Volcker Hedging Exemption Said Disputed by Gensler, Stein
Officials at two of the agencies charged with writing the Volcker rule banning U.S. banks from trading for their own accounts are insisting on strengthening a key provision.
Gary Gensler, chairman of the Commodity Futures Trading Commission, and Kara Stein, a Democrat on the Securities and Exchange Commission, want to make it more difficult for banks to classify such trading as legitimate hedging activity, according to three people familiar with the negotiations. The dispute could make it harder for the five agencies drafting the rule to meet a White House-imposed year-end deadline for completing the regulation.
Gensler and Stein say they are concerned that the latest draft of the rule wouldn’t prevent another episode like last year’s “London Whale” trades at JPMorgan Chase & Co. (JPM) that cost the bank more than $6.2 billion in losses, said one of the people, who spoke on condition of anonymity because the deliberations aren’t public. At the time, the bank argued the losing derivatives trades would have been permitted under an exemption for portfolio hedges.
Satish M. Kini, a partner at Debevoise & Plimpton LLP in Washington, said a more restrictive rule could be a setback for Wall Street, which has fought to loosen the rule’s provisions.
“If a banking organization has to connect its hedging activity to a specific contract or position, I think the concern may be that there may be incomplete hedges,” Kini said in an interview. “The viability of that hedging exemption is very important for the safety and soundness of banking organizations.”
The rule named for former Federal Reserve Chairman Paul Volcker, who championed it as an aide to President Barack Obama, is aimed at preventing banks with insured deposits from engaging in the kind of speculative trading that could threaten their stability. While the five regulators drafting the measure had already revised it in response to the JPMorgan losses, Gensler and Stein say it may not go far enough, the person said.
Kate Gallagher, a spokeswoman for Stein, didn’t respond to telephone and e-mail requests for comment on the commissioner’s position. John Nester, an SEC spokesman, and Steve Adamske, the spokesman for Gensler, also declined to comment.
Until this dispute, the agencies had reached broad agreement on Volcker -- a last major piece of the Dodd-Frank regulatory overhaul meant to prevent a repeat of the 2008 financial crisis. Obama and Treasury Secretary Jacob J. Lew have held meetings in the last two months directing the regulators to move quickly, and Lew has insisted the rule should be finished this year.
Bank profits are on the line in the final stage of rule-writing. Standard and Poor’s has estimated that Volcker could sap combined profits at the eight largest U.S. banks by $2 billion to $10 billion a year, depending on the final provisions.
While Volcker’s focus is on the largest banks, it could also affect operations at nearly all 7,000 U.S. depository institutions. A few of the biggest companies, including New York-based Goldman Sachs Group Inc. and Morgan Stanley (MS), ranked fifth and sixth respectively by assets, have shut down some proprietary trading operations and withdrawn investments that are likely to be outlawed under the rule.
Final draft language continues to circulate among the five agencies, including the SEC, CFTC, Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp., the people said. The deliberations have highlighted differences among the agencies -- while the banking regulators usually work with companies in private to ensure their safety and soundness, the SEC and CFTC monitor public markets with a focus on full disclosure and fair practices.
The job of policing a poorly written rule will largely fall on the SEC and CFTC, said Republican SEC Commissioner Daniel Gallagher. The rule could force his agency to chase minor missteps that banking regulators would have the ability to fix behind closed doors, he said in an interview.
“It will be up to the commission, not the banking regulators, to enforce large swaths of it,” Gallagher said. Flaws could create a “flurry of technical violations that could result in enforcement actions” and impede practices such as market-making -- where banks take the other side of transactions for clients.
The five agencies are pushing to comply with the year-end target date for completion despite such last-minute wrangling, the people said. Additional delays are also possible because the CFTC staff was barred from working on the rule during the recent U.S. government shutdown.
“Hell or high water, we’re getting it done,” Comptroller of the Currency Thomas Curry said in an interview last month.
Curry said the final rule will clarify “what is appropriately risk-mitigating hedging” and what constitutes proprietary trading. His agency and others fined JPMorgan $920 million last month for having weak internal controls and misleading regulators in the London losses.
Stein, who took office Aug. 9, worked as a senior policy adviser to Senator Jack Reed, a Rhode Island Democrat who supported the Volcker rule. She has hired Ty Gellasch, a former staff member of Volcker rule co-author Senator Carl Levin, as a top aide in her SEC office.
Levin, a Michigan Democrat, said in a letter to regulators last year that the final version of Volcker “should require hedges to have a high correlation with both the underlying asset and the specific risk that is being mitigated.”
Dennis Kelleher, president of Washington-based advocacy group Better Markets, cautioned against moving so fast the regulators make mistakes.
“Meeting an artificial deadline with a rule that doesn’t do the job or protect taxpayers is irresponsible,” Kelleher said today in an interview. To make the rule meaningful, the regulators need to insist the hedging exemption makes sure hedging is direct and specific to the risk at hand, he said. “With computers now, they know with a degree of certainty that’s almost incomprehensible, how to do hedges.”
In addition to the ban on proprietary trading, the rule would forbid banks from holding more than a 3 percent stake in hedge funds and private-equity funds.
Last month, New York-based Citigroup, the third-largest U.S. lender, said it will sell its $6 billion emerging-markets private-equity unit. In June, New York-based JPMorgan, the largest U.S. bank by assets, announced plans to break off its private-equity unit One Equity. JPMorgan reported about $7.7 billion in total private-equity holdings in recent filings.
The SEC’s Gallagher said the agencies should re-propose the rule and give companies three weeks to identify what they consider its most damaging provisions -- a process he called a “fatal flaw” review. He acknowledged a re-proposed rule is unlikely.
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