After the onset of the financial crisis in 2008, the US government has undertaken a review of certain financial institutions, believing they had developed unsustainably high risk models and regulators had little or unsatisfactory access to look behind the scenes. As part of the financial reform law programme initiated in 2010 under Dodd Frank, the Volcker rule (named for former Federal Reserve Chairman, Paul Volcker) was added as an amendment to the Dodd-Frank Bill in January 2010.
At the core of the Volcker Rule is the prevention of financial institutions from taking risky speculative investments with their own money and thus preventing possible conflicts of interest between those of the financial institutions and those of their clients’ activities. Financial institutions and banks were essentially prevented from undertaking proprietary trading and from investing or sponsoring funds. The main purposes of the Dodd-Frank Wall Street Reform and the Consumer Protection Act of 2010 which include the Volcker Rule are to protect consumers and to improve transparency in the financial sector. Part of it imposed for example a 3% cap on bank’s shareholdings in hedge funds and private equity funds. The Volcker Rule is not an overall ban of activities and exceptions (including municipal and treasury bonds) are provided in the law.
The implementation of the Volcker Rule means for banking institutions losing a huge part of their key profit (and risk) areas and having to introduce massive compliance programs to meet the new regulation standards and financial institutions have responded variously – some taking the highly conservative approach and banning all proprietary trading whilst at the other end of the spectrum, there are some that are running a line closer to the boundary of what is permitted. For those that are spinning off prop desks, a raft of opportunities have emerged for companies which provide independent fund services such as fund administrators (NAV pricing, fund accounting etc) and middle office outsourcers. These types of firms are reaping the benefits as these “startups” or breakaway groups seek new providers of many of the services which historically may have been provided by the financial institutions themselves.
The Volcker Rule, which was supposed to have become effective in July 2012, has been plagued with delays as it is finalised with industry comment and push-back. Further complicating the finalisation of the Rule is the fact that five federal agencies (the Fed, Office of the Comptroller of the Currency, Securities and Exchange Commission, Commodity Futures Trading Commission, and Federal Deposit Insurance Corporation) have to reach agreement. Not all Dodd-Frank rules have required this level of co-ordination and actually getting these agencies to a common resolution, is in part causing the delays.
Political divisions over financial regulatory issues are another reason the process is moving slowly. SEC has been evenly divided between Democrats and Republicans since the departure of former chairwoman Mary Schapiro in December. One of the five seats on the commission will remain empty until Congress approves someone to fill it, and getting nominees to financial agencies through Congress has been difficult since the onset of the GFC.
Public comments in relation to the Volcker Rule have been robust and voluminous (in the order of tens of thousands) and hence the agencies have been capacity constrained to even be able to position themselves in response to the proposed legislation.
Through the haze of public comment and back and forth, what has become clear is that the implementation of the Volcker Rule before its third birthday in July 2013 is looking very unlikely.