On August 20, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) approved a set of changes to the Volcker Rule’s proprietary trading and compliance provisions. The other three Volcker Rule agencies – the Federal Reserve, the Securities & Exchange Commission and the Commodity Futures Trading Commission – have yet to approve the changes but are expected to do so.
Specifically, the FDIC and OCC adopted a Final Rule giving banks more flexibility to conduct proprietary trading activities and invest in hedge funds or private equity funds, depending on the size and scope of their trading assets and liabilities. In a statement, FDIC Chairman Jelena McWilliams said the amendments “will provide more clarity, certainty, and objectivity around the Volcker Rule, while tailoring the requirements to focus on those banks that conduct the overwhelming majority of trades.” Comptroller of the Currency Joseph Otting said the changes simplify the Volcker rule “in a common sense way that preserves the safety and soundness of the federal banking system and eliminates unintended negative consequences of the prior rule.”
FDIC Board member Marty Gruenberg voted against the changes, saying it would allow the largest, most systemically important banks and bank holding companies to engage in speculative proprietary trading funded by the public safety net.
Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Volcker Rule, prohibits banking entities from engaging in proprietary trading and from owning or controlling hedge funds or private equity funds. However, since the post-Financial Crisis era law passed, regulators and the industry have struggled to implement the reforms, including provisions that require distinguishing between what qualifies as proprietary trading and what does not, according to McWilliams.
Industry proponents for changes to the rule applauded the agencies’ action. The Bankers Association’s president and chief executive, Rob Nichols, said the amendments will allow bank supervisors to focus on systemic risk, while providing the tailored and precise oversight that was the Volcker Rule’s original purpose.
Under the final rule, firms with a significant level of trading activity will remain subject to the most stringent compliance requirements, while those firms with lower amounts of trading activity will be subject to tiered compliance programs.
The agencies estimate that banks classified as having significant trading activity hold approximately 93 percent of the trading assets and liabilities in the U.S. banking system, or approximately 99 percent if combined with the trading assets and liabilities of those banking entities classified as having moderate trading activity. The final rule thus reflects the fact that most of the activity covered by this final rule is conducted by relatively few banks.
The final rule includes the following:
- Retains the short-term intent prong of the “trading account” definition from the 2013 rule only for banking entities that are not, and do not elect to become, subject to the market risk capital rule prong;
- Replaces the rebuttable presumption that instruments held for fewer than 60 days are covered under the short-term intent prong with a rebuttable presumption that instruments held for 60 days or longer are not covered;
- Clarifies that banking entities that trade within internal risk limits set under the conditions in this final rule are engaged in permissible market making or underwriting activity; and
- Streamlines the criteria that apply when a banking entity seeks to rely on the hedging exemption from the proprietary trading prohibition.
While it retains the three-tier approach to compliance programs based on the size of an institution’s gross trading assets and liabilities (TAL), the final rule offers some relief for the industry by:
- Increasing the threshold for “significant” TAL from $10 billion to $20 billion.
- Changing all TAL calculations for foreign banking organizations so that they are based on combined U.S. operations only;
- Limiting the need for CEO attestation to only significant TAL banks;
- Excluding all obligations of or guaranteed by the U.S. government or a U.S. agency from the TAL calculation; and
- Further simplifying compliance program and reporting requirements based on materiality.
The final rule will have an effective date of January 1, 2020, and a compliance date of January 1, 2021, however, banks may voluntarily comply with the rule changes before it goes into effect.