Volcker Rule - Joint Agencies Final Rule, December 2013

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Gavel.png FINAL RULE: On December 10, 2013, the CFTC, FDIC, SEC, Federal Reserve, Office of the Comptroller of the Currency and Treasury Department released a joint final rule.
Dodd-Frank Timeline, Volcker Rule
Final Rule Released Effective Date Compliance Date
December 10, 2013 April 1, 2014 July 21, 2015

On December 10, 2013, the U.S. Securities and Exchange Commission (SEC), the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board, the Office of the Comptroller of the Currency and the Commodity Futures Trading Commission (CFTC) released its final rules to implement Section 619 of the Dodd-Frank Act, the so-called "Volcker Rule," which will prohibit banking entities from engaging in proprietary trading of derivatives and limit the ownership or sponsorship of hedge funds and other private funds to three percent of Tier 1 capital.

The document details which entities will be subject to the prohibitions, and explains the types of financial transactions that will be exempt from the bans. The Dodd-Frank Act mandated that the rule become effective on July 21, 2012, followed by a two-year compliance transition. However, a delay in the release of the rule has pushed the effective date to April 1, 2014 and banking entities will have until July 21, 2015 to come into compliance - three years after the date mandated by Dodd-Frank. Banks with $50 billion or more in trading assets will be required to report certain metrics to regulators beginning in July 2014.[1][2]

The Federal Reserve and FDIC approved the rule unanimously, but CFTC Commissioner Scott O'Malia and SEC commissioners Michael Piwowar and Daniel Gallagher voted against the rule, arguing that the rule was put before the commissioners without reasonable time for meaningful consideration.[3] Commissioner Gallagher, in his statement of dissent, referred to the rule as "a solution in search of a problem" and further complained that, since most "pure proprietary trading" by banks had ceased, the commission was putting the capital markets at risk because of the one percent of prop trading that still exists in the banks.[4]

The final rule entered the Federal Register on January 31, 2014, and will become effective April 1, 2014.

Rule Summary

Under the final rules, banking entities will be generally prohibited from:

  • engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account.
  • owning, sponsoring, or having certain relationships with hedge funds or private equity funds, referred to as ‘covered funds.’[5]

The rule includes definitions and characteristics of prohibited and permitted transactions. The rule exempts:

  • Underwriting: for distributions of securities;
  • Market-making: in an amount not to exceed the reasonably expected near-term demands of customers;
  • Risk-mitigating hedging: or activity that is designed to reduce, and demonstrably reduces or significantly mitigates, specific, identifiable risks of individual or aggregated positions of the banking entity;
  • Trading in certain government obligations: - proprietary trading will be permitted in U.S. government, agency, state, and municipal obligations;
  • Certain trading activities of foreign banking entities: provided the trading decisions and principal risks of the foreign banking entity occur and are held outside of the United States; and
  • Trading on behalf of a customer in a fiduciary capacity.

Also, banking entities will be required to set up programs to ensure and monitor compliance with the rules. Larger banks will be required to set up more rigorous compliance regimes; tsmaller banks will have less rigorous requirements. Banking entities that do not engage in any activity subject to the final rules, other than trading in exempt government and municipal obligations, are not required to establish a compliance program.

Finally, banks will be required to maintain documentation so regulators can monitor activities for violations.

Background

In January 2011, the Financial Stability Oversight Council released an 81-page study and recommendations on proprietary trading by financial institutions, and on these institutions’ relationships with hedge funds and private equity funds. The study, which discussed how the Volcker rule should be implemented by regulators, gave general direction to regulators, but left specific approaches for defining proprietary trades for later rule proposals.[6] The study recommended ten actions to effectively implement the Volcker Rule:

  1. Require banking entities to sell or wind down all impermissible proprietary trading desks.
  2. Require banking entities to implement a robust compliance regime, including public attestation by the CEO of the regime's effectiveness.
  3. Require banking entities to perform quantitative analysis to detect potentially impermissible proprietary trading without provisions for safe harbors.
  4. Perform supervisory review of trading activity to distinguish permitted activities from impermissible proprietary trading.
  5. Require banking entities to implement a mechanism that identifies to Agencies which trades are customer-initiated.
  6. Require divestiture of impermissible proprietary trading positions and impose penalties when warranted.
  7. Prohibit banking entities from investing in or sponsoring any hedge fund or private equity fund, except to bona fide trust, fiduciary or investment advisory customers.
  8. Prohibit banking entities from engaging in transactions that would allow them to bailout a hedge fund or private equity fund.
  9. Identify similar funds that should be brought within the scope of the Volcker Rule prohibitions in order to prevent evasion of the intent of the rule.
  10. Require banking entities to publicly disclose permitted exposure to hedge funds and private equity funds.[7]


Related Documents: Federal Register Entry, Final Common Rules; Fact Sheet

References

  1. Regulators seek to curb Wall St. trades with Volcker rule. Reuters. Retrieved on December 10, 2013.
  2. Regulators Should Delay Volcker Rule, House Lawmakers Say. Bloomberg. Retrieved on December 23, 2011.
  3. Statement of Dissent by Commissioner Scott D. O’Malia on the Volcker Rule. CFTC. Retrieved on December 18, 2013.
  4. Dissenting Statement Regarding Adoption of Rule Implementing the Volcker Rule. SEC. Retrieved on December 18, 2013.
  5. The government’s ‘fact sheet’ on the Volcker Rule. MarketWatch. Retrieved on December 10, 2013.
  6. Volcker Supports Work on Volcker Rule. Wall Street Journal Online. Retrieved on January 19, 2011.
  7. Study and Recommendations on Prohibitions on Proprietary Trading and Certain Relationships with Hedge Funds and Private Equity Funds ("the Volcker Rule"). Financial Stability Oversight Council. Retrieved on January 19, 2011.

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