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 The measure known as the Volcker rule was a late addition to the
2010 Dodd-Frank Wall Street reform law and seeks to ensure that
banks can't make speculative trades that are so large and risky that
they threaten individual firms or the wider financial system.
Banks had hoped to substantially soften the rule, but JPMorgan's $6
billion trading loss in 2012, dubbed the "London Whale" because of
the huge positions the bank took in credit markets, motivated
regulators to devise a tough version.
After more than two years crafting the complex reform, five
regulatory agencies signed off on the roughly 900-page rule with new
narrower exemptions for legitimate trades.
Former Federal Reserve Chairman Paul Volcker had promoted the
restriction on proprietary trading as a simple measure to reduce
risk, and U.S. officials acknowledged the final version was not as
streamlined as they had hoped.
Banks said they were still poring over the details, but did not
immediately expect to make further major changes to their
operations. Large banks such as Goldman Sachs and Morgan Stanley
have already wound down parts of their trading desks in anticipation
of the rule.
But experts said the reform could still erode revenues, depending on
how forcefully regulators police banks to make sure they are not
trying to mask speculative bets as permissible trades.
"At some point someone is going to have to write up a manual for
examiners on what to look for and ... how to enforce that stuff.
That's going to be a really important document," said Bradley Sabel,
a lawyer at Shearman and Sterling.
Another outstanding question is whether banking groups will mount a
legal challenge. Wall Street banks have long warned that an overly
restrictive rule could damage market liquidity and limit their
ability to hedge against risks.
Better Markets, a Washington-based group critical of large banks,
reacted positively to the final rule, calling it a "major defeat for
Wall Street."
Bank of America Chief Executive Brian Moynihan said at a conference
on Tuesday that it cost his bank up to $500 million of revenue per
quarter when it exited the trading activity banned under the Volcker
rule.
But he said the final text should not force the bank to make any
further significant adjustments. "I don't think it changes anything
dramatically," Moynihan said.
The Volcker rule applies only to banks that have access to the
Federal Reserve's discount window or other government backstops.
Financial firms that do not have access, such as Jefferies, can
continue to own hedge funds or engage in proprietary trading.
LEGITIMATE TRADES
U.S. regulators have struggled for years to agree on a text that,
while prohibiting risky activities, would still allow banks to take
on risk on behalf of clients as market-makers, to hedge risk, or
when underwriting securities. Banks have argued these functions are
critical to markets.
The proposal released in October 2011 was vague and included more
than 350 questions, including on how to create bright lines between
legitimate trades and proprietary trades.
In a blow to banks, regulators strictly limited portfolio hedging, a
practice in which banks entered all kinds of trades that were
supposed to hedge risk elsewhere in the business but that could be
used as veiled speculation.
Another addition will make bank managers attest that their banks
have appropriate programs in place to achieve compliance with the
rule, though they would not themselves have to confirm their banks
are in compliance.
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Further, traders could no longer be paid big bonuses for taking on
undue risk, the rule says, and compensation should be "designed not
to reward ... prohibited proprietary trading."
Regulators also eased the rule in some areas, including a wider
exemption for the trading of government bonds, and scaling back the
definition of which hedge funds and private equity funds fall under
a rule limiting banks' investment to a maximum of 3 percent of
funds' total value.
Regulators also extended the deadline by which banks have to fully
comply with the new regulations by one year to July 2015, a widely
expected move after they repeatedly missed deadlines for the rule.
Further delays were also possible, the regulators said in the text
of the rule.
DISSENTERS
Even before the five regulators adopted the rule on Tuesday, lawyers
were looking for weak spots, preparing for a potential fight in
court to try to knock out the Volcker rule — possibly helped by
dissent within the agencies.
Scott O'Malia, a Republican member of the Commodity Futures Trading
Commission, said he had only three weeks to review the lengthy
document, which he said flouted proper rulemaking.
Dan Gallagher at the Securities and Exchange Commission likened the
rule to President Barack Obama's flawed launch of the HealthCare.gov
website, accusing regulators of pressing ahead with "massive,
untested governmental intrusion."
Such remarks, laid down in written dissenting statements, can be a
powerful tool during later lawsuits and lay out a possible roadmap
banks could use to challenge the rule.
Legal experts are generally expecting a court challenge, for
instance from Wall Street trade groups, though none of these have so
far announced plans to do so.
The banks affected by the rule have such sprawling legal structures
engaging in various financial activities that the rule needed to be
adopted by a patchwork of U.S. agencies.
In addition to the CFTC and SEC, three bank regulators approved the
rule: the Federal Reserve, the Office of the Comptroller of the
Currency and the Federal Deposit Insurance Corp.
Banks have already done away with many of the riskiest trading
operations common before the crisis.
Morgan Stanley in January 2011 said it would spin off its
proprietary trading unit Process Driven Trading, which had 60
employees around the world.
Goldman Sachs said it had shut down two proprietary trading desks,
one known as GSPS and another that did global macro trading, by
February 2011. And Citigroup has closed a loss-making unit that had
traded stocks.
(Additional reporting by Sarah N. Lynch
and Aruna Viswanatha in Washington and David Henry, Peter Rudegeair
and Dan Wilchins in New York, editing by Karey Van Hall, Tim Dobbyn
and Krista Hughes)
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