Draft Report exempts Repo and Sec Lending from the Volcker Rule

Fears over exemptions to Volcker rule

By Tom Braithwaite, the Financial Times,  in New York, September 18, 2011

The Volcker rule, which bans US banks from trading for their own account, is set to include exemptions that some officials fear will weaken its impact,
people familiar with the situation have warned.

In the wake of UBS’s $2.3bn loss last week, alleged to have been caused by the actions of a lone trader, proponents of a tough rule to constrain banks’
proprietary trading are concerned that dangerous activity will continue under the guise of customer-related transactions.

According to a 174-page draft of the rules seen by the Financial Times, and confirmed by people familiar with discussions between regulatory agencies,
so-called “repo” transactions and securities lending, and near-term trading in currency and commodities – but not futures – will be permitted.

The draft rules exempt from the prop trading ban “positions arising under certain repurchase and reverse repurchase agreements or securities lending
transactions [and] bona fide liquidity management”. They also allow “positions in loans, spot foreign exchange or commodities”.

In line with the statute, which was passed by Congress as part of last year’s Dodd-Frank financial overhaul, securitisations are permitted, including a
related “limited amount of interest rate or foreign exchange derivatives”.

Some officials say the exemptions are based on the law that created the Volcker rule and are needed to ensure that US financial markets are not damaged by bans on safe transactions.

The rule was named after its champion Paul Volcker, the former Federal Reserve chairman, who pushed for last year’s financial regulatory overhaul toto include a crackdown on the “casino” activities of banks. Regulators, led by the Fed, are trying to translate the law into detailed rules.

As officials wrangle over the final form, the language could change. The draft, dated last month, would ban short-term trading that might
“significantly increase the likelihood that the banking entity would incur a substantial financial loss or would fail”.

That could be a tough prohibition, according to people familiar with the process. But some fear that anything held outside the narrowly defined
“trading account” might escape the restriction and that the prohibition is vague and impractical. Trading for under 60 days is automatically
scrutinised, while longer-term positions, such as Goldman Sach’s stake in Facebook, may escape.

The draft leaves open the issue of whether bank chief executives will have to sign attestations that their companies do not engage in prop trading. Banks
had been concerned about that aspect of the rule.

The draft also leaves open the question of whether there should be a “central data repository” to collect and analyse bank trades, which the rule’s
advocates say is crucial to its enforcement but which banks are concerned could lead to leaks of sensitive information.

The issues around the chief executive attestation and the central data repository could be settled before a rule is published but they could also be
left open pending more comment from the industry.

The Fed, the US Treasury and other regulatory agencies have been trying to translate the law into rules that will govern which activities are outlawed and which can continue.

Many banks have already spun off prop desks, which would clearly fall foul of the new rules, but a vast grey area of activity remains, with which the
regulators must try to grapple in deciding what activity is bank’s short-term trading for themselves and what is “market-making” for customers.

Even sceptics of the effort say the officials have done a good job in developing indicators to divide trading into the two buckets. Swings in a
trading desk’s “value at risk” will be one of a number of red flags used by regulators to decide whether they are engaging in risky, prohibited activity.

© THE FINANCIAL TIMES LTD 2011 FT and ‘Financial Times’ are trademarks of The Financial Times Ltd.

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