Volcker rule enforcement: Regulators attempt a united front
By Henry Engler, Compliance Complete
NEW YORK, Feb. 19 (Thomson Reuters Accelus) – The question of which regulator will take the lead in enforcing the complex Volcker rule took center stage this week, as U.S. lawmakers voiced concern over the lack of clear leadership among the five agencies in charge of the statute.
In testimony before the House Financial Services Committee on Wednesday, the heads of the five agencies — the Federal Reserve, Office of the Comptroller of the Currency, Securities Exchange Commission, FDIC, and Commodities Futures Trading Commission – found themselves questioned repeatedly over which agency was at the helm.
“Who’s in charge? I’ve yet to hear really who’s in charge,” said Rep. Shelley Moore Capito, R-W.Va. “Nobody’s in charge. So nobody makes a decision. Or you make a decision over one another and then all of the sudden there’s three or four decisions that have been made. And how are the institutions supposed to react in the best interest of their client?”
Echoing Rep. Capito’s concerns, others focused on how exactly the agencies would resolve a dispute over trades that appeared to step over the line into proprietary trading.
“Do you know yet how they’re going to coordinate enforcement of the Volcker Rule?” asked Rep. Carolyn Maloney, D-N.Y. “What if one agency thinks that a trade violates the Volcker Rule, but another agency thinks that it’s acceptable? How are you going to solve that? Are you working on a memorandum of understanding on enforcement? But what happens if two regulators disagree on an action?”
Inter-agency working group
As if almost anticipating the barrage of criticism from lawmakers, the heads of the five agencies unveiled an inter-agency working group that was charged with reviewing the Volcker rule and ensuring that there was agreement across a range of issues. While they did not go into detail over the group’s mandate, industry experts said the focus was tilted towards interpretation issues.
“My understanding is that the purpose of the group is to address legal questions about the interpretation of the rule,” said Kathy Dick, managing director at Promontory Financial Group. “I think they will be less involved in the actual supervision of any individual company.”
In terms of how the rule would be enforced, the agencies provided a united front, underlining the need to consult and coordinate when necessary. Each official emphasized that the manner in which their oversight was carried out today would remain in place. For example, broker-dealer subsidiaries of a large institution would continue to have the SEC as their primary regulator. Similarly, the activities within a firm that was under the domain of the OCC would remain in place.
But there was recognition that at times there would need to be cross-agency consultation.
“At the end of the day, we have independent agencies, with independent responsibilities,” said SEC chair Mary Jo White. “I think there was an acute awareness . . . from, I think, all the panelists about the need not only to coordinate and reach consistency on interpretive guidance, but also for compliance and enforcement.”
Trading across legal entities
The challenge, it seems, would most often arise when there were questionable trades that involved several legal entities within one institution, bringing into play the regulatory remit of more than one agency. For example, a derivative transaction might originate within the “bank” side of the firm, but then hedged within the broker-dealer. Under such scenarios, where the OCC might have reason to question whether the initial derivative contract was proprietary in nature, the hedging leg of the deal would also bring in the expertise of the SEC.
How frequent might such cross-entity transactions occur? Industry observers say that while a lion’s share of broker-dealer activities might be enclosed within that legal entity, there is a considerable amount of trading at the largest institutions that span more than one entity. It is in these circumstances where agency cooperation and agreement becomes critical should proprietary trading be suspected.
‘London Whale’ as a model
Similarly, the five agencies might also pool their resources when a lapse in controls is found in one part of the institution. Experts pointed to JPMorgan’s London Whale episode as an example of where inadequate risk management controls found in the Chief Investment Office unleashed a broader investigation into controls across the bank. With proprietary trading, should weaknesses be discovered on the banking side of an institution, it could spark greater scrutiny of the broker-dealer, for example.
In addition, there is the expectation that the five agencies will collect information on “best practices” across the industry and use the data to identify control and compliance gaps at firms. The inter-agency working group might also be a forum for such research and analysis.
(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)