Government regulators ushered in a new era of oversight Tuesday aimed at reining in Wall Street risk-taking, voting to prevent big banks from trading for their own benefit.
The “Volcker rule,” named after former Federal Reserve chairman Paul Volcker, also bars banks from owning hedge funds and private-equity funds. The centerpiece of the 2010 Dodd-Frank financial overhaul law took three years to complete as government infighting and intense lobbying by banks slowed the process.
“Our financial system will be safer and the American people are more secure because we fought to include this protection in the law,” President Obama said in a statement.
Lawmakers devised the measure to prevent banks with government backstops such as deposit insurance from making risky trades for their own benefit, arguing that the bets could endanger taxpayers. The challenge for regulators has been restricting such proprietary trading without impeding acceptable practices, such as firms trading on behalf of clients as market-makers or hedging their risk against fluctuations in interest rates.
But banking industry officials continued to warn that the rule goes too far. “Many bankers will struggle to understand complex provisions that have no application to their business model and are open to conflicting interpretations,” Frank Keating, president of the American Bankers Association, said in a statement.
On Tuesday, the Federal Deposit Insurance Corp. board and the Federal Reserve unanimously approved the final version of the rule. The Securities and Exchange Commission voted 3 to 2 in favor, while the Commodity Futures Trading Commission adopted it in a 3 to 1 vote.
Supervision will ultimately be the responsibility of the Office of the Comptroller of the Currency, the CFTC and the SEC.
“Issuing a final rule is only the beginning of the process,” Comptroller of the Currency Thomas J. Curry said at the FDIC board meeting. “The OCC will be especially vigilant in developing a robust examination and enforcement program that ensures our largest institutions will remain compliant.”
The 71-page rule, a streamlined version of the 298-page draft, addresses many concerns about which activities and investments are allowed, but gives regulators flexibility to interpret the rules.
Institutions are allowed to take positions to help clients trade, but their inventories cannot exceed “the reasonably expected near-term demands of customers,” according to the rule.
There are a host of requirements for banks to prove they are not engaging in speculative gambling but acting to serve client needs or protect against market risks. The rule also lifts the ban included in the original draft on proprietary trading in foreign government debt.
A key part of the rule calls for firms to provide a rationale of their hedging strategy to prevent another “London Whale,” the $6.2 billion trading fiasco at JPMorgan Chase. The 2012 blunder turned the tide of the debate as supporters of change gained the upper hand in calling for tough restrictions on risky hedges.
As analysts had anticipated, the Fed has extended the amount of time banks have to conform to the rule by pushing the deadline back one year to July 21, 2015.
By then, banks must have developed programs to monitor their compliance with the rules. The chief executives of large banks will also have to attest in writing annually that their banks have a process in place to enforce, review and test the compliance program.
Institutions with at least $50 billion in trading assets and liabilities will have to report seven quantitative measurements, including the amount of risk that a trading desk is permitted to take at a point in time.
“The strength of the rule is the scope of the compliance regime,” said Marcus Stanley, policy director of Americans for Financial Reform. “The regulators correctly realized that most proprietary trading is hidden within supposedly innocent activities like hedging or market-making.”
He said the rule offers guidelines that are only as effective as the regulators that implement them.
Dennis Kelleher, chief executive of Better Markets, which advocates for financial overhauls, added: “Make no mistake about it: Regulators now own the Volcker rule. They have to aggressively enforce it, ensure it is complied with or answer for any future blowups.”
In anticipation of the rule, many large banks, including JPMorgan Chase and Goldman Sachs, have shuttered or spun off their proprietary trading desks, as well as their private-equity arms and hedge funds. Still, industry groups worry that the Volcker rule will sink profits at some of the nation’s largest banks and diminish the amount of capital in the markets.
“The Volcker rule will still make it too hard in too many cases for bankers to provide services that many bank customers rely upon every day, posing no risk to the financial system,” said Keating of the American Bankers Association.
Regulators acknowledge that the transition period and eventual implementation of the rule could be challenging for bankers.
“There is no doubt that, consistent with our experience in other rulemakings, questions will arise following today’s action, some of which will require clarification,” SEC Chairman Mary Jo White said in a statement. “We must be alert to both unintended impacts and regulatory loopholes as we move forward.”