03.29.2017
By Rob Daly

Volcker Rule Scrutinized

Without proof of the rule’s success, representatives from industry associations, academia, and think tanks testified before the Subcommittee on Capital Markets, Securities, and Investments of the House Financial Services Committee that the controversial Volcker Rule should be tweaked, if not replaced entirely.

“There are other ways in which risk taking can be regulated,” noted Charles Whitehead, professor of law, technology and entrepreneurship at Cornell University. “A robust focus on risk-based capital requirements, designed to boost the amount of loss-absorbing common equity within a financial firm, may be the more appropriate tool,” he said.

Ronald Kruszewski, chairman and CEO of Stifel Financial Corp. and who spoke on behalf of Securities Industry and Financial Markets Association, suggested that regulators could make two changes to the 950-page Rule to make it more palatable to the markets.

His first revision would be to reverse the Rule’s language so that regulators should not consider all trades as proprietary until they are disproved by the firm. Second, he would delete vaguely worded and undefined terms, such as “a reasonable expected near-term demand” as defining the necessary threshold for market making.

“Seven years after the enactment of Dodd-Frank, I am no closer to understanding what that term means or how to implement something so amorphous,” Kruszewski added. “The ability to provide market liquidity requires an anticipation of supply or demand, which if proven wrong with the benefit of hindsight, would violate the Volcker Rule.”

The non-transparent manner in which the five government agencies gather quantitative data used to enforce the Rule has also has raised the concern of many.

The regulators have been collecting that data since July 2014, a year before the Rule’s effective date, noted Whitehead.

Charles Whitehead,
Cornell University

“When adopting the Final Rule, the regulators committed to ‘evaluate the data collected during the compliance period both for its usefulness as a barometer of impermissible trading activity and excessive risk-taking and for its costs,”’ he said. “To date, the regulators have not announced the status of any analysis or any results, nor have they commented on how the data may be used to enforce compliance with the Rule.”

In the meantime, the Rule continues to regulate risky trading behavior in the wrong fashion, according to Kruszewski.

“I do not believe the way to regulate risk, systemic or otherwise, is by inhibiting trading or traditional market making, which provides liquidity and depth to our capital markets, but rather through capital and liquidity rules addressing the balance sheet of our financial institutions,” he explained.

Kruszewski also stated that the markets have now had enough experience with the Rule to reasonably conclude that “its existence has needlessly impeded beneficial market functions without producing any measurable improvement to the safety of our systems.”

Yet, ranking subcommittee member Rep. Carolyn Maloney (NY-D) remained unconvinced during the hearing.

In her opening statement, the member of Congress cited in her opening statement the first hard data from the Federal Reserve that demonstrated that market-making activities did not disappear under times of stress and that there was no evidence that banks are engaging in a significant amount proprietary trading.

“Bank trading desks are now making the vast majority of their money from legitimate market-making activities, and not from inappropriate proprietary trading,” she said. “The data also show that the Volcker Rule has not caused banks to pull back from market-making activities, even during periods of market stress. This is exactly what Congress intended.”

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