New era for Wall Street? US passes landmark rule to limit risky trading
The rule was approved Tuesday by five financial institutions despite dissent from the Commodity Futures Trading Commission and the Securities and Exchange Commission, the Financial Times reports.
Named after former Federal Reserve Chairman Paul Volcker who pushed Obama and Congress to reform Wall Street, the rule hopes to protect America from a similar debacle to the so-called 'London Whale', when JPMorgan’s speculative bets resulted in a $6.2 billion loss in 2012.
Banning proprietary trading and hedging at US financial institutions, the Volcker rule is considered the centerpiece of the 2010 Dodd-Frank bank reform legislation.
“The Volcker rule will make it illegal for firms to use government-insured money to make speculative bets that threaten the entire financial system, and demands a new era of accountability from CEOs who must sign off on their firm’s practices,” President Obama said.
Banks will now be required to report on risks such as portfolio hedging, which in theory will help avoid any repeats of the 'London Whale' incident.
Propriety trading, as it is known, is when a department unrelated to any client orders use of its own capital to gamble on market moves, and profits from the spread and movement of prices.
Goldman Sachs, JP Morgan Chase, Morgan Stanley, Citigroup, and Bank of America, the five megabanks of Wall Street, will have to change the way they do business and initiate a new, stricter reporting regime on proprietary trading.
Compliance will be costly for Wall Street’s most profitable banks, which have as much as $44 billion in revenue in market-making provisions, Bloomberg News reported.
Shares in big banks rose on the news, Morgan Stanley increased 1.3 percent, and Goldman Sachs climbed 1.2 percent, a three-month high for the firm.
The over 900 page edict will keep corporate lawyers gainfully employed for years to come, as they pour through it and advise banks what they now can, and cannot legally do. Banks have until 2015 to get in line with the new rule, a deadline which was extended by one year.
High compliance costs and lower revenue will likely move banks to challenge Volcker, as the new rule could shave as much as $10 billion pre-tax profit from the eight biggest US banks, according to an estimate by Standard & Poor’s.
Many critics of the new rule say it isn’t tough enough on banks, and won’t prevent a 'London Whale' scenario, as the rule still allows banks the following leniencies:
- Banks will still be able to hedge on government bonds, including mortgage bonds which led to the housing bubble bursting in 2008.
- Commodity and FOREX trading will allow banks to gamble on oil, gold, and spot currency contracts.
- Foreign debt can still be owned by banks.
- Bank CEOs will not be held personally accountable for compliance with the new rule.
- Overstepping stable bank capital reserves will continue, as the rule ignores the need to increase bank capital.
A closing chapter on the Dodd-Frank financial overhaul of 2010, Volcker himself seems pleased with the agreement.
“The result should help the process of restoring trust and confidence in commercial banking institutions,” Volcker said Tuesday. “It is, after all, those institutions which benefit from explicit and implicit public support that we count on to provide a strong, safe, and effective financial system.”