Sunday, October 09, 2011 3:41:44 AM
The Multibillion-Dollar Leak
Paul Volcker: No comment until the final version is released.
Bloomberg News
Draft of 'Volcker Rule' Hits Internet, Rocking Wall Street, Washington; 'Proprietary Trading' on Line
By SCOTT PATTERSON And VICTORIA MCGRANE
OCTOBER 7, 2011
Bankers, lobbyists and lawmakers from Wall Street to Washington scrambled to dissect, analyze and react to a leaked proposal for one of the most controversial elements of the Dodd-Frank financial-overhaul law: the "Volcker rule."
Billions of dollars are at stake for big banks, which have been working for months to shape the rule aimed at curbing risky trading activities that played a part in the financial crisis.
The latest frenzy erupted late Wednesday when a website posted a 205-page draft [ http://cdn.americanbanker.com/media/pdfs/093011VolckerRulePreamble_FINAL_DRAFT.pdf ; http://online.wsj.com/public/resources/documents/093011volcker_draft.pdf ] of a memo, dated Sept. 30, that laid out critical elements of the proposed Volcker rule.
The leak left regulators fuming and opened a new front in Wall Street's battle to soften the blow of the proposed rule. The draft gave banking industry lobbyists several days to discuss it before Tuesday, when the Federal Deposit Insurance Corp. is scheduled to consider issuing a version for public comment.
The response came quickly. A team of seven lawyers at the law firm Davis Polk & Wardwell, which represents a number of large banks, worked through the night in New York to ensure clients got briefings with their Thursday breakfast. Congressional staffers pored over the document looking for clues about how strict or lenient it could be.
Talk spread that the leak could prompt regulators to move more quickly to release an official version. A lobbyist for a large Wall Street bank assigned a staffer to continuously monitor the website of the Federal Reserve, which is helping draft the rule.
The rule is named for former Fed Chairman Paul Volcker, who argued that trading by banks for their own profit, an activity known as proprietary trading, encouraged financial institutions to take excessive risks.
A spokesman for Mr. Volcker declined to comment on the draft and said he will only comment when the official version has been released.
For years, banks racked up profit from proprietary-trading desks that acted in many ways like hedge funds. They made big bets on everything from stocks to commodities, often using borrowed money that amplified gains but also increased risk.
According to a July report by the U.S. Government Accountability Office, proprietary trading accounted for $15.6 billion in revenue at the six largest bank holding companies for the 13 quarters from June 2006 to December 2010, amounting to a fraction of combined revenue.
During five quarters spanning the financial crisis, however, proprietary trading accounted for $15.8 billion in losses, wiping out the gains of the previous 4½ years.
Congress effectively banned those activities in the Dodd-Frank law passed last year, but left it to regulators to write the rules implementing the law. Wednesday's leak was the first chance many bankers and lobbyists had to see how the rule is taking shape.
The Volcker rule already has triggered major changes at large U.S. banks. Several institutions shut down trading desks that made bets with the firm's own capital, and many of those traders moved to smaller firms that aren't subject to the rule. Its impact on the industry's profitability and risk-taking appetite will be hard to gauge until after the rule takes effect, likely sometime next year.
It is too early to estimate the rule's cost, but Glenn Schorr, an analyst at Nomura Equity Research, predicted it would "at a minimum" increase the cost of funding for U.S. companies, as banks pass on some of the higher expenses they face. The price tag for banks could be at least $2 billion a year, Mr. Schorr wrote.
The leaked document, posted on the American Banker website [ http://cdn.americanbanker.com/media/pdfs/093011VolckerRulePreamble_FINAL_DRAFT.pdf ], was labeled as a draft and was authored by FDIC, the Federal Reserve, the Comptroller of the Currency and the Securities and Exchange Commission. After the FDIC's meeting Tuesday, the SEC is scheduled to meet Wednesday to consider the rule and the Fed is expected to follow suit as early as next week. The CFTC, which has been focusing on complex derivatives rules, is expected to take up the matter but has no immediate plans to consider the rule.
The draft memo set Dec. 16 as the deadline for public comments, but that date could be extended for several months.
One bank lobbyist Thursday noted that, while the rule language was couched in terms of avoiding disruptions to markets, it also contained language indicating that trading at banks "must be designed to generate revenues primarily from fees, commissions…or other income not attributable to appreciation in the value of covered financial positions it holds in trading accounts."
That could cause problems for bond-trading desks, where traders routinely build up inventories of bonds in anticipation of selling them for a higher price later to clients. Cutting this out of trading, some Wall Street pros fear, might shrink trading desks, hurting profit but also making it harder for investors to buy and sell quickly at competitive prices.
