Volcker Rule: the market reacts

Author: Zoe Thomas | Published: 13 Dec 2013
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  • The Volcker was finalised on Tuesday, but there are still some lingering concerns over clarity;
  • Market participants see it as a mixed bag, noting it was not as harsh as some had anticipated but still with major negative aspects;
  • The cost of implementing these new checks will likely be staggering to banks.

The final Volcker rule has been met with a sigh of relief by the financial sector.

While the five regulators charged with agreeing the final version of the rule have not crafted a rule as strict as had been expected, there are still several negatives aspects. A notable example is the CEO attestation, and lack of clarity as to which regulator will take the lead in providing guidance and relief.

It’s likely that banks will need to sort through the weeds of the rule in early to mid-2014, to determine which parts of their business need to be altered or dropped.

"It’s certainly positive that they did listen and review the comment letters and make changes in the light of the comment letters," said Greg Lyons from Debevoise & Plimpton.

"I think comment letters concerning insurance companies, in particular, provided them significant benefits," he said. "On the other hand I think the negative side is the CEO attestation is going to make banks all the more leery of engaging in actives that are not expressly permissible."

See also

Bumps on the EU/US Path Forward

Dodd-Frank's push-out provision: the next steps

CFTC Chairman: prepare for mandatory SEF

Positive expectations

It has taken three-and-half years for the Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC), Federal Reserve, Office of the Comptroller of the Currency (OOC) and Federal Deposit Insurance Corporation (FDIC) to complete the final rule.

The continued back and forth of proposals and comment letters between the five regulators has kept many in the market guessing as to what the final version would look like.

The JP Morgan so-called London whale incident made the market particularly concerned that regulators would take a hard line in crafting the details. But some inclusions have lightened the mood regarding what is otherwise is a hefty and complex regulatory burden.

"One area of marked improvement relates to the treatment of foreign banks with respect to trading outside of the US," said Kevin Petrasic from Paul Hastings. "Similar to the foreign bank exemption on the fund side of the rule, foreign bank trading is carved out of the prop trading ban."

Another area of exemptions came for the insurance industry which may still be able to engage in a lot of trading activity, and could possibly pick up business disregard by banks as because it is prohibited or too expensive.

Regulatory clarity

Given the involvement of so many regulatory agencies, it is still unclear which should be relied upon to offer targeted relief or guidance going forward.

Debevoise & Plimpton's David Portilla explained that while the language of the rule in certain areas called for coordination between the regulators it wasn’t clear who should take the lead. There is a concern that if consensus is required, the time to receive guidance or relief could be particularly pronounced.

"There are places in the rules that say the agency may make joint determinations, but the rule doesn’t make clear the legal framework for doing this," said Portilla.

"The rule is complex and the fear of many market participant is the ambiguity for how to seek interpretive guidance hasn’t been laid out," he added. "As we’re seen though the entire regulatory reform process, ambiguity can inhibit and hinder business decisions."

In his last public speech as chairman of the CFTC on Wednesday, Gary Gensler noted that the agency could be the right body to take the lead. But given budgetary and personnel restrains would need to coordinate with other regulators.

Cost of implementation

Given the scale, complexity and some continued ambiguity, it is not completely clear what other issues may arise.

Banks will need to weigh the costs of continuing with some sections of their business. Other market participant, such as private equity firms, may see opportunities to acquire or launch business to replace the gap left by regulated entities.

New reporting requirements showing what trades are being used to hedge and demonstrating client participation will add their own costs to banks’ systems.

"I think the systems requirements are staggering," said Lyons. "The banks are going to have to spend a fortune to handle this."

In addition there is an unknown cost linked to ambiguity left in the rule itself.

"It’s not a slight on regulators, because this area is so nuanced and so complex that unless you draw very bright, very negative lines that no one wanted or thought was appropriate, it was almost impossible to have complete clarity," Lyons added.

Further reading

Bumps on the EU/US Path Forward

Dodd-Frank's push-out provision: the next steps

CFTC Chairman: prepare for mandatory SEF