Markets Wired

[1] Bank Holding Company Act Rel. No. 7 (Sept. 18, 2019) [hereinafter Final Rule]. Although I cannot support this rule amendment, I do want to express my appreciation to my colleagues in the Division of Trading and Markets, Division of Investment Management, Division of Economic and Risk Analysis, and Office of General Counsel for their work on this rule.

[2] See, e.g., S. Rep. No. 111-176 at 8 (Apr. 30, 2010) (“Section 619 of Title VII prohibits or restricts certain types of financial activity—in banks [and] bank holding companies []—that are high-risk or which create significant conflicts of interest between these institutions and their customers. . . . When losses from high-risk activities are significant, they can threaten the safety and soundness of individual firms and contribute to overall financial instability. Moreover, when the losses accrue to insured depositories or their holding companies, they can cause taxpayer losses.”).

[3] See 12 U.S.C. § 1851(a); and 12 C.F.R. §§ 248.1 to 248.2.

[4] See generally Nat’l Comm’n on the Causes of the Fin. and Econ. Crisis in the U.S., The Financial Crisis Inquiry Report, at xvii-xxiii (2011). The report also noted that, as certain financial instruments became more and more complex, “regulators increasingly relied on the banks to police their own risks.” Id. at 45 (quoting Paul Volcker: “It was all tied up in the hubris of financial engineers, but the greater hubris let markets take care of themselves.”).

[5] See Martin J. Gruenberg, Member, FDIC Board of Directors, Statement on Adoption of Changes to the Volcker Rule (Aug. 20, 2019). Director Gruenberg’s statement draws from Y-9YC and call report data as of year-end 2018. It demonstrates that $565 billion, or 46% of the financial instruments subject to the 2013 Volcker Rule’s trading restrictions for banks, are scoped out of this final rule as amended. For bank holding companies, about $549 billion, or 25% of the financial instruments subject to the 2013 Volcker Rule’s trading restrictions, are scoped out. I am aware that much of the additional proprietary trading activity permitted by these amendments may occur outside of the registrants for which the SEC is primarily responsible. However, the agencies are jointly responsible for, and must consider the wisdom of and vote on, the Volcker Rule as a whole. Changes to the definition of trading account remove a large class of financial instruments from the scope of the rule’s prohibitions and represent a significant weakening of the rule.

[6] See, e.g., Final Rule, supra note 1, at 51 (adopting a presumption of compliance with the prohibition on proprietary trading for banking entities that voluntarily elect to apply the market risk capital prong), 54-55 (eliminating the rebuttable presumption that positions held for fewer than 60 days are proprietary trading and implementing a new rebuttable presumption that positons held for 60 days or longer are not proprietary trading), 93-96 (providing banking entities with flexibility to determine the scope of the “trading desk”), 115-122, 129-133 (establishing a presumption of compliance with RENTD requirements for both underwriting and market-making activities based on compliance with a banking entity’s internally set limits), 150-155 (reducing the requirements related to risk-mitigating hedging and eliminating the need for banking entities with moderate or limited trading assets and liabilities to have a separate internal compliance program for compliance with the risk-mitigating hedging requirements), and 190-201 (removing enhanced minimum standards requirements for all banking entities, allowing banking entities with moderate trading assets and liabilities to establish a simplified compliance program that does not require a CEO attestation, and providing banking entities with limited trading assets and liabilities with a presumption of compliance with the Volcker Rule and no CEO attestation requirement).  

[7] See, e.g., Gregg Gilzinis, Center for American Progress, Hollowing Out the Volcker Rule: How Regulators Plan to Undermine a Pillar of Financial Reform 3 (Oct. 3, 2018) (“On 30 separate pages of the proposal, regulators merely cite their experience implementing the rule as the reason why the changes are appropriate.”).

