The Volcker Rule Statute becomes effective on July 21, 2012, regardless of whether or not implementing regulations have been finalized. In the absence of final rules, financial institutions must examine the degree to which they have “bright line” proprietary trading activities and begin conforming those activities in line with the effective date of the statute. However, since most financial institutions do not have “bright line” proprietary trading operations, a high degree of uncertainty remains as to the what banks must do as of July 21, 2012, and and how they should prepare for what will likely be required once a final rule is issued. Brandon Greenberg and Donald Lamson explore this topic in a DerivSource video (see homepage).
The July 21st deadline is the effective date of the the Volcker rule statute but as of yet there has been no issuance of final implementing regulations. The persistent question from financial institutions is what exactly do we need to do by July 21st 2012 given that there is not a final Volcker Rule?
There are two groups of financial institutions who must prepare to comply with the first of many deadlines, explains Brandon Greenberg, independent consultant and president of Greenberg Partners. The first audience is comprised of banks who know they have “bright-line” proprietary (prop) trading activities. Most of those firms are moving to conform to that activity and they are going to move it away or discontinue it in line with the Volcker Rule (statute) because they know that they will not be able to rely on any of the exemptions set forth in the Volcker Rule (statute). The second group is comprised of banks that do engage in principal trading; however, this activity is largely to facilitate client trades, hedge risks, or fund the entity or engage in any of the other exemptions set forth in the Volcker Rule (statute). It is not clear to them that they will actually need to conform that activity or that it rises to the likely level that the regulators are going to regard as “proprietary” trading.
However, recent guidance and industry view is that after July 21, 2012, banks can enter into new covered fund investments and engage in new proprietary trading so long as there is a conformance plan around that activity. “As a practical matter, I don’t see any clients initiating new activity, but guidance from the Fed and a series of law firms seems to indicate that that is actually allowable after July 21st,” said Greenberg.
The problem with the July 21st deadline is the distinction between permitted market-making and permitted proprietary trading, explains Donald Lamson, counsel in financial institutions advisory and financial regulatory group of global law firm Shearman and Sterling.
There is a lot of confusion as to what the regulators mean and market participants have to wrestle with that issue. What is also unclear is the idea of permitted hedging; anyone who reads the newspaper is aware of the incident involving JP Morgan. Lamson said it is appropriate to recognize that this incident prompted regulators to revisit their views on what permitted market making and hedging might be.
Outside the US exception for foreign organizations is presenting a lot of interpretive issues as well, explains Lamson. Despite the July 21st deadline looming, people are still trying to differentiate what is covered from what is not. With respect to the new trading, it is fine to get involved in new activities but not to overdo it. Before one embarks on this, it is the sort of thing one should do after having a series of conversations with one’s regulator, said Lamson.
