The controversial Volcker Rule that restricts proprietary trading of U.S. banks may also be enforced on foreign banks with operations in the country, Bloomberg reported on Friday, following communication with four people familiar with the matter.
The legislation is part of the Dodd-Frank Act, which significantly overhauled the U.S. financial system after the near collapse of Wall Street during the 2007–2010 recession.
While the proposed rule is still pending its final draft with an October 18 deadline, the plan to stretch it to overseas banks may cause further delay as federal regulators will have to reach a consensus on the impending law.
Meanwhile, questions arise on whether this extension will aid economic recovery or a pose threats to the already-feeble job market? The possibilities of both the results made it a matter of debate. Before discussing the pros and cons, let’s have a quick look on the basics of the rule and its progress so far.
The What and Why of Volcker Rule
The Volcker Rule, named after Paul Volcker, a former Federal Reserve chairman who advises the Obama administration, was designed to restrict types risky investments including proprietary trading and private equity investments that triggered the financial crisis.The primary intension of the rule is to keep the risky bets that banks play with their own money in check.
However, the rule includes exemptions for government-guaranteed investments, hedging, market-making and insurance-company transactions.
Reacting Banks
Though the restrictions under the Volcker Rule are yet to be finalized, many big U.S. banks including Goldman Sachs (GS), Citigroup Inc. (C) and Bank of America Corp. (BAC) have already started responding in its favor. These banks continue to shed theirproprietary trading operations.
Bank of America has already spun off its last large private equity fund through the creation of North Cove Partners. Also, the bank has significantly contracted its proprietary trading desk by retrenching one third of its employees related to the business last year.
For Goldman, proprietary trading has been a major contributor to its profitability. However, the company took the decision to fold its principal-strategies unit, which handles proprietary equities trading.
Citigroup has also shuttered its $400 million Quantitative Strategies fund in order to comply with the Volcker Rule.
Likewise, Morgan Stanley (MS) and JPMorgan Chase (JPM) are on the brinkof taking decisions to trim theirproprietary trading operations.
A New Threat?
According to the foreign banks, if the Volcker Rule applies to them because of their U.S. operations, they will be forced to retrench or relocate employees involved in the related businesses.
The Institute of International Bankers (IIB) believes the Volcker Rule should not be extended to foreign banks with operations in the U.S. if they do risky businessoffshore, without putting American investment at risk.
In a letter written to the U.S. regulators in May, IIB chief Sally Miller said that if the involvement of U.S. employees in overseas proprietary trading by foreign banks restricts them to continue their businesses, these banks would simply retrench and relocate the related units.
Among the foreign concerns facing risks are Deutsche Bank AG (DB) and Credit Suisse Group (CS). According to IIB, over 250,000 U.S. workers are dependent on the operations of international banks in U.S.
Considering the current job market situation, wouldn’t the extension of the Volcker Rule put all these jobs at stake? Already, the outcome of Obama’s $447 billion job bill is uncertain. Now, if these foreign banks layoff so many employees, the country will actually be left with a heavier jobless burden. This leaves us to wonder, won’t this boomerang on the country’s finances system that is desperately trying to recover?
The vice president of the American Bankers Association, Wayne Abernathy is confident that Americans will not lose jobs at U.S. operations of foreign banks. Their requirement will always remain as these foreign banks will try to diversify their activities in the U.S. market where domestic banks are struggling with weak financials. Also, the VolckerRule exempts proprietary trading conducted outside of the country.
Cause of Confusion
The problem was actually with the language of the bill that should have been well interpreted by regulators in the first place. The definition of operations conducted “solely” outside the country is still vague.
The fear is that proprietary trading managed by U.S. operations of foreign banks or involvement of U.S. workers in offshore proprietary trading could be subject to the Volcker Rule, even if no U.S. investments are involved. What ensued is a general fear that either proprietary trading managed by U.S. operations of foreign banks or U.S. workers involved in offshore proprietary trading could be axed by the Volcker Rule, even if U.S. investments are not involved.
To Conclude…
It’s clear that the U.S. jobless claims will shoot up, should the Volcker Rule touch foreign banks. However, the rule will significantly rationalize the $600 trillion derivatives market, which was a main culprit of the latest meltdown.
So, while the U.S. government has every noble intention of controlling risky businesses, materialization of the latest rumor may turn out to be a curse in disguise. So, keeping job market challenges in mind, it would be in the best interest of the country’s economy at large if the regulators first define the phrase related to U.S. operations of foreign banks before finalizing the rule. That would clear so many doubts.
BANK OF AMER CP (BAC): Free Stock Analysis Report
CITIGROUP INC (C): Free Stock Analysis Report
CREDIT SUISSE (CS): Free Stock Analysis Report
DEUTSCHE BK AG (DB): Free Stock Analysis Report
GOLDMAN SACHS (GS): Free Stock Analysis Report
JPMORGAN CHASE (JPM): Free Stock Analysis Report
MORGAN STANLEY (MS): Free Stock Analysis Report
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