Fed Rolls Out Proposed Changes to Volcker Rule

Chris Gaetano
Published Date:
May 31, 2018
By Dan Smith - Own work, CC BY-SA 2.5

The Federal Reserve has proposed changes that would relax some of the requirements in the Volcker Rule, which Congress instituted in the wake of the financial crisis to prevent banks from engaging in proprietary trading and from owning or controlling hedge funds or private equity funds. The move follows the recent passage of legislation that exempts all but the largest banks from the Dodd-Frank Act's most stringent regulations. 

The Federal Reserve announced that the overall idea behind the Volcker Rule would be preserved, with the proposed changes representing more of a streamlining of the process to ease compliance and enforcement. 

"The agencies responsible for implementing the rule see many opportunities to simplify it and improve it in ways that will allow firms to conduct appropriate activities without undue burden and without sacrificing safety and soundness," Federal Reserve Chairman Jerome H. Powell said. "The proposal will address some of the uncertainty and complexity that now make it difficult for firms to know how best to comply, and for supervisors to know that they are in compliance."

While the Federal Reserve is the agency presenting the proposed changes, they were developed in coordination with the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission. 

Under the current rules, banks are generally prohibited from engaging in proprietary trading (engaging as principal for the trading account of the banking entity in any purchase or sale of one or more financial instruments), and any financial instrument held by a banking entity for fewer than 60 days (or that substantially transfers risk within 60 days of the purchase or sale) is presumed to be for proprietary trading. The bank can rebut this presumption by demonstrating, based on all relevant facts and circumstances, that it did not make the purchase for that purpose. 

The proposal would eliminate that presumption, and replace it with a presumption of compliance when it comes to such short-term deals. So long as the values of the daily net gain and loss figures for the preceding 90-calendar-day period do not exceed $25 million, the activities of that desk will be presumed to be in compliance with the prohibition on proprietary trading, and so the bank would have no obligation to demonstrate that its activities follow the rules. If the total amount does exceed $25 million, then the banking entity would have to demonstrate compliance as usual. 

The proposal would also expand the applicability of the current exemption for risk-mitigating hedging activity. For entities with less than $10 billion in tradable assets, all requirements to qualify for the hedging exemption would be discarded save the one providing that the hedging activity must be designed to reduce or otherwise mitigate one or more specific, identifiable risks arising in connection with one or more identified holdings, and that the hedging activity be recalibrated to maintain compliance with the rule. For the largest banks, those with $10 billion or more, the rules will remain largely the same; however, the proposal would remove the requirement that the hedging activity “demonstrably reduces” or otherwise “significantly mitigates” risk. It would also reduce documentation requirements associated with these risk-mitigating hedging transactions, and remove the requirement to perform a correlation analysis. 

It also establishes a presumption that trading within an internally set risk limit satisfies the requirement that permitted underwriting and market making-related activities be designed not to exceed the reasonably expected near-term demands of clients, customers, or counterparties. 

At the same time, banks with $10 billion or more in assets would be required to establish a six-pillar compliance program. This program would have to include: 

* Written policies and procedures reasonably designed to document, describe, monitor and limit trading activities and covered fund activities and investments conducted by the banking entity; 

* A system of internal controls;

* A management framework that, among other things, includes appropriate management review of trading limits, strategies, hedging activities, investments, incentive compensation and other matters identified in the rule or by management as requiring attention; 

* Independent testing and audits;

* Training for certain personnel; and

* Recordkeeping requirements.

The proposal would also eliminate enhanced minimum standards for compliance programs of banking entities engaged in significant trading activities, though the current rule that requires the CEO's attestation about the compliance programs would still apply. 

The proposal also intends to streamline the metrics reporting and recordkeeping requirements by tailoring the requirements based on a banking entity’s size and level of trading activity, completely eliminating particular metrics based on experience working with the data, and adding a limited set of new metrics. The proposal also would provide certain firms with additional time to report metrics to banking regulators beyond the initial deadline. 

Comments will be accepted for 60 days after the proposal's publication in the Federal Register.

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