02.01.2012
By Terry Flanagan

Volcker Rule Exemptions Sought

Canada’s government and financial institutions say rule in present form would seriously impact financial stability.

The financial sector in Canada is mounting a full-court press on U.S. regulators to scale back proposed restrictions on proprietary trading, commonly known as the Volcker Rule.

The Volcker Rule, as proposed by federal banking regulators and the SEC, prohibits banking entities from engaging in prop trading, i.e., in trading for their own account.

The proposed rule, whose comment period expires on Feb. 13, 2012, implements exemptions for underwriting and market making-related activities. For each of these permitted activities, the proposed rule provides a number of requirements that must be met in order for a banking entity to rely on the applicable exemption.

The Volcker Rule is an especially acute concern for Canadian banks and the Canadian
financial system more broadly given the deep inter-linkages that have existed for many decades between the Canadian and U.S. financial sectors.

Canadian financial institutions use U.S.-owned infrastructure to conduct financial transactions in support of their market-making activities in Canada, and in their risk management activities more broadly in support of their Canadian and U.S. banking operations.

Canada’s five largest banks—BMO Financial Group, Scotiabank, CIBC, RBC, and TD—collectively manage more than C$527 billion in Canadian mutual funds, hedge funds and segregated account mandates. Of the C$773.7 billion Canadian public fund industry, the banks sponsor and manage approximately C$321 billion.

The banks are urging U.S. authorities to exclude Canadian public funds from the Volcker Rule.

The Volcker Rule, as enacted, excludes funds registered for public sale in the U.S. under the Investment Company Act, but fails to provide a similar exclusion for Canadian public funds.

In the absence of such an exclusion, the Volcker Rule would have unintended extraterritorial effects that would seriously disrupt the market for Canadian public funds.

“Canadian public funds are managed differently here than the U.S., and represent varying proportions of each country’s wealth,” Renee Colyer, president of Forefactor, told Markets Media. “Smaller markets are hurt more by sweeping regulations that consider the U.S. market micro-structure only.”

Such effects include forcing Canadian public funds to exclude all investors who might now or in the future be resident in the U.S., in particular “snowbirds” and other temporary residents who are not U.S. citizens.

The Volcker Rule would also make it more expensive for the Canadian government and provinces to borrow money.

Ontario, for example, borrowed $2.6 billion dollars in the domestic bond market during the second half of January, according to the Ontario Financing Authority. Ontario is a frequent issuer in the U.S. market; its commercial paper, notes and bonds are purchased by U.S. investors.

Under the proposed Volcker Rule, Canadian banks with branches or affiliates in the U.S. may be prevented from purchasing Canadian federal and provincial government bonds for their own account, thereby reducing Ontario’s access to capital, the Authority said.

Also, restrictions on proprietary trading would negatively affect the liquidity for Canadian bonds in the secondary market. The present draft of the Volcker Rule contains an exemption for U.S. Treasury and municipal bonds which has not been extended to other foreign government obligations.

This has implications for Canadian banks operating in the U.S. or with U.S. affiliates who will be limited in their ability to buy and trade Ontario’s bonds.

Ontario therefore is requesting that U.S. agencies adopt an exemption for Canadian government obligations, which would apply to short-term and long-term government debt and cover both U.S. and non-U.S. banking entities.

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