The Volcker Rule is the newest legal threat posed to Wall Street, and it is quickly gaining approval from various regulatory bodies. Over a year ago, a House-Senate committee first approved a final revision of the bill on June 24th, 2010. Next, in September 2011, the agencies responsible for the deal, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Federal Reserve, released a 205-page draft. Lastly, on October 11th and 12th, the FDIC and SEC, respectively, voted in favor of the initial version. However, in the midst of all the politics involved for approval remains the basic question: What is the Volcker rule and what are its ramifications?
The Volcker rule, named after the Federal Reserve chairman who proposed it (Paul A. Volcker), aims to restrict Wall Street firms' ability to make risky trades. In other words, the rule will attempt to ban proprietary trading, which refers to the practice of using the firm's money to make trades rather than selling and trading for clients. Over the past few years, and especially recently with the UBS case, many large trading losses have occurred because a rogue trader used the firm's money to make a risky bet. The Volcker rule aims to prohibit such behavior, as well as a few other banking activities. For example, the rule prohibits Wall Street firms from investing their own money in private equity firms or hedge funds.
However, there are several gray areas that the rule does not clearly address. One such unclear area arises because the rule does not actually ban all proprietary activities. For example, trading in government bonds, commodities, and foreign currencies is still allowed. The regulators made this exemption because they believe these markets may not function properly without Wall Street activity. Furthermore, some trades that are otherwise forbidden may be allowed if they are used as a hedge. Lastly, and perhaps the trickiest territory, is market making. Traders have always participated in market making because it allows them to buy securities from client with plans to sell them later to another client. However, it is difficult to ascertain if a trader is actually creating the market for a client or making the trade for the firm.
Regardless of certain vague sections, the Volcker Rule as a whole poses a serious threat to the basic operations of many Wall Street firms. Read more on how Wall Street has reacted at: http://dealbook.nytimes.com/2011/10/11/with-volcker-rule-wall-street-braces-for-change/
By Meha Patel