WASHINGTON — As regulators meet Friday to discuss ways to streamline a Dodd-Frank Act rule barring banks from proprietary trading, analysts are questioning whether the reforms on the table are likely to bring significant benefits to institutions.
The Financial Stability Oversight Council, a multiagency body overseen by the Treasury Department and charged with identifying and mitigating sources of systemic risk, is slated to meet in a closed session in the afternoon to discuss Treasury’s recommendations concerning the so-called Volcker Rule, among other matters. The council has met twice since Treasury Secretary Steven Mnuchin took office in January, but Friday’s meeting is the first that has named the Volcker Rule specifically as part of the agenda.
Though individual regulators have pledged to ease Volcker Rule enforcement on their own if necessary, using the FSOC to simplify the rule makes sense, analysts said, since six agencies were responsible for writing and enforcing it.
“The FSOC is going to become the coordinating body for deregulatory action for the Trump administration,” said Isaac Boltansky, an analyst for Compass Point Research & Trading. “Changing the Volcker Rule has to happen in a coordinated fashion, and the best body for that is the FSOC.”
Mnuchin reiterated Thursday that revamping the Volcker Rule is at the top of his priority list.
“I think the biggest problem with the Volcker Rule is its complexity and regulatory overlap,” Mnuchin told the House Financial Services Committee. “Even if it is our intent not to have proprietary trading within banks, we need to make sure that bank understand how the regulation works.”
Ever since former Federal Reserve Chairman Paul Volcker lent his name to the idea of barring banks from engaging in proprietary trading, regulators have been struggling with how broadly to apply that principle.
Banks had begun winding down their proprietary trading desks and positions well in advance of the rule’s ultimate enactment in December 2013. But uncertainty about what counts as proprietary trading and what doesn’t has dogged banks for years — particularly as it applies to market making, seed funding, position hedging and new products.
That uncertainty is widely acknowledged. During Thursday’s hearing, Mnuchin cited a joke by JPMorgan Chase CEO Jamie Dimon that trading desks need “a psychiatrist and a lawyer” to be able to determine whether their activities might violate the Volcker Rule. Federal Reserve Gov. Jerome Powell, who chairs the agency’s supervisory committee, similarly said in January that the rule requires supervisors to “look into the mind and heart of every trader on every trade to see what the intent is.”
Even former Fed Gov. Daniel Tarullo, who headed the central bank’s supervisory committee during the Obama administration and was a driving force behind much of the post-crisis regulatory structure, acknowledged in his farewell address earlier this year that the rule was “too complicated” as it was envisioned.
“The hope was that, as the application of the rule and understanding of the metrics resulting from it evolved, it would become easier to use objective data to infer subjective intent,” Tarullo said. “This hasn’t happened, though. I think we just need to recognize this fact and try something else.”
Yet it remains unclear what exactly regulators can do, or whether those changes will go far enough for the banks.
Fed Chair Janet Yellen has lent her support to a handful of changes — specifically an exemption for community banks — but has not been explicit about where she thinks the asset threshold should be to define which institutions would benefit from that exemption. She also said during her testimony before the Senate Banking Committee earlier this month that implementation of the rule has been “complex and burdensome,” but believed the issues could be solved between banking regulators.
“We look forward to working with the other agencies that have a role in rule writing. It’s a very complex rule … but I think we could find ways to reduce the burden, and it should be a multiagency effort," she said.
Chris Cole, executive vice president and senior regulatory counsel for the Independent Community Bankers of America, said the compliance burden for community banks is somewhat haphazard, since small banks generally do not have a great deal of bright-line proprietary trading activities to speak of. Volcker compliance issues tend to come into play when those small banks hedge against interest rate risk, he said.
“It depends on many factors, but sometimes it can be a significant burden if examiners are questioning whether this is a true hedge or not,” Cole said. “I have not heard any actual exam criticisms because of Volcker, but ... it is part of the checklist that the examiners look at when examining the bank, and if they see Interest rate hedging that can be an issue.”
