Regulators are poised to issue a major financial regulation to limit banks’ risky trading, finalizing one of the largest outstanding rules from the 2010 Dodd-Frank Wall Street reform bill.
Financial regulators from five different agencies are scheduled to review the Volcker rule this week and approve what many believe will be tough standards limiting banks’ ability to make profits off of their trading and fund investments.
For supporters of financial reform, the rule has been a long time coming.
“I think the types of firewalls that it puts in place are really important to protecting our economy and protecting taxpayers as long as we have institutions that are too big to fail,” Center for American Progress vice president for government affairs Tamara Fucile said. “I think we need protective firewalls in place.”
All five agencies are required to approve the regulation.
The rule, named after former Federal Reserve Chairman Paul Volcker, prohibits banks from investing with their own money for profits in what’s known as proprietary trading, and limits investments in hedge funds and private equity funds.
Financial institutions worry it could blunt their bottom lines, which would send ripple effects throughout the market.
“Absolutely this is a game-changer for the markets,” said Richard Foster, the head of the Financial Services Roundtable’s regulations department. “This is a sea change.”
The rule’s language has not been made publicly available ahead of the votes, and many financial industry officials were hesitant to discuss the rule openly before the final product is unveiled.
Ahead of this week’s votes, Treasury Secretary Jacob Lew said the product of years of haggling over the Volcker rule was tough but fair.
“Regulators have worked hard to find the right balance that protects our economy and taxpayers while also leaving room for well-functioning financial markets that fuel growth and help the private sector create jobs,” Lew said during a speech last week.
Lew contended the final regulations would accomplish the goal laid out in Dodd-Frank: to keep banks from gambling with taxpayers’ money.
“Rule-writers will soon put forward a tough Volcker Rule that I expect to be true to President Obama’s vision and the statute’s intent,” Lew said.
However, as details of the rule leaked out in recent days, concerns mounted in the financial industry. By all accounts, the rule to be issued this week is significantly more restrictive than a draft issued two years ago, which industry groups opposed at the time.
“This rule came out and it struck us as fairly difficult complex and unworkable in its proposed version,” said Anthony Cimino, the head of government affairs at the Financial Services Roundtable. “This was something that we would oppose from the beginning and it’s only become worse as they’re getting more strict on it."
Some within the financial sector contend that toughened restrictions would raise banks' cost of doing business and potentially have unintended market consequences.
"By ceasing proprietary trading, you're reducing the liquidity of markets,” said Don Lamson, a longtime OCC official who helped draft the initial language during a stint at the Treasury Department. Lamson is now a partner at Shearman & Sterling’s Financial Institutions Advisory & Financial Regulatory Group.
Outgoing CFTC Chairman Gary Gensler and new SEC Commissioner Kara Stein have been some of the most vocal supporters of a tougher new rule, which is believed to have nearly doubled from its 2011 draft to some 950 pages.
The rule was originally set to take effect last July, but was pushed back to accommodate regulators’ continuing negotiations. Earlier this year, the Obama administration set an end-of-the-year deadline for the rule.
Among the reported toughened provisions is a clampdown on so-called “portfolio hedging,” a risk-limiting practice that was used in JP Morgan’s notorious “London Whale” debacle in which the bank lost more than $6 billion.
“I think there will be areas where they have probably tightened things because of the London Whale for instance,” a former financial regulator told The Hill. “I suspect there are other areas where they took the comments, the various commenters into account, and thought ‘We could do it that way, that would make more sense.’”
In November, Federal Reserve Governor Daniel Tarullo said that “one of the key mandates” for the agencies writing the rule was to ensure that the incident “couldn’t happen again.”
But barring banks from taking measures to cut risk would have adverse impacts on the financial industry that would extend to the broader economy, critics worry.
"If you're not hedged, it means you have to charge higher prices to your consumers,” Lamson said.
Organizations like the U.S. Chamber of Commerce have also worried that they have not been able to comment on changes made to the text since it was first proposed in 2011.
The regulations to be issued Tuesday will be in final rule form, but regulators will still need to implement the requirements, and banks will have until the summer of 2014 to comply.
That remaining time could expose the regulation to court battles or even possible legislative fixes, if industry groups and their supporters find it especially unpalatable.
Reform advocates are pledging to stay engaged until the regime is completed.
“It certainly is not game over on Tuesday,” Fucile said. “It’s the beginning of the next phase.”