Volcker Rule

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Dodd-Frank Timeline, The Volcker Rule
Proposal Date Comment Deadline Final Rule Released
October 12, 2011 February 13, 2012 December 10, 2013
Dodd-Frank Timeline, "Volcker Rule," CFTC
Proposal Date Comment Deadline Final Rule Released
February 14, 2012 April 16, 2012 December 10, 2013

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]

Summary

  • The Volcker Rule prohibits banking entities, which benefit from federal insurance on customer deposits or access to the discount window, from engaging in proprietary trading and from investing in or sponsoring hedge funds and private equity funds, subject to certain exceptions.
  • The proprietary trading provisions prohibit a banking entity from engaging in trading activity in which it acts as a principal in order to profit from near-term price movements.
  • The hedge fund and private equity fund provisions generally prohibit a banking entity from investing in, or having certain relationships with, any fund that is structured under exclusions commonly used by hedge funds and private equity funds under the Investment Company Act of 1940.

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.[3] 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.[4]

To ensure that the economy and consumers continue to benefit from robust and liquid capital markets and financial intermediation, the Volcker Rule provides for certain permitted activities that represent core banking functions such as certain types of market making, asset management, underwriting, and transactions in government securities. As Volcker, former Chairman of the Board of Governors of the Federal Reserve System, explained in his testimony to the Senate Banking Committee when he urged adoption of this provision:

"What we can do, what we should do, is recognize that curbing the proprietary interests of commercial banks is in the interest of fair and open competition as well as protecting the provision of essential financial services. Recurrent pressures, volatility and uncertainties are inherent in our market-oriented, profit-seeking financial system. By appropriately defining the business of commercial banks... we can go a long way toward promoting the combination of competition, innovation, and underlying stability that we seek."[5]

News for the Volcker Rule

  • On April 19, 2012, the CFTC, SEC, FDIC, Federal Reserve, and Treasury Department issued a joint policy statement regarding the conformance period for the Volcker Rule.[6] According to the release, banks will have until July 21, 2014 to conform to Section 619 of the Dodd-Frank Act, so long as they make a "good faith effort" to meet the deadline. The statement also leaves open the possibility that the conformance period may be extended beyond July 2014. For more information, see the policy statement in the "Related Documents" section below.
  • On February 29, 2012, Federal Reserve Chairman Ben Bernanke said in a House Financial Services Committee meeting that the Volcker Rule will not be ready by its mandated effective date July 21, 2012. Though the rule is set to go into effect regardless of its "readiness," Bernanke stated that the regulators could issue implementation extensions. He also said that the rule would not be enforced until "firms have an adequate period of time to adjust their systems and comply with the rule." [7]
  • On January 18, 2012, a joint hearing of the House Financial Services Subcommittees on Capital Markets and Government Sponsored Enterprises, Financial Institutions and Consumer Credit was held to discuss business impacts of the Volcker Rule (view MRW summary HERE. The hearing featured two panels. The first panel consisted of regulatory authorities, including Gary Gensler of the CFTC, Mary Schapiro of the SEC, and Martin Gruenberg of the FDIC. The second panel included representatives of market participant groups such as SIFMA, leading academics, and heads of financial services firms.[8] View the entire witness list and links to witness statements HERE.
  • At its January 11, 2012 open meeting, the CFTC narrowly approved its own Volcker Rule proposal.

George Bollenbacher of Kinetix Trading Solutions & Kim Olson of Deloitte & Touche Discuss the Volcker Rule

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Section 619 of the Dodd-Frank Act, the so-called "Volcker Rule,” would prohibit banking entities from engaging in proprietary trading of and limit the ownership or sponsorship of hedge funds and other private funds, subject to certain narrow exceptions. The statutory effective date is July 21, 2012, followed by a two-year conformance period. There has been much discussion recently on the potential impact of the Volcker Rule and the timing of the statutory effective date. George Bollenbacher of Kinetix Trading Solutions and Deloitte & Touche’s Kim Olson discussed the regulatory response to the 17,000 Volcker Rule comment letters, the key challenges associated with the Volcker Rule, and how banks are preparing for the rule’s implementation. Published April 12, 2012.

Related Documents: Federal Register Entry, The Volcker Rule, October 2011; CFTC Volcker Rule, January 2012; Joint Policy Statement on Conformance Period, April 2012

References

  1. Regulators release plan for Volcker Rule limits on bank trading. Washington Post. Retrieved on October 12, 2011.
  2. Regulators Should Delay Volcker Rule, House Lawmakers Say. WBloomberg. Retrieved on December 23, 2011.
  3. Volcker Supports Work on Volcker Rule. Wall Street Journal Online. Retrieved on January 19, 2011.
  4. 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.
  5. Prohibiting Certain High-Risk Investment Activities by Banks and Bank Holding Companies before the S. Comm. on Banking, Housing & Urban Affairs, 111th Cong. 5 (2010) (testimony of the Honorable Paul Volcker, Chairman, President‘s Economic Recovery Advisory Board), Retrieved January 19, 2011
  6. Fed clarifies when Volcker rule kicks in. Reuters. Retrieved on April 20, 2012.
  7. Bernanke Says Dodd-Frank’s Volcker Rule Won’t Be Ready by July 21 Deadline. Bloomberg. Retrieved on February 29, 2012.
  8. Joint hearing entitled “Examining the Impact of the Volcker Rule on Markets, Businesses, Investors and Job Creation”. House Committee on Financial Services. Retrieved on January 23, 2012.

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