UK and Japan Warn Volcker Rule Poses Threat to Recovery

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The UK and Japan have urged the U.S. to rewrite its so-called “Volcker rule”, claiming that trading restrictions on U.S. banks could hit the international sovereign debt market at a delicate moment in the global recovery.

George Osborne, the British chancellor, has joined forces with Jun Azumi, his Japanese counterpart, in warning in a column in today’s Financial Times that the U.S. banking reforms could make it “more difficult, costlier and riskier for countries to issue and distribute debt”, at a time when many eurozone countries are already under strain.

The article is the highest profile expression of international concern about the impact of the U.S. reforms, coming from the finance ministers of two countries regarded as among Washington’s greatest economic allies.

The Volcker rule imposes new curbs on U.S. banks that restrict their ability to trade with their own capital, starting in July 2012, imposing what many bankers believe would be a restriction in liquidity from equities to corporate bonds.

The rule — named after Paul Volcker, former Federal Reserve chairman — is intended to prevent risky activity by U.S. banks, but the reforms include a carve-out to allow them to buy U.S. government securities but not other sovereigns.

Mr Osborne has raised his concern about the “unintended consequences” of the reforms privately with Tim Geithner, U.S. Treasury secretary. But today’s article, published ahead of a G20 finance ministers’ meeting in Mexico, raises the stakes.

UK Treasury insiders believe that a final consultation on the Volcker rule will address the issue, not least because U.S. regulators will not want to make reforms which could potentially destabilize fragile bond markets.

“The rule could also disincentivize foreign firms from transacting with their U.S. counterparties, reducing market liquidity, potentially increasing price volatility regarding financial transactions such as foreign exchange swaps,” Mr Osborne and Mr Azumi write.

Mr Volcker has defended proposed trading rules, claiming earlier this year that it would not disrupt international bond markets. “There will be plenty of proprietary trading in securities without the half dozen or so American banks participating in it,” he said last month.

Canada has also warned the U.S. government over the rule, amid fears that big banks like Goldman Sachs

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Meanwhile the two finance ministers lay down their terms for making new contributions to the International Monetary Fund , which wants more firepower to deal with potential economic crises in the eurozone.

Mr Osborne and Mr Azumi say any new IMF funding should be drawn from a wide range of countries and should not be a substitute for further steps by the eurozone members to support their own currency. The issue will be discussed at this week’s talks in Mexico.