Europe's New Volcker Rule Enrages Everyone Equally
Today the European Commission proposed rules that would prohibit systemically important European banks from engaging in proprietary trading. It's part of a big glop of other rules designed to make those banks safer, and I confess I haven't read the whole glop, and in any case it hasn't been approved yet, so there's a European Volcker Rule only in the sense that there was a Volcker Rule in the U.S. for the like three years before the regulators actually wrote it.
Here you can read about how "Bank lobbyists reacted angrily" to the proposal, and how anti-bank lobbyists reacted with equal anger, and how the proposal's author, EU commissioner Michel Barnier, takes this equal and opposite anger as a good sign:
"I'm not surprised by these reactions. When I put them all on the table...I tell myself we have found an equilibrium," Mr. Barnier said.
I guess "enrage everyone equally" is no worse a regulatory approach than any other.
What's fun about the Volckerish proposal is that it says that those systemically important banks "shall not: engage in proprietary trading." That's it! 1 There's some other stuff about other things that aren't allowed, but the not allowing prop trading comes in the form of saying "you shall not engage in proprietary trading." Bracingly quick, especially compared to the infinity billion pages of the U.S. Volcker Rule. 2
Of course that rule means nothing without a definition of "proprietary trading." Here it is: 3
"proprietary trading" means using own capital or borrowed money to take positions in any type of transaction to purchase, sell or otherwise acquire or dispose of any financial instrument or commodities for the sole purpose of making a profit for own account, and without any connection to actual or anticipated client activity or for the purpose of hedging the entity's risk as result of actual or anticipated client activity, through the use of desks, units, divisions or individual traders specifically dedicated to such position taking and profit making, including through dedicated web-based proprietary trading platforms;
That's sort of delightful! I mean, it's 95 words. I just went and looked at my post on the US. Volcker Rule, and it's got a 124-word block quote from the rule about how a market-making desk has to mitigate the risk of financial exposures from its hedging strategies or whatever. That's like a subsection of a subsection of a subsection.
And yet the sprawling U.S. rule and the slim European one get to not that different a place, at least with regard to proprietary trading. That "specifically dedicated" bit jibes with my reading of the U.S. Volcker Rule, which is that it's aimed at eliminating prop desks -- people who are not in the client-facilitation business -- rather than prop trades -- individual trades with no customer-facing purpose. The European rule just says that explicitly, while also carving out the two exemptions -- client activity and hedging -- that the U.S. carves out at great length. 4
I don't know. If you want to say that Eurovolcker is a dumb rule, you can. I mean: Everything that a bank does is "for the sole purpose of making a profit for its own account." 5 Or on the other hand, nothing is for that sole purpose: Every hedge fund will tell you that they're in the business of providing capital to the real economy and liquidity to the markets. If you read that paragraph literally, it seems to say that banks can do whatever they want other than specifically dedicate a desk to proprietary trading that can't, no matter how hard you squint, be said to provide any benefits to third parties. That hardly seems like a challenge.
But it's not meant to be a challenge! We've talked a little about principles-based and rules-based regulation, and this is a decent example of how Europe tends more towards principles than the U.S. does. The U.S. regulation games out everything that (regulators can think of that) banks might think of to get around the intent of the rule, and then has a subsection saying "don't do that." It makes for exhausting reading.
The European rule pretty much just says "don't prop trade" and leaves it to everyone's common sense and public-spiritedness to work out exactly what that means. Is that a better approach? Oh, I don't know, there are pluses and minuses. Surely it only works if everyone approaches the rule with some minimum of public-spiritedness: If you wanted to, you could get around the rule in, um, the time it took to read this post, maybe less. I'm not sure if that's always the case; in any case, you can't exactly say that European banking regulation has been an unmitigated success in the last few years. But it sure makes for quicker reading.
To be fair, the U.S. Volcker Rule passed by Congress says "Unless otherwise provided in this section, a banking entity shall not engage in proprietary trading," which is almost as short, but that "Unless" says a lot.
Article 5, section 4 (page 24 of the proposal).
Oh, also, two other exceptions similar to the U.S. rule -- sovereign bonds (here, of course, of EU states) and riskless-ish cash management -- are carved out in Article 6, section 2. I may have lied a little about how simple the European rule is. But only a little.
That's loose. You could propose other theories, like "everything a bank does is for the sole purpose of increasing its employess' comp." But, for the most part, banks run their business lines to make profits, no?
To contact the author on this story:
Matthew S Levine at firstname.lastname@example.org