Four years after Paul Volcker suggested that banks should not do proprietary trading (a cause of global financial turbulence), there has been no action.

One of the most controversial regulations of recent times, the Volcker Rule is yet to see the light of the day in USA. It has been now almost four years since the idea of prohibiting banks from doing proprietary trading was thought of in USA, which is the core of Volcker Rule, but till date nothing substantial has happened but timeline for implementation has got extended many times. The USA is abuzz with the news of another extension.  As per Financial Times report,” The Federal Reserve is considering a delay in the compliance date for the highly anticipated Volcker regulation, giving banks additional time to conform to its provisions, according to people familiar with the matter. Banks are currently required to comply with the rule – which bans proprietary trading that puts a bank’s own capital at risk – by July 2014. But regulators are still putting the final touches on the long-delayed proposal, and the final rule will probably not be released until December – giving banks less than a year to make changes to comply with the proposal.”
 

It all began with the financial crisis that engulfed the largest economy of the world in 2008. The rule, named after former Federal Reserve Chairman Paul Volcker, was put forth in 2010 to restrict banks from making speculative bets and trades with their own capital.
 

The key feature of the “Volcker Rule” is that it prohibits an insured depository institution and its affiliates from:
 

• • engaging in “proprietary trading”
   
• • acquiring or retaining any equity, partnership, or other ownership interest in a hedge fund or private equity fund; and
   
• • sponsoring a hedge fund or a private equity fund.
   

The Volcker Rule has been debated (over last 4 odd years) at length but some of issues have remained unresolved till now and implementation of the regulation has been getting extended.
 

Why is it that the implementation of Volcker Rule is getting delayed? There is more than one reason for this. Let us look at some of prominent reasons for the delay:
 

Hedging Exemption:  While Volcker Rule has a provision to ban proprietary trading for the depository institutions, it allows proprietary trading for the purpose of hedging. As per the rule the hedging exemption covers a banking entity’s purchase or sale of a covered financial position designed to reduce specific risks in connection with or related to certain positions, contracts, or other holdings of the banking entity. The hedging exemption is available subject to certain terms and conditions as per the proposed legislation which says ,” The banking entity should have an established internal compliance program to ensure, among other things, that the subject activities are risk-mitigating hedging activities, including written policies and procedures regarding the instruments, techniques and strategies that may be used for permissible hedging activities”. The recent London Whale Scandal has highlighted that hedging activity can put investment banks at risk and hence banning proprietary trading alone does not serve the purpose.  Hedging provision for Volcker Rule has become the main bone of contention. This is very clearly reflected in the public comments from some senior politicians and regulators.
 

Misuse of market making provisions:  Another grey area in the rule is the market making provision. The Commodity Futures Trading Commission (CFTC), the commodity market regulator, has made its stand clear on the implementation of Volcker rule in context of current market making provision. It is very clear that it is difficult to identify the difference between market making provisions and proprietary trading.  Recently CFTC chairman Gary Gensler has indicated that he wants a more stringent application of the market-making and risk-mitigating hedge exemptions which are a part of Volcker Rule. This has come in the wake of London Whale trading scandal, in which JP Morgan's incurred losses of approximately $6.2 billion in the credit default swap market. What was initially thought to be a hedging strategy was later on found motivated by attempts to reduce the unit's consumption of regulatory capital.
 

It is feared in USA that market making may become home to proprietary trading, thereby defeating the purpose of Volcker rule which attempts to prevent misuse of proprietary trading. The CFTC chairman has recently stated that "I spent 18 years on Wall Street, and a lot of proprietary trading happens on market-making desks. If you are a good market-making trader, you often use the flow of that market-making to do some proprietary trading, whether that is for three minutes or three days”.
 

Cultural Gap causing the rift:  Many men, many minds is another issue with finalisation of Volcker Rule. The Dodd-Frank statute convenes the Federal Reserve Board, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Commodity Futures Trading Commission to write the Volcker Rule. It is conflict between banking cops and market cops which is getting too difficult to manage. While regulators such as Fed and FDIC are responsible for banking regulations, SEC and CFTC are market regulators. Arriving at a consensus seems to be an issue because of difference in approaches.
 

For an economy devastated by wrong doings of banks, Volcker Rule was thought to be the panacea to prevent the wrong doings in the future. Whether banks will be reined in a better way post implementation of Volcker Rule needs to be tested yet, the bigger challenge is the finalisation of the provisions of rules. The war of words on the drafting of legislation needs to be managed first.