After years of debate, federal regulators are hashing out the final version of a politically charged rule that means big changes for the banking industry. (The Washington Post)

Wall Street is anxiously awaiting federal regulators’ expected approval Tuesday of a sweeping rule that would restrict banks’ ability to make risky investments with their own money.

The centerpiece of the 2010 Dodd-Frank financial overhaul law, known as the “Volcker rule,” was stalled for years amid government infighting and intense lobbying by banks to weaken it. But after several drafts, policymakers are expected to unveil a tougher-than-expected rule on “proprietary trading” that could have a significant impact on the operations of financial firms.

“Limiting proprietary trading is going to increase costs to our institutions, which will be passed on to consumers,” said Anthony Cimino, head of government affairs for the Financial Services Roundtable, one of Wall Street’s most prominent lobbying groups.

He continued, “If you force banks to limit the types of investments they can provide, whether its from a hedging or investment perspective, you’re diminishing the amount of capital in the market.”

The warnings slowed down the rule-writing process, but Treasury Secretary Jack Lew has pushed for a robust policy.

Lew told an audience at Pew Charitable Trusts on Thursday that the proposed rule will include “tough restrictions” on banks’ trading and be “true to President Obama’s vision and the statute’s intent,” signaling that there may be few concessions to Wall Street.

Proprietary trading has produced tremendous profits for financial firms but was also blamed for huge losses during the financial crisis. Supporters of the rule say that banks with government backstops such as deposit insurance should not trade for their own account, because the risky bets could endanger taxpayers.

Industry groups have argued that the rule, named after former Federal Reserve chairman Paul Volcker, unnecessarily limits some safe forms of trading and will sink profits at some of the nation’s largest banks. They have called for broad exemptions, but the efforts were weakened when JPMorgan Chase lost $6.2 billion in the “London Whale” trading debacle.

The bank described the trade as a portfolio hedge — trades designed to protect against losses held in a broad portfolio of assets that could be used to bolster profits.

In his speech, Lew said the rule would prohibit “risky trading bets like the London Whale that are masked as risk-mitigating hedges.”

Regulators will also likely track where hedging activities are used to offset risks that accompany trading with clients, as opposed to driving revenue, Jason M. Goldberg, a Barclays analyst, said in a research report. He expects the rule to say that hedging activity should reduce or cut “specific, identifiable risks such as market risk, currency or foreign-exchange risk,” not create new or added risk.

In anticipation of the Volcker rule, many large banks, including JPMorgan, have shuttered or spun off their proprietary trading desks, as well as their private-
equity arms and hedge funds. That could blunt the full force of the rule, analysts say.

Still, bankers are leery of how regulators will define the buying and selling of securities on behalf of clients, known as market making.

Another key concern among bankers is the deadline for compliance. Dodd-Frank calls for Volcker to take effect in July 2014, but analysts and industry groups anticipate an extension in light of the delays in finalizing the rule.

Many banks are also concerned that the rule may require chief executives to certify that they are in compliance with the rules. Lew has said the proposed rule “puts in place strong compliance requirements that require those in charge of financial institutions to make sure that the tone at the top sends the right signal to the whole firm.”

Having the five financial regulators set to approve the rules before the end of the year is an accomplishment for Lew, who has promised since taking office in February to have it done this year.

The law instructed banking regulators to jointly write a rule that could be reconciled with versions crafted by the Securities and Exchange Commission and the Commodity Futures Trading Commission. The SEC joined the banking regulators, including the Federal Reserve and Office of the Comptroller of the Currency, in issuing a 300-page draft in October 2011.

Since then, regulators have been tweaking details, including what kind of funds banks can invest in and how the rule will apply to trades done overseas. The back-and-forth has generated a final rule that spans nearly 1,000 pages, according to people familiar with the process who were not authorized to speak publicly. Many of those pages will be responses to the 19,000 comment letters regulators received, the people said.

Tuesday’s vote will not be the end of the fight, analysts say. Law firms, including Gibson Dunn, are contemplating legal action to dismantle the rule. House Republicans are also keeping a close eye on the language to decide whether to introduce legislation to curb the impact.