Nearly four years after President Obama first proposed curbs to rein in the risky bets on Wall Street, US regulators have finally ratified a strict new regime aimed at stopping banks from making speculative trades that could cause another meltdown.
But the final text of the Volcker rule, so called after the former Federal Reserve chair Paul Volcker, the reform's chief proponent inside the administration at the time, also made important concessions to the financial industry, which has been lobbying against the proposals.
The rule was published as all the regulatory agencies involved in drafting the reform, including the Federal Reserve, the Securities and Exchange Commission, moved to ratify the text.
The aim of the reform was to end the practice of large banks making bets on the markets, often using arcane financial instruments, for their own gain and from their own accounts. It was also meant to limit their involvement in riskier corners of Wall Street, such as hedge funds.
"If financial firms want to trade for profit, that's something they're free to do," the President said in January 2010. "But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people."
The final text of the rule, which was mandated by the Dodd-Frank financial reform law passed by Congress in 2010, does impose firm restrictions on most kinds of propriety bets – but it stops short of calling for a blanket ban.
Instead, banks can still make risky bets if they are acting for clients or if they are hedging (or protecting themselves) against clearly defined risks – something that, it is hoped, will prevent another trading implosion like the so-called "London Whale" fiasco that rocked JP Morgan, run by its chief executive, Jamie Dimon, last year.
Hedging against broad risks will be curbed. Banks will also have to make sure that their compensation practices are such that traders are not encouraged to make risky propriety bets.
The rule allows banks to buy up securities such as shares if, for example, they are engaged as market makers – in other words, if they are doing so for their clients, not for themselves. It does, however, demand that the inventory of securities should not go beyond "the reasonable expected near-term demands of customers."
Other exceptions cover proprietary trading in certain government securities, and positions connected to a bank acting as an underwriter in a public or private offering of shares.
The reform will also require chief executives at large banks to tell regulators every year that their institutions have processes in place to ensure they comply with the rules.
The prospect of reform has already led to changes on Wall Street, with banks moving over the last two and half years to shed their propriety trading desks. And although the final text was published yesterday, they still have time to change or adapt their practices as the regime is not due to take effect until 2015. Questions also remain about enforcement, which analysts say will determine how far the new rules will succeed in limiting large trading-related losses.
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