Meanwhile, officials inside the government agencies that drafted the document fumed about the leak. They worried that it could lead to pressure to change the language ahead of the FDIC's meeting next week. Alternatively, the regulators could feel pressure to refrain from changes that could make it appear that they had given in to industry pressure.
As people drilled down into the details of the draft, many were concerned that it appeared to require very granular policing of individual traders at banks as part of the stringent, multilevel compliance regime described in the document.
"They have chosen the most burdensome way of doing it," said Tim Ryan, chief executive of the Securities Industry and Financial Markets Association, a Wall Street trade association, in an interview.
The more permitted market-making and other trading a bank engages in, the more intricate their compliance program will have to be. Among the many prescriptions for these compliance regimes: Banks with trading assets of $1 billion or more in trading assets and liabilities would have to measure their trading with a variety of quantitative formulas, and periodically report these metrics to regulators. The specific reporting requirements would vary by the scale and scope of a banks' trading activity, according to the document.
Trading units would have to calculate the required metrics each trading day, and report them on a monthly basis.
The proposed rule stops short of requiring a firm's CEO to attest to their company's compliance, which had been part of a set of recommendations made in January by the Financial Stability Oversight Council, a body that comprises top U.S. financial regulators and is headed by Treasury. Instead, the proposal asks for comment on whether such an attestation should be required. That is one of hundreds of questions posed by regulators in the proposal.
Among the more controversial elements of the rule is a provision that would allow banks to make trades described as hedges, or bets that offset other positions, on a "portfolio basis." The rule would include "the hedging of one or more specific risks arising from a portfolio of diverse holdings, such as the hedging of the aggregate risk of one or more trading desks."
Such trades would have to be "demonstrably risk-reducing," according to the document.
The language is seen as a victory for Wall Street banks, which have long favored such language. The Wall Street Journal previously reported that a draft of the rule that emerged in August included language allowing for portfolio-style hedging.
Critics say that by allowing banks to hedge risks on a portfolio-wide basis, the rule could open the door to more aggressive trading tactics. A bank could claim that its portfolio is at risk from an economic turn, such as a recession, and take positions that protect it from such an event, they say.
Such nuances are likely to take years before banks, regulators and law makers know how the rule will be applied in practice.
—Aaron Lucchetti and Jean Eaglesham contributed to this article.
Write to Scott Patterson at scott.patterson@wsj.com
Copyright ©2011 Dow Jones & Company, Inc.
http://online.wsj.com/article/SB10001424052970204294504576615382298044922.html [with comments]
===
Volcker Rule Will Hit Goldman Sachs, Morgan Stanley Hardest
Halah Touryalai
10/07/2011 @ 2:31PM
The Volcker rule scared bankers perhaps more than anything else coming out of the Dodd-Frank reform, and now a leaked draft of the rule shows regulators may be giving them some breathing room.
The rule, named after former Federal Reserve Chairman Paul Volcker, was put forth to restrict banks from making speculative bets and trades with their own capital. Banks made huge profits on what’s known as proprietary trading in the years leading up to the financial crisis (over $15 billion by some measures), and were rightfully nervous about how the Volcker rule would eat into their bottom lines in the future.
This week banks and their lawyers got an inside look at what the rule might look like. A draft version of the rule was leaked and posted on the American Banker’s website [ http://cdn.americanbanker.com/media/pdfs/093011VolckerRulePreamble_FINAL_DRAFT.pdf ], and was the first detailed look at the rule the industry has been able to get its hands on.
In a note yesterday Nomura analyst Glenn Schorr said the draft rules could seem harsh but the final rules likely won’t be so cut and dried. “Given the challenges of distinguishing what is improper trading and what is not, we believe that it is impractical for regulators to propose and implement overly prescriptive rules. We believe that regulators understand that, if the rules are too restrictive, then liquidity would be hampered, placing U.S. banks at a competitive disadvantage vs. global peers,” Schorr writes.
Banks have been worried that regulators will over-regulate prop trading to an extent that it harms their other activity. While banning prop trading seems simple enough, there are areas of trading activity that may be tougher to define that also fall under the Volcker Rule. For instance , the Volcker Rule also hits on market-timing, hedging and investments in hedge funds and private equity. How regulators will decipher whether or not a bank is engaging in those activities for legit reasons vs. improper trading is something that still needs to be made clear. Here’s how Schorr puts it:
“For example, certain asset classes, such as corporate bonds, credit default swaps, or even “off the run” U.S. Treasuries, necessitate inventory accumulation and exposure to price movements due to the illiquid nature of those markets. Furthermore, certain securities or derivatives, such as corporate bonds or swaps, contain various dimensions of risk exposures (i.e., credit, interest rate, counterparty risk) that may require the use of more than one type of financial instrument to mitigate those risk exposures. Banks need to be able to hedge on a portfolio level across asset classes.
