Federal Reserve, FDIC Approve Volcker Rule

The rule would limit proprietary trading and bank dabbling in hedge funds.

Former Federal Reserve Bank Chairman Paul Volcker speaks during a meeting of the State Budget Crisis Task Force at the National Constitution Center, Tuesday, June 25, 2013, in Philadelphia.
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Federal Reserve and Federal Deposit Insurance Corp. officials on Tuesday unanimously approved the final version of the so-called Volcker rule, a regulation designed to limit risky trading by banks. But even once the rule is in place, there still could be more challenges ahead for the new regulation.

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The rule, originally part of the 2010 Dodd-Frank financial reform bill, gets its informal moniker from former Fed Chairman Paul Volcker, who proposed it in the post-financial crisis era. In its final version, the rule will prevent proprietary trading, which is when a firm trades assets like securities with its own money and for its own direct gain, as opposed to trading for its customers. The rule also will prohibit banks from owning or having other types of relationships with hedge funds or private equity funds, and it will increase firms' reporting requirements to regulators.

Though the rule will limit an entire category of trading, there are considerable exceptions carved out. For example, there will be exceptions for common practices like market-making, in which a firm holds stocks and is ready and willing to buy and sell them on exchanges like the New York Stock Exchange. Hedging, a way to mitigate investment risks using things like futures contracts, also will be allowed.

All of the various exceptions and definitions of types of trades and funds have helped to make the rule 71 pages long, with an additional 850-page preamble, Bloomberg reports. Federal Reserve Governor Daniel Tarullo, head of the bank supervision and regulation committee, on Tuesday acknowledged that the rule was not as lean as he had hoped it would be.

"Many of us – myself included – had hoped for a final rule substantially more streamlined than the 2011 proposal. I think we need to acknowledge that it has been only modestly simplified," he said at an open Federal Reserve Board of Governors meeting Tuesday, at which the rule was approved. The 2011 proposed rule was nearly 300 pages long.

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During the rule's creation over nearly three years, , there have been floods of criticism – when it was first proposed in 2011, the five agencies who crafted the rule received more than 18,000 comments, as CNBC reports. Banks have said they fear the rule will reduce profits, and critics of the rule also have said it is difficult to determine the difference between a proprietary trade and a market-making or hedging transaction.

"Of course, the fundamental challenge is to distinguish between proprietary trading, on the one hand, and either market-making or hedging, on the other. The difficulty in doing so inheres in the fact that a specific trade may be either permissible or impermissible depending on the context and circumstances within which that trade is made," Tarullo said, adding later that for reasons like these, implementation will be even more important for the Volcker rule than for many other regulatory rules.

Banks and big business groups spelled out their concerns in a Dec. 4 letter to the five regulatory agencies. In the letter, a coalition of business groups, including the U.S. Chamber of Commerce and Business Roundtable, told agencies that they believe the rule will result in increased costs for borrowers and investors and also will hurt U.S. banks' competitiveness, since foreign banks will not be subject to the same rule.

However, proponents of the rule have said the outrage is overblown. A 2012 report from consumer advocacy group Public Citizen found that less than 0.1 percent of banks would see any change in their activities as a result of the Volcker Rule.

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Though the Fed and the FDIC have approved the rule, other agencies still must sign off on it. As The Wall Street Journal reports, the Office of the Comptroller of the Currency is expected to approve the rule later on Tuesday, and the SEC also is likely to approve the rule, but without a public meeting.