Wall Street nears a big win in the latest revamp of Volcker Rule
Jesse Hamilton and Ben Bain
In a win for Wall Street banks, the latest effort to overhaul the post-crisis Volcker Rule is moving toward a narrower and clearer definition of what types of trades are prohibited, said people familiar with the matter.
Regulators appointed by President Donald Trump took a first stab last year at toning down Volcker’s trading limits, which were meant to prevent bankers from threatening the financial system. However, bankers blasted the revamp, arguing it might make it even harder for firms to buy and sell securities. In response to that criticism, the watchdogs are now focused on erasing the 2018 proposal’s centerpiece — known among regulators as the “accounting prong” that would have determined which trades are banned.
A less onerous method embedded in the original Volcker has become the favored replacement for the accounting test, said three people who asked not to be named because an expected rewrite hasn’t been completed. Senior officials at the five federal agencies revising Volcker met April 16 to discuss the new direction, the people said. The change would be an unmistakable victory for megabanks, which have been lobbying to weaken Volcker ever since its inclusion in the 2010 Dodd-Frank Act.
Spokesmen for the federal agencies involved declined to comment.
The original rule was meant to prevent lenders with federally backed deposit insurance from suffering huge trading losses, as they did before the 2008 financial crisis. Named for its advocate, former Federal Reserve Chairman Paul Volcker, the rule prohibits proprietary trading — the practice of banks betting on markets with their own capital. Transactions are perfectly fine if they’re executed on behalf of clients.
But detractors say confusion over which short-term trades pass muster has made banks too cautious, prompting a retrenchment from certain assets that — according to much-debated research — could dry up liquidity when markets are under stress.
Getting Wall Street relief from Volcker has been a top priority for Treasury Secretary Steven Mnuchin and other administration officials. While it’s unclear how soon that will happen, rewriting last year’s proposal could delay the process by months.
In their 2018 proposal, known as Volcker 2.0, the Fed and other agencies sought to give more certainty over which trades are permitted by introducing the accounting prong. It would have forced banks to apply accounting standards to certain transactions, and if the firms experienced sharp enough gains or losses, the trades would be presumed to be violating Volcker.
Banks ripped the idea — with Goldman Sachs Group Inc. leading the charge. The firm, in an October 2018 letter to the Fed, called the proposal “highly problematic” because it could rope in a lot of transactions not even outlawed by the existing version of Volcker.
In recent discussions, regulators have weighed dumping the accounting measure and relying more heavily on something known as the market-risk capital prong, the people said. That method, which is already in Volcker, prohibits trades involving financial instruments that are generally held for sale in the short term. The change would probably be appealing to banks because it’s based on rules they already have to follow.
The bottom line: Compliance under the market-risk capital test would be less burdensome because lenders would no longer have to make subjective calls about their intentions with each trade. Whether Wall Street trading books would swell is harder to predict.
In their current re-write, officials are also seeking to ease constraints on banks’ investments in private equity and hedge funds, the people said, an area largely ignored in the 2018 proposal. The Fed, which is leading the effort, might relax restrictions on foreign lenders’ investment funds, and it could give U.S. banks more leeway to provide credit to certain funds, according to the people.
The five agencies responsible for the rule — the Fed, the Office of the Comptroller of the Currency, Federal Deposit Insurance Corp., Securities and Exchange Commission and Commodity Futures Trading Commission — are also working to streamline the data that’s supposed to be reported to regulators under Volcker, the people said.
A new Volcker proposal to replace last year’s version — an effort one agency head joked could be called Volcker 2.1 — would push back a final overhaul of the trading rule. Still, several officials including Treasury Department counselor Craig Phillips, who has led that agency’s work on regulatory policies, have openly suggested a re-proposal may be necessary.
Even when proposing Volcker 2.0 in 2018, Fed Vice Chairman for Supervision Randal Quarles said regulators might not be done with the job, calling it “an important milestone in comprehensive Volcker rule reform, but not the completion of our work.”