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November 11, 2013 5:07 pm
In January it will be four years since President Barack Obama vowed to stop banks trading for their own account.
“If these folks want a fight, it’s a fight I’m ready to have,” he said as he announced the Volcker rule, alongside the former Federal Reserve chairman who proposed it and after whom it was named.
The years have passed, Mr Obama has been re-elected, but his pledge has gone unfulfilled. Regulators have failed to implement the rule. And most of the fighting has occurred not between the White House and Wall Street but between the five agencies supposed to draft it.
Now, finally, officials are optimistic that the rule will be delivered by the end of the year. Banks are nervous about the outcome and furious at what they say is stonewalling by the regulators.
In anticipation of the rule, all the proprietary trading desks where banks took their own positions on stocks, bonds or derivatives have been disbanded and the traders redeployed in-house or hired by hedge funds where such activity is still permitted.
But that does not mean the banks are already compliant. A loss of more than $6bn by a JPMorgan Chase trader known as the London Whale using the bank’s money to invest in credit derivatives last year also influenced the rule’s development. Though executives said it was a “hedge” and not a proprietary bet.
For more than three years regulators have been arguing over where to draw the line between prohibited prop trading on the one hand and permitted market making for clients and hedging on the other.
One of the top areas of contention, according to people familiar with the discussions, is limits on fund ownership to prohibit a bank from acquiring or maintaining an equity investment in a “covered fund”. This could preclude banks from backing hedge funds, private equity funds, investment trusts or joint ventures.
There are exceptions, but they are unclear and banks have only until January to submit an extension request for a rule they have not seen.
People close to the discussions say the battle is continuing and is expected to intensify before the rule goes to a vote by officials in December.
If these folks want a fight, it’s a fight I’m ready to have
- Barack Obama, US president
“Some firms have hundreds of investments that could be covered,” says Whitney Chatterjee, a partner at law firm Sullivan & Cromwell. “In almost every case, there is an economic cost to leaving those ventures. And if you are thinking of getting into one, you are likely sitting on the sidelines until this is resolved.”
Bankers say it is not acceptable for regulators to impose a final rule after such a long delay and argue it should go back a step, to be “reproposed”, giving the industry an opportunity to analyse the latest text. Some regulators, including SEC commissioner Michael Piwowar, agree.
If the push for a reproposed rule fails, banks want as long a grace period as possible. Some officials are sympathetic to the idea of giving the banks more time but it is unclear whether they will get the full two years they want.
All principal positions should be prohibited and only agency trading on behalf of customers be permitted
- Greg Smith, former Goldman banker
For the banks, much remains unclear, partly because of an unusual veil of secrecy. “There’s been radio silence,” says one banker.
Banks’ claims to have been shut out are disputed by some officials. But a review of the agencies’ disclosures of industry meetings shows only a handful on the subject in the past year.
One of the few people that Fed officials have seen is Greg Smith, the Goldman Sachs banker who resigned from the institution to rail against its “toxic” culture and told Fed staff that “all principal positions should be prohibited and only agency trading on behalf of customers be permitted”.
His is not exactly the message that banks hope will be heard from their lawyers and lobbyists.
Officials retort that banks have had plenty of opportunity to put forward their views before this year when regulators have had to write the rule and respond to 16,000 comment letters, many of them from the financial industry.
US bankers reckon their foreign competitors could have an advantage. “If you are in Europe, you can move from Goldman to Deutsche and continue to do what you’re doing without regards to this rule,” says one US banker.
It’s much more complicated than I would like to see
- Paul Volcker,former Fed chairman
A European banker disagrees, saying the rule has proved a compliance problem even before it is implemented and will be just as arduous for non-US banks operating in New York.
At the Commodity Futures Trading Commission, commissioner Scott O’Malia has twice publicly asked when officials could see a copy of the Volcker rule, arguing he needs time to process the proposal that is expected to be about 1,000 pages long.
CFTC chairman Gary Gensler, who has been working on the draft with other regulators, said last week it was not ready yet but he expects to have a public hearing on the rule in mid-December. A CFTC spokesman declined to comment.
The rule is set to include a process for data collection and analysis so regulators do not have to make snap judgments about whether it has been violated.
We can’t have a document that fails to permit market making and fails to permit hedging
- Gary Gensler, CFTC chairman
Another outstanding issue is the limit on “portfolio hedging” – banks taking a broad position, for example by buying credit protection on a derivatives index, to offset a collection of risks in other areas of the balance sheet. This was what JPMorgan Chase claimed the London Whale was trying to do.
There is still a chance that the process will unravel once more if disagreements prove insurmountable between regulators who want the strictest curbs, such as Mr Gensler and Kara Stein, a Democrat at the SEC, and those who want a more moderate approach.
To the left of the political spectrum, the delay is evidence of the negative influence of the banks on rulemaking. To the right, it is evidence of the inefficient work of government bureaucrats, paralysed by turf wars.
But either way, it has been a long wait for Wall Street, Mr Obama and 86-year-old Paul Volcker himself.
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