President Donald Trump’s team of regulators is set to hand banks another big win by increasing their freedom to take short-term risks, just a week after Trump signed the first major deregulation bill since the 2008 Wall Street crash.
Five independent agencies, starting with the Federal Reserve on Wednesday, will propose simplifying one of the key regulations designed to avert another crisis: a rule that prevents banks from making trades to profit off short-term price changes in the markets.
The so-called Volcker rule — a 2013 regulation named after the former Fed chairman who came up with the concept — has long been criticized by the industry as convoluted, costing big banks millions of dollars to comply with and perhaps billions more in revenue.
But even the bureaucrats, who have sought to encourage trades that are good for the financial system while banning those that are merely profit-driven gambles, have been unsatisfied with their current approach.
Some details of the proposal have already leaked out, boosting hopes from banks that the changes will give them a much clearer picture of when they’re allowed to make quick trades with stocks, bonds and other financial assets. But those details have also fed fears from financial reform advocates that regulators could end up hobbling the regulation and endangering the economy.
“This proposal is going to be a major weakening of the rule,” predicted Marcus Stanley, policy director at Americans for Financial Reform, warning that it risked turning the regulation "into a dead letter."
Despite the obscure terms and acronyms that fill the 1,000-page regulation, its contents strike at the heart of how the U.S. financial system operates.
The rule is a step back toward the era when banks weren’t allowed to mix consumer and investment banking, under a now-repealed provision enshrined in the Depression-era law known as the Glass-Steagall Act.
But rather than the wholesale reinstatement of that restriction, the Volcker rule tries to protect depositors’ money from being used for risky bets by banks.
The regulation was mandated by the 2010 Dodd-Frank Act, the landmark law that led to sweeping new restrictions on financial institutions. Yet even the rule’s namesake, former Fed Chairman Paul Volcker, complains that his original, straightforward idea was weighed down by the input of too many lobbyists.
Under the rule, traders are given leeway when it comes to potentially dangerous bets made on behalf of a client; for example, if a client wants to trade a financial product for which there is not yet a market, a bank might have to conduct trades to create one, a process known as market making.
There are multiple other exemptions to the short-term trading ban, such as making an investment to balance out the risk of other holdings, known as hedging; or underwriting an initial public offering of a company’s stock.
But some in financial markets have argued that the confusion about what’s acceptable under the rule has hurt the ability of small- and mid-sized companies to raise funding through the stock market.
“Whenever you take market participants out of the market, you’re hoping other people can come in and fill that gap, but that didn’t happen here,” said Chris Iacovella, CEO of Equity Dealers of America, which represents brokerages.
With less market participation by banks, investing in smaller businesses has become even more expensive, directing capital instead to big-name companies, he said.
“To the extent that you allow more players to come in and buy and sell into the marketplace, you put the oil back into that engine, and you make it run a lot smoother,” Iacovella said.
Fed regulatory chief Randal Quarles, a Trump appointee, said in March that regulators wanted banks to be able to make responsible trades “with less fasting and prayer about their compliance with the Volcker rule.” He has also called it “inarguable” that the regulation has hurt markets.
The proposal will likely have the biggest impact on regional and mid-sized banks with perceptible trading activity that aren’t major players like JPMorgan Chase or Goldman Sachs, though banks of all stripes will benefit.
A source familiar with the proposal told POLITICO that it would tailor restrictions depending on an institution’s level of trading activity.
The smallest banks that don’t do much trading will ultimately be exempt entirely from the rule, thanks the new bank deregulation law.
All but one of the five regulatory chiefs involved in drafting the proposal were appointed by Trump, but some Obama-era regulators had also expressed a desire to simplify the rule.
“I think the hope was that, as the application of the rule and understanding of the metrics resulting from it evolved, it would become easier to use objective data to infer subjective intent,” said former Fed regulatory chief Dan Tarullo in his farewell speech in April 2017. “This hasn’t happened, though. I think we just need to recognize this fact and try something else.”
The only remaining Obama appointee involved in the Volcker rewrite is FDIC Chairman Martin Gruenberg, who is set to be replaced imminently by a longtime Senate aide and former banker, Jelena McWilliams. Gruenberg’s participation has been a signal to banks not to expect sweeping changes, given his history of being highly skeptical of rolling back any post-crisis rules.
But it has provided little comfort for some backers of the rule, who are sounding the alarm about a big expected change: The bank will no longer have to prove that a trade is acceptable under the rule. Instead, regulators will have to prove that it’s not.
Tyler Gellasch, a former Senate aide who helped craft the Volcker language in Dodd-Frank, said the regulation was already weaker than its statutory authors had hoped.
“Volcker as it was implemented covered a fraction of what we expected,” Gellasch said. And if the change is as broad as he fears, “it raises the question of whether it’s more intellectually honest to just repeal the whole thing,” he added.
Gellasch said if regulators are actually getting rid of the presumption that trades held for less than 60 days fall under the scope of the rule, “what they’ve done is they’ve made it much, much less likely that you’ll see anything ever identified as [illegal under the rule] again, except a major blowup.”
But sources close to the matter said regulators should not aim to make the rule so specific that they are dictating to executives how to run their institution. The ban on short-term speculative trading remains in place, and bank CEOs are required to attest that they’ve put in place proper controls to prevent such trading. At some point, they are responsible for the risks they’re taking, they said.
The biggest banks, meanwhile, have expressed mild enthusiasm for the expected changes, arguing that financial reform advocates unfairly cast even the smallest changes as disastrous.
The forthcoming proposal, as reported, “saves a lot of paperwork both for banks and regulators but doesn’t materially change the substance or allow any new activities,” said a senior official at a large bank heavily involved in markets. “Not that anyone will believe that.”