The proposed regulations implementing the Volcker Rule provisions of the Dodd-Frank Act may unintentionally narrow the scope of permitted activities, such as market making, that Congress preserved and could siphon liquidity from capital markets and harm US capital formation, said Senator Kay Hagan (D-NC). In a letter to the SEC and CFTC, the Senator noted that, in crafting Section 619(d), Congress acknowledged that market-making, underwriting, and asset management are critical to capital formation and essential to preserving robust liquidity in U.S. capital markets. The Volcker Rule prohibitions were never intended to restrict or prohibit legitimate structures, she continued, including foreign funds, joint ventures, venture capital funds, loan funds, securitization vehicles, and structured notes, that are not usually thought of as private equity or hedge funds and do not relate to trading the firm's own capital.
Senator Hagan is also concerned that the proposed regulations could inadequately clarify the treatment of certain investments made by insurers. Section 619(d)(I)(F) of Dodd-Frank includes trading in an insurance company's general account as a permitted activity and, by its terms, exempts permitted activities from the proprietary trading ban. While the proposed regulations do provide an exemption from the proprietary trading restrictions for the general account of an insurer, she noted, the section that provides this exemption does not address covered funds.
Further, the covered funds section does not expressly extend the exemption that permits proprietary trading activities on behalf of the general account to allowing the general account to hold an ownership interest in a covered fund. The Senator urged the regulators to conform the rule to Section 619's directive to accommodate the business of insurance and include investments in covered funds within the exemption for insurers.
In Section 619(d)(I)(B) of Dodd-Frank, Congress explicitly permitted market making.
While acknowledging the difficulty in distinguishing market making from prohibited activities, the Senator emphasized the importance of ensuring that regulatory limits on proprietary trading do not unnecessarily prevent firms from engaging in the accepted and legitimate activities necessary to preserve orderly markets and service clients.
Restrictions that impede the ability of firms to make markets could reduce liquidity and trigger unintended consequences, said the Senator. Moreover, the complex monitoring regime proposed by the regulators has the potential to reduce liquidity in secondary markets by causing dealers to limit the size of the positions that they purchase for fear of tripping prohibitions. A reduction in liquidity could limit the ability of mutual funds, pension funds, and other institutions to adequately serve investors, including many US retail customers. Senator Hagan urged regulators to carefully evaluate the impact of the proposal on the ability of firms to make markets and to avoid regulations that could reduce market liquidity, discourage investment, limit credit availability, and increase the cost of capital for companies.