What’s ahead on the regulatory front for the Federal Reserve, in particular the always-controversial Volcker rule?

During a speech this week at the Institute of International Bankers Annual Washington Conference, Vice Chairman for Supervision Randal Quarles detailed some of the Fed’s highly anticipated initiatives.

“In my estimation, [post-Crisis] reforms have gone a long way toward meeting our goal of a more resilient financial system. That said, we are now at a point, with ten years of experience in setting up and living with the body of post-crisis regulation, where it is both relevant and timely to examine the post-crisis reforms and identify what is working well and what can be improved,” Quarles said. “We should be looking to see where we could achieve our regulatory objectives in ways that maintain our measures' effectiveness, but improve their efficiency, transparency, and simplicity. As part of that effort, we will consider additional tailoring and flexibility of our regulations in light of their impact on foreign banking organizations (FBOs) based on lessons learned over the past several years.”

A focus of the speech was the Dodd-Frank Act’s Volcker rule and continuing efforts to scale back the ban on proprietary lending by federally insured banks.

“I believe the regulation implementing the Volcker rule is an example of a complex regulation that is not working well,” Quarles said. “We have to ask how to improve the framework of the implementing regulation to make it more workable and less burdensome in practice from both a compliance and supervisory perspective.”

“I think we all can agree that the implementing regulation is exceedingly complex,” he added. “As one example of specifics, among many, the statute and implementing regulation's approach to defining ‘market making-related activities’ rests on a number of complex requirements that are difficult or impossible to verify objectively in real time. As a result, banks spend far too much time and energy contemplating whether particular transactions or positions are consistent with the Volcker rule.”

Despite the best of intentions in crafting the regulations, “no one seems to be happy with the complex rule we wound up with,” Quarles said.

The Federal Reserve, he said, is actively working with other regulators “in seeking ways to further tailor and to reduce burden, particularly for firms that do not have large trading operations and do not engage in the sorts of activities that may give rise to proprietary trading.” They also appreciate “the broad extraterritorial impact of the rule in its current form for foreign banks' operations outside of the United States.”

“We have, with the full cooperation of all five Volcker regulatory agencies, picked back up the process that was begun last fall to engage in a rulemaking process subject to the Administrative Procedures Act and develop a proposal for public comment that would make material changes to the Volcker rule regulations,” Quarles said. That process will “take account of the views of market participants and other interested parties,” while working within the confines of the statute.

One popular idea under consideration: providing an exemption from the Volcker rule for community banks, something Quarles also supports.

Improvements that may be possible within the regulation itself? It should be clearer and more transparent what is subject to the Volcker rule's implementing regulation and what is not, Quarles said. The definition of key terms like "proprietary trading" and "covered fund" should be as simple and clear as possible.

“It should not be a guessing game or require hours of legal analysis of complex banking and securities regulations to determine if a particular entity is a covered fund,” he said. “It should not happen, although it has happened, that our supervised firms come to us and ask questions about whether a particular derivative trade is subject to the rule, and we cannot give them our own answer or a consistent answer across the five responsible agencies.”

The exemption for market making-related activities also requires greater clarity, according to Quarles: “The rule contains a gaggle of complex regulatory requirements, but the statute contains merely one, that the market making-related activities are designed not to exceed the reasonably expected near-term demands of clients, customers, or counterparties.”

“We want banks to be able to engage in market making and provide liquidity to financial markets with less fasting and prayer about their compliance with the Volcker rule,” he said.

There are certain foreign funds, organized outside the U.S. by foreign banks in foreign jurisdictions and offered solely to foreign investors, that are subject to the Volcker rule due to Bank Holding Company Act control principles. Last summer, the banking agencies, in consultation with the Securities and Exchange Commission and the Commodity Futures Trading Commission, issued guidance that effectively stayed enforcement of the Volcker rule to these foreign funds in light of the technical and complex issues they raise. “I expect we would continue this period of stay while we continue to consider these important issues,” Quarles said.

The statute also contains exemptions for FBOs to allow foreign banks to continue trading and engaging in covered fund activities solely outside the U.S. “One possibility that has been suggested by market participants is a simple approach that focuses on the risk of the booking location,” he said. “Of course, we would have to consider whether this is possible in light of the language of the statute and principles of competitive equity, but the suggestion is illustrative of the possibility of a more workable approach.”

Regulators are also “considering broad revisions to the Volcker rule compliance regime,” Quarles said. “We would like Volcker rule compliance to be similar to compliance in other areas of our supervisory regime.”