Wayne Abernathy, executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association, said there appears to be widespread understanding that the kinds of behaviors that the Volcker Rule is meant to prevent — namely excessive risk-taking on proprietary accounts — are only truly relevant for banks whose activities can have a systemwide impact.
There is still debate about how to distinguish a systemically risky bank from a bank that poses no risk, he said, but clearly banks under $10 billion of assets would qualify under any measure, and that is where regulators are likely to start.
“I think there’s a really strong consensus, although expressed in different words, in applying Volcker only where there is systemic risk,” Abernathy said. “How that forms into what is actually done remains to be seen, but I would be surprised if something weren’t done sooner rather than later.”
But Dan Ryan, banking and capital markets leader at PricewaterhouseCoopers, said that while regulators could tailor their enforcement and supervisory approaches toward smaller institutions, without a change to the law it would be impossible to exempt them from the Volcker Rule entirely.
"The regulators could certainly change the timing and level of enforcement, but those banks are still required to comply with the rule,” Ryan said. “They may be able to drive 75 in a 55, but the sign will still say 55."
A Treasury Department blueprint released in June outlines a handful of changes that would affect the Volcker Rule — some are regulatory, while others would require congressional approval. PwC issued a report this week suggesting that not all of those suggestions are equally beneficial to banks — or equally likely to being enacted.
Ryan said the prospects of a regulatory off-ramp or a broad renegotiation of the Volcker Rule is fairly unlikely. That is in part because those moves would probably require Congress to pass a law and partly because the fairly recent experience of the “London Whale” — a roughly $2 billion loss at JPMorgan that was traced to a single trader — greatly informed the way the Volcker Rule was written and implemented.
“The London Whale really changed the way regulators went about implementing and drafting the Volcker Rule,” Ryan said. “Memories are pretty long around how much runway the biggest guys will get, so we wouldn’t see them escaping this. That’s the least likely path … and most of them have made the adjustments to live with that.”
The PwC note examines eight separate recommendations in the Treasury report: simplifying the proprietary trading definition; easing the burden of hedging; reducing compliance burdens; improving coordination among agencies; increasing flexibility for market-making; simplify covered funds restrictions; exempting smaller institutions; and enacting a regulatory off-ramp for highly capitalized banks.
Of those policy suggestions, the PwC report identifies the ones most likely to be enacted and that carry the biggest bang for the buck as the definition of proprietary trading, simplifying hedging and reducing compliance costs. Ryan said some of the other ideas, such as a regulatory carve-out for small banks, may have broad support but are unlikely to get a bill passed in Congress.
But Ryan said that though the administration is likely to make a grand demonstration of rolling back the Volcker Rule, the banks that are most affected have already moved on from seeking substantial changes to the law.
“I think the regulators and the administration are going to want to show a win here, so they will make a big deal out of the rollback,” Ryan said. “On the other hand, I don’t think that behind the scenes it’s going to make as much of a splash, in terms of what the banks do day in and day out. I don’t think it’ll have as much as an impact as the headlines will draw.”
Boltansky said there is virtually no way of quantifying the benefits of a particular change to the Volcker Rule. There are several reasons of that — for one, banks have different business models, so a change that benefits one model might do nothing for another. Another reason is that much of the marginal benefits will be known only to the banks themselves and their supervisors, so there would be no provable benefit to any given bank, but rather the presumption of benefit.
The most significant benefit banks are likely to enjoy will be any changes in the market’s attitude about regulators’ supervisory approach, which is hard to confine to Volcker alone. And in that case, Boltansky said, as with other administration promises, the expectations may outrun the real deliverable changes.
“Market forces are going to be more impactful than any of the marginal changes in the Volcker Rule that we expect,” Boltansky said. “Whether it’s tax, whether it’s reg relief, whether it’s infrastructure, any of them — what they will get will be less than what they expect, and it will be later. If they get it at all.”