Volcker Rule Overview

FINANCIAL SERVICES
A Disputed Proposal
An overview of the financial industrys response to the Volcker Rule
kpmg.com KPMG INTERNATIONAL
2 | A Disputed Proposal
Executive Summary
The Volcker Rule.
Those three little words are enough to send shudders down the spine of any Wall Street investment banker. The proposed rule, an element of the Dodd-Frank Act, was created to prevent banks from placing risky bets with funds insured by the federal government. The brainchild of former Federal Reserve Chairman Paul Volcker, the proposed rule is one of the most contentious, controversial and hotly debated measures in this postfinancial crisis era of regulatory reform. For the most part, the controversy revolves around one central question: How can regulators enforce a ban on proprietary trading without inadvertently impacting legitimate types of trading done by banks to help keep markets flowing smoothly for investors? The Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the U.S. Securities and Exchange Commission (collectively known as the Agencies) issued the proposed Volcker Rule regulations in a 298-page document in October of 2011. At the same time, the Agencies solicited comments from banks, investors and other interested parties about how the proposed rule might impact market-making liquidity, foreign institutions and private equity and hedge fund investments. What followed was a tidal wave of responses more than 17 ,000 in all from a wide range of banking entities, industry associations, investors and consumer advocacy groups. The Agencies continue to wade through these 17 ,000-plus comment letters. In the meantime, however, banking entities are expected to implement the appropriate compliance and reporting requirements by July 2012 in order to satisfy the Volcker Rules ban on short-term proprietary trading. For the most part, the industrys responses to the proposed rule have been unenthusiastic, ranging from skepticism to outright frustration and apprehension. And while we examine some of the more common areas of concern in this paper, the prevailing sentiment is that it will prove extremely difficult under this new regime to distinguish banned proprietary trading from its bona fide counterpart, the buying and selling of securities on behalf of clients. The majority of industry participants contend that market liquidity in the United States (U.S.) will be negatively impacted, transaction costs will rise, trading volumes will be driven to other jurisdictions and the U.S. economy will suffer as a result of the Volcker Rule. The stakes are high, the timelines are short and the range of comments and opinions submitted by industry participants and observers are both vast and complex. Regulators have been inundated with submissions encouraging them to loosen, tighten, modify and/or scrap the proposed rule altogether. In the following pages, KPMG provides a synopsis of some of the key issues and themes that have emerged following a detailed examination of the formal responses from a wide range of investment banks, industry associations and other influential players. We provide this report in hope it helps clients better understand scope of this regulation, its potential impact on their business and what measures may need to be contemplated in order to comply.
2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.
A Disputed Proposal | 3
The Volcker Rule An Overview

Named after former Federal Reserve Chairman Paul Volcker, the Volcker Rule is Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rule amends the Bank Holding Company Act of 1956 with a new section entitled, Prohibitions on Proprietary Trading and Certain Relationships with Hedge Funds and Private Equity Funds. The rule contains two primary components: A prohibition on proprietary trading, with allowances for activities such as market-making, underwriting and the hedging and trading of government securities; A prohibition on investing in or sponsoring hedge funds and private equity funds. While the Volcker Rule is set to take effect in July 2012, there are already rumblings that regulators will be unable to review all of the industry submissions and make the required changes to the rule by the deadline. In his testimony to the House Financial Services Committee in Washington on 28 February 2012, Federal Reserve Chairman Ben Bernanke said the Agencies will not be able to review the 17 ,000 comments and finalize the regulations by July. In addition, he did not give a date by which he thought the regulations would be completed. According to the current draft regulations, banking entities have until 2014 to conform to the Volcker Rule a deadline the government has the ability to delay until 2017 . Once the rule is finalized, it is expected that banking entities will need to make significant investments in technology and infrastructure in order to comply with its intensive monitoring and reporting requirements.
The Definition of Covered Fund

