Getting Serious About the Volcker Rule
|| Financial Industry Consultant
|| Kinetix Trading Solutions, G.M. Bollenbacher & Co.
|| New York
| Web site
By George Bollenbacher, Kinetix Trading Solutions
Now that the comment period has expired for the Volcker Rule, we can start to see how its implementation will pan out and what market participants need to do to get ready. It’s time to get serious.
The first question people are asking is whether the Volcker Rule will be implemented at all. In the words of John McEnroe, “You can’t be serious!” The only way it wouldn’t be implemented would be to have portions of the Dodd-Frank Act repealed. If you are betting on that, I want some of your action. With the current standing of banks in the public’s mind, the chance that Congress would cut them a big break by repealing part of Dodd-Frank is essentially nil.
On to more pertinent issues. Many of the comment letters came from foreign governments and financial institutions, complaining about the exemption for US government and municipal bonds without a comparable exemption for foreign equivalent securities. This is indeed a thorny issue, and some foreign issuers have threatened economic or financial retaliation if the rule goes forward as-is.
The problem here is that this exemption language is in the Dodd-Frank statute, not just in the rule as proposed by the regulatory agencies. This leaves very little room for interpretation. In addition, simply broadening the exemption to include all sovereign debt opens up huge risks, as the MF Global experience proves. It is possible to exempt foreign sovereign debt with a rating of, say, A or better, but that immediately opens the door for A- rated or better corporates to ask for admission to the club. It’s a slippery slope that I don’t think anyone wants to start down. What’s the right answer? I’m listening, and I’m sure the agencies are as well.
Another pertinent issue is in the market-making exemption, where numerous commenters pointed out the difficulty of determining the source of profit (or loss) in principal trading positions. The agencies were well aware of this difficulty, and in the rule they proposed several methods of determining the source, none of them particularly efficient or effective.
In fact, in conversations and public statements the agencies have indicated that they can’t monitor every trade, and can’t really determine exemption on a trade-by-trade basis. Thus they have indicated that they will focus on documented compliance programs and how well they are followed. If your plane strays over the border by accident, it won’t be shot down; they will be looking for invasions, not accidents.
That leads us to what banks can do to get ready, now that the comment period is over. The first task is to decide whether you want to be an underwriter, a market-maker, or to hedge risks using principal trades. If so, you will have to qualify for the exemptions, however they are laid out.
If you do want to fill these roles, the next task is building and documenting a compliance program. The rule has some very specific documentation requirements, and most current trading systems can be modified relatively easily to incorporate rules and monitor adherence. That work can begin now, while the agencies are still finalizing the rule. Then, as the agencies fill in the blanks you can fill in the missing pieces. When the rule is finalized, and everyone else is scrambling to comply, you will be ahead of the game and in front of the pack. Not a bad payoff for taking this all seriously.