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Republicans Take Aim at Volcker Rule

The US ban on proprietary trading known as the Volcker rule has emerged as the main partisan fight over regulatory reform, with huge implications for the biggest US institutions.

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After winning control of the House of Representatives in last week’s midterm elections, Republicans are ramping up efforts to weaken the prohibition, which is named after Paul Volcker, the former Federal Reserve chairman.

Spencer Bachus, the favourite to replace Barney Frank as chairman of the House financial services committee, wrote to the Financial Stability Oversight Council to question the “doubtful” benefits and warn regulators not to spark an “exodus” of talent from US banks.

Mr Volcker and a group of Democratic senators led by Carl Levin of Michigan wrote to the FSOC to urge a strong application of the new rules.

Although the Dodd-Frank financial reforms passed by Congress last July enshrine the ban in law, there is considerable latitude for regulators to decide what activity is allowed.

Short-term proprietary trading is prohibited; banks are also limited to owning 3 per cent of a hedge fund or private equity fund, an investment that must not exceed 3 per cent of the banks’ tier one capital.

But banks and their lawyers have been poring over the rules looking for loopholes. One of the most obvious is to disguise trading as customer-related activity, which is allowed under the law.

Market making, buying and selling securities on behalf of a client, is explicitly permitted. The line drawn with proprietary trading may not be clear cut.

Banks have also looked to principal investment as another potential grey area. Bank of America’s 14 per cent stake in Hertz, the car hire company, was not made through a private equity fund and is not a short-term investment.

Would it be permitted under the rules? Institutions believe that they may be able to continue making such investments, even though they can be as risky as short-term trading.

Lobbying on the subject has stoked the ire of Mr Levin. “The American people are furious about bank bail-outs, and they certainly are not calling on Washington to ease up on efforts to prevent a repeat of the financial crisis,” he said.

“Just the opposite; they want tough rules that keep banks from once again risking taxpayer money.”

The senator managed to toughen the rule in Congress by removing a requirement for regulators to study the ban before implementation, curbing their ability to modify it and introducing a separate “conflict of interest” ban to clamp down on banks marketing securities they then bet against.

He said the language was “clear and strong, and I am hopeful the regulators will implement it accordingly”.

Much of the industry is hoping for the opposite. Regulators can decide to enforce narrow exemptions for market making and a broader ban on principal investments.

But cheered by a perceived lack of enthusiasm from the Treasury and the Fed for implementing the proposal, the banks believe they might not.

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