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Financial Services Law Insights and Observations

Federal Reserve Board issues proposed joint revisions to Volcker rule

Federal Issues Federal Reserve Volcker Rule Bank Holding Company Act OCC FDIC SEC CFTC

Federal Issues

On May 30, the Federal Reserve Board (Board) announced proposed revisions designed to simplify and tailor compliance with Section 13 of the Bank Holding Company Act’s restrictions on a bank’s ability to engage in proprietary trading and own certain funds (the Volcker rule). The proposal, subject to public comment for 60 days after publication in the Federal Register, was developed in coordination with the OCC, FDIC, SEC, and CFTC, and would modify regulations finalized in December 2013 to reduce compliance costs for banks. Two information collections were issued along with the proposal: Information Schedules and Quantitative Measurements Daily Schedule.

According to a Board memo, the proposed amendments would tailor Volcker rule requirements to better align with a bank’s level of trading activity and risks. The proposal would establish the following three categories based on trading activity: (i) “significant trading assets and liabilities,” which would consist of banks with gross trading assets and liabilities of at least $10 billion, and require a comprehensive compliance program tailored to reflect the Volcker rule’s requirements; (ii) “moderate trading assets and liabilities,” which would include banks with gross trading assets and liabilities of at least $1 billion but less than $10 billion, and impose reduced compliance obligations; and (iii) “limited trading assets and liabilities,” which would include banks with less than $1 billion in gross trading assets and liabilities, and subject them to the lowest level of regulatory compliance.

In addition, the proposal would, among other changes:

  • provide more clarity by revising the definition of “trading account” to be an account used to buy or sell financial instruments recorded at fair value under commonly used accounting definitions;
  • clarify that banks whose trades do not exceed appropriately developed internal risk limits are engaged in permissible market-making-related activity;
  • streamline the criteria that applies when a bank relies on the hedging exemption from the proprietary trading prohibition, and remove a requirement that a trade “demonstrably reduces or otherwise significantly mitigates” a specific risk;
  • ease the documentation requirement banks face when demonstrating trades are hedges, and eliminate requirements that a bank with only moderate or limited trading activity must develop “a separate internal compliance program for risk-mitigation hedging”;
  • eliminate the 60-day rebuttable presumption for trades;
  • expand the scope of the “liquidity management exclusion” in the Volcker rule to allow banks to use foreign exchange forwards, foreign exchange swaps, and physically settled cross-currency swaps as a part of liquidity management activities;
  • limit the impact of the Volcker rule on foreign banks’ activity outside of the U.S.; and
  • simplify the type of trading activity information that banks will be required to provide to the agencies.

Federal Reserve Board Chair Jerome Powell noted that after nearly five years of experience applying the Volcker rule, the proposed rule is a way to “allow firms to conduct appropriate activities without undue burden, and without sacrificing safety and soundness.”

Federal Reserve Board Governor Lael Brainard also commented that “[r]ather than requiring banking institutions to undertake specific quantitative analyses prescribed by the regulators, the proposed revisions would require banking institutions to establish internal risk limits to achieve the principle of not exceeding the reasonably expected near-term demands of customers, subject to supervisory review.”

Federal Reserve Board Vice Chair of Supervision Randal Quarles stated that while the regulatory relief bill signed into law on May 24 exempts banks with less than $10 billion in total assets from the Volcker rule (see previous InfoBytes coverage here), the “proposed rule, however, would recognize that small asset size is not the only indicator of reduced proprietary trading risk.” Furthermore, the proposed rule is a “best first effort at simplifying and tailoring the Volcker rule” and does not represent the “completion of [the Board’s] work.”

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