Wall Street Journal: Regulators Clash Over Volcker Rule Definitions

Oct 22, 2012

The following article was published in the Wall Street Journal on October 22, 2012:

Regulators clash over Volcker Definitions

By Victoria McGrane and Scott Patterson


A rift has emerged among regulators responsible for crafting the so-called Volcker rule, one of the most complex and contentious regulations of the landmark Dodd-Frank financial overhaul.

The dispute, between U.S. banking regulators and the Securities and Exchange Commission, casts doubt on whether regulators will finish drafting the rule by the end of the year and raises the unattractive possibility that the agencies will issue conflicting standards.

The SEC and a trio of banking regulators are butting heads over how to define the buying and selling of securities on behalf of clients, known as market-making, as well as over banks’ ability to invest in outside investment vehicles such as hedge funds, according to officials close to the discussions. Since brokers, which are overseen by the SEC, conduct market-making activities, the SEC is pushing for more influence over the issue, these people said.

The Volcker rule aims to make the financial system safer by curbing risky trading by banks that enjoy a government safety net. The rule goes about this in two main ways: Banks are banned from making bets with their own money, known as proprietary trading, but are allowed to continue market-making.

In addition, the rule sharply limits the amount banks can invest in lightly-regulated investment pools such as hedge funds.

Former Fed Chairman Paul Volcker pitched the measure to prevent banks from turning to taxpayers for help when they lose money trading for their own profit. Critics say the rule could hurt the competitiveness and profitability of U.S. banks.

In a report released Monday, Standard & Poor’s analysts estimated that if regulators further tighten the rule it could ding pretax profits at the eight largest U.S. banks by as much as $10 billion a year, up from earlier estimates of a $4 billion pretax hit.

The SEC faces an uphill battle in getting its way since the three banking agencies are already on the same page. Federal Reserve Governor Daniel Tarullo, acting Federal Deposit Insurance Corp. Chairman Martin Gruenberg and Comptroller of the Currency Thomas Curry broadly agree on the contours of a final version of the Volcker rule, according to officials, including on how to differentiate between permitted market-making activities and banned proprietary trading.

The fifth and final agency responsible for implementing the Volcker rule, the Commodity Futures Trading Commission, expects to have a role in shaping the final language after the banking regulators finish the main points, a CFTC official said.

Besides the disagreement between the SEC and banking regulators regarding market-making, the other main point of contention involves how to define the funds in which banks are prohibited from investing.

The law specifies that banks are limited in investing or owning hedge funds or private-equity funds, but defines those terms broadly. In a study of the Volcker rule, the Treasury Department recommended the agencies consider narrowing the definition to avoid unintentionally capturing too many investment vehicles.

Big banks including Goldman Sachs Group Inc. and Morgan Stanley have been pressing regulators to exempt vehicles known as credit funds, arguing that the funds don’t fit the law’s description of restricted funds.

It isn’t clear where the regulators disagree on these definitions, and the agencies continue to try to reach a compromise, officials said. An SEC spokesman said the groups meet regularly and that the agency has “a great working relationship with federal banking regulators.”

If the groups remain deadlocked, it could further delay the final Volcker rule, which had a July deadline. An even worse outcome in the eyes of the financial industry would be if the banking regulators and the SEC put out different versions of the final rule. Unlike with other Dodd-Frank provisions, the Volcker rule doesn’t require the five regulators to produce the exact same version. Only the three banking regulators must approve identical language.

Industry officials warn that conflicting versions of the Volcker rule would be a recipe for chaos, with banks unable to be sure which regulators’ rule applied to a particular transaction.

Messrs. Tarullo, Gruenberg and Curry decided over the summer that they would work out an agreement on the Volcker rule among themselves, concluding that no progress was being made by staff-level talks, according to officials. Motivating their effort was a joint desire to wrap up the contentious rule by the end of the year, these officials said.

The shift is in part in response to J.P. Morgan‘s “London whale” trading loss, officials said, and aims to ensure that similar trades would be covered by the rule. The regulators still believe they can meet their end of the year goal, though it is unclear if they can convince the SEC to sign on by then.

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