The 37 words inserted into the 848-page Dodd-Frank law overhauling the regulation of America’s financial institutions seemed innocent enough. Lawmakers wanted regulators to come up with strictures that would prevent banks from gambling with deposits insured by the federal government. The resulting rule, named after a prominent proponent, Paul Volcker, a former head of the Federal Reserve, prohibits banks from “proprietary trading,” meaning transactions conducted purely for their own gain, rather than to serve clients. On December 10 five different regulatory agencies approved the Volcker rule; it will come into force, awkwardly enough, on April 1.
During the three years between its conception and birth, the rule has grown into something much bigger and more complicated than its origins would have suggested. The final version boasts 963 pages, and contains 2,826 footnotes as well as 1,347 questions. (Much of this is a preamble addressing public comments, but that will nonetheless serve as guidance for the rule’s implementation.)
The immediate impact of all this verbiage will be small. America’s biggest banks had already eliminated the most obvious forms of proprietary trading in anticipation of the rule. Their share prices rose slightly after its release, perhaps out of relief that it was not as burdensome as some had expected.
By June large banks must begin reporting some data; full compliance with the rule is not required until July 21, 2015. The rule aims not just to curb risk-taking directly, but to enhance monitoring of it too. Bosses will have to sign statements attesting to the existence of compliance schemes, although not to compliance itself — the kind of carefully constructed arrangement that underscores how very conscious bank executives are of risk, if only on their own account, as it were.
The final rule could have been more onerous than it was. An earlier draft had proposed prohibiting banks from buying securities unless they knew that their clients wanted to buy them. In effect, this would have prevented “market-making,” whereby banks keep a supply of securities on hand, so that they can sell them to a customer on demand, or buy them from one even when they do not have another client lined up to pass them on to.
Without the liquidity banks provide in this way, pension funds and insurers would find it harder, more time-consuming and more expensive to buy and sell bonds and other financial instruments. The rule alleviates this worry somewhat by allowing banks to buy securities to meet “reasonably expected” demand from customers.
In practice banks will probably respond by making markets for a narrow range of securities that already trade frequently, and thus might reasonably be expected to do so in future. Meanwhile, the securities that now change hands less frequently are likely to be shunned, making them even harder to trade. Government bonds are exempted from these rules, so banks may pile into them, although they are currently trading at unusually high prices, and so are far from risk-free.