A significant number of financial institutions have expressed outright frustration with what they perceive as the Volcker Rules overly broad scope of the term covered fund1 applicable to the provisions prohibiting investing in or sponsoring hedge or private equity funds. In its current form, the prohibition on these investments and sponsorships would apply to traditional hedge and private equity funds, certain types of foreign funds and commodity pools. In its comment letter, JPMorgan Chase & Company wrote, We believe that the proposed rule makes matters worse by increasing rather than decreasing the scope of the term covered fund, and by unnecessarily exporting these problems to overseas funds and bank subsidiaries. The company goes on to assert, the proposed definition of covered fund exceeds the statutory mandate by applying its restrictions abroad, and would therefore do unnecessary harm to the competitiveness of U.S. firms and investors. The Commercial Real Estate Finance Council also conveyed dismay with the proposed definition of covered fund, saying the term is unnecessarily broad, and would sweep in certain types of securitization issuers and structures despite the fact that such entities are not involved in the brand of speculative activities the Volcker Rule seeks to address. The council recommended in its submission that the definition of covered fund be interpreted more narrowly, in a manner that is more consistent with the intent and purpose of the Volcker Rule. The Bank of America echoed these sentiments in its submission, referencing what it sees as a key distinction between hedge funds and covered banking institutions. And to avoid what it sees as causing harm to banking entities asset management businesses, Goldman Sachs has put forward a number of specific recommendations to the Agencies with respect to the definition of covered fund. The global investment banking and securities firm is asking that regulators limit the scope of covered funds to include only foreign funds that resemble hedge funds or private equity funds and that would be subject to the Volcker Rule if they were offered in the United States. Goldman Sachs also recommends the Agencies limit the scope of covered funds to include only commodity pools that are primarily engaged in trading commodity interests. To capture all commodity pools as covered funds, they say, could subject registered mutual funds and a variety of U.S. businesses (even non-financial firms) seeking to hedge the risks arising from their day-to-day operations to the Volcker Rule and all of its compliance and other burdens. Another of the multitude of objections about the covered fund definition is from the worlds largest asset manager, BlackRock, Inc., which wrote the proposed definition of covered funds is overly expansive and would capture, we believe unintentionally, a wide variety of funds that a diversified asset management firm offers to its clients globally. While a firm that engages solely in the U.S. hedge fund or private equity fund businesses would feel little impact from such an expansive definition, it creates adverse consequences for any firm that offers other types of funds to clients within and outside the United States.
Hedge funds are purely proprietary traders. Covered banking entities, on the other hand, are expected to provide liquidity to their clients, even in distressed markets, and the agencies should not introduce new risks to the economy by assuming that these other unproven and untested sources of liquidity will materialize.
1
Covered Funds, in relation to the Volcker Rule includes private equity funds, hedge funds and a various other private investment vehicles e.g. venture capital funds and different corporate entities.
Widespread Concern Over Market Liquidity

