A proposal to simplify a rule banning banks from proprietary trading, rather than making life easier for Wall Street, could ensnare billions of dollars’ worth of assets not currently caught by the regulation.
This little-noticed wrinkle, if it were to make it into the final rule, could prompt Wall Street firms to overhaul their Treasury, trading and merchant banking operations and change their accounting practices, lawyers and executives told Reuters.
On May 30, U.S. regulators unveiled a plan to modify the so-called Volcker Rule introduced following the 2007-2009 financial crisis, aiming to make compliance easier for many firms and relieving small banks altogether.
Wall Street has long complained about the complexity and subjectivity of the rule, which bans banks that accept U.S. taxpayer-insured deposits — such as Goldman Sachs, JPMorgan Chase, and Morgan Stanley — from engaging in short-term speculative trading.
Republicans, the business lobby and analysts initially welcomed the proposal as a long overdue move to streamline and clarify the rule, while consumer advocates and progressive Democrats criticized it as a risky Wall Street giveaway.
But after digesting the 494-page consultation, financial industry executives and lawyers said it could actually create new headaches for big banks by banning a swath of trades and long-term investments not currently covered by the rule.
“It’s going to capture trades that wouldn’t be captured by the current regulation and that’s the bogeyman people would want to avoid in this proposal,” said Jacques Schillaci, a banking lawyer at Linklaters who has studied the proposal.
The draft is subject to a 60-day consultation period during which industry participants will lobby for changes, with a final version, which is likely to be substantially revised, expected around January.
One of the most-hated aspects of the Volcker Rule presumes purchases and sales of instruments within 60 days count as proprietary unless the bank can prove they qualify for an exemption, such as market making or hedging.
This part of the rule aims to identify short-term trades that are intended to be speculative in nature, but banks say it is too subjective because it would require second-guessing traders’ intentions.
Regulators have proposed replacing it with a more objective test, based on the accounting treatment of the instruments traded.
Under the new test, trading activity by desks that daily book net realized or unrealized gains and losses exceeding $25 million is only allowed if the bank shows that trading qualifies for the rule’s exemptions.
Since the crisis, however, banks have applied this mark-to-market or “fair value” accounting treatment to a range of longer-term investments to better manage their risk.
As a result, the proposal would bring under the rule the vast majority of equity investments, derivatives and a range of fixed income securities that banks hold for many years but not to maturity.
While some of these investments, such as U.S. Treasurys, other government-related securities, and some derivatives, would qualify for exemptions, many would end up being prohibited given the relatively low $25 million thresholds, the industry experts said.
This could disrupt how bank groups structure their trading desks and manage their strategic investments and risk. The proposal may also prompt banks to elect not to mark-to-market some assets.
Spokespeople for the Federal Reserve, Securities and Exchange Commission, Commodity Futures Trading Commission and the Federal Deposit Insurance Corporation declined to comment.
A spokesman for the Office of the Comptroller of the Currency said the agency looked forward to reviewing stakeholder comments.