Sunday, August 03, 2014

House Oversight Chair Takes Treasury Secretary to Task over Volcker Rule’s Adverse Impact on Bond Market

Noting the Volcker Rule’s adverse impact on the corporate bond market, House Financial Services Committee Chair Jeb Hensarling (R-TX) suggested that Treasury Secretary Jacob Lew is not doing his duty to ensure that the Volcker Rule does not imperil or disrupt the capital markets. In a letter to Secretary Lew, Chairman Hensarling said that the Secretary’s recent testimony before the Committee denying the Volcker Rule’s ill effects on liquidity in the corporate bond market in the face of overwhelming evidence to the contrary puts into stark relief that the duty to monitor the Volcker Rule for ill effects on the financial markets is not being fulfilled. While Chairman Hensarling requested quarterly reports on corporate bond market liquidity from thel five regulators charged by the Dodd-Frank Act with implementation of the Volcker Rule, the SEC, FDIC, CFTC, Fed and the OCC. The oversight Chair believes that it is incumbent on the Treasury Secretary as Chair of the Financial Stability Oversight Council to ensure that the Volcker Rule does not adversely impact the capital markets.

In the letter, Chairman Hensarling noted that, beyond compliance, the restrictions on proprietary trading in the Volcker Rule, with limited exemptions, will likely have a chilling effect on fixed-income markets, including the corporate bond market. Yet, said the Chair, in recent testimony before the Committee, the Secretary downplayed these concerns, stating that it was premature to evaluate the effect of the Volcker Rule on the corporate bond market because the regulatory implementation process is in its early stages and the Volcker Rule has not taken effect in the marketplace. Contrary to that testimony, asserted the oversight Chair, the Volcker Rule’s adverse impact on the corporate bond market has been apparent since at least 2012 and liquidity in that market has only worsened in the intervening two years.

The Chair cited a June 2012 Financial Times article reporting that large investment and asset management firms were finding it harder to purchase or sell bonds from dealer banks because the banks were reducing their own holdings of corporate bonds partly because of new regulations, one of which was identified as the Volcker Rule. He also pointed to September 2012 remarks by SEC Commissioner Daniel Gallagher echoing these concerns. Moving up to January of 2014, the Chair noted SEC staff guidance entitled ``Risk Management in Changing Fixed Income Market Conditions’’ in which the staff observed that primary dealer inventories of corporate bonds appear to be at an all time low. The staff noted that this reduction in market making capacity may be a persistent change to the extent it results from broader structural changes such as fewer proprietary trading desks at broker-dealers and increased regulatory capital requirements at the holding company level. The guidance posited that a significant reduction in dealer market-making capacity has the potential to decrease liquidity in the fixed income markets.

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