Of the wide range of issues raised by industry participants in their formal submissions about the Volcker Rule, the most frequently occurring and contentious complaint revolves around potential challenges to market liquidity. The general sentiment from the majority of banking entities and associations is that the proposed rule would likely have a harmful effect on liquidity, which could, in turn, lead to a range of other unpalatable side effects, including but not limited to: Increased market volatility, Price uncertainty, A reduced capacity for institutions to raise capital and/or hedge risk, Impaired U.S. competitiveness, and Potential vulnerability to legal challenge. For example, in its submission to the Agencies, Citigroup suggested that the Volcker Rule, with its extensive controls, multiple metrics and onerous compliance requirements, would unintentionally reduce liquidity in markets and impair the availability of credit. To avoid scrutiny related to accumulated inventory, market-makers are likely to reduce trades to a size and tenor that can be quickly sold or hedged. The company said, We believe the proposal would not adequately preserve the very activities that Congress stated were critical and fundamental functions of financial institutions. Insurer Met Life expressed similar apprehensions in a strongly worded comment letter to the Agencies, citing the potential impact the Volcker Rule will have on overall liquidity in the marketplace, particularly in the fixed income markets. As part of its submission, Met Life is also urging regulators to adopt a phase-in of the requirements over an extended period to help mitigate potential risks that might arise as a result of the rule. The company says we are very interested in seeing the Volcker Rule implemented in a manner that achieves it objectives with respect to proprietary trading without fundamentally affecting the efficiency of the markets in which we participate. A failure to do so, it warns, will undermine market liquidity in fixed income markets and impede the companys ability to manage its fixed income portfolio and ultimately lead to higher priced products and lower returns for its policyholders. And while the Clearing House Association and ABA Securities Association say they support many aspects of ongoing regulatory reform, the groups submitted a joint letter expressing
substantial concerns that the Proposed Rule will, in certain crucial respects, adversely affect safety and soundness and financial stability and, in other respects, will jeopardize the economic recovery.
Cleary Gottlieb Steen & Hamilton was yet another of the many respondents to voice concerns about liquidity problems in its submission to the Agencies. Specifically, the company said it anticipated the proposed rule would have a negative impact on the market for privately placed structured finance securities because the rules market-making exemption doesnt adequately address the purchase of covered fund interests. The structured finance market depends heavily on dealers to provide liquidity, the company said in its submission. Prohibiting banking entities from engaging in market-making in such securities will significantly impede the secondary market. Without a viable secondary market, demand for new issuances will also suffer. If not revised, this aspect of the Proposed Rule would contravene congressional intent and have significant adverse effects on an important segment of the securities market. These are but a few of the hundreds of such warnings, concerns and protestations about the imminent risks for market liquidity from investment houses, banking entities and industry organizations. For his part, Mr. Volcker, who is championing the trading restrictions, is refuting such arguments and defending the proposed rule. In a February 2012 letter sent to the five regulatory agencies that have approved a draft version of the rule, Volcker wrote that, The restrictionsare not at all likely to have an effect on liquidity inconsistent with the public interest. He went on to say, At the end of the day, I feel confident that the restrictions imposed by the Volcker Rule can be reasonably and effectively administered.
Market Liquidity: An International Perspective

Reviewing the thousands of industry responses to the Volcker Rule, it is clear that the widespread anxieties about the rules potential impact on liquidity extend beyond Americas borders. In fact, a long list of countries including Japan, Britain, Canada and the European Union have expressed worries that the proposed rule could end up penalizing banks and reducing liquidity for their respective sovereign bonds. Officials from each of these countries submitted letters to the U.S. Treasury Department and other regulatory bodies suggesting the Volcker Rule would not only lead to erosion of global liquidity, but that it was also likely to have a damaging effect on international cooperation. Regulators should limit the scope of the rule only to the territory of the United States, said Michel Barnier, European Union Financial Services Commissioner in the groups letter to the Agencies. The current exemption for non-U.S. banks as well as for activities outside of the U.S. would appear very restrictive. The proposed rule has also come under fire from a number of foreign banks, including the Bank of Japan. While he said he fully agreed with the reasoning of the Volcker Rule, Kiyohiko Nishimura, the Deputy Governor of the Bank of Japan wrote that unless the proposed rule exempted trading in foreign debt, the liquidity of those markets could be negatively impacted. The banks letter also voiced a concern that given the intense time constraints to re-craft the rule, regulators might not fully consider all possible alternatives and outcomes. Adding fuel to the international outcry were six Canadian banks, which said the Volcker Rules inclusion of Canadian securities in the proprietary trading ban would be in violation of the North American Free Trade Agreement (NAFTA). In their joint letter to the Agencies, the Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and the Toronto Dominion Bank argued that NAFTA guarantees that banks be allowed to trade equally in both U.S. and Canadian debt obligations. Failure to exclude Canadian public funds will undermine years of cooperation between U.S. and Canadian regulators as demonstrated by NAFTA provisions and by efforts to carefully adapt the U.S. securities laws to the realities of the growing economic and business integration of Canada and the United States, the banks said in their submission.
Issues Around Asset-Liability Management

