Volcker Rule Draft Gives Banks Ability To Hedge Risk: Report

WASHINGTON (Dave Clarke) - A draft proposal of the Volcker rule that cracks down on banks' proprietary trading gives firms flexibility to hedge risk, and sets stringent limits on such trading beyond U.S. borders to address fears the rule will put U.S. firms at a disadvantage.

The draft posted online by The American Banker publication and widely circulated by the financial industry on Wednesday also contained an exemption for market makers, but an industry group immediately said it was concerned the exemption may not be broad enough.

The Volcker rule, named after former Federal Reserve Chairman Paul Volcker, is part of last year's Dodd-Frank financial oversight law, designed to avoid a repeat of the 2007-2009 financial crisis.

It aims to prevent banks from recklessly engaging in risky trades by prohibiting them from trading for their own profit in securities, derivatives and certain other financial instruments.

It will also prohibit banks from investing in, or sponsoring, hedge funds or private equity funds.

The ban is one of the most controversial parts of Dodd-Frank, and a key issue has been how regulators will craft exemptions included in the law.

Both supporters and opponents of the ban were critical of how regulators are handling some these exemptions based on a roughly 200-page draft rule that was dated September 30.

Kenneth Bentsen, executive vice president of public policy and advocacy at the Securities Industry and Financial Markets Association, raised concerns about whether the exemption is too narrow for trades intended to make markets for customers.

"Upon first glance it seems to have some complex and potential burdensome provisions that may impede Congress's stated intent to allow for traditional market-making activities, and sponsorship of funds," he said in a statement.

A supporter of the ban, who requested anonymity to discuss the rule before it is released next week, took aim at how regulators dealt with the exemption for hedging against risk related to trades done for customers.

Supporters of the Volcker provision contend too broad of a hedging exemption could leave room for banks to engage in proprietary trading.

At issue is whether this hedging can be done on a portfolio basis or tied more closely to specific trades.

The draft rule would allow hedging against portfolio risks, which is common now on Wall Street.

"That's crap," the supporter said.

U.S. banking regulators will discuss the rule at a meeting of the Federal Deposit Insurance Corp board on October 11. The draft says the public will be allowed to comment on the rule until December 16.

An FDIC spokesman declined to comment on the draft posted online.

The rule will mostly impact the largest banks such as Goldman Sachs Group Inc, Bank of America Corp and JPMorgan Chase & Co.

The proposed rule narrowly tailors the exemption for proprietary trading done outside of the United States, to address fears that the crackdown will send trading activity offshore, harming U.S. firms and capital markets.

The proposal lays out four conditions that a transaction done outside the United States has to meet to escape the Volcker rule restrictions.

They are: the transaction is conducted by a bank not organized under U.S. laws, no party to the transaction is a U.S. resident, no bank employee involved in the transaction is physically located in the United States, and the transaction is executed wholly outside the United States.

For market-making activity, the draft proposal lays out six criteria that banks must meet for an exemption to the rules, including confining revenue to fees, commissions, and the spreads between bid and ask prices.

Market-makers are key to ensuring market liquidity by standing ready to buy or sell on behalf of customers. Many dealers fear that the Volcker rule will prevent them from performing market-making functions.

Other criteria set out in the draft for a market-making exemption include having a comprehensive compliance program, engaging in bona fide market making activity, and being sure not to exceed the reasonably expected near-term demands of clients.

Banks will also need to make sure they are following the proper registration rules under federal commodity and securities laws, and they must have compensation practices in place to prevent undue risk-taking.

(Reporting by Dave Clarke, Karey Wutkowski and Sarah N. Lynch; Editing by Tim Dobbyn and John Wallace)

Copyright 2011 Thomson Reuters. Click for Restrictions.

Comments

[DARK STAR]

07:06 AM on 10/07/2011

Why exempt market makers and could someone please give me a cogent explanation of what a "market maker" actually does?

[fortyfiveseventy]

05:58 AM on 10/07/2011

This Bill, named after the two congressmen most responsible for the housing bubble, will go down as the biggest job-killer in American history. Ultimately, it will be slowly dismantled in the coming years.

[frank1946]

01:20 AM on 10/07/2011

Paul Volcker is Right on this One !

[ggs83]

01:13 PM on 10/06/2011

I think it is time for the American people to adopt the GOP mantra and say NO--NO to weakening the Volcker rule, NO to giving in to the bankers and their lobbyists, NO to increasing risks that Main Street has to cover. NO NO NO

In fact, I think that a major Obama mistake was listening to Geithner instead of Volcker. Investmetn houses should not have the protection of being called a bank. NO
And if Obama were smart, he would trade Geithner for Volcker; it would help his re election possibilities. Geithner is a NO
Geithner is whining that banks/Wall Street are still complaining about Obama as if he thinks reason instead of greed prevails there--NO it does not
Time for the 99% to start saying NO

[ccairnes]

11:59 AM on 10/06/2011

What do you mean "the 2007-2009 financial crisis"? Do you mean to imply that the trouble magically ended in 2009 when it was dumped onto the Obama administration and now it is merely a failure of the new president's leadership. Bunk. The 2007 financial crisis, 30 years in the making, is not over.

[WalterJesseSmith]

09:32 AM on 10/06/2011

Let us not fear any Volcker Rule.

First off, it will be watered down to a similar extent as was Dodd-Frank.

Secondly, as with watered-down Dodd-Frank, Obama and Geithner will prevent any Volcker
Rule, no matter how emasculated, from even going into effect.

Thirdly, as with former elections, the 2012 election will feature a choice between Wall Street's two favorite candidates - precisely what Edward Abby called a choice between the evils of
two lessers. They will compete for Wall Street's favors so Wall Street wins no matter who you vote for.

Relax. Listen to your loved ones and neighbors. The ethical, moral, political, spiritual, economic, and overall cultural stagnation now enters the implosive stage.
candidates

[mrclark]

08:53 AM on 10/06/2011

The part I liked was the limits on the banks support of hedge funds. Until the banks are held accountable for their role in the Wall Street implosion for 2007 and taken off the FED window they will pay lip service to these rules while trying to get around them to invest in the market in commodities and seemingly sovereign debt. In the end though it comes down to one thing which is that the TBTF institutions will need broken up before America can come out of this depression for the working and middle classes. They are too big and are sucking the lifeblood out of our economy to maintain their profit margin. It is a matter of time until the public comes to this consensus and when they do everything will change for their backers even in Washington. The American people are seeing the disparity in treatment for them and for Wall Street which illustrates the class warfare that has been ongoing over the last thirty years. This is one of the primary reasons why average Americans in increasing numbers are wanting to raise taxes significantly on the rich.