4 big questions ahead of Volcker 2.0 rollout
WASHINGTON — The industry is hopeful that changes are near to make the Volcker Rule more tolerable, but it remains to be seen if regulators will give the nation's largest banks all the relief they have sought under the proprietary trading ban.
Five federal regulators are poised to finalize changes to the Dodd-Frank Act measure that they proposed in May 2018, with the Federal Deposit Insurance Corp. first up to consider the rule at a meeting Tuesday morning. The other agencies, including the Federal Reserve Board and Office of the Comptroller of the Currency, are expected to follow soon.
The May 2018 proposal uniquely garnered hostility from both the banking industry and consumer groups. Banks argued that revising the standard of prohibited trades would actually ban more trades. Proponents of the regulation — first devised by former Fed Chairman Paul Volcker — voiced concern that Volcker 2.0 would undermine the post-crisis framework of supervision and enforcement.
Some reports have indicated that the five agencies are poised to scrap key portions of their original proposal that banks opposed. The FDIC board meeting Tuesday should provide a long-awaited answer as to whether the agencies will maintain a standard abhorred by banks that bans trades with "short-term intent," or propose a new definition entirely.
Yet that could be seen by some as a giveaway to Wall Street at a crucial point in the presidential campaign where prominent Democrats such as Sens. Elizabeth Warren, D-Mass., and Bernie Sanders, I-Vt., have bemoaned the Trump administration’s treatment of large banks.
In advance of the FDIC meeting, the Office of Financial Research released a report earlier this month that reinforced the financial industry’s case for regulatory relief by showing that the trading ban has weakened market liquidity.
Here are four questions that are likely to frame the conversation around the Volcker Rule’s future:
What will happen to the "rebuttable presumption"?
Under the regulation, short-term intent is triggered for trades held for less than 60 days, which are prohibited. Yet banks can attempt to argue that such a short-term trade should be allowed.
Bankers have fiercely opposed the "rebuttable presumption," but they appeared to oppose the agencies' proposed alternative even more. In their May 2018 plan, the regulators proposed a new standard applying the ban to accounts where trading instruments are recorded at fair value.
But banks argued that the proposed accounting prong would actually cover a wider range of trading activities and assets and make the Volcker Rule even more burdensome.
The regulators have acknowledged these concerns in speeches since the comment period closed in October on the Volcker 2.0 proposal.
“We rightfully so thought that we had proposed something that would be easy from an accounting perspective, but the market told us that we were encapsulating other trades that really weren’t proprietary in nature,” Comptroller of the Currency Joseph Otting said in a speech in May. “So I think we’re having dialogue about what to do.”
Bloomberg reported that the regulators would vote to approve a final Volcker revamp that would completely scrap the accounting prong, which would be a win for the largest banks.
In that case, the regulators could decide to revert back to the rebuttable presumption that is already in place, or try to advance a new definition altogether.
In comment letters to the agencies, trade groups representing the largest banks suggested that the regulators should instead clarify that trades held for longer than 60 days are accepted, exempt instruments that mature within the 60-day window and improve the process for rebutting a regulator's finding that a certain position is banned.
“Our expectation is that the regulators ultimately will provide relief close to what the biggest banks have sought,” wrote Jaret Seiberg, an analyst with Cowen Washington Research Group, in a note. “This likely will encourage banks to hold some additional inventory as part of their market making activities though it is hard to see how the banks could return to their pre-Volcker Rule days.”
What other provisions besides the “trading account” definition will be in the final rule?
Other proposed revisions drew less opposition from the industry than the “accounting prong.” But in other key areas, such as the scope of the “covered funds” definition limiting banks’ dealing with private-equity interests, financial institutions had urged the regulators to go much further.
The industry supported the proposal’s additions to the exemptions for foreign banks making proprietary trades outside the U.S.; efforts to streamline exemptions for market-making, underwriting and risk-mitigating hedging activities; and a broader exclusion for certain instruments meant for liquidity management.
But the agencies could go further in easing the so-called covered fund definition. The proposal did not address changes to that definition but asked for comment on whether that definition should be revised.
“The Regulation’s ‘covered fund’ definition is much too broad and captures a variety of funds that were never intended to be covered under the Volcker Rule,” Timothy E. Keehan, vice president and senior counsel at the American Bankers Association, said in an Oct. 17, 2018, comment letter.
The proposal would also establish three compliance tiers to tailor the regulation based on a bank’s trading activities. Companies with $10 billion or more of trading assets and liabilities would be subject to the most rigorous compliance regime, followed by banks with $1 billion to $10 billion of TALs and banks with less than $1 billion of TALs. The latter category would be “presumed to be in compliance” with the Volcker Rule, yet banks have urged the regulators to establish a higher threshold for such a presumption, and to establish fewer tiers.
How will industry groups, progressives react?
Whatever the regulators do to change the Volcker Rule will likely face criticism from industry and consumer groups alike.
“I’m thinking this release tomorrow is going to be just enough to leave everyone angry,” said Isaac Boltansky, director of policy research at Compass Point Research & Trading. “It’s just enough to where Democrats will write angry letters saying it’s too much and Republicans will send angry letters saying this is not enough and the world keeps spinning.”
Banks will likely see a reduction in compliance for the rule, but Boltansky added that the potential changes are “unlikely to catalyze structural shifts in bank earnings, financial stability or market liquidity.”
Boltansky said “the banks are going to say it doesn’t sufficiently change their operating realities.”
But progressives in Congress and consumer groups have been critical of most of the recent efforts to change the Volcker Rule.
After reports in March that regulators were considering a redo of the Volcker Rule, Sen. Sherrod Brown, D-Ohio, the ranking member of the Senate Banking Committee, warned that the Trump administration’s regulators would write an even weaker proposal.
“It’s no surprise that when Wall Street banks complained that the proposed rewrite of the Volcker Rule wasn’t weak enough, Trump regulators went to work watering it down further,” Brown said in a March statement. “It is sad to see critical Wall Street Reform Act protections get picked apart piece-by-piece.”
And consumer groups are already preparing for a weaker Volcker Rule that will benefit the industry.
Marcus Stanley, policy director at Americans for Financial Reform, said he expects regulators to drop the accounting prong that the banking industry opposed in the initial rule.
“I expect tomorrow to be a win for the banks,” said Marcus Stanley, policy director at Americans for Financial Reform.
Stanley added that he expects regulators “to narrow the scope of the rule in the range of bank activities that the Volcker Rule applies to.”
Will the Fed and FDIC boards be unanimous in supporting the final rule?
One potential yardstick for how far the regulators go in their final rule is the degree to which there is consensus among agency officials.
Martin Gruenberg and Lael Brainard — the two members of the FDIC and Fed boards, respectively, appointed by the Obama administration — have opposed other regulatory relief initiatives undertaken by the agencies during the Trump administration. Yet the Volcker Rule was an exception. Both of them supported the May 2018 proposal, saying a revision of the compliance process was appropriate. (Gruenberg was still chairman of the FDIC board at the time.)
But if Gruenberg and Brainard take a pass on supporting the final rule, it would be a sign that the regulators have embraced a more substantial overhaul of the trading ban to the industry’s liking.