The Volcker Rule was finally approved and the full text released. We take a look at how it impacts repo and securities lending.
A link to the text is here.
Earlier versions exempted repo and securities lending. We wondered if anything had changed. Over a year ago we wrote about noise that Senators Merkley and Levin, primary authors of the original legislation, about not allowing repo to be exempt. They wrote in a letter dated February 13, 2012 to the Federal Reserve:
“….One of the most ill-advised aspects of the Proposed Rule is its creation of a raft of exclusions from the definition of “trading account” for a variety of transactions, including trades in…repurchase agreements and reverse repurchase agreements, and trades conducted pursuant to asset liability management. These exclusions were not contemplated by the statute, create new complexities, undermine the law, and should be stricken…”
But repo seems to have survived the latest revisions.
Subpart B “Proprietary Trading” section (d) starts out “Proprietary trading does not include:” and then lists
“…(1) Any purchase or sale of one or more financial instruments by a banking entity that arises under a repurchase or reverse repurchase agreement pursuant to which the banking entity has simultaneously agreed, in writing, to both purchase and sell a stated asset, at stated prices, and on stated dates or on demand with the same counterparty;
2) Any purchase or sale of one or more financial instruments by a banking entity that arises under a transaction in which the banking entity lends or borrows a security temporarily to or from another party pursuant to a written securities lending agreement under which the lender retains the economic interests of an owner of such security, and has the right to terminate the transaction and to recall the loaned security on terms agreed by the parties…”
But also said;
“…(iv) Limits any securities purchased or sold for liquidity management purposes, together with any other instruments purchased or sold for such purposes, to an amount that is consistent with the banking entity’s near-term funding needs, including deviations from normal operations of the banking entity or any affiliate thereof, as estimated and documented pursuant to methods specified in the plan…”
The Volcker Rule continues to exempt banks from restrictions on activity necessary to manage their liquidity. That is totally sensible. We are not lawyers – and boy will they have a field day unpacking this – but we wonder if the rule does limit repo activity to just what is necessary to manage a bank’s liquidity? Could “an amount that is consistent with the banking entity’s near-term funding needs” be interpreted as clamping down on the part of repo activity that is speculative? It is difficult, if not impossible, to distinguish between trading that is part of managing a bank’s liquidity and that which is simply “lend long, borrow short” punting the yield curve.