Regulators are apparently warm to the idea of an exemption for hedging against risk related to customers’ trades. The exemption has some worried that it will open the doors improper trading.
Not surprisingly Schorr says the Volcker Rule would impact investment banking giant Goldman Sachs the most followed by Morgan Stanley. The two firms derive 48% and 27% of their total consolidated revenues from principal transactions respectively. Schorr says Volcker will pact 20% of Goldman trading revenue.
Meanwhile Bank of America and JPMorgan Chase see about 9% and 8% of their total consolidated revenue come from such transactions. Citigroup will be the least hit with just 5% of its total revenue at stake.
“The takeaway here is that the Volcker Rule is more significant for GS and MS and less so for Citigroup. We emphasize that the revenue won’t all go away but just that GS and MS would be more impacted by the Volcker Rules. Nevertheless, we strongly believe that an overly restrictive set of rules is bad for everyone, will hurt liquidity in the markets, and will put U.S. banks at a competitive disadvantage,” Schorr writes.
When the rule was announced on January the market slid and the Financial Sector ETF dropped 5% over the next five days. Goldman Sachs stock fell $6.92, or 4.1 percent. Still though firms like Goldman, JPMorgan, Bank of America announced plans to wind down their proprietary trading operations.
Schorr adds, “A draconian form of the Volcker Rule will likely have unintended consequences, such as reduced liquidity, higher funding costs for U.S. companies, less credit for small businesses, higher trading costs and lower investor returns, less ability to transfer risk, and competitive disadvantages for U.S. banks relative to foreign banks. We are hopeful regulators are mindful of these risks and doing their best to write fair, yet effective, rules.”
The final rules are scheduled to be issued October 18.
Copyright 2011 Forbes.com LLC™
http://www.forbes.com/sites/halahtouryalai/2011/10/07/volcker-rule-will-hit-goldman-sachs-morgan-stanley-hardest/ [with comments] [ http://investorshub.advfn.com/boards/read_msg.aspx?message_id=67814101 ]
Paul Volcker: No comment until the final version is released.
Bloomberg News
Draft of 'Volcker Rule' Hits Internet, Rocking Wall Street, Washington; 'Proprietary Trading' on Line
By SCOTT PATTERSON And VICTORIA MCGRANE
OCTOBER 7, 2011
Bankers, lobbyists and lawmakers from Wall Street to Washington scrambled to dissect, analyze and react to a leaked proposal for one of the most controversial elements of the Dodd-Frank financial-overhaul law: the "Volcker rule."
Billions of dollars are at stake for big banks, which have been working for months to shape the rule aimed at curbing risky trading activities that played a part in the financial crisis.
The latest frenzy erupted late Wednesday when a website posted a 205-page draft [ http://cdn.americanbanker.com/media/pdfs/093011VolckerRulePreamble_FINAL_DRAFT.pdf ; http://online.wsj.com/public/resources/documents/093011volcker_draft.pdf ] of a memo, dated Sept. 30, that laid out critical elements of the proposed Volcker rule.
The leak left regulators fuming and opened a new front in Wall Street's battle to soften the blow of the proposed rule. The draft gave banking industry lobbyists several days to discuss it before Tuesday, when the Federal Deposit Insurance Corp. is scheduled to consider issuing a version for public comment.
The response came quickly. A team of seven lawyers at the law firm Davis Polk & Wardwell, which represents a number of large banks, worked through the night in New York to ensure clients got briefings with their Thursday breakfast. Congressional staffers pored over the document looking for clues about how strict or lenient it could be.
Talk spread that the leak could prompt regulators to move more quickly to release an official version. A lobbyist for a large Wall Street bank assigned a staffer to continuously monitor the website of the Federal Reserve, which is helping draft the rule.
The rule is named for former Fed Chairman Paul Volcker, who argued that trading by banks for their own profit, an activity known as proprietary trading, encouraged financial institutions to take excessive risks.
A spokesman for Mr. Volcker declined to comment on the draft and said he will only comment when the official version has been released.
For years, banks racked up profit from proprietary-trading desks that acted in many ways like hedge funds. They made big bets on everything from stocks to commodities, often using borrowed money that amplified gains but also increased risk.
