By Rob Daly

Fed Hints at Volcker Reform

Federal Reserve Chairperson Janet Yellen raised a trial balloon for tweaking The Dodd-Frank Act’s Volcker Rule during her speech on the first day of the Fed’s annual conference in Jackson Hole, Wyoming.

Acknowledging the concerns that market participants have regarding transacting credit trades, such as in corporate bonds, in volume and at low costs, she noted that the corporate bond market is robust currently.

Janet Yellen,
Federal Reserve

“The healthy condition of the market is apparent in low bid-ask spreads and the large volume of corporate bond issuances in recent years,” she said.

Yellen also noted that the corporate bond market liquidity is in the midst of a change as larger dealers continue to abandon the principal business model in favor an agency model.

As a result of the market’s evolution, the Fed is unsure whether the algorithmic traders and institutional investors who provide a growing amount of liquidity to the market would be willing to contribute liquidity during times of market stress, according to Yellen

“While no single factor appears to be the predominant cause of the evolution of market liquidity, some regulations may be affecting market liquidity somewhat,” she said. “There may be benefits to simplifying aspects of the Volcker rule, which limits proprietary trading by banking firms, and to reviewing the interaction of the enhanced supplementary leverage ratio with risk-based capital requirements.”

At the same time, Yellen stated that the new regulatory framework overall has made dealers more resilient to shocks, which tempers an important historical driver of market illiquidity.

She quickly set expectations when she stressed that “any adjustments to the regulatory framework should be modest and preserve the increase in resilience at large dealers and banks associated with the reforms put in place in recent years.”

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