Volcker rule ushers in era of increased U.S. oversight of trades

Fund Investments

The proprietary trading rule seeks to limit banks’ speculative bets in another way: by curbing their investments in private equity, hedge funds and commodity pools.

U.S. banks have already begun cutting their stakes, with further reductions needed to meet the law’s limit of 3% of Tier 1 capital invested in the funds. For example, Goldman Sachs cut its investment in such funds to $14.9 billion as of Sept. 30, down from $15.4 billion when Dodd-Frank was passed.

Regulators granted broader exemptions for some types of funds. Under the final rule, joint ventures, issuers of asset- backed securities and wholly-owned subsidiaries are among exempt funds.

In an effort to limit the provision’s impact, bank representatives told regulators too many types of investments were included in the 2011 proposal. The draft restrictions went beyond traditional private equity and hedge funds, they said.

Bankers argued that using such a broad definition would capture investment vehicles used when loans are bundled into securities, as well as commodity pools and funds based overseas. In a February 2012 letter to regulators, lobbying groups for the largest banks called the covered funds definition the “most far-reaching flaw” in the proposal.

CEO Responsibility

Apart from the specific limits on bank investments and trading practices, the Volcker rule includes efforts at changing part of the culture of trading on Wall Street.

The approach was underscored by a speech in Washington last week by Treasury Secretary Jacob J. Lew, who said executives in charge of financial firms need to ensure that the “tone at the top” reflects a strong desire to prevent violating the rule.

Toward that end, the rule has a section entitled “responsibility and accountability,” that details how banks should set up compliance programs. They must have written procedures and be approved by the board of directors as well as the senior management of the bank, according to the rule.

The board and top managers “are responsible for setting and communicating an appropriate culture of compliance,” the rule said.

The centerpiece of the governance changes is a requirement that CEOs “annually attest in writing” that the company has “procedures to establish, maintain, enforce, review, test and modify” the compliance program.

The wording will be a relief to Wall Street chiefs who were concerned that they would have to personally guarantee that their firms were in compliance with the rule, according to people familiar with the banks’ thinking. Executives already file a similar certification with the Financial Industry Regulatory Authority, a self-regulatory group for brokerage firms.

The certification wasn’t part of the Volcker rule when it was first proposed two years ago; it was added to send a signal that regulators weren’t bending to a massive lobbying campaign by financial firms, according to two officials familiar with the rule.

Supervisory Focus

In the end, after hundreds of pages outlining numerous what-if’s, exemptions and special circumstances, the rule reiterates that banks will now have to prove to supervisors that they are adhering to the overriding principle that Volcker and Obama put forward in 2010 as a way to prevent another financial meltdown.

According to documents released by the Fed, the rule prohibits “any transaction or activity” exposing banks to high-risk assets or strategies “that would substantially increase the likelihood that the banking entity would incur a substantial financial loss or would pose a threat to the financial stability of the United States.”


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