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Banking Agencies Adopt Volcker Rule

By    |   Wednesday, 11 Dec 2013 01:20 PM

In various ways, the five federal financial regulators voted in favor of final approval of the Volcker rule to implement provisions of the Dodd-Frank Act that would prohibit banking entities from engaging in trading for their own accounts, so-called "proprietary trading," and from having specified relationships with hedge funds or private equity funds.

However, the rule contains significant exceptions and exemptions that would enable banks to continue many risky trading activities if they establish compliance systems that document the mission and purpose of the activities and monitor them to ensure they continue to comply over time.

The exceptions are so broad that even rogue trading is not prohibited by the rule, and as one Fed staffer pointed out, there are plenty of ways banks can lose a lot of money while remaining in compliance with the rule.

Banks have been given an extra year to comply with the rule, so that it would not take effect until July 21, 2015, five full years after the enactment of Dodd-Frank, and two more one-year extensions are contemplated by the rule.

The actions of the five agencies were as follows:

• Federal Reserve Board. Held a meeting and unanimously approved the rule.

• FDIC. Held a meeting and unanimously approved the rule.

• Office of the Comptroller of the Currency. This agency has only one member, the comptroller, so no meeting was necessary.

• Securities and Exchange Commission. No meeting was ever scheduled, but somehow the Commission voted to approve the rule by a vote of 3-2, with Commissioners Gallagher and Piwowar, the two Republicans, dissenting.

• Commodity Futures Trading Commission. A meeting was scheduled and cancelled, but somehow the Commission voted to approve the rule by 3-1 vote, with the Republican Commissioner O'Malia dissenting.

The Federal Reserve Board succinctly summarized the provisions roughly as follows:

• Proprietary trading prohibited, subject to many exceptions.

• Quantitative measures required to be reported to the agencies to help them monitor compliance.

• Prohibits ownership or specified relationships with hedge funds or private equity funds.

• Requires establishment of internal compliance programs to document compliance.

Several members of the Federal Reserve Board and the staff hastened to curb expectations as to how significant this rule will be. They stressed that it is part of a growing "arsenal" of measures the regulators are supposed to take to control risks to the financial system, especially from the activities of the largest banks and nonbanks.

Several Board members referred to the rule as balanced, but Chairman Ben Bernanke called the balance "a good balance," rather than the "right" balance. (This is like a football referee announcing that the ruling on the field "stands," but refraining from saying it is "confirmed.")

Most importantly, the Board stressed that the rule does not prescribe "bright lines" to circumscribe the risks banks can take. Thus, they are free to define their risk appetites as they choose, as long as they document what the mission is and, if a transaction is supposed to be a hedge, tie it to a specific risk and document that it continues to perform.

For me, the main concern is that this rule retains the flaws of earlier rules that relied on the sound judgment and good will of bankers and the capital and liquidity of banks to protect the financial system from disaster.

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In various ways, the five federal financial regulators voted in favor of final approval of the Volcker rule to implement provisions of the Dodd-Frank Act.
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Wednesday, 11 Dec 2013 01:20 PM
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