A senior UK Minister is concerned that the proposed regulations implementing the Dodd-Frank Volcker Rule provisions would impact adversely impact the liquidity of global funding markets and particularly non-US sovereign debt markets. In a letter to Fed Chair Ben Bernanke, Chancellor of the Exchequer George Osborne said that the proposed regulations would make it more difficult and costlier to provide market making services in non-US sovereign markets. Any consequent withdrawal of market-making services by banks would reduce liquidity in sovereign markets, he noted, which in turn would engender greater volatility and make it more difficult, riskier and costlier for countries such as the UK to issue and distribute their debt.
The Chancellor also said there may be a risk that the proprietary trading restrictions will continue to have implications for firms foreign to the US which use US exchanges or other market infrastructure to carry out their business. Unless exemptions are sufficiently broad, he cautioned, the risk is that the Dodd-Frank Volcker provisions could disincentivize transactions with US counterparties, which could reduce market liquidity and lead to investors experiencing higher costs, delays, and potentially greater price volatility. Over the medium term, this may encourage a migration of market making to outside the regulated banking sector.
The Minister asked for US financial regulators to engage in a dialogue with UK officials in an effort to fully understand the underlying financial stability objectives of the extra-territorial aspects of the Volcker rule and to ensure that we learn from each other in taking forward these important reforms. I hope that a dialogue about these measures would be mutually beneficial and help support greater policy consistency between the US and UK.
In this context, Chancellor Osborne noted that the UK government has formally accepted the recommendations of the Vickers Commission to ring-fence retail banks from investment banks. Thus, the US and the UK are both implementing structural reforms to create a safe and sustainable global banking system. The Vickers proposals reflect the importance that the stability of the financial services industry within the UK economy, reasoned the Chancellor, while recognizing the international character of the financial sector and the desire to avoid measures that would have extra-territorial effect.
The UK government will draft legislation implementing the Vickers Commission recommendations to ring-fence retail traditional banking activities from investment banking activities. While proprietary trading and investments in hedge funds would not be prohibited, these activities would be outside the ring-fence and thus isolated from retail banking where implicit government guarantees appear strongest. In addition, the ring-fenced bank would be legally and operationally independent from the rest of its corporate group. According to the Vickers Commission, effective ring-fencing also requires measures for independent governance to enforce the arm’s length relationship, with the board of the ring-fenced retail subsidiary having a majority of independent directors.