By Bora Yagiz
NEW YORK, Sept. 19 (Thomson Reuters Accelus) - The question what distinguishes a “trading account” from a legitimate liquidity management program will be a primary concern as no less than four regulators, namely the Federal Reserve, the Securities and Exchange Commission (SEC), the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, finish work on the “Volcker rule” limiting risky trading by banks. The regulators jointly proposed last year the provisions for implementing section 619 of the Dodd Frank Act. Final rules are expected by year end.
The July 2012 statutory deadline for what is commonly referred to as the Volcker rule has already been missed, and the 298-pages of proposed rules have attracted more than 17,000 comment letters and sparked a heated debate across the industry. This is because the regulators aim for a complete overhaul of trading activities by severely restraining any “banking entity” from “proprietary trading,” thereby preventing undue risk exposure of consumers’ and taxpayers’ money.
The devil will be in the interpretation of many of these rules. The definition of “trading account” will likely be the most critical premise, as the rest of the rules will be built upon it.
Since the inception of the Volcker rule, named after former Federal Reserve Chairman Paul Volcker, who promoted it, much of the discussion has revolved around what constitutes “proprietary trading.” Dodd-Frank defines it as “engagement in an activity by a deposit-taking institution as a principal for its trading account in the purchase or sale of a security, derivative, future or an option contract. “
The interest in proprietary trading is not surprising, as significant losses incurred by banks during the recent financial crisis came from proprietary positions in trading accounts, mostly from mortgage-backed and asset-backed bonds tied to toxic loans. More recently, JPMorgan’s “London whale” trade debacle, where the company lost $5 billion, raised the question of whether it was a legitimate form of portfolio hedging or a speculative play on short-term price movements.