Another recurring theme in a significant number of the responses from the banking industry revolved around AssetLiability Management (ALM). In their formal submissions about the proposed rule, many prominent industry players strongly recommended that regulators preserve banking entities ability to engage in legitimate ALM activities. There are a number of provisions within the Volcker Rule, they contend, that have the potential to impair the banking industrys ability to engage in ALM. As a result, many financial institutions are lobbying for an exemption for ALM within the rule. In its formal response, the Clearing House Association and the ABA Securities Association wrote that ALM is at the very heart of the safety and soundness of the banking industry and that it is critically important that the Agencies implementation of the Volcker Rule preserve, and not inhibit, the ability of banking organizations to engage in bona fide ALM activities. The associations argue that the proposed rules definition of the term trading account is overly broad and that this degree of ambiguity could cause important ALM activities to fall under the prohibited banner, which they suggest would be damaging to banking organization and financial markets. Another major source of contention for the banking industry is the provision within the Volcker Rule that applies to accounts that are used for trades that are held for less than 60 days. The associations maintain that unless a new exemption is introduced within the Volcker Rule, many legitimate ALM activities will end up falling under its proprietary trading prohibition. The current exemptions, they say, are simply insufficient for a wide array of ALM activities. It will often be impossible for risk managers to know at the outset of a transaction whether the transaction falls within the exemption because of the uncertainty created by the foregoing requirements and the fact that a risk managers judgment in applying these requirements to a particular transaction will always be subject to after-the-fact review by one or more of the Agencies. This uncertainty will have a chilling effect on the exercise of a crucial safety and soundness function. In an attempt to rectify this perceived dilemma, the associations have recommended that the Agencies replace the current proposed exclusion with one that is broader and which addresses the definition of the term trading account. There are many examples in which trades may be held for less than 60 days (e.g. mortgages, etc.). In many cases, an ALM account will likely fall under the Proposed Rules definition of trading account if the Proposed Rule is adopted, they said in their comments paper. The associations also made specific mention of the need to protect risk-mitigating hedging activities under the proposed rule. One of their key areas of concern is the 60-day time limitation used as one of the factors to determine whether a trade is proprietary in nature. The exemption for riskmitigating hedgingis so narrowly drafted that it would fail to protect or, at least, leave in doubt the protection of numerous bona fide and desirable hedging transactions undertaken in connection with ALM activities, the group wrote in its submission. Flexibility as to the timing of hedges is required for effective ALMthe purpose is not to profit from short-term price movements. The groups were also emphatic in their warnings and protestations with respect to ALM in a new post-Volcker regime and, in its strongly worded comment letter, went so far as to say that,
The importance to both banking organizations and the broader financial system of preserving the ability of banking organizations to engage in bona fide ALM activities cannot be questioned.
To help protect such activities going forward, the groups are proposing a modified concept under which regulators would have specific assurances that ALM activities were being conducted in a sound, authentic manner but which would at the same time afford banks the flexibility required to manage their risks in the manner deemed most prudent.
Extraterritorial Application
It seems that no matter which jurisdiction responding financial institutions or associations hailed from, they expressed significant concerns about the proposed extraterritorial application of the Volcker Rule. In their formal comment letters to the Agencies, many foreign banks and associations conveyed equal measures of surprise and concern to learn that the rule would apply not only to their U.S. branches, agencies and affiliates, but also to their businesses outside the U.S. (to the extent that those businesses engaged in transactions with a U.S. connection). And in their responses, many American institutions warned that the proposed approach to extraterritorial application of the rule could end up driving significant foreign investment dollars outside the U.S., creating a competitive disadvantage for U.S. firms and leading to negative implications such as reduced liquidity in the domestic marketplace. Two groups that were particularly vocal in their criticism of the proposed extraterritorial application of the Volcker Rule were the Institute of International Bankers and the European Banking Federation. The institute of International Bankers members represent more than 35 countries and have a combined US$5 trillion in assets in their U.S. operations. In the joint submission, the organizations focused their comments predominantly on the potential cross-border issues and implications for international banks with banking operations in the U.S. In our view, the Proposed Rules interpretation of the statutory exemption for activities conducted solely outside of the United States is inconsistent with the plain language of the statute, congressional intent, the Volcker Rules policy objectives and longstanding U.S. policies limiting the extraterritorial scope of U.S. banking law, said the institute in its formal comment letter. The group went on to argue that the proposed rule would envelop a wide range of nonU.S. trading and fund activities that Congress deliberately intended to exclude from its scope, something it says would erode financial stability and lead to negative effects both inside and outside the U.S. economy. We urge the Agencies to reconsider their proposed approach to the extraterritorial application of the Volcker Rule, and to adopt an approach based on the plain language and core policy objectives of the Volcker Rule namely, to reduce risks to U.S. taxpayers and U.S. financial stability.
Ambitious Timelines and Onerous Implementation Requirements

