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Volcker Rule Green-Lighted by Five Federal Agencies

In a series of separate votes Tuesday, five federal agencies -- the Board of Governors of the Federal Reserve System, Commodity Futures Trading Commission (CFTC), Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Securities and Exchange Commission (SEC) -- all issued final rules developed jointly to implement the Volcker Rule, which limits risk-taking by banks with federally insured deposits. 

The 900-page reform measure, several years in the making, bars banks from making trades for their own profit and imposes limits on banking entities' investments in, and other relationships with, hedge funds or private equity funds.

CFTC Chairman Gary Gensler, who supported the final rule, said it "strikes an appropriate balance regarding banking entities investment in hedge funds and private equity funds.

"As Congress directed -- other than for de minimis investments -- banking entities are prohibited from sponsoring, owning, and having certain relationships with hedge funds or private equity funds. The final rule focuses the prohibition on entities formed for investing or trading in securities or derivatives and that are typically offered to institutional investors and high-net-worth individuals. The final definition was tailored to exclude entities that are offered more broadly to retail investors or have a more general corporate purpose, such as loan securitizations."

The votes came almost two years after the CFTC voted out the rule, which was originally proposed by economist and former Federal Reserve Chairman Paul Volcker in the wake of the 2008 banking crash (see Daily GPI, Jan. 12, 2012; July 22, 2010).

The Federal Reserve Board announced that banking entities covered by section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act have until July 21, 2015, to fully conform to the statute and regulations.

The final rules bar federally insured depository institutions and their affiliates from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on those instruments. Like the Dodd-Frank Act, the final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, and insurance company activities. A number of banks already have scaled back their trading functions.

The final rules also clarify that certain activities are not prohibited, including acting as agent, broker or custodian.

Some regulators are already looking toward enforcement of the newly adopted rules.

"Today's adoption of the Final Rule is an important step, but it is not the end of the process. The success or failure of the Volcker Rule will depend on the manner in which banking entities comply with the letter and spirit of the rule, and on the willingness of regulators to enforce it," said SEC Commissioner Luis Aguilar. "Proactive, strong, and effective enforcement by the commission is vital to investor protection and maintaining the stability of the U.S. financial system."

Daniel Gallagher, one of two SEC commissioners who voted against the rules, compared the Volcker rule to the Affordable Care Act, which he labeled a catastrophe.

"What makes today's flawed rulemaking particularly egregious is the fact that the financial institutions that are subject to the Volcker Rule have long since abandoned their pure prop trading desks," Gallagher said. "Notwithstanding three years of fraught negotiations over the implementing regulations, the legislative text was clear from day one: banking entities and their affiliates are prohibited from proprietary trading, as well as from sponsoring or investing in 'covered funds' such as hedge funds or private equity funds. The financial institutions impacted by the Volcker Rule long ago accepted this fact and, from all accounts, have acted accordingly. The banks targeted by the rule have long since shut down their pure proprietary trading operations and taken steps to ensure their compliance with the legislative text in anticipation of final implementing regulations."

One recent analysis of Dodd-Frank concluded that Congress took away financial tools that energy producers and consumers use to circumvent energy price volatility when it passed the legislation, and it needs to make changes and clarifications to the law to avoid hurting energy markets (see Daily GPI, Nov. 20). The Abraham Group asserted that the "use of swaps and futures hedging by energy businesses had nothing to do with triggering the Great Recession...Dodd-Frank disrupts and puts at risk long-standing and effective use of hedging and swaps to protect both businesses and consumers from energy volatility.

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