The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed in July 2010, arguably the most momentous change to financial regulation in the United States since the Great Depression. The goal of this legislation was: “An Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end “too big to fail”, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes”. After many years of heated debate over the effectiveness of the regulation and the nature of implementation, the focus seems to have subsided. Nevertheless, the Dodd-Frank Act remains a heavy burden on most banks and in particular the Volcker Rule, which is set to come into effect from July 21st 2015.
What is the Volcker Rule?
The Rule’s purpose is to prevent banks from making the same speculative investments that contributed to the 2008 financial crisis. Volcker is intended to not only prohibit banks from conducting proprietary trading, but also restricts their ownership of, and relationships with, hedge and private equity funds (aka. “covered funds”). In a nutshell, banks will be prohibited from trading money from depositors’ accounts for a profit.
Come the effective date, all banks will be required to be fully compliant with the Rule and submit their preliminary versions of a Volcker Rule compliance policy and procedures manual, alongside a demonstration that the proprietary ban is being enforced.
With just over a month before the Volcker Rule goes into effect, are the banks ready?
The answer, in simple terms, is no. Banks of all sizes are struggling to comprehend the intricacies and ambiguities of the Rule. Use of uncertain language and terms has undermined attempts to define parameters and assess the Rule’s impact.
The most obvious question relates to the depth in which compliance requirements should apply. For example, the Rule does not specify how granular banks should go in defining in-scope desks for reporting and compliance purposes. Furthermore, once desks are defined, which metrics are most appropriate? Regulators appear to be asking for multiple metrics (e.g. P&L attribution, inventory aging etc.), however producing them for every desk is very difficult.
When it comes to hedging activities, what constitutes risk-mitigating hedging? There are certain occasions when a bank must engage in hedging, but the Rule does not specify under which circumstances this is required and therefore allowable under the rules.
Meanwhile, the affect the Rule will have on foreign banks also continues to be a subject of confusion and conjecture. The application of the exemption for trades “wholly executed” outside the US remains uncertain. Activities as simple as a transaction transmitting payment through a US payment system could potentially be captured by and subsequently violate the Rule.
Aspects of the Rule have provided regulators with a wide scope for interpretation and implementation. After the July 21st 2015 deadline, regulators will be forced to provide specifics and agree on how regulation will be coordinated. This leaves affected institutions limited opportunity to mobilise the resources required and make the necessary changes to comply. As often is the case, new and ambiguous regulation leaves industry participants scrambling at last minute to comply and then spending the subsequent years unravelling the tactical changes. Only time will tell the true impact of Volcker.