Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The U.S. Department of the Treasury previously issued its first in a series of reports to President Donald J. Trump examining the United States’ financial regulatory system. The report included detailed recommendations regarding the financial regulatory system, many of which would not require further legislation to implement. Some of those recommendations relate to the Volcker Rule.

The report recommends entirely exempting banking entities with less than $10 billion in assets from the Volcker Rule. The relatively small risk that these institutions pose to the financial system does not justify the compliance burden of the rule, and the risk posed by the limited amount of trading that banks of this size could engage in can easily be addressed through existing prudential regulation and supervision.

Likewise, Treasury suggests banks with over $10 billion in assets should not be subject to the burdens of complying with the Volcker Rule’s proprietary trading prohibition if they do not have substantial trading activity. Trading conducted in amounts below designated thresholds would not warrant the extensive burden of compliance with the Volcker Rule but rather can be more efficiently addressed through appropriate capital requirements and through prudential supervision and regulation.

Five different regulators have responsibility for overseeing implementation of the Volcker Rule. In some cases, two agencies have responsibility for a single banking entity, such as a national bank that is a swap dealer.  This fragmentation of responsibility for determining how the rule should be applied to a particular banking entity or trading desk is inefficient for both the banks and the regulators.  Treasury recommends the regulatory agencies should ensure that their interpretive guidance and enforcement of the Volcker Rule is consistent and coordinated.

According to the report, the definition of “proprietary trading” should also be simplified. One prong of the definition, the “purpose test,” turns on a fact-intensive, subjective inquiry. To evaluate a trade under the purpose test, a banking entity is required to determine whether a trade was made principally for the purpose of short-term resale, benefitting from actual or expected short-term price movements, realizing short-term arbitrage profits, or hedging such a position.  To mitigate the subjective inquiry, the regulations create a rebuttable presumption that any position held for fewer than 60 days constitutes proprietary trading.  According to Treasury, this presumption, simply replaces one problem with another—exchanging subjectivity for overbreadth.  Treasury recommends the proprietary trading prohibition should be revised by eliminating the regulations’ rebuttable presumption that financial positions held for fewer than 60 days constitute proprietary trading. In addition, Treasury believes policymakers should assess whether the purpose test should be eliminated altogether, to avoid requiring banks to dissect the intent of a trade.

Other recommendations in the report include:

  • Providing increased flexibility for market-making.
  • Reducing the burden of hedging business risks.
  • Focusing and simplifying covered funds restrictions.
  • Creating an off-ramp for highly capitalized banks.