WASHINGTON — The regulators charged with implementing the Volcker Rule have posed a whopping 1,300 questions to the public, but on Wednesday they fielded one query they seemingly hadn't considered.

Rep. Michael Grimm, R-N.Y., described a scenario in which a foreign firm with no U.S. operations sells a security, as a part of a proprietary trading strategy, to an American firm.

"Does that fall under the purview of U.S. regulators? Is that subject to the Volcker Rule?" Grimm asked during a House hearing.

Following a pause and some requests for clarification, Securities and Exchange Commission Chairman Mary Schapiro responded, "I believe — and I'd like to confirm this for you — that if the foreign banking entity sells to a U.S. customer, they lose the exemption from the Volcker Rule."

The brief confusion underscored the massive complexity of the Volcker Rule — an effort, conceived by former Federal Reserve Board Chairman Paul Volcker — to prevent banks from making risky bets that are ultimately backed by taxpayers.

Volcker's original idea became an 11-page section in the Dodd-Frank Act. The 2010 measure restricts the ability of banks to make proprietary trades and to invest in hedge funds or private equity funds. But it also contains numerous caveats — for example, allowing banks to continue making trades for the purpose of hedging or market-making.

Last year, the Fed and other regulators released a nearly 300-page draft proposal for implementing the Volcker Rule, which contained hundreds of questions for public comment. The comment period was recently extended to Feb. 13, and at Wednesday's hearing, regulators made clear that they don't believe they have all the answers regarding how the Volcker Rule should be implemented.

"It's been noted by many that the proposal contains an unusually large number of questions," Acting Comptroller of the Currency John Walsh said. "While the number of questions may seem daunting, they were driven by our desire to understand what may be quite complicated and significant consequences of elements of the proposal, and to provide a sound legal basis for adjusting key areas of the rule where the agencies deem that necessary."

Much of Wednesday's House hearing — held jointly by the capital markets and financial institutions subcommittees — resembled a replay of the legislative debate over the Volcker Rule in 2010.

Republican opponents of the plan expressed fears that the measure will restrict liquidity in financial markets and ultimately will hurt economic growth.

"There has to be capital for investment. And I believe this will restrict capital," said House Financial Services Committee Chairman Spencer Bachus, R-Ala. "I believe it will drive up the cost of loans."

But the committee's top Democrat, Rep. Barney Frank, challenged the idea that greater liquidity is always the most important consideration.

"There is a cost-benefit analysis that has to be applied," Frank said. "I have bonds I'd like to be able to sell, but I don't think they have to be sold in eight seconds for me to be … satisfied."

Asked about the impact of the Volcker Rule on liquidity in corporate bond markets, Federal Reserve Governor Daniel Tarullo said, "Will there be some incremental effect on liquidity in some markets at the margin? I think the answer is probably yes."

Beyond that, Tarullo said that the impact on liquidity would depend in part on how many unregulated firms, such as hedge funds, step into the void left by banks that have been doing proprietary trading.

"I think at least one firm has already stated publicly that they see enormous opportunities here," Tarullo said.

Walsh said that some of the proprietary trading business in U.S. banks may also migrate overseas. Foreign banks that have U.S. banking operations are subject to the Volcker Rule, but foreign banks that operate exclusively overseas generally are not.

"Hedge funds and others may take up that business. Some of it may go to foreign firms," Walsh said. "So we are creating some such limitations, and that business will presumably migrate elsewhere."

In that context, House Republicans reprised their argument that the Volcker Rule will place the United States at a disadvantage internationally.

"In the international context, Volcker was supposed to be one of our 'Field of Dreams' regulations. If we build it, they will come," said Rep. Francisco Canseco, R-Texas. "Yet no other country has adopted anything similar to the Volcker rule."

Much of the testimony by regulators focused on their uncertainty over where to draw the line between what is permissible — including market-making and hedging — and what is prohibited. They repeatedly emphasized that they are seeking public comment in order to get a better grasp on that issue.

Tarullo testified that proprietary trading and market-making activities can be indistinguishable from each other based solely on the features of the trade. The Volcker Rule attempts to distinguish between the two based on whether the bank intends to resell soon and to earn a profit from short-term price fluctuations.

The regulators have proposed a framework that sets forth factors that the regulators see as differentiating trades that are prohibited from those that are permitted, and it requires banks to establish a compliance program in accordance with those factors.

"There is no question that this is not a simple test," Tarullo said.

Republicans pressed the regulators to go back to the drawing board in implementing the Volcker Rule and to push back the date, currently scheduled for July 21, when the measure becomes effective. But they did not get any commitment from agency officials.

Frank, one of the main authors of the Dodd-Frank Act, pushed back forcefully against the idea that more time is necessary to consider the impact of the Volcker Rule.

"I must say that it does seem to me that delay here is a stalking horse for opposition in the case of most people," Frank said. "And they blame a lot on uncertainty. So what are they asking for now? More uncertainty. They are asking for a delay in this rule, in the statute, that's coming."

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