The loosening of the Volcker rule announced this week opens the door to a rebound in risky behaviour on Wall Street, proponents of the initial legislation have warned, even as investors and analysts insist there will be little impact on bank profits.
Implemented as part of the Dodd-Frank law in the wake of the financial crisis, the original rule banned big lenders from making short-term investments with their own money, a practice known as proprietary trading. Positions held for less than 60 days were assumed to be prop trades, requiring banks to apply for specific exemptions.
The amended version, the latest step in President Donald Trump’s push to ease regulations on American business, will make it the banks’ responsibility to determine which short-term positions require an exemption. And positions held for more than 60 days will be presumed compliant — banks are permitted to make long-term investments for their own benefit under Dodd-Frank.
While Wall Street has long lobbied against the legislation, which it sees as imposing an unnecessary compliance burden, supporters of the original rule fear the overhaul is a step in the wrong direction.
“What is the problem being solved here? Big banks are making record revenues and profits,” said Dennis Kelleher, of the advocacy group Better Markets. The amendment, he said, shifted the burden of proof from banks to regulators and loosened record-keeping requirements, “making it impossible for the supervisors to assess what is a proprietary trade . . . banks can assert [compliance] without documentation”.
Tyler Gellasch, who as a Senate aide helped draft both Dodd-Frank and the Volcker rule, said that “as watered down, the Volcker rule is becoming the worst type of regulation — it appears impactful and imposes compliance burdens, but would provide only limited substantial protections”.
One investor who until recently managed a trading desk at a big US bank said the rule had been “quite powerful in lowering proprietary trading in banks and quite frankly the gambling mentality — it definitely made capital markets trading businesses focus more on clients”.
He worried that the amendments opened the way for the return of conflicted interests, as banks traded simultaneously for themselves and their clients. “It looks like a case of regulatory capture to me,” he said.
However, lawyers tasked with interpreting the rules played down the role of the original Volcker rule in pushing banks out of proprietary trading, saying other provisions of the Dodd-Frank law had been more significant.
“Many people who are interested in good regulation of banks think the Volcker regulations create a lot of compliance burdens without being particularly effective in addressing regulatory concerns about overly risky activities,” said Jai Massari, a financial regulations lawyer at the law firm Davis Polk.
“It is hard to know how much of the change in banks’ behaviour after the financial crisis is attributable to the Volcker rule versus other reforms, such as those governing capital and liquidity requirements,” she added. More stringent capital rules have the effect of making many trading activities less profitable.
Rodgin Cohen, a lawyer specialising in banks at Sullivan & Cromwell who thinks the Volcker rule had a significant impact, said that while the amended rule did “not really roll back the fundamental restrictions . . . what it does is reflect a new willingness to look at compliance burdens”.
Analysts, meanwhile, said banks’ trading operations would gain little economic benefit from the relaxed requirements because the costs associated with Volcker rule compliance had already been sunk into reporting and compliance systems.
“We do not expect any material impact on overall capital market revenues,” wrote Goldman Sachs analyst Richard Ramsden in a note to clients, saying the other post-crisis regulations — the stress-testing regime and higher capital requirements — would keep traders’ inventories of securities low.
Several other analysts and bank investors echoed the sentiment.
“I don’t think [the rule] made a huge difference — every management team I talked to said [it] was another safety net and confidence-builder externally, and that it wasn’t unreasonable,” said Patrick Kaser, a portfolio manager at Brandywine Investment Management. “I don’t think much will materially change.”
The market appears to agree with this view. Bank stocks tracked the market on Tuesday, when the amended rule — which was less stringent than some observers had feared it would be — was revealed.
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