Volcker Rule
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of the
Dodd–Frank Wall Street Reform and Consumer Protection Act The Dodd–Frank Wall Street Reform and Consumer Protection Act, commonly referred to as Dodd–Frank, is a United States federal law that was enacted on July 21, 2010. The law overhauled financial regulation in the aftermath of the Great Recess ...
(). The rule was originally proposed by American economist and former United States
Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
Chairman
Paul Volcker Paul Adolph Volcker Jr. (September 5, 1927 – December 8, 2019) was an American economist who served as the 12th chairman of the Federal Reserve from 1979 to 1987. During his tenure as chairman, Volcker was widely credited with having ended th ...
to restrict United States banks from making certain kinds of
speculative Speculative may refer to: In arts and entertainment *Speculative art (disambiguation) *Speculative fiction, which includes elements created out of human imagination, such as the science fiction and fantasy genres **Speculative Fiction Group, a Per ...
investments that do not benefit their customers. Volcker argued that such speculative activity played a key role in the
financial crisis of 2007–2008 Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fi ...
. The rule is often referred to as a ban on
proprietary trading Proprietary trading (also known as prop trading) occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money (instead of using depositors' money) in order to m ...
by commercial banks, whereby deposits are used to trade on the bank's own accounts, although a number of exceptions to this ban were included in the Dodd–Frank law. The rule's provisions were scheduled to be implemented as part of the Dodd–Frank Act on July 21, 2010, with preceding ramifications, but were delayed. On December 10, 2013, the necessary agencies approved regulations implementing the rule, which were scheduled to go into effect April 1, 2014. On January 14, 2014, after a lawsuit by community banks over provisions concerning specialized securities, revised final regulations were adopted. The rule came into effect on July 21, 2015. On August 11, 2016, several large banks requested a 5-year delay to exit
illiquid In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between th ...
investments.Reuters
/ref> On January 30, 2020, the Federal Reserve put forward a proposal to roll back some provisions of the rule, specifically rules that limit bank investment in
venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to start-up company, startups, early-stage, and emerging companies that have been deemed to have high growth poten ...
and securitized
loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that ...
s. These changes were adopted on June 25, 2020.


Background

Volcker was appointed by
President Barack Obama Barack Hussein Obama II ( ; born August 4, 1961) is an American politician who served as the 44th president of the United States from 2009 to 2017. A member of the Democratic Party, Obama was the first African-American president of the ...
as the chair of the
President's Economic Recovery Advisory Board The President's Council on Jobs and Competitiveness, originally the President's Economic Recovery Advisory Board (PERAB), was an ad hoc panel of non-governmental experts from business, labor, academia and elsewhere that President of the United State ...
on February 6, 2009. President Obama created the board to advise the Obama Administration on economic recovery matters. Volcker argued vigorously that since a functioning commercial banking system is essential to the stability of the entire financial system, for banks to engage in high-risk speculation created an unacceptable level of systemic risk. He also argued that the vast increase in the use of
derivatives The derivative of a function is the rate of change of the function's output relative to its input value. Derivative may also refer to: In mathematics and economics * Brzozowski derivative in the theory of formal languages * Formal derivative, an ...
, designed to mitigate risk in the system, had produced exactly the opposite effect.


Entry into legislation

The Volcker Rule was first publicly endorsed by President Obama on January 21, 2010. The proposal was to specifically prohibit a bank or institution that owns a bank from engaging in
proprietary trading Proprietary trading (also known as prop trading) occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money (instead of using depositors' money) in order to m ...
, and from owning or investing in a
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...
or private equity fund, and also to limit the liabilities that the largest banks could hold. Also under discussion was the possibility of placing restrictions on the way market-making activities are compensated; traders would be paid on the basis of the spread of transactions rather than any profit that the trader made for the client. On January 21, 2010, under the same initiative, President Obama announced his intention to end the mentality of "
Too big to fail "Too big to fail" (TBTF) and "too big to jail" is a theory in banking and finance that asserts that certain corporations, particularly financial institutions, are so large and so interconnected that their failure would be disastrous to the great ...
". In a February 22, 2010 letter to ''
The Wall Street Journal ''The Wall Street Journal'' is an American business-focused, international daily newspaper based in New York City, with international editions also available in Chinese and Japanese. The ''Journal'', along with its Asian editions, is published ...
'', five former Secretaries of the Treasury endorsed the Volcker Rule proposals. As of February 23, 2010, the U.S. Congress began to consider a weaker bill allowing federal regulators to restrict proprietary trading and hedge fund ownership by banks, but not prohibiting these activities altogether. Senators Jeff Merkley, Democrat of Oregon, and Carl Levin, Democrat of Michigan, introduced the main piece of the Volcker Rule – its limitations on proprietary trading – as an amendment to the broader Dodd–Frank financial reform legislation that was passed by the
United States Senate The United States Senate is the upper chamber of the United States Congress, with the House of Representatives being the lower chamber. Together they compose the national bicameral legislature of the United States. The composition and pow ...
on May 20, 2010. Despite having wide support in the Senate, the amendment was never given a vote. When the Merkley-Levin Amendment was first brought to the floor, Senator Richard Shelby, Republican of Alabama, objected to a motion to vote on the amendment. Merkley and Levin responded by attaching the amendment to another amendment to the bill put forth by Senator
Sam Brownback Samuel Dale Brownback (born September 12, 1956) is an American attorney, politician, diplomat, and member of the Republican Party (United States), Republican Party who served as the United States Ambassador-at-Large for International Religious Fr ...
, Republican of Kansas. Shortly before it was due to be voