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While waiting for regulators to fully understand the effects, small banks should proactively take measures to prepare themselves from the Volcker rule, just like their larger counterparts.
February 10 -
During a House Financial Services Committee hearing featuring top regulatory officials, lawmakers repeatedly returned to the question of whether the five agencies involved in writing the Volcker Rule can enforce it consistently across the various entities they oversee.
February 5
While the Volcker Rule was monopolizing headlines, the Federal Reserve Board issued another final rule that has received far less attention than it should.
In early December, the board revised its market risk capital rule to conform to the Basel III revised capital framework. The market risk capital rule will be used by institutions with significant trading activities to calculate regulatory capital requirements for market risk. These are likely the same firms that will be most affected by the Volcker Rule's prohibitions on proprietary trading and ownership restrictions in hedge funds and private equity funds.
Everyone acknowledges that implementation of the Volcker Rule is likely to be one of the most complex and controversial regulatory regimes ever to be introduced into the financial services industry. But most industry experts fail to mention that the addition of the new market risk capital rule will add another twist to that complexity and introduce a new level of uncertainty.
Why might this be the case? The Volcker Rule is quite prescriptive in how it defines "trading accounts" to include "the short-term, market risk rule, and dealer trading accounts." Proprietary trading is defined as "engaging as principal for the trading account of the banking entity in any purchase or sale of one or more financial instruments." In finalizing the Volcker Rule, the agencies argued that the compliance burden is reduced for "banking entities with substantial trading activities by establishing a clear, bright-line rule for determining that a trade is within the trading account."
Unfortunately, there are a number of definitions included in the Volcker Rule that do not fully align to the definitions contained in the market risk capital rule. Indeed, the preamble of the market risk capital rule, as issued on August 30, 2012, acknowledges as much, stating that the definition of a "covered position" is "substantially similar to the definitions of similar terms used" in the proposed Volcker Rule. Additionally, it further states that the proposed Volcker rule "would cover all positions of a bank that receives trading position treatment under the final market risk capital rule because they meet a nearly identical standard."
The full impact of the final Volcker Rule on both institutions and financial markets more generally will take time to unfold, but clearly definitions in the Volcker Rule and the market risk capital rule that are "substantially similar" and "nearly identical" as opposed to actually identical will likely prove to be very problematic, very quickly.
The Volcker Rule also established "clarifying exclusions" from the definition of the trading account that are likely to not align very well with trading positions covered by the market risk capital rule. Under the Volcker Rule, no account is a trading account to the "extent that it is used to acquire or take certain positions under repurchase or reverse repurchase arrangements, positions under securities lending transactions, positions for bona fide liquidity management purposes, or positions held by derivatives clearing organizations or clearing agencies."
However, for entities subject to the market risk capital rule, any account that contains positions that qualify for trading book capital treatment would be considered "covered positions" under the market risk capital rules, which are positions that are "generally held with the intent of sale in the short-term" and, therefore, fall under the Volcker Rule prohibition.
Is that perfectly clear or are you confused about what a "covered position" and/or "clarifying exclusion" is?
These discrepancies illustrate how important it is for regulatory agencies and industry practitioners to work together during the Volcker Rule conformance period to ensure that compliance programs are developed appropriately. This will not be an easy nor simple task, but one that is of vital importance and absolutely necessary.
Pamela Martin is managing director of the Americas' Financial Services Center of Excellence at KPMG.