The anticipated effective date of the Volcker Rule is 21 July 2012, leaving scarce little time for institutions to proactively assess the impact of the rule on their businesses and prepare for the extensive requirements of its significantly enhanced compliance and reporting programs. Concerned about meeting the tight timelines and demanding infrastructure requirements that compliance would necessitate, many financial institutions are pushing back, asking regulators to delay the introduction of the rule and/or to adopt a phased-in approach to implementation. said Joseph Engelhard, Senior Vice President of Capital Alpha Partners LLC. Theres no way the banks will have all the infrastructure in place so they will have to delay parts even if they keep it similar to how it is. The industry suspicions were confirmed with Ben Bernankes stated to the House Financial Services Committee, I dont think [the final regulations] will be ready for Julywe have a lot of very difficult issues to go through, so I dont know the exact date. A number of industry players are also urging regulators to consider adopting a more measured and strategic approach to implementing a proposed rule with such a large scope and wide-reaching ramifications. In its comment letter, Barclays wrote that, We recommend that the Agencies provide for a phase-in approach to implementation of the Proposed Rules reporting, recordkeeping and compliance program requirements over the conformance period. It is not only the banking entities themselves that are cognizant of the need for a measured approach to the proposed rule. In a speech at the Credit Suisse Global Equity Trading Forum on 17 February 2012, SEC Commissioner Daniel Gallagher admitted that regulators are in a difficult position, because the markets and the public need regulatory guidance and certainty, but that certainty can and should not come at the cost of hasty and ill-considered regulatory initiatives that will damage the real economy that Dodd-Frank ostensibly is designed to protect.
Regardless of how the final rule turns out, it will be a shock to the U.S. financial system, as banking entities will need to take extraordinary measures to attempt to implement it, saidBarry Zubrow, Executive Vice President of JPMorgan Chase & Co. in the firms 67-page comment letter.
Other firms are predicting that given the herculean amount of work that needs to be accomplished in such a short window of time, regulators will have no choice but to delay the finalization and implementation of the proposed rule. Icant see how they would put all of this into effect by July,
Opinions on the Financial Metrics of the Volcker Rule

