Amendments to the Volcker rule approved by two of the five federal agencies with jurisdiction over it relax prohibitions on proprietary (“prop”) trading and bank ownership of hedge funds and private equity funds. Changes to the Volcker rule also eliminate a “rebuttable presumption” that financial instruments held for less than 60 days are considered proprietary trading.
The Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) announced the changes on Aug. 20. Approval by the U.S. Commodity Futures Trading Commission (CFTC), the Federal Reserve Board, and the Securities and Exchange Commission (SEC)—all of which have jurisdiction over the interagency rule—is expected soon.
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The changes are slated to become effective on Jan. 1, 2020, after publication in the Federal Register with a compliance date of Jan. 1, 2021. Banking entities may voluntarily comply with the revised rule prior to the Jan. 1, 2021, deadline.
Origin of the Volcker rule
Emerging from the nation’s experience in the Great Depression, the Great Recession, and everything in between, the Volcker rule, a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, was aimed at preventing federally insured banks from engaging in proprietary trading or controlling hedge funds or private equity funds.
It got complicated, though. Distinguishing between proprietary trading and other trading proved challenging, and banks seemingly engaging in traditional banking activities and those that conducted very little trading still had to undertake compliance activities just to make sure they did not violate the rule.
“One of the post-crisis reforms that has been the most challenging to implement for regulators and industry is the Volcker rule,” FDIC Chair Jelena McWilliams said when the agency’s approval of the new Volcker rule was announced. “Distinguishing between what qualifies as proprietary trading and does not has proven to be extremely difficult.”
Regulatory requirements sometimes proved to be burdensome.
“Banks that do relatively little trading are required to go through substantial compliance exercises to ensure that activities that have long been considered traditional banking activities do not run afoul of the Volcker rule,” McWilliams said.
The initial regulations implementing the Volcker rule were promulgated in 2013. Amendments to these requirements were proposed in 2018 for public comment. Just last month, the agencies issued a final rule that excludes certain community banks from the requirements of the rule.
Notable changes to the new Volcker rule
The latest iteration of the Volcker rule simplifies it “in a common-sense way that preserves the safety and soundness of the federal banking system and eliminates unintended consequences of the prior rule,” said Comptroller of the Currency Joseph Otting on the day he signed the changes to the rule. “The limits and protections put in place by the prior version of the Volcker rule remain to ensure inappropriate risk practices do not recur,” he maintained. “At the same time, we have made substantial progress eliminating ineffective complexity and addressing aspects of the rule that restrict responsible banking activity,” Otting said.
Tiered requirements: Under the latest revisions to the Volcker rule, compliance programs are subject to tiered requirements based on the amount of a banking entity’s assets. Those with significant trading assets and liabilities—at least $20 billion—are subject to the most requirements: a six-pillar compliance program, annual CEO attestation, and metrics requirements.
Banking entities with more moderate total consolidated trading assets and liabilities—between $1 billion - $20 billion—are subject to simplified compliance obligations under the new Volcker rule. Banking entities with limited trading assets—less than $1 billion—get a presumption of compliance. Metrics requirements have been eased. Organizations subject to metrics collection requirements must report them 30 days after the end of each quarter.
An eliminated presumption: The new Volcker Rule also addresses restrictions on proprietary trading. While proprietary trading is still not allowed, short-term trades will no longer be presumed to be inappropriate. The final version of the rule reverses the “rebuttable presumption” that financial instruments held for less than 60 days are within the short-term intent prong of a trading account. Instead, the new Volcker rule adds a rebuttable presumption that financial instruments held for 60 days or more are not within the short-term intent prong of a trading account.
Acceptable trading within limits: While proprietary trading is prohibited generally, exemptions to that prohibition under the new Volcker rule mean that underwriting and market-making activities as well as risk-mitigating hedging and trading by foreign banks are OK. There is a presumption of compliance with reasonably expected near-term demand requirements for trading within limits. Banks just need to maintain records of any breaches of limits and make those records available upon request. To maintain the presumption of compliance, banks also need to follow internal escalation and approval procedures.
Lori Tripoli is a writer based in the greater New York City area who focuses on legal and regulatory issues.