WASHINGTON — Less than a week after President Trump signed a regulatory relief package into law, regulators officially took the next significant step Wednesday toward recalibrating the post-crisis regime: revisions to the Volcker Rule.
The Federal Reserve Board became the first agency to unveil proposed changes to the proprietary trading ban — named for former Fed Chairman Paul Volcker — including adjustments to the compliance process, how prohibited trades are defined and tailoring for institutions with different trading volumes, among other things. (The Federal Deposit Insurance Corp. is expected to approve the proposal Thursday.)
"We have had almost five years of experience in applying the Volcker Rule," said Fed Chairman Jerome Powell, referring to the 2013 regulation that implemented a provision of the Dodd-Frank Act. "The agencies responsible for implementing the rule see many opportunities to simplify and improve it in ways that will allow firms to conduct appropriate activities without undue burden, and without sacrificing safety and soundness."
Here are five takeaways from the Fed's release of the proposal.
Proprietary trading is still banned, but Volcker Rule compliance would get easier for certain institutions
Regulators proposed several changes to the compliance program within the Volcker Rule by streamlining certain standards to place greater emphasis on banks with the largest trading operations and more regulatory relief for those that engage in less trading.
The proposal applies different compliance standards based on three different tiers of banks: “significant” for banks with at least $10 billion in trading assets; “moderate” for banks with $1 billion to $10 billion; and “limited” for banks with less than $1 billion in trading assets.
The banks deemed “limited” would not need to establish an enhanced compliance program unless their regulator says otherwise, according to the proposal.
While the recent regulatory relief bill signed into law exempts banks with less than $10 billion in total assets from the Volcker Rule, "the proposed rule ... would recognize that small asset size is not the only indicator of reduced proprietary trading risk," said Randal Quarles, vice chair of supervision at the Fed.
"This proposal is a good example of the general principle that we should tailor our regulations and supervision to the size and risk profile of individual firms," Quarles said.
Fed Gov. Lael Brainard, who has been vocally cautious about altering the Volcker Rule, said during the Fed board meeting Wednesday that she particularly supported streamlining compliance based on trading asset sizes.
“The application of the Volcker Rule to firms with little trading activity results in compliance costs without a commensurate benefit to financial stability,” she said in prepared remarks.
The banks with the largest trades would have to implement a so-called “six-pillar compliance program,” while banks with moderate trading would have a “simplified compliance program,” the proposal said. By doing this, the regulators would also end the current “enhanced minimum standards” compliance requirements in the 2013 Volcker Rule.
Reactions to the proposal were wildly different
The initial responses to the proposal ran the spectrum from seeing the proposed changes as a recalibration of how banks comply with the Volcker Rule to seeing the proposal as an open invitation for banks to reengage in proprietary trading.
“Even as banks make record profits, their former banker buddies turned regulators are doing them favors by rolling back a rule that protects taxpayers from another bailout,” said Sen. Elizabeth Warren, D-Mass., said on Twitter.
Sen. Jeff Merkley, D-Ore., called the proposal “a massive giveaway to the biggest banks.”
But that was in contrast to others’ reaction describing the proposed changes as more middle-of-the-road and the assessment of Volcker himself, who has suggested that the regulators’ 2013 regulation implementing the trading ban was overly complex.
“I welcome the effort to simplify compliance with the Volcker Rule,” the former Fed chairman said in a statement. “What is critical is that simplification not undermine the core principle at stake — that taxpayer-supported banking groups, of any size, not participate in proprietary trading at odds with the basic public and customers’ interests.”
Revised definition of “trading account” should please banks
As the Fed staff put it in a summary released before the board meeting, the proprietary trading ban in Dodd-Frank applies “to positions taken as principal for the trading account of a banking entity.”
But how regulators define “trading account” to implement the statute has proven a challenge. Among the factors that can indicate a trading-account position is if there is “short-term intent,” which is reflected by a bank holding an instrument for 60 days or less. However, banks can try to make a case to regulators that just short-term trades are not banned.
The industry has panned that so-called “60-day rebuttable presumption,” saying it cancels out trades that the Volcker Rule did not intend to ban.
“Proprietary trading remains illegal. What is changing is how the agencies will look at short-term positions that a bank keeps in its trading account,” Jaret Seiberg of Cowen Washington Research Group wrote in a research note.
Under the proposal, the 60-day rebuttable presumption would be replaced with a new “accounting prong” that applies the ban to accounts where trading instruments are recorded at fair value.
But the proposal goes even a step further.
The “trading account” definition currently has other prongs, such as one where an instrument is bought or sold by a bank that must register as a dealer, swap dealer or securities-based swap dealer (known as the “dealer prong”). Under the proposal, trading desks where only the “accounting prong” applies are considered in compliance with the Volcker Rule.
Banking agencies appear to be moving in lockstep on Volcker Rule changes
Other efforts to roll back post-crisis regulations have revealed divisions among some federal regulators, but that did not appear to be the case on Wednesday with proposed changes to the Volcker Rule.
In April, the Fed and Office of the Comptroller of the Currency issued a proposal easing a big-bank capital measure known as the “enhanced supplementary leverage ratio.” But Brainard voted against the proposal, and the FDIC — which had helped write the original eSLR rule — withheld support for the changes. (Both Brainard and FDIC Chairman Martin Gruenberg were appointed by former President Barack Obama.)
But the Fed’s vote on Wednesday was unanimous, and the FDIC and OCC are expected to support the Volcker Rule proposal later this week, along with the Securities and Exchange Commission and the Commodity Futures Trading Commission.
“Although I do not currently see a case for changes to the core capital and liquidity framework, I support efforts to implement the Volcker Rule more effectively,” Brainard said in a statement.
Foreign banks with a U.S. presence will find it easier to make non-U.S. trades
Regulators tweaked a few of the restrictions pertaining to foreign bank entities by allowing more exemptions for foreign banks to make propriety trades outside the United States. Currently, the Volcker Rule restricts such trading by a foreign bank if the person, affiliate or office arranging the trade is within the U.S., among other restrictions.
However, regulators are proposing to restrict “the relevant personnel” rather than “any personnel,” as currently written, from a transaction in the U.S. The proposal also lifts two other restrictions related to whether the proprietary trade was financed through a U.S. office, affiliate or through a U.S. entity.
Regulators said the proposal is meant to address concerns from foreign banks that they were “unduly limited” in getting the exemptions to make proprietary trades outside the U.S.
“The proposed changes seek to reduce the impact of the 2013 final rule on foreign banking organizations’ operations outside of the United States by focusing on where the principal risk and actions of the purchase or sale take place,” the regulators said in the draft proposal.
Agency staff said roughly half of the 18 largest banks that would be categorized as having “significant” trading operations are foreign banks.