At the very heart of the Volcker Rule rests the notion of being able to determine the intent behind a particular trade. In their proposal aimed at accomplishing this massive, complex and unprecedented feat, the Agencies have put forth a set of 17 separate metrics intended to help regulators distinguish the difference between short-term proprietary trading and legitimate market making activities. In reviewing the myriad industry comment letters about the rule, there is significant concern among leading financial institutions about the ultimate effectiveness of these proposed metrics. JPMorgan, for example, expressed serious concern over the inapplicability to ALM activities, as well as the short calculation periods of various proposed Volcker Rule metrics. More specifically, JPMorgan said the proposed risk management metrics would be of no use in helping to distinguish between valid risk mitigating hedging activities and prohibited proprietary trading. Morgan Stanleys submission to the Agencies implied that the same set of metrics would not be calculable or useful across all asset classes and markets. The company recommended that the proposed risk management metrics be refined and implemented over the course of the Volcker Rule conformance period. Morgan Stanley also went on to describe a number of the proposed metrics as being burdensome and irrelevant. Citigroup voiced its support for a set of appropriately calibrated risk-based metrics (with particular emphasis on Value-at-Risk, Risk Factor Sensitivities and Risk and Position Limits. However, the company said it believes strongly that the other proposed Volcker metrics have a greater capacity to obscure, rather than elucidate, what is or is not permitted trading activity. And for its part, Bank of America wrote that the application of 17 metrics would generate an unmanageable amount of data across hundreds of trade units globally. This is just a small sample of the pushback from responding firms over the proposed metrics under the Volcker Rule. As the rule is finalized, banks will need to implement entirely new and incredibly sophisticated monitoring and reporting systems in order to ensure compliance. In the meantime, as regulators study the numerous industry responses, it remains to be seen what that final set of metrics will look like and how effective they will be.
In Summary
Since the beginning of the global financial crisis in 2008, the financial services industry has been faced with an incredible and unprecedented amount of regulatory scrutiny and change. Of the myriad changes the industry has had to manage, none has provoked the kind of vocal, critical and consistent opposition from industry players as the Volcker Rule. Judging by the thousands of formal responses submitted to the Agencies by the industry, however, it appears the primary focus of their opposition is not on the proposed regulations premise, but rather on its ability to actually achieve the intended objectives while also mitigating a host of potentially negative and unintended consequences. The overly-broad definition of a covered fund, many stated, inhibits asset managers from hedging risks and hampers banks ability to provide adequate liquidity to clients. Numerous players suggested the regulations, in their current form, would significantly impact market liquidity possibly to the point of impeding an economic recovery. On the whole, they also felt the proposed regulations restrict financial institutions ability to engage in legitimate asset liability management. In addition, many of the metrics proposed to help detect proprietary trading have been criticized as overly bureaucratic, costly to implement and, in some cases, ineffective in determining whether or not a trade is of a proprietary nature or a function of simple risk mitigation. Several domestic and numerous global industry players suggested the broad definitions of key terms in the regulations will impact banks all over the world, contravening longstanding U.S. policies by extending regulations that impact banks well beyond the U.S. borders. And finally, there is nearly unanimous consent that the proposed effective date of July 2012 and compliance date of 2014 are simply unachievable, particularly given the scope of the regulations, the significant challenges associated with implementing the necessary measures to comply and the massive volume of commentary and submissions the Agencies still need to review before finalizing the rule. For now, important questions remain: How will the more than 17 ,000 comments and formal industry submissions impact the agencies thinking as they prepare to write the final regulations? Will the agencies then hew closely to the initial proposals or make substantial changes? Regardless of those very important particulars, it is safest to assume that the Volcker Rule will be implemented in some form. Financial institutions will be restricted from proprietary trading and they will be required to monitor their trading activities to prove they are in compliance. Therefore, it is important for financial institutions continue to assess their requirements and begin the implementation process for the Volcker Rule.
Contact us Mike Conover Global Sector Head, Capital Markets Partner, KPMG in the US T: +1 212 872 6402 E: mconover@kpmg.com Howard Margolin Partner, KPMG in the US T: +1 212 954 7863 E: hmargolin@kpmg.com James J. Suglia Principal, KPMG LLP National Advisory Sector Leader Investment Management T: +1 617 988 5607 E: jsuglia@kpmg.com Jonathan Cohn Principal, KPMG in the US T: +1 212 954 5815 E: jcohn@kpmg.com Eamonn Maguire Advisory Managing Director, KPMG in the US T: +1 212 954 2084 E: emaguire@kpmg.com
kpmg.com
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis--vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: Investor Assurance: The Road to Transparency Publication number: 120417 Publication date: April 2012

Volcker Rule Overview

Hochgeladen von

Dokumentinformationen

Originalbeschreibung:

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Volcker Rule Overview

Hochgeladen von

Copyright:

Verfügbare Formate

FINANCIAL SERVICES

The Volcker Rule An Overview

The Definition of Covered Fund

Widespread Concern Over Market Liquidity

Market Liquidity: An International Perspective

Issues Around Asset-Liability Management

Ambitious Timelines and Onerous Implementation Requirements

Opinions on the Financial Metrics of the Volcker Rule

Das könnte Ihnen auch gefallen