After the U.S. Securities and Exchange Commission received more than 15,000 comment letters asking for revisions and clarification, the proposed Volcker rule will likely be delayed from its July 21 deadline, although no official announcement has been made. The brokers want changes to the rule's language regarding what are permissible market-making activities as well as what metrics are to be used to measure compliance.
James Brigagliano, partner in the securities and futures group at law firm Sidley Austin LLC and former deputy director of the Division of Trading and Markets at the SEC, says that broker-dealers want changes to the rule that would make it easier for them to do business and conduct the customer-oriented businesses the statute endorses—like underwriting and market making. He expects regulators to make modifications in the coming months.
"We are likely to see the timetable for Volcker rule's completion further extended," Brigagliano says, noting the SEC wants more time to analyze and incorporate input from comment letters. The SEC historically has focused on how the business of trading is conducted, not on what trading businesses are allowed, he says.
The Volcker rule, named for Paul Volcker, the former Federal Reserve Chairman and former chairman of the Economic Recovery Advisory Board under President Obama, seeks to limit risky trading practices by banks. Such practices are believed to have contributed to the financial crisis of 2008.
The final Volcker Rule included in the Dodd-Frank Act prohibits banks from proprietary trading and restricts investments in hedge funds and private equity by commercial banks and their affiliates.
However, the rule exempts certain activities of banks, their affiliates and non-bank institutions identified as systemically important. These would include market making, hedging, securitization and risk management.
"Volcker is a different kind of animal," Brigagliano says of the rule. The SEC, he says, normally focuses on preventing market manipulation and transparency. The rule strays from that focus and into restricting the ability of banks to conduct certain activities, such as prop trading. That has spurred the brokerage industry into action. First, the brokers want more generous language that would allow market making-related activities, which would be broader than the current rule permits on making markets.
"The agency model is used in equities and doesn't always work," says one bulge bracket executive. "This model really doesn't work in fixed income at all. We want broader latitude in making markets."
The executive also says his firm wants to see a clearer definition of what constitutes proprietary trading. That is, broker-dealers want a broader interpretation of the rule so they can build up inventories and hold them longer than 60 days. Under the rule's current language, holding a position for more than 60 days is considered proprietary trading.
The brokers are also looking for more latitude in how they hedge positions. As written now, the rule says once a brokerage carries a position, they must be hedged with a near exact instrument on a one-for-one basis. This makes it harder and more costly for the brokers to carry positions, another brokerage executive says. "It's going to be very hard to find similar size hedges for positions that have a similar yield and duration," the executive adds.
Finally, the brokerage industry wants simplicity in the compliance process in meeting the rule's mandates, Brigagliano says. In its current form, the rule requires brokers to perform upwards of 17 separate tests to measure compliance in some instances. "Brokers hope to pare this back to a more manageable and less costly number," he says. "Also, the metric used to measure compliance would be more asset class specific-so equities trading can be measured by benchmarks that best measure equities and not, say, fixed income."