If the banking industry has its way, regulators would give financial institutions so many exceptions from the Volcker Rule's limits on risky activities that it might as well not exist at all.
In comment letters to regulators studying how to implement the rule, banks are seeking laundry lists of carve-outs, including broad exceptions from what is considered proprietary trading and greater freedom to invest in private-equity firms and hedge funds.
Though banks lost the battle in Congress to prevent the Volcker Rule's inclusion in regulatory reform, the letters make it clear many are hoping to win the war as regulators implement its restrictions.
Some in the business community are hoping regulators will ignore the rule altogether.
"The implementation issues presented by the Volcker Rule may create a system that is too rigid for vibrant, dynamic capital markets," wrote David Hirschmann, the president and CEO of the Chamber of Commerce's Center for Capital Markets Competitiveness. "The CCMC has serious concerns that the Volcker Rule is unworkable and will harm the U.S. financial services sector because it will place American firms at a competitive disadvantage."
The length and breadth of the exceptions being sought run the gamut.
Many banks are targeting the definition of "proprietary trading," which is meant to cover trades that are made for the benefit of the bank, not a customer. But some are also seeking to widen exemptions already granted under the law. The Dodd-Frank Act bans proprietary trading but makes exceptions for the trading of government obligations, activities related to underwriting and market-making, risk-mitigating hedging, insurance activities and Small Business Administration small-business investment company investments.
The industry is also trying to broaden the exemptions from a ban on investments in private-equity firms and hedge funds. Under the law, banks are allowed to own as much as 3% of the interests of a fund, with an overall cap that cannot exceed 3% of a bank's Tier 1 capital. But banking companies like Bank of New York Mellon, Northern Trust and State Street are focused on exemptions from the requirement for trustee services or custodial activities.
The Volcker Rule's defenders clearly anticipated the onslaught of industry comments. Former Federal Reserve Board Chairman Paul Volcker has warned regulators to be careful as they write the rules and not to be overly swayed by bankers' complaints.
"Clear and concise definitions, firmly worded prohibitions, and specificity in describing the permissible activities will be of prime importance for the regulators as they implement and enforce this law," wrote Volcker. "Bankers and their lawyers and lobbyists will no doubt search for and discover ambiguities within the language of the law."
Lawmakers, meanwhile, are taking sides. Sens. Jeff Merkley, D-Ore., and Carl Levin, D-Mich., who pushed to include the Volcker Rule in the Dodd-Frank bill, urged regulators to reject banks' arguments to weaken it before it is even implemented. They were backed by Sen. Tom Udall, D-N.M., who said regulators should create clear, concise definitions to avoid ambiguity.
"Without strong definitions of permitted activities, it will only be a matter of time before unscrupulous actors return to perilous trading practices," Udall wrote. "Any implementation will be futile without the creation of enforceable guidelines, including clear oversight responsibilities among regulators."
But other lawmakers pushed for certain exemptions. Sen. Tom Harkin, D-Iowa, for example, said regulators must not target insurance investments as part of the proprietary trading ban; these are not risky investments, he argued.
"So long as those separate accounts are managed for the benefit of those programs and the insurance company's customers, then it seems that these activities may be appropriately protected by the permitted activity allowing for investments 'on behalf' of customers, regardless of whether the insurance company is technically the 'owner' of the assets of the account," Harkin wrote.
Bankers generally were focused on how regulators would define "proprietary trading" and on key exemptions already in the law.
The Clearing House Association LLC, a group of commercial banks, called for several products to be exempted from the ban, including the purchase and sale of loans, portfolio hedging, asset and liability management, trading in loans and loan participations, securities not treated as trading securities under generally accepted accounting principles, agency trades, riskless principal trades and any other trade initiated for a customer.
The association also argued for expanding the existing market-making and hedging exceptions in the law.
"It is apparent from the text of the statute that Congress intended for this authorization to be interpreted and implemented broadly," wrote Joseph Alexander, a senior vice president and deputy general counsel at the Clearing House. "Had the intent been otherwise, the statute would have limited the activities permitted to 'market making,' as opposed to the broader 'market-making-related' activities."
The exempted market-making activities should include letting banks provide firm or indicative prices to customers on securities, building inventory or warehousing positions, taking positions in anticipation of customer demand, managing and assuming basis risk between customized risks and engaging in arbitrage to create liquidity for clients.
