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Regulators Approve Volcker Rule, the Core of Dodd-Frank

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After three years of collaboration, five regulators on Tuesday approved the Volcker Rule, 100-plus pages of rules and regulations at the center of the Dodd-Frank financial reform law. The Volcker Rule primarily prohibit banks from engaging in proprietary trading as well as owning, sponsoring, or having certain relationships with a hedge fund or private equity fund.

The rule was adopted jointly by the Federal Reserve Board, the Federal Deposit Insurance Corp., the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Commodity Futures Trading Commission.

The Fed and FDIC unanimously voted to adopt the rule, while the SEC passed it by a 3-2 vote. The two Republican SEC Commissioners Michael Piwowar and Daniel Gallagher voted against the rule. Piwowar, who joined the agency in August, told CNBC at the ICI Global Trading and Market Structure Conference in London recently that he would vote against the proposed rule in its current form. “The devil’s in the detail,” he told CNBC. “The question for me has always been: How do you define the terms?”

All five agencies proposed the same common rules in 2011 and 2012. Those proposals generated more than 18,000 comment letters.

President Barack Obama on Tuesday said the final rule, as part of Wall Street reform, “makes sure big banks can’t make risky bets with their customer’s deposits” by making “it illegal for firms to use government-insured money to make speculative bets that threaten the entire financial system, and demand a new era of accountability from CEOs who must sign off on their firm’s practices.” He encouraged Congress to provide the regulators with adequate funding to “effectively and efficiently” implement the rule.

SEC Chairwoman Mary Jo White said in a statement that the Volcker Rule “is central to the framework put in place by the Dodd-Frank Act to promote the financial stability of the United States in the wake of the financial crisis.”

To carry out the mandate of Section 619 of the Dodd Frank Act, “the final rule seeks to focus U.S. banks and their affiliates on customer-directed activities, and to prevent the risks to U.S. taxpayers that can flow from proprietary trading and investments in private funds,” White said. The final rule “has been written to carry out these objectives while maintaining the strength and flexibility of the U.S. capital markets by allowing both domestic and foreign financial firms to continue to participate meaningfully in those markets where they are permitted to do so.”

Senate Banking Committee Chairman Tim Johnson, D-S.D., released a statement that approval of the Volcker Rule was “a key milestone in the full implementation of Wall Street reform,” adding that these trading restrictions “will help improve the integrity of our banking system.”

The final rules become effective April 1, 2014, however the Fed has extended the conformance period until July 21, 2015. The rule will apply to large bank holding companies but not to community banks with less than $10 billion in assets that don’t participate in activities listed under the rule.

Like the Dodd-Frank Act, the final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, insurance company activities, and organizing and offering hedge funds or private equity funds. The final rules also clarify that certain activities are not prohibited, including acting as agent, broker or custodian. The compliance requirements under the final rules vary based on the size of the banking entity and the scope of activities conducted. ”Banking entities with significant trading operations will be required to establish a detailed compliance program and their CEOs will be required to attest that the program is reasonably designed to achieve compliance with the final rule,” according to the SEC. Independent testing and analysis of an institution’s compliance program will also be required.

As White explained, the final rule “faithfully and strongly implements the statutory prohibitions on proprietary trading by U.S. banks and their affiliates and the limitations on the ability of such entities to sponsor or invest in hedge funds or private equity funds, called ‘covered funds’ in the rule.”

As to market making and underwriting, White said the rule “takes a measured, tailored approach to market making and underwriting activities as statutory exceptions to the prohibition on proprietary trading.” Permitted market making activities, she said, “can include trading in a wide variety of financial and derivative instruments, including those for which there is relatively limited liquidity, but only provided the firm is ready, willing, and able on request to provide quotes and respond to trading interest on both sides of the market.”

The prohibition on proprietary trading does not apply to all transactions entered into by a foreign bank and its foreign affiliates. “The final rule will permit these entities to engage in certain limited proprietary trading activity with U.S. firms, but only if the risks of such trading activity are held and managed outside the United States,” White said. “Foreign banks will, for example, be able to conduct cleared transactions through U.S. exchanges and with unaffiliated, regulated U.S. market intermediaries, she explained.

As to the scope of covered funds, the final rule also fulfills the statutory goal of limiting the ability of U.S. banks and their affiliates to sponsor or invest in hedge funds and private equity funds. “The Dodd-Frank Act defined a ‘hedge fund’ and ‘private equity fund’ by reference to regulatory exemptions that are commonly used by such funds,” White said. “The proposal carried forward this definition of a “covered fund,” and included certain commodity pools and foreign funds as well.”

But White said that adoption of the final rule is just the beginning. “Our work… does not end with today’s rule. We begin a new phase of monitoring and responsive engagement to ensure that the Volcker Rule is a strong, workable framework that achieves the objectives set for us.”

Consistent with the agency’s experience in other rulemakings, she said, “questions will arise following today’s action, some of which will require clarification. We must be alert to both unintended impacts and regulatory loopholes as we move forward.”


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