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U.S. Regulators Weigh Volcker Exemption for Sovereign Debt

George Osborne Britain’s Chancellor of the Exchequer
“I am concerned that the regulations could have a significant adverse impact on sovereign debt markets, including here in the U.K.,” George Osborne, Britain’s Chancellor of the Exchequer, wrote in a letter to Federal Reserve Chairman Ben Bernanke. Photo: Scott Eells/Bloomberg

Feb. 1 (Bloomberg) -- U.S. banking regulators are exploring whether they can exempt sovereign debt from the Dodd-Frank ban on proprietary trading after foreign governments complained that the rule could raise borrowing costs and impede the flow of capital, a person familiar with the talks said.

Five regulatory agencies are taking public comments on a proposed version of the so-called Volcker rule, which was included in the 2010 financial regulatory overhaul to ban deposit-taking banks from trading with their own money.

While foreign government bonds would fall under the rule as proposed, U.S. government debt would be exempt. Officials from Canada, Japan, and the United Kingdom have sent letters to the Treasury Department and regulators saying the measure would harm their ability to raise money.

“It will be difficult for regulators to ignore a sizable number of the G-20 countries, which will all be saying something similar -- which is the Volcker rule’s extraterritorial reach will hinder these countries’ sovereign debt markets,” said Douglas Landy, a Washington partner in law firm Allen & Overy LLP who represents Canadian banks.

Dodd-Frank has provisions allowing regulators to exempt an activity from the Volcker rule if such a move would “promote and protect the safety and soundness of the banking entity and the financial stability of the United States.” Making that case for a sovereign-debt exemption may be possible though challenging, said the person familiar with the discussions among regulators, who spoke on condition of anonymity because the matter isn’t public.

Lobbying Effort

The global backlash against the Volcker rule has been welcomed by U.S. banks, which have been lobbying Congress and regulatory agencies to delay and weaken numerous provisions in the 298-page proposal released in October.

The rule would allow banks to continue short-term trades for market-making or hedging. It also would limit investments in private-equity and hedge funds. Dodd-Frank, enacted in response to the 2008 credit crisis, requires that the rule be in place by July 21.

“I am concerned that the regulations could have a significant adverse impact on sovereign debt markets, including here in the U.K.,” George Osborne, Britain’s Chancellor of the Exchequer, wrote in a letter to Federal Reserve Chairman Ben Bernanke.

“In particular, although we understand that the primary legislation makes an exemption for market-making activities in practice, the regulations would appear to make it more difficult and costlier to provide market-making services in non-U.S. sovereign markets.”

‘Double Standard’

Richard Bove, a bank analyst at Rochdale Securities LLC, wrote in a Jan. 30 research note titled “Volcker Hypocrisy,” that regulators are creating a “double standard” for sovereign debt by allowing proprietary trading in U.S. government securities and not foreign government securities.

Regulators have signaled they may be open to the concerns. Noting the sovereign debt issue, acting Comptroller of the Currency John Walsh testified at a House Financial Services subcommittee hearing Jan. 18 that U.S. banks would operate at a “competitive disadvantage” due to the Volcker rule.

“It’s certainly something that we want to pay careful attention to,” Walsh said.

Granting an exemption may have to overcome skepticism in Congress in the midst of the European debt crisis and the probe of MF Global Holdings Ltd., which collapsed after making a $6.3 billion bet on European government bonds.

‘Hard Sale’

“In political terms post MF Global’s failure, it’s a hard political sale at least up on the Hill,” said Brian Gardner, senior vice president of Washington research for Keefe Bruyette & Woods Inc. “MF Global will be the bloody shirt that Volcker supporters wave. It’s going to be a very, very effective argument against expanding exemptions around the Volcker rule.”

The Volcker debate intensified at last week’s World Economic Forum in Davos, Switzerland, where Bank of Canada Governor Mark Carney said he had “some obvious concerns” about the rule. Carney was named in November to succeed Mario Draghi as chairman of the Financial Stability Board, which has been charged by Group of 20 leaders with making recommendations for global financial reform and to monitor progress.

“No other government bond market is carved out” of Volcker, Carney said in an interview in Davos with Bloomberg Television. “U.S.-based institutions are significant players in those markets, and so there is a potential for real liquidity change.”

Complaint to Geithner

Michel Barnier, the European Union’s financial services chief, said in a Wall Street Journal interview that he would complain to U.S. Treasury Secretary Timothy F. Geithner next month about the Volcker rule and its “extraterritorial consequences.”

Julie Dickson, Canada’s superintendent of financial institutions, wrote in a Dec. 28 letter to Treasury and bank regulators that an exemption should be created at least for foreign banks with U.S. branches.

“A failure to include these additional exemptions at least for banking entities whose parent bank is located outside of the U.S. would undermine the liquidity of government debt markets outside of the U.S.,” Dickson wrote. “This is an especially acute concern for Canadian banks and the Canadian financial system more broadly given the deep inter-linkages that have existed for many years between the Canadian and U.S. financial systems.”

European Debt

The Securities Industry and Financial Markets Association will be submitting ideas to regulators on how to exempt sovereign securities in its comment letter later this month, Rob Toomey, the trade group’s managing director and associate general counsel, said in an interview. Sifma represents Wall Street securities firms including Goldman Sachs Group Inc. and JPMorgan Chase & Co., which have been strong opponents of the Volcker rule.

Toomey said the current concerns over European debt shouldn’t influence regulators in their decision. “There are a couple countries where it’s problematic right now but look at the countries that have weighed in - the Canadians, the Japanese, the U.K. -- all of these are significant sovereign issuers,” Toomey said.

To contact the reporter on this story: Cheyenne Hopkins at;

To contact the editors responsible for this story: Christopher Wellisz at; Maura Reynolds at

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