The Financial Services Roundtable had more suggestions, such as permitting underwriting activity, loan trading, principal trading permitted by other banking laws, insurance company investment activities, venture capital funds, public welfare investments, traditional financings and acquisition, securitization and similar activities.
The group asked regulators to interpret the Volcker Rule with "restraint."
"As a general matter, we ask the [Financial Stability Oversight Council] to recommend that the most appropriate way to reflect these and other important distinctions is not by writing detailed regulations that attempt to delineate precise boundaries for permitted and impermissible activities but by requiring covered banking entities to develop and implement appropriate policies and procedures that are conducive to market-making-related and hedging activities rather than prohibited proprietary trading activities," wrote Richard Whiting, the group's executive director and general counsel.
In their letter, Merkley and Levin opposed broadly defining market-making activities; they defined them as activities in which "a firm acts to provide liquidity to clients, customers or counterparties, while simultaneously seeking to avoid any long or short exposures to the instruments it is trading. The goal of a true market-maker is to provide clients with buy and sell opportunities without incurring substantial risk."
The senators argued that timing is the key to distinguishing market-making.
"If a firm allows a position on its books for more than a brief period … , the activity loses its character as a market-making activity aimed at facilitating client trades and instead becomes a proprietary investment," Merkley and Levin wrote.
"A firm is clearly acting as a market-maker only when it takes a long or short position for a relatively brief period … and, during the holding period, takes appropriate steps to limit its exposure to price changes in the instrument, both up and down."
But Randolph Snook, executive vice president at the Securities Industry and Financial Markets Association, or Sifma, said it is not so easy to define many parts of the Volcker Rule, even including what constitutes a hedge fund or private-equity firm.
"The [Securities and Exchange Commission] and other regulatory agencies have never been able to agree upon precise definitions for hedge funds and private-equity funds," Snook wrote. "It is virtually impossible to define a moving target with a static definition."
The American Bankers Association Securities Association is hoping to add more to the list of permissible principal activities, to include trading in government securities, long-held investments and capital investment transactions, portfolio and macro hedging activity and positions in connection with market-making. Just to be safe, openings for future exemptions should be provided, the group said.
"Finally, ABASA recommends that the FSOC recommend that a process be established for the Federal Reserve to provide exemptions from all or part of the Volcker Rule, consistent with the intent of that rule, so that there is a mechanism to address readily any unintended application of the rule, in order to facilitate the orderly functioning of the markets affected by the rule," wrote Carolyn Walsh, the ABA securities group's deputy general counsel.
E. William Parsley, the treasurer of PNC Financial Services Group and one of the few bankers who commented for the study, said proprietary trading is not a phrase that is easily defined.
"The primary purpose of such trading is not the generation of profits but rather the mitigation of risk," Parsley said. "Any such profits or losses are purely incidental. The use of bank funds to make these trades and the likelihood of profits or losses should not by itself be seen as representing undue risk to a bank nor as adversely impacting its safety and soundness."
In a joint letter, Bank of New York Mellon, Northern Trust and State Street focused on exemptions for investing in hedge funds and private-equity firms, requesting carve-outs for trustee services or custodial activities.
"Preventing banks from offering normal banking services in connection with directed trustee services to funds would be highly disruptive, particularly for pension plan sponsors and beneficiaries, and could undermine the competitiveness of U.S. custodial banks," wrote Jane Sherburne, the general counsel and senior executive vice president at Bank of New York Mellon Corp.; Kelly Welsh, an executive vice president and general counsel at Northern Trust Corp., and David Phelan, the general counsel and an executive vice president at State Street Corp.
The American Bankers Association even had concerns about the scope of regulators' plan to define a "banking entity" for the purpose of the ban.
"The inclusion of the term 'affiliate,' which includes subsidiary as defined in the Bank Holding Company Act, implicates a group of entities that is significantly broader than the term 'banking entity' itself would suggest," wrote Lisa Bleier, a vice president and senior counsel in the Center for Securities, Trust and Investments at ABA. The 3% de minimis allowance for investments in hedge funds and private equity also dissatisfied some bankers.
Parsley of PNC said the 3% allowance level is simply too low.
"We do not see this exemption as providing meaningful opportunities for many banks to make any investments at all in this asset class," he wrote.
This story has been reprinted with permission from American Banker.
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Corrected November 19, 2010 at 10:01AM: yes