House Panel Troubled by Differing Versions of Volcker Rule Among SEC, CFTC and Banking Agencies, Hears Suggested Legislative Corrections

The House Financial Services Committee examined the efforts of the SEC, CFTC and banking agencies to implement the Dodd-Frank Act Volcker Rule provisions in Section 619 amidst reports that the financial regulators are struggling to adopt a consistent and coordinated final Volcker Rule for the US financial industry. The Committee also entertained industry and investor suggestions for changes to Section 619 as part of any Dodd-Frank corrections legislation in the 113^th Congress.

Committee Chairman Spencer Bachus (R-AL) is extremely troubled that the SEC, CFTC and the banking agencies have been unable to agree on a final single version of the Volcker Rule. He said that competing versions of the Volcker Rule will make it difficult for market participants to know what their obligations are and how to comply with them, especially if they find themselves subject to conflicting obligations enforced by different regulators. More broadly, Chairman Bachus called for the repeal of the Volcker Rule in the 113^th Congress, adding that the rule does not make the financial system any safer. The oversight Chair said that the Volcker Rule will impose significant costs on consumers, savers and businesses, and may even hamper the ability of asset managers and pension funds to grow the value of their portfolios.

Rep. Carolyn Maloney (D-NY), a key member of the Committee, cautioned that a conflicting set of Volcker regulations could leave the financial industry in total disarray. She advised the SEC, CFTC and the banking agencies to act in a coordinated fashion, resolve their differences, and put forth a consistent set of regulations. Rep. Maloney also said that the complexity of the proposed regulations implementing the Volcker Rule should not be carried into the final regulations.

The Chair-designate of the Committee in the 113^th Congress, Rep. Jeb Hensarling (R-TX), said that his approach to the Volcker Rule, and any other financial regulation, is to try to separate the purported benefit of the regulation from its actual benefit and weigh the actual benefit against the actual cost of the regulation. He noted that former Fed Chair Volcker said that he would have written a simpler rule than the one proposed by the financial regulators. He is also concerned about the impact of the Volcker Rule, not so much on large complex financial institutions, but on entities like public utilities.

Rep. Barney Frank (D-MA), the Committee’s Ranking Member, said that the Volcker Rule can help with ending too big to fail because it offers a logical and functional way to diminish the size of financial institutions. He also noted that it is important that the financial regulators finalize the Volcker regulations this year. He predicted that the regulators will adopt a uniform Volcker Rule.

Rep. Shelley Moore Capito (R-WV), Chair of the Financial Institutions Subcommittee, is concerned about the impact of the Volcker Rule on community banks and the businesses they serve. Rep. Capito also expressed concern that market making activities could be construed as proprietary trading under the proposed regulations and that the Volcker Rule could impact liquidity. She called on the SEC and the banking agencies to ensure that community banks and liquidity are not adversely affected by the final Volcker regulations.

Tom Quaadman of the US Chamber of Commerce testified that the Volcker Rule must be viewed in conjunction with international regulatory initiatives such as the Basel III accord on capital and liquidity. Rep. Steve Stivers (R-OH) asked if this conjunction of the Volcker Rule with other international initiative makes the US more or less competitive. Less competitive, responded Mr. Quaadman, because at this point the Volcker Rule is a unilateral US effort.

Rep. Maxine Waters (D-CA), Committee Ranking Member-designate for the 113^th Congress, asked about the efficacy of legislation introduced by Rep. Peter King, (R-NY), H.R. 6524, the U.S. Financial Services Global Viability Act, which would stay the enforcement of the Volcker Rule pending a certification that other nations are also abiding by a similar regulatory framework. Rather than quickly passing H.R. 6524, Dennis Kelleher, CEU of Better Markets, advised a watchful waiting period that would allow the financial regulators to do their job and then observe how the Volcker Rule works in practice, and then revisit the Volcker regulations with actual knowledge of how they are working.

Panelists also set forth recommendations to change the Volcker Rule as part of any Dodd-Frank Corrections legislation considered in the 113^th Congress. On behalf of the Association of Institutional Investors, Jeff Plunkett asked Congress to clarify the exemption for proprietary trading in State or municipal agency obligations by adopting the definition of “municipal securities” already included in Section 3(a)(29) of the Securities Exchange Act.

He also asked Congress to clarify that regulators should focus on trading activities that are conducted solely for the purpose of executing trading strategies that are expected to produce short-term profits without any connection to customer facilitation or intermediation. This would limit proprietary trading to situations that are not difficult to identify and would be consistent with former Federal Reserve Chairman Paul Volcker’s statements that it should be easy to recognize proprietary trading.

Similarly, Congress should clarify that market making activities taken on behalf of customers fall within the market making exemption. The meaning of the phrase “reasonably expected near term demands of clients, customers, or counterparties” in Section 619(d)(1)(B) should also be clarified to state that “near term” does not limit the market making trading activity in markets that are illiquid or have episodic liquidity.

Congress should also clarify that regulators must allow coordinated aggregate risk-mitigating hedging activities that are implemented across trading units. Additionally, Congress should define the term ‘trading unit’ and the correlation to risk-mitigating hedging activities in the corrections legislation to ensure that banking entities may continue to hedge adequately their trades with institutional clients.

The institutional investors group also urged Congress to narrow the definition of “hedge fund” or “private equity fund” to exclude all registered investment companies and specifically identify the factors that must exist in other pooled vehicles before the regulators may designate them as “similar funds.” Also, foreign funds that are not actively marketed to U.S .investors and non-U.S. regulated funds, such as UCITS funds and other European regulated funds, which are subject to a degree of regulation in foreign jurisdictions, such as the Alternative Investment Fund Managers Directive, should also be excluded from the definition.

Similarly, Investment Company Institute CEO Paul Schott Stevens asked Congress to provide an express exclusion in Section 619 of Dodd-Frank for mutual funds from the definition of hedge fund and private equity fund, as well as an express exclusion for non-US retail funds. Further, since these funds are neither managed nor structured like hedge funds or private equity funds, they should never be categorized as ``similar funs’’ under the Volcker Rule.