January 31, 2012 11:26 pm

Volcker downplays risks to bond markets

Paul Volcker has defended proposed trading rules for US banks that are being criticised by foreign governments as likely to disrupt the operation of their national bond markets.

Japanese, UK and Canadian regulators, together with European bankers, have recently warned that the Volcker rule, which is designed to prohibit “proprietary trading” by US banks, could reduce flows in global markets and damage liquidity. The topic was raised at the recently held World Economic Forum in Davos and the European Commission plans to raise objections with the US.

“There will be plenty of proprietary trading in securities without the half dozen or so American banks participating in it,” said Mr Volcker, speaking with John Bogle, the father of index investing, at the John Bogle Forum held in New York on Tuesday.

The former Federal Reserve chairman said: “Trading is permitted. Underwriting is permitted, if a foreign government wants to engage in underwriting with the assistance of an American bank,” said Mr Volcker, an economic adviser to President Barack Obama. “What is not permitted is a proprietary position.”

The Volcker rule is designed to prohibit most “prop trading” by banks, where institutions take positions for their own accounts but Wall Street has argued that the restrictions will also hamper “market making”, where a bank stands between a buyer and seller of securities. That has sent alarm bells ringing in other countries that have bond markets that rely on US banks setting prices.

European bankers and officials are worried that the Volcker rule could compound strains in the $13tn eurozone government debt market and argue that prop trading provides much needed liquidity at a time of stress.

Mr Volcker expressed surprise at this stance, given the recent history of enmity towards speculative trading in the eurozone.

“What I’ve heard repeatedly out of European governments in the past is their concern about all this speculative activity in financial markets by hedge funds taking proprietary positions and destroying our currency,” he said. “Now I understand they want more speculative activity in their currencies and it’s suddenly become healthy and wonderful for their currencies, this activity they used to frown upon.”

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