Fears Grow Over Volcker Rule Interpretation

Terry Flanagan

The capital markets are pushing hard against the Volcker Rule, arguing that it stifles productivity and raises uncertainty.

“Regulators have reserved unto themselves the right to examine our plans to determine if we’re making an effort to comply,” said Stephen Norman, chief information officer, markets, at Royal Bank of Scotland, at the Bloomberg Enterprise Technology Summit in Manhattan on May 10.

“We are implementing Volcker Rule compliance processes because we may never know when the regulators will come calling. It creates a very uncertain environment.”

The arguments being made from within the markets against the Volcker Rule, which prohibits banks from engaging in proprietary trading and imposes restrictions on investments in hedge funds and private equity firms, are in sharp counterpoint to those made from outside the markets in its favor.

Proponents of the Volcker Rule say the disclosure by J.P. Morgan of a $2 billion trading loss underscores the need for the Volcker Rule.

Market participants, however, remain spooked by what they say is a lack of clarity around the extraterritorial applicability of the Volcker Rule.

“There’s lots of uncertainty over who is impacted,” said Norman, who proceeded to provide some hypothetical examples.

“If an RBS branch in London were to trade euro swaps with a German client and report that trade, as we do today, to the DTCC [Depository Trust & Clearing Corp., a U.S.-based post-trade company], does that mean the trade comes under the Volcker Rule?”

“Or if we clear through LCH.Clearnet [a clearing house based in London], which has a U.S. affiliate, does the transaction come under the Volcker Rule?” Norman said. “The complications are quite profound.”

The Volcker Rule presents also significant risks for the buy side.

Depending on how the rule is implemented and enforced, it could result in materially lower liquidity in bond and stock markets and potentially less efficient and more expensive trades.

“Equity traders are less concerned,” Paul Haaga, chairman of Capital Research and Management, a Los Angeles-based investment fund, said at the Investment Company Institute General Membership Meeting on May 10 in Washington. “Fixed income traders are extremely concerned.”

Ronald O’Hanley, president of asset management and corporate services at Fidelity Investments, said: “We have spent as much time on the Volcker Rule as we have on any [other piece of developing regulation].”

Liquidity in fixed income markets has been waning since around 2008, and with the Volcker Rule looming, “we worry this will continue”, O’Hanley added.

Although the effective start date for the Volcker Rule remains July 21, the Federal Reserve issued a statement last month that it will interpret the rule to afford banking entities the full two-year period provided by the statute to conform their activities and investments to the rule’s prohibitions and restrictions.

That’s hardly a ringing endorsement of clarity, however.

“The Federal Reserve has not given any indication whether it may extend this period,” according to a client memo by law firm Shearman & Sterling. “Any gratitude it has earned may soon turn to impatience. It will only be a matter of time until we hear calls for additional clarity.”

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