Wednesday, December 11, 2013

Volcker Rule Approved by Five Federal Agencies

A rule pursuant to the 2010 Dodd Frank Act, which sought to address the nation's financial system to prevent a financial crisis similar to that of 2008, was approved by five federal agencies with banking oversight duties.  Known as the "Volcker Rule" after former federal reserve chairman Paul Volcker, who proposed the regulation, the rule limits proprietary trading and investments intended as hedge strategies.  The rule continues to allow holdings of securities by banks to act as market makers for their customers.
 
One issue that may arise in the enforcement of the rule is determining whether the accumulation of securities by a bank is in furtherance of proprietary trading or as a market maker.  Both could involve the accumulation of a substantial block of illiquid holdings.  It is anticipated that a bank will have to be able to establish that its position in a security is based on historical demand of its customers for the security or some other tangible evidence that the holding is to meet the demands of its customers rather than for its own account.  Similarly, there is an issue regarding the accumulation of securities for hedge positions.  The rule requires that the bank determine exactly what position it is hedging against.  Thus, securities holdings cannot be justified as a general hedge against risk.
 
The proposed rule has been a point of contention between regulators and large banking institutions since its proposal in connection with the 2010 passage of the Dodd Frank legislation overhauling the nation's banking regulatory scheme.  Until recently, momentum was on the side of the banks.  In the aftermath of the Great Depression Congress passed what is referred to as the Glass Steagall Act as part of the Banking Act of 1933.  Glass Steagall required the separation of commercial banking from investment banking.  In 1999 Congress repealed Glass Steagall ending the separation.  In the aftermath of the 2008 financial crisis Congress chose not to re-enact a law similar to Glass Steagall.  Instead, the issue fell to regulators to propose new rules regulating banking investment activity.  Banks fought against tough new rules; however, the 2012 multibillion dollar trading lose suffered by J.P. Morgan Chase & Co. in its London office created new momentum for the Volcker Rule.
 
The five agencies adopting the identical language for the rule were the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, and the Securities and Exchange Commission.
 

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