Responding to strident criticism of proposed regulations implementing the Volker Rule, former Fed Chair Paul Volker and the Senate authors of the Dodd-Frank Volker Rule provisions defended the rule as absolutely vital and urged the SEC and banking agencies to eliminate unjustified exclusions and exemptions, such as proposed hedging exemptions related to bank investments in private funds.
In his letter, Paul Volker dismisses the argument that US banks complying with the proposed restrictions on proprietary trading would suffer competitively against international banks as "superficial at best." He points out that only a very few very large banking organizations engage in continuous market making on any significant scale, and it is those institutions that will require the regulatory scrutiny.
My understanding is that only a very few very large banking organizations engage in continuous “market making” on any significant scale. Clearly, it is those institutions that will require the attention of the regulatory authorities. I also understand that the lawful restrictions do extend to all banking organizations, including community and regional banks normally inactive. The management of those institutions must understand the nature of the restrictions. However, consistent with effectively administering the law, oversight and reporting of those institutions may be less intrusive than that appropriate for active trading operations. For small banks, infrequent transactions with customers who may not have easy access to fluid public markets may at time lead to rather longer holding periods – subject to the review of the customer relationship and relevant record keeping. More generally, when or if there is demonstrably clear understanding and enforcement by management of the principles, detailed rules may be less necessary and oversight less intensive.
Volker also emphasized that sound public policy demands that "the continuing explicit and implicit support by the Federal government of commercial banking organizations can be justified only to the extent those institutions provide essential financial services." Proprietary trading of financial instruments, which is essentially speculative in nature, engaged in primarily for the benefit of limited groups of highly paid employees and of stockholders does not justify the taxpayer subsidy implicit in routine access to Federal Reserve credit or deposit insurance. In addition, Volker feels strongly that proprietary trading activity, and speculative ventures like hedge funds and equity holdings should should be exposed to the full set of forces in the market place, not protected by access to bank capital, to the official safety nets, and to any expectation of public assistance as failure threatens.
Proprietary trading of financial instruments – essentially speculative in nature - engaged in primarily for the benefit of limited groups of highly paid employees and of stockholders does not justify the taxpayer subsidy implicit in routine access to Federal Reserve credit, deposit insurance or emergency support.
For their part, the Senate authors of the Dodd-Frank Act's Volker Rule provisions, Senators Carl Levin (D-MI) and Jeff Merkley (D-OR), in their
letter defended the proposed new rules on bank proprietary trading and relationships with private funds, and suggested that the proposed rules implementing the Volker provisions are not quite strong enough. Levin and Merkley stressed that the Volker Rule provisions they authored were intended to be "a modern version of the Glass-Steagal Act." As such, they urged regulators to eliminate unjustified exclusions and exemptions, mentioning specifically the proposed hedging exemptions related to bank investments in private funds. Instead of creating exemptions that remove certain activities from the Volcker restrictions, the final regulations should set standards by which banking activities are measured, and make determinations on those activities based on criteria ensuring that permitted activities are low risk, conflict- free, and subject to appropriate safeguards and supervisory oversight. In some cases, the final rules need to draw brighter lines, remove unnecessary complexities, and enable cost-effective, efficient enforcement.
With this in mind, Sens Levin and Merkley made some suggestions on what should guide the implementation of the Volker Rule:
- Focus on economics.
- Ban high risk activities and conflicts of interest.
- Provide clear and consistent lines for all firms.
- Eliminate unjustified exclusions and exemptions.
- Utilize capital charges and other restrictions as additional tools.
- Collect, centralize, and analyze more data.
- Enhance disclosure and unleash private market enforcement mechanisms.
- Hold boards and CEOs accountable for compliance.
Powerful forces in the financial industry, government, and globally are working diligently to affect the regulatory process; and given the scope of activities involved and the serious economic consequences at stake, getting these rules right while at the same time balancing growth, innovation, competition, and managing unintended consequences remains a paramount challenge to regulators.