The Obama
administration, currently stumbling through the health
care overhaul, has reached a critical stage in its other
signature effort: reining in Wall Street.
The push to
reshape financial oversight hinges on negotiations in the coming
weeks over the so-called Volcker
Rule, a regulation that strikes at the heart of Wall
Street risk-taking. The rule, which bans banks from trading for
their own gain, has become synonymous with the Dodd-Frank overhaul
law that Congress adopted after the financial
crisis.
Treasury
Secretary Jacob
J. Lew has strongly urged federal agencies to finish
writing the Volcker
Rule by the end of the year — more than a year after they
had been expected to do so — and President Obama recently stressed
the importance of the deadline.
While
regulators are optimistic they will complete the rule soon, even
after facing a lobbying onslaught from Wall Street, they have
little time to overcome the internal wrangling that has stymied
them for years.
The tension among regulators — five
agencies are writing the rule — has centered on just how stringent
to make it.
Some regulators are pushing to close
potential loopholes, saying the rule will prevent future trading
blowups at big banks, a concern that gained traction when JPMorgan
Chase sustained a $6 billion trading loss in London. Yet
some officials at other agencies, including the Federal
Reserve and the Securities
and Exchange Commission, have at times worried that the
rule might inhibit banks from activities that are considered
important for their health and the functioning of
markets.
The tenor of the negotiations
underscores how the Volcker Rule has emerged as a litmus test of
the strength of Dodd-Frank, especially after regulators weakened
other rules under that 2010 law. And although the Volcker Rule is
only one of 400 regulations to arise from the sweeping overhaul,
its symbolic significance has captivated Washington and Wall Street
alike.
“Banks and their lawyers are all looking at the calendars
wondering when the financial regulatory agencies are going to issue
the Volcker Rule,” said Donald N. Lamson, a partner at the law firm
Shearman & Sterling.
Mr. Lamson, who
helped write aspects of Dodd-Frank while working at the Treasury
Department, said that delays were inevitable, given the involvement
of five agencies: the Federal Reserve; S.E.C.; Commodity
Futures Trading Commission; Federal
Deposit Insurance Corporation; and Office
of the Comptroller of the Currency. The Fed has driven
the process, operating as something of a broker between the
agencies.
“Regulators like to be perceived as a
monolith, but they each look at markets differently,” Mr. Lamson
said.
Kara M. Stein, a Democratic commissioner at the S.E.C.
who favors a strict Volcker Rule, recently submitted a four-page
list of requested changes to a current draft of the rule, according
to the officials briefed on the negotiations who were not
authorized to speak publicly. Ms. Stein could hold the swing vote
in the five-member commission, with the two Republican
commissioners unlikely to support it.
Gary
Gensler, head of the Commodity Futures Trading
Commission, also wants to make it harder for banks to disguise
speculative wagers as permissible trading done for customers,
according to the officials briefed on the discussions. Underscoring
the tension, other regulators privately groused that Mr. Gensler’s
agency — which spent most of the last few years completing dozens
of other new rules under Dodd-Frank — was too slow to raise
concerns about the Volcker Rule.
“This is one of
the most challenging rules to get done in a balanced way, but
everyone is working in good faith along that path” Mr. Gensler said
in an interview. Mr. Gensler is leaving his agency when his term
expires at the end of the year.
In recent
weeks, officials say, regulators have added language stricter than
the initial version of the rule. Mr. Lew, according to officials,
recently told Wall Street executives at a private meeting that the
rule would be tougher than banks once
thought.
Even at this late stage, the Volcker
Rule is a work in progress. While the agencies have reached a broad
agreement on most issues, a new version of the draft is being
circulated among regulators nearly every day, officials say. The
draft, with all its varied edits, spans about a thousand pages. And
agencies might ultimately split off and vote
separately.
“This is not an easy task, but we are
heartened by the progress of the five rule-writing agencies,” a
spokeswoman for Mr. Lew said in a statement. “Secretary Lew has
clearly stated his desire to see a final rule by the end of the
year, and we are optimistic that we will reach that
goal.”
From the outset, the Volcker Rule was the product of
compromise. The Obama administration declined to favor legislation
forcing banks to spin off their turbulent Wall Street operations
from their deposit-taking businesses. At the same time, it did not
want regulated banks, which enjoy deposit insurance and other forms
of government support, trading for their own profit. That business,
known as proprietary trading, had long been a lucrative, albeit
risky, business for Wall Street banks.
Paul
A. Volcker, a former chairman of the Federal Reserve who
served as an adviser to President Obama, urged that Dodd-Frank
outlaw proprietary trading. And over the objections of Wall Street,
the administration inserted into Dodd-Frank what became known as
the Volcker Rule.
The rule, however, does not ban types
of trading that are thought to be part of a bank’s basic business.
Banks can still buy stocks and bonds for their clients — a practice
called market making — and place trades that are meant to hedge
their risks.
For regulators, the headache comes with
finding practical ways to distinguish proprietary trading from the
more legitimate practices. If they wrote the exemptions for market
making and hedging too loosely, the banks might find loopholes. If
they made them too strict, banks might not be able to engage in
activities that Congress had said were
permissible.
Now, just weeks away from the
administration’s deadline to finish the rule, regulators are still
struggling to strike a balance.
Mr. Gensler,
officials briefed on the negotiations said, wants to insert
language that would tighten the market making definition. In the
real world of Wall Street, traders at a bank might keep buying
shares of Apple until they have a substantial position in the
company.
On the surface, that might look like
market making, since clients have in the past wanted to buy Apple
shares. But the bank may have actually amassed the position because
it thinks the shares will rise in the future, effectively making it
a speculative proprietary position. To prevent that sort of
maneuver, Mr. Gensler’s agency is pushing to limit the ability of
banks to stockpile such large positions.
Mr. Gensler
also argued recently that the rule offered too broad an exemption
for hedging, officials said, warning that it would fail to prevent
a repeat of the JPMorgan trading loss episode. As regulators
compromised and strengthened the language last week, officials
said, Mr. Gensler withdrew his objection.
But other
aspects of the hedging exemption might still concern supporters of
the rule. The Fed sent out a draft last month that removed a
sentence that required hedging to be “reasonably correlated” with a
bank’s risks, according to three people briefed on the
negotiations. Other agencies saw this as a weakening of the rule
because it could make it easier for a bank to pass off speculative
trading as hedging. After some debate, the words were reinserted,
though it was not clear whether they would carry the same weight in
the final draft.
The Volcker Rule takes other steps to
stamp out proprietary trading. The final version is expected to
contain a provision that requires bank chief executives to attest
that they are not doing proprietary trading, officials say, a
victory for the rule’s supporters. The tougher version of this
provision would have a chief executive make this certification in
the bank’s public securities filings, which are audited and are
expected to have a high degree of accuracy. A more modest version
would have the executive attest to a bank’s board of
directors.
The Volcker Rule also addresses
traders’ compensation. The final wording is likely to require that
traders engaged in market making and hedging not be paid on the
basis of simply how much money their units made. Instead, the risks
involved in taking positions would also have to be
considered.
Since the Volcker Rule was first
proposed in 2011, regulators have had to contend with a fierce
lobbying campaign by the banks. But that effort lost momentum last
year, after JPMorgan’s trading debacle revealed that its traders
were placing enormous speculative bets under the guise of
hedging.
“I think you’re going to have a
reasonable interpretation of the law,” Mr. Volcker said about the
rule last year. “And an interpretation that can be reasonably
followed by the banks and enforced by the
regulators.”