Restricting Speculative Investments: The Volcker Rule

The Volcker Rule forms a key part of the Dodd-Frank Wall Street Reform and Consumer Act – specifically section 619 – aiming to restrict banks in the United States from making speculative investments that will not, and do not, benefit their customers.

Though the Dodd-Frank act is already law, the Rule itself is set to come into play in July of 2014 (the Act allows for a two year conformance period), having been the centre of regulatory debates since it was first proposed, and will affect every US federally insured depository institution. It will also affect any company that controls an insured depository institution (IDI). Any private investment funds dealing with the affected banks will also be subject to the rulings.

What does the Volcker Rule do?

The Volcker Rule aims to prohibit banks from engaging in what it terms “proprietary trading” – which is, in the words of the Rule itself, defined as: “engaging as principal for the trading account of the covered banking entity in any purchase or sale of one or more covered financial positions.  Proprietary trading does not include acting solely as agent, broker, or custodian for an affiliated third party.”

The Rule does not stop the banks from trading completely, but it tightens the controls on such activity and requires stronger documentation. It will be overseen and implemented by five separate government entities: the Federal Reserve, the U.S. Securities and Exchange Commission (SEC), U.S. Commodity Futures Trading Commission (CFTC), Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC).

Who will the Volcker Rule affect?

Although the rule primarily bounds only banking institutions in the US, all global banks will likely be subject to Volcker, as any party to a trade that is in the US will be included in the agreement. This means any affiliates of US banks, including overseas bank branches, as well as any foreign banks with operations in the States, will be affected.

Non-banking financial institutions like insurance companies and hedge funds are not affected, and only the larger investment banks – such as Morgan Stanley, who agreed during the financial crisis to become banking institutions – will come under the remit of the Rule.

Ensuring conformity

Any organisations that are affected by the Rule will need to establish a compliance program to address their conformity, and meeting these standards will not be easy for many more complex institutions. Distinguishing market-making from proprietary trading, which is restricted by the Volcker Rule, requires regulators to apply five factors: risk management, source of revenues, revenue relative to risk, customer facing activity and payment of fees and commissions.

Institutions have two years from the date of Dodd-Frank’s enactment, giving a final deadline for compliance of July 21st 2014. During this time, they must perform four key duties:

- Prepare for full compliance in 2014

- Put together a detailed conformance plan

- Show a “good faith” effort to achieve compliance during this period

- Prepare for possible record-keeping and reporting requirements that federal agencies may impose before the 2014 implementation

Tools such as the London Stock Exchange’s UnaVista can help with conformance by providing data consolidation, regulatory reporting, reconciliation and advice for any one affected by these and similar legislations.