New rule bars banks’ trading for own gain

5 agencies also OK limits on investing, exec rewards

Ben Bernanke, chairman of the Federal Reserve (left), and Janet Yellen, vice chairman, attend a meeting of the Board of Governors of the Federal Reserve in Washington, D.C., on Tuesday.
Ben Bernanke, chairman of the Federal Reserve (left), and Janet Yellen, vice chairman, attend a meeting of the Board of Governors of the Federal Reserve in Washington, D.C., on Tuesday.

Federal regulators voted Tuesday to approve a rule that strikes at the heart of Wall Street risk-taking, after three years of internal quarreling and bank lobbying over an effort to reshape the financial landscape.

The so-called Volcker Rule, a centerpiece of the Dodd-Frank financial overhaul law and a symbol of efforts by President Barack Obama’s administration to rein in risk-taking after the financial crisis, received approval from all five regulatory agencies writing the rule: the Federal Reserve, the Federal Deposit Insurance Corp .,the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Comptroller of the Currency. The trading commission voted in private because of inclement weather in the Washington area.

The votes on the rule represent a turning point in financial changes. Although it is only one of 400 rules under Dodd-Frank - and nearly two-thirds of the regulations remain unfinished - the Volcker Rule became synonymous with the law. And with regulators easing other rules under Dodd-Frank, the Volcker Rule became a barometer for the overall strength of the law.

In some crucial areas, regulators adopted a harder line than Wall Street had hoped. Under the rule, which bars banks from trading for their own gain and limits their ability to invest in hedge funds, the regulation includes new wording aimed at preventing the sort of risk-taking responsible for a $6 billion trading loss at JPMorgan Chase last year. The rule also requires banks to shape compensation packages for executives so that they are not rewarded for “prohibited proprietary trading.”

In addition, it requires chief executives to attest to regulators annually that the bank “has in place processes to establish, maintain, enforce, review, test and modify the compliance program,” a provision that did not appear in an October 2011 draft of the rule.

But the rule, designed to draw a line between everyday banking and risky Wall Street investment, has its limits. For example, the regulation leaves it largely up to the banks to monitor their own trading. Some critics of Wall Street also wanted chief executives to attest that their banks are in compliance with the rule, not just that they were taking steps to comply.

And in another concession, regulators will delay the effective date of the rule to July 2015. Until then, bank lawyers are expected to scour the rule for weaknesses and to consider filing lawsuits against the regulators.

The votes, which come more than a year after Congress required the agencies to finalize the Volcker Rule, offer the financial industry some long-sought clarity. Until recent days, regulators appeared unlikely to meet the recommendation of Treasury Secretary Jacob Lew, who urged the agencies to complete the rule this year.

“For a time, I had begun to think that the Volcker Rule was destined to become the Jarndyce v. Jarndyce of administrative rule-making,” said Daniel Tarullo, the Federal Reserve governor who led much of the negotiating on behalf of the agency, referring to the long-running litigation at the center of the Charles Dickens novel Bleak House. “But I think the text before us is an improvement, both normatively and technically, on the proposed rule issued in October 2011.”

Ben Bernanke, the Fed chairman, also referred to the delay, saying that “getting to this vote has taken longer than we would have liked, but five agencies have had to work together to grapple with a large number of difficult issues and respond to extensive public comments.”

Wall Street expressed displeasure with the rule. In a statement, the U.S. Chamber of Commerce said it was “disappointed that regulators may have sacrificed an effective process that could have avoided adverse consequences for Main Street businesses.”

Some lawyers predict a smooth transition. Most big banks have already complied with sections of the rule, shutting down stand-alone proprietary trading desks. The banks are now planning to throw resources at new compliance manuals and training their traders to comply with the rule.

The rule traces to Paul Volcker, a former Fed chairman and adviser to President Obama, who championed a ban on banks trading for their own gain, a practice known as proprietary trading. Such a prohibition, Volcker argued, would curb risk-taking and avert future bailouts of Wall Street.

The idea gained traction as a politically viable alternative to legislation that would have restored a requirement that banks spin off their Wall Street operations from their deposit-taking businesses. Ultimately, over the objection of Wall Street and most Republicans, Democratic lawmakers inserted the measure into Dodd-Frank in 2010.

The rule, a draft of which regulators proposed in October 2011, stood out for its complexity. And regulators conceded Tuesday that such complexity remained in the final draft.

“Many of us - myself included - had hoped for a final rule substantially more streamlined than the 2011 proposal,” Tarullo said. “I think we need to acknowledge that it has been only modestly simplified.”

To address the sort of risk-taking that fueled JPMorgan’s trading blowup, which became known as the “London Whale” - the bank contended that it was trading to hedge its broader risks, but in fact it built a sprawling speculative position that spun out of control - the rule will require banks to identify the exact risk that is being hedged. The risks, the rule said, must be “specific, identifiable” rather than theoretical and broad.

The rule also requires banks to conduct a “correlation analysis” as well as “independent testing” to ensure that the trades used for hedging “may reasonably be expected to demonstrably reduce” the risks.

To further prevent banks from masking proprietary trading as a hedge, the rule requires banks to conduct an “ongoing recalibration of the hedging activity by the banking entity to ensure” that the trading is “not prohibited proprietary trading.”

Some critics of Wall Street praised the final rule.

“The rule recognizes that compliance must be robust, that CEOs are responsible for ensuring a compliance program that works, that compensation must be limited, and that banned proprietary trading cannot legally be disguised, as market making, risk mitigating, hedging or otherwise,” said Dennis Kelleher, the head of Better Markets, an advocacy group. “Those requirements will not end all gambling activities on Wall Street but should limit them and reduce the risk to Main Street.”

Front Section, Pages 1 on 12/11/2013

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