Updated Friday, September 4, 2015 as of 9:12 PM ET

Volcker Rule Eases Market-Making While Hedges Face Scrutiny

(Bloomberg) -- Wall Street’s biggest banks will face curbs on some trading and chief executive officers won’t be personally responsible for ensuring compliance in the final version of the Volcker rule, U.S. regulators’ landmark attempt to rein in the financial industry.

The Federal Reserve, the Federal Deposit Insurance Corp. and three other agencies are set to sign off today on the proprietary trading ban, which has been contested by JPMorgan Chase, Goldman Sachs Group and their industry allies for more than three years. Agencies were proceeding with plans to release the rule in Washington even as a snowstorm forced the federal government to close.

Wall Street’s lobbying paid off in part. Regulators granted a broader exemption for banks’ market-making desks, on the condition that traders aren’t paid in a way that rewards proprietary trading, according to a draft of the final rule. The final version also exempts securities tied to foreign sovereign debt. At the same time, regulators gave banks less leeway for bets considered hedges for other risks.

“It prohibits risky proprietary trading while protecting economically essential activities like market-making,” Treasury Secretary Jacob J. Lew said last week. “Regulators have worked hard to find the right balance that protects our economy and taxpayers while also leaving room for well-functioning financial markets.”


The rule is named for Paul Volcker, the former Fed chairman credited with taming rampant inflation in the 1970s and who served as a top adviser to President Barack Obama. Volcker, 86, proposed the ban as a means of restoring stability to Wall Street following the 2008 financial crisis, arguing that banks that benefit from federal deposit insurance and discount borrowing shouldn’t be permitted to take risks that could trigger a taxpayer-funded government bailout.

The rule, enshrined by the Dodd-Frank Act of 2010, allows exemptions for market-making and some hedging, and defines limits for banks’ investments in private equity and hedge funds.

“This has got to be the most convoluted way to deal with a simple problem -- stopping banks from risking depositors’ funds,” said Satyajit Das, author of a half dozen books on financial risk. “Market-making will be a nightmare to define and police, as will hedging,” said Das, who is based in Sydney.

Bill Isaac, a former FDIC chairman who is chairman of Cincinnati-based Fifth Third Bancorp, said the rule will pinch revenue and income at the biggest banks and some regional lenders, limiting their ability “to fulfill the full range of needs of their largest and most consequential customers.”

“These companies will turn elsewhere for these services, including foreign banks and non-regulated firms,” Isaac said in an e-mail.


With Wall Street banks having already shut proprietary trading desks in anticipation of the rule, its impact rests largely in the fine print -- how regulators address other banking activities, primarily market-making and hedging.

The final version set for approval by the Fed, FDIC, Securities and Exchange Commission, Commodity Futures Trading Commission and Office of the Comptroller of the Currency sets parameters for how banks may buy and sell financial products for clients and manage their own risks in the process.

Wall Street’s five largest firms had as much as $44 billion in revenue at stake on the outcome of just one part of the debate -- how market-making is defined and exempted -- according to data for the year ended Sept. 30. JPMorgan, the biggest U.S. lender by assets, had as much as $11.4 billion riding on the answer.

What follows are summaries of five of the rule’s major provisions:


The Volcker rule bans banks including New York-based Goldman Sachs and Morgan Stanley from trading to profit for their own accounts, while allowing them to continue making markets for clients. Distinguishing between those two practices has been one of the most difficult tasks for regulators.

In the final draft, the regulators eased the criteria banks must meet to qualify for the market-making exemption. To receive the exemption, a trading desk must both buy and sell contracts or enter into both long and short positions of those instruments for its own account.

The trades must not exceed, on an ongoing basis, the “reasonably expected near-term demands of clients.” Further, the final draft also requires that compensation arrangements not be designed to reward prohibited trading.

Bankers became concerned about the rule’s potential to ban big parts of their business almost immediately after Dodd-Frank was passed in 2010. The 2011 draft included a list of criteria to be met for trading to be exempted as market-making.

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