According to a July report by the U.S. Government Accountability Office, proprietary trading accounted for $15.6 billion in revenue at the six largest bank holding companies for the 13 quarters from June 2006 to December 2010, amounting to a fraction of combined revenue.
During five quarters spanning the financial crisis, however, proprietary trading accounted for $15.8 billion in losses, wiping out the gains of the previous 4½ years.
Congress effectively banned those activities in the Dodd-Frank law passed last year, but left it to regulators to write the rules implementing the law. Wednesday's leak was the first chance many bankers and lobbyists had to see how the rule is taking shape.
The Volcker rule already has triggered major changes at large U.S. banks. Several institutions shut down trading desks that made bets with the firm's own capital, and many of those traders moved to smaller firms that aren't subject to the rule. Its impact on the industry's profitability and risk-taking appetite will be hard to gauge until after the rule takes effect, likely sometime next year.
It is too early to estimate the rule's cost, but Glenn Schorr, an analyst at Nomura Equity Research, predicted it would "at a minimum" increase the cost of funding for U.S. companies, as banks pass on some of the higher expenses they face. The price tag for banks could be at least $2 billion a year, Mr. Schorr wrote.
The leaked document, posted on the American Banker website [ http://cdn.americanbanker.com/media/pdfs/093011VolckerRulePreamble_FINAL_DRAFT.pdf ], was labeled as a draft and was authored by FDIC, the Federal Reserve, the Comptroller of the Currency and the Securities and Exchange Commission. After the FDIC's meeting Tuesday, the SEC is scheduled to meet Wednesday to consider the rule and the Fed is expected to follow suit as early as next week. The CFTC, which has been focusing on complex derivatives rules, is expected to take up the matter but has no immediate plans to consider the rule.
The draft memo set Dec. 16 as the deadline for public comments, but that date could be extended for several months.
One bank lobbyist Thursday noted that, while the rule language was couched in terms of avoiding disruptions to markets, it also contained language indicating that trading at banks "must be designed to generate revenues primarily from fees, commissions…or other income not attributable to appreciation in the value of covered financial positions it holds in trading accounts."
That could cause problems for bond-trading desks, where traders routinely build up inventories of bonds in anticipation of selling them for a higher price later to clients. Cutting this out of trading, some Wall Street pros fear, might shrink trading desks, hurting profit but also making it harder for investors to buy and sell quickly at competitive prices.
Meanwhile, officials inside the government agencies that drafted the document fumed about the leak. They worried that it could lead to pressure to change the language ahead of the FDIC's meeting next week. Alternatively, the regulators could feel pressure to refrain from changes that could make it appear that they had given in to industry pressure.
As people drilled down into the details of the draft, many were concerned that it appeared to require very granular policing of individual traders at banks as part of the stringent, multilevel compliance regime described in the document.
"They have chosen the most burdensome way of doing it," said Tim Ryan, chief executive of the Securities Industry and Financial Markets Association, a Wall Street trade association, in an interview.
The more permitted market-making and other trading a bank engages in, the more intricate their compliance program will have to be. Among the many prescriptions for these compliance regimes: Banks with trading assets of $1 billion or more in trading assets and liabilities would have to measure their trading with a variety of quantitative formulas, and periodically report these metrics to regulators. The specific reporting requirements would vary by the scale and scope of a banks' trading activity, according to the document.
Trading units would have to calculate the required metrics each trading day, and report them on a monthly basis.
The proposed rule stops short of requiring a firm's CEO to attest to their company's compliance, which had been part of a set of recommendations made in January by the Financial Stability Oversight Council, a body that comprises top U.S. financial regulators and is headed by Treasury. Instead, the proposal asks for comment on whether such an attestation should be required. That is one of hundreds of questions posed by regulators in the proposal.
Among the more controversial elements of the rule is a provision that would allow banks to make trades described as hedges, or bets that offset other positions, on a "portfolio basis." The rule would include "the hedging of one or more specific risks arising from a portfolio of diverse holdings, such as the hedging of the aggregate risk of one or more trading desks."
Such trades would have to be "demonstrably risk-reducing," according to the document.
The language is seen as a victory for Wall Street banks, which have long favored such language. The Wall Street Journal previously reported that a draft of the rule that emerged in August included language allowing for portfolio-style hedging.
Critics say that by allowing banks to hedge risks on a portfolio-wide basis, the rule could open the door to more aggressive trading tactics. A bank could claim that its portfolio is at risk from an economic turn, such as a recession, and take positions that protect it from such an event, they say.
Such nuances are likely to take years before banks, regulators and law makers know how the rule will be applied in practice.
