Today, government financial regulators adopted the Volcker Rule, a sweeping piece of legislation that essentially restricts big banks from trading for their benefit versus the benefit of their customers, three years after the Obama administration called for institution of the measure.
The Volcker Rule, named for former Federal Reserve Chairman, Paul Volcker, bars banks from making trades for mere profit as well as prohibits them from owning hedge-funds or private-equity funds. The Volcker Rule is the centerpiece of the 2010 Dodd-Frank financial overhaul law took years to complete, as government in-fighting and intense lobbying from banks slowed the process considerably.
Lawmakers designed the measure to prevent banks with government backstops such as deposit insurance from making risky trades for their own benefit, instead of at the benefit of depositors and investors with the bank, because the bets could endanger their customers, as well as taxpayers. The challenge for regulators has been restricting such proprietary trading without impeding acceptable practices, such as firms trading on behalf of clients as market-makers or hedging their risk against fluctuations in interest rates.
On Tuesday, the FDIC board and the Fed unanimously voted to approve the final version of the rule. The SEC voted 3-2 in favor, while the Commodity Future Trading Commission adopted the measure with a vote of 3-1. Supervision and regulation of the rule will ultimately be the responsibility of the Office of the Comptroller of the Currency, the CFTC and the SEC.
In a statement, President Obama said: “Our financial system will be safer and the American people are more secure because we fought to include this protection in the law. I encourage Congress to give these regulators adequate funding to effectively and efficiently implement the rule.” Institutions are allowed to take positions to help clients trade, but their inventories cannot exceed “the reasonably expected near-term demands of customers,” according to the rule.
In order for banks to prove they are staying compliant with Volcker and not engaging in speculative, high-risk gambling, but instead are making responsible decisions on behalf of their customers, banks must satisfy a host of requirements. The rule also lifts the restriction included in the original draft on proprietary trading in foreign government debt.
A key part of the rule calls for firms to conduct an analysis and provide a rationale of their hedging strategy to prevent another “London Whale,” the $6.2 billion trading fiasco at JPMorgan Chase. The 2012 blunder turned the tide of the debate as supporters of change gained the upper hand in calling for tough restrictions on risky hedges.