[8] See, e.g., Letter from Paul A. Volcker to Jerome H. Powell, Chairman, Bd. of Governors of the Fed. Reserve Sys. (Aug. 20, 2019) (stating that credible studies show strong overall market liquidity and that “[t]hese facts belie any justification for the new rule. It bolsters the view of skeptics who believe that the ‘simplification’ effort was merely a ploy to weaken the core elements of reform.”). See also Final Rule, supra note 1, at 45 (“The agencies have provided further clarity to the trading account definition in the final rule by adding additional exclusions from the ‘proprietary trading’ definition.”), 55-56 (“Replacing the 2013 rule’s rebuttable presumption with a rebuttable presumption that financial instruments held for sixty days or longer are not within the short-term intent prong will provide clarity for banking entities with respect to such positions, without imposing the burden associated with the 2013 rule’s rebuttable presumption.”), 86 (“The agencies have determined to explicitly exclude [mortgage servicing asset hedging] from the definition of ‘proprietary trading’ to provide greater clarity to banking entities that are subject to the short-term intent prong.”), 88 (“The agencies have determined to exclude the purchase or sale of assets that would not meet the definition of trading asset or trading liability from the definition of ‘proprietary trading’ to provide greater clarity to banking entities that are subject to the short-term intent prong.”), and 89 (“Excluding any purchase or sale of a financial instrument that would not be classified as a trading asset or trading liability on [the applicable bank report] . . . is expected to provide additional clarity to banking entities subject to the short-term intent prong.”).

[9] See Robert J. Jackson, Jr., Comm’r, U.S. Securities and Exchange Comm’n, Statement on Volcker Rule Amendments (Sept. 19, 2019) (dissenting to adoption of changes to the Volcker Rule).

[10] A review of the adopting release reveals that all of the significant policy choices, where there was disagreement among commenters, were made uniformly in favor of comments provided by banks and banking interests. These policy choices include: 1) rejection of limits on compensation arrangements; 2) rejection of penalties for rule violations; 3) raising the floor for entities with significant trading assets and liabilities from $10 billion to $20 billion; 4) limiting the short-term intent prong by scoping out banks relying on the market risk capital rule; 5) eliminating the rebuttable presumption that positions held less than 60 days are in the trading account; 6) establishing a new rebuttable presumption that positions held for 60 days or more are outside the trading account; 7) expansion of the scope of activities covered by the liquidity management exclusion; 8) adding an exclusion for error trades; 9) adding an exclusion for financial assets that are not listed trading assets or liabilities on an applicable banking report; 10) adding a presumption of compliance for underwriting and market-making activities based on banks’ internally set limits; 11) eliminating the requirement for an internal compliance program for firms with less than $20 billion in trading assets and liabilities; 12) easing the compliance and documentation requirements for risk-mitigating hedging permitted activity; 13) changes to foreign banking entity permitted activity to allow arranging, negotiating, and executing trades by U.S. personnel and eliminating the financing and counterparty tests; 14) changes to the covered fund provisions to drop the requirement that a banking entity aggregate the value of any ownership interests of a third-party covered fund acquired or retained in accordance with the underwriting or market-making exemptions; 15) changes to the covered funds provisions to allow a banking entity to acquire or retain an ownership interest in a covered fund as a hedge when acting as intermediary on behalf of a customer that is not itself a banking entity to facilitate the exposure by the customer to the profits and losses of the covered fund; 16) changes to the covered funds provisions to remove the financing prong of the foreign fund exemption; 17) implementing the three-tiered compliance requirements and dropping the Appendix B enhanced compliance program requirements; and 18) dropping the CEO attestation requirement for firms with less than $20 billion in trading assets and liabilities.

[11] See, e.g., The Financial Crisis and the Role of Federal Regulators: Hearing before the H. Comm. On Oversight and Gov. Reform, 110^th Cong. 45 (Oct. 23, 2008) (testimony of Alan Greenspan, Chairman, Bd. of Governors of the Fed. Reserve Sys.) (“I made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such is that they were best capable of protecting their own shareholders and their equity in the firms.”); U.S. Gov’t Accountability Off., GAO-11-696, Federal Reserve System: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance 1 (July 21, 2011) (“From late 2007 through mid-2010, Reserve Banks provided more than a trillion dollars in emergency loans to the financial sector to address strains in credit markets and to avert failures of individual institutions believed to be a threat to the stability of the financial system.”); id. at 15 (“Between late 2007 and early 2009, the Federal Reserve Board created more than a dozen new emergency programs to stabilize financial markets and provided financial assistance to avert the failures of a few individual institutions.”). See also Letter from Paul A. Volcker, supra note 8 (“[T]he new rule amplifies risk in the financial system, increases moral hazard and erodes protections against conflicts of interest that were so glaringly on display during the last crisis.”).