—Aaron Lucchetti and Jean Eaglesham contributed to this article.
Write to Scott Patterson at scott.patterson@wsj.com
Copyright ©2011 Dow Jones & Company, Inc.
http://online.wsj.com/article/SB10001424052970204294504576615382298044922.html [with comments]
===
Volcker Rule Will Hit Goldman Sachs, Morgan Stanley Hardest
Halah Touryalai
10/07/2011 @ 2:31PM
The Volcker rule scared bankers perhaps more than anything else coming out of the Dodd-Frank reform, and now a leaked draft of the rule shows regulators may be giving them some breathing room.
The rule, named after former Federal Reserve Chairman Paul Volcker, was put forth to restrict banks from making speculative bets and trades with their own capital. Banks made huge profits on what’s known as proprietary trading in the years leading up to the financial crisis (over $15 billion by some measures), and were rightfully nervous about how the Volcker rule would eat into their bottom lines in the future.
This week banks and their lawyers got an inside look at what the rule might look like. A draft version of the rule was leaked and posted on the American Banker’s website [ http://cdn.americanbanker.com/media/pdfs/093011VolckerRulePreamble_FINAL_DRAFT.pdf ], and was the first detailed look at the rule the industry has been able to get its hands on.
In a note yesterday Nomura analyst Glenn Schorr said the draft rules could seem harsh but the final rules likely won’t be so cut and dried. “Given the challenges of distinguishing what is improper trading and what is not, we believe that it is impractical for regulators to propose and implement overly prescriptive rules. We believe that regulators understand that, if the rules are too restrictive, then liquidity would be hampered, placing U.S. banks at a competitive disadvantage vs. global peers,” Schorr writes.
Banks have been worried that regulators will over-regulate prop trading to an extent that it harms their other activity. While banning prop trading seems simple enough, there are areas of trading activity that may be tougher to define that also fall under the Volcker Rule. For instance , the Volcker Rule also hits on market-timing, hedging and investments in hedge funds and private equity. How regulators will decipher whether or not a bank is engaging in those activities for legit reasons vs. improper trading is something that still needs to be made clear. Here’s how Schorr puts it:
“For example, certain asset classes, such as corporate bonds, credit default swaps, or even “off the run” U.S. Treasuries, necessitate inventory accumulation and exposure to price movements due to the illiquid nature of those markets. Furthermore, certain securities or derivatives, such as corporate bonds or swaps, contain various dimensions of risk exposures (i.e., credit, interest rate, counterparty risk) that may require the use of more than one type of financial instrument to mitigate those risk exposures. Banks need to be able to hedge on a portfolio level across asset classes.
Regulators are apparently warm to the idea of an exemption for hedging against risk related to customers’ trades. The exemption has some worried that it will open the doors improper trading.
Not surprisingly Schorr says the Volcker Rule would impact investment banking giant Goldman Sachs the most followed by Morgan Stanley. The two firms derive 48% and 27% of their total consolidated revenues from principal transactions respectively. Schorr says Volcker will pact 20% of Goldman trading revenue.
Meanwhile Bank of America and JPMorgan Chase see about 9% and 8% of their total consolidated revenue come from such transactions. Citigroup will be the least hit with just 5% of its total revenue at stake.
“The takeaway here is that the Volcker Rule is more significant for GS and MS and less so for Citigroup. We emphasize that the revenue won’t all go away but just that GS and MS would be more impacted by the Volcker Rules. Nevertheless, we strongly believe that an overly restrictive set of rules is bad for everyone, will hurt liquidity in the markets, and will put U.S. banks at a competitive disadvantage,” Schorr writes.
When the rule was announced on January the market slid and the Financial Sector ETF dropped 5% over the next five days. Goldman Sachs stock fell $6.92, or 4.1 percent. Still though firms like Goldman, JPMorgan, Bank of America announced plans to wind down their proprietary trading operations.
Schorr adds, “A draconian form of the Volcker Rule will likely have unintended consequences, such as reduced liquidity, higher funding costs for U.S. companies, less credit for small businesses, higher trading costs and lower investor returns, less ability to transfer risk, and competitive disadvantages for U.S. banks relative to foreign banks. We are hopeful regulators are mindful of these risks and doing their best to write fair, yet effective, rules.”
The final rules are scheduled to be issued October 18.
Copyright 2011 Forbes.com LLC™
http://www.forbes.com/sites/halahtouryalai/2011/10/07/volcker-rule-will-hit-goldman-sachs-morgan-stanley-hardest/ [with comments] [ http://investorshub.advfn.com/boards/read_msg.aspx?message_id=67814101 ]
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