into effect.
The rule, designed to keep banks from taking excessive risks, attempts to prevent them from using their own money to make short-term bets while allowing them to buy and hold securities temporarily in anticipation of future customer demand for the trade.
Foreign banks, like their U.S. rivals, will have to prove that their buying and selling amounts to market-making for clients, not proprietary trading. They also can’t own more than a 3 percent stake in any hedge funds or private-equity funds that do business with U.S. residents, which would rule out most such investments, bankers and lobbyists say.
Exporting Volcker Rule
The proposed restriction would, for example, prevent a foreign bank’s London-based trading desk from using the firm’s capital to bet on any security traded on a U.S. exchange, according to the Institute of International Bankers, a New York- based lobbying group for overseas lenders with U.S. operations.
That London unit also can’t make any bets involving investors who are U.S. residents, and the bank’s U.S.-based brokers can’t take part in transactions, even if both the buyer and the seller are outside the U.S., the IIB wrote in a Feb. 13 letter to regulators.
“The proposed version basically exports the Volcker rule to our banks’ home-country operations,” said Richard Coffman, IIB’s general counsel. “The only way they could avoid the rule’s reach is by de-banking from the U.S.”
Senators Merkley and Levin backed restrictions on proprietary trading of sovereign bonds other than U.S. Treasuries in their letter to regulators. They said dabbling in such debt could increase risk for U.S. banks. Greece, whose debt was rated investment grade as recently as 2010, is in the process of swapping sovereign bonds held by banks and hedge funds for new ones worth about 70 percent less as the EU tries to avert a default which could result in even greater losses.
In their letter, the senators explained that Treasuries were exempted because they’re safe, don’t pose a foreign- exchange risk for U.S. banks holding them and are used for liquidity management by the country’s lenders. That isn’t the case for other sovereign bonds, the senators said.
“For the EU to be treated as safe as U.S. Treasuries is laughable when they’re restructuring one of their member’s debt,” said Simon Johnson, an economics professor at the Massachusetts Institute of Technology. “The lesson we’ve learned from the EU crisis is that a bank should only consider as safe the debt backed by its own central bank.”
Volcker has said that barring U.S. banks from trading other countries’ bonds won’t hurt liquidity in the market for those securities. The largest banks in Europe, Japan and Canada should be able to pick up the slack, Volcker, 84, wrote in the Financial Times on Feb. 14.
Stanford’s Admati said she doubts restrictions on trading sovereign bonds will raise borrowing costs in any significant way. A study by Thomas Philippon, a professor of finance at New York University, showed that increasing liquidity in financial markets over the past 140 years has made it costlier for companies to borrow or raise capital. More trading activity results in a transfer of economic resources to the financial industry, Philippon wrote in the November paper.
Even if borrowing costs rise when liquidity drops, complaints from foreign governments are akin to asking for a subsidy, Admati said.
“Why should the U.S. taxpayer subsidize other governments’ borrowing costs?” Admati said. “When banks insist they must be the ones providing market-making, they in effect want the U.S. government to subsidize this activity through its safety net. This can reduce the borrowing costs of governments only if you don’t consider the cost to U.S. taxpayers of the safety net.”
Admati made a similar argument in response to complaints from banks as far away as Singapore that they will have to abide by the Volcker rule in their global operations even though they have only a tiny U.S. presence -- a single branch that helps corporate clients with trade finance. Those banks can receive support from the Fed during a financial crisis, she said.
One example: Norinchukin Bank (NORZ), which pools the resources of Japanese agricultural and fishing cooperatives. It has only one branch office in the U.S. and should be exempt from the Volcker rule, the Tokyo-based lender wrote in a Jan. 25 letter to regulators. Norinchukin borrowed as much as $22 billion of emergency funds from the Fed during the financial crisis, according to data released by the central bank and compiled by Bloomberg News.
While applying the Volcker rule to foreign banks may help level the playing field for U.S. firms, it won’t go far enough in alleviating the burden imposed by new regulations, said Margaret Tahyar, a New York-based partner at Davis Polk & Wardwell LLP who represents some of the largest U.S. banks.
“The Volcker rule was already a 90-degree tilt against U.S. banks in the Dodd-Frank Act, hurting their competitiveness internationally,” Tahyar said. “Regulators have used some discretion to lower that disadvantage, but it’s now a 70-degree tilt -- still pretty steep.”
The international outcry, while it may help U.S. banks make their case for revising the Volcker rule, won’t undermine its basic premise, said Kim Olson, a principal at Deloitte & Touche LLP in New York and a former bank supervisor. A similar global campaign against capital rules proposed by the Basel Committee on Banking Supervision in 2010 didn’t deter regulators from going ahead, she said.
“The big question is whether the merits of the outcry are solid enough to sway the views of the regulators,” Olson said.
MIT’s Johnson said the lobbying strategy could backfire.
“It’s a miscalculation by the banks,” Johnson said. “The lobbyists have backed the regulators into a corner. They can’t give in when all these foreign governments are pressing them. It would look bad before elections to cave in to foreign demands when your public wants you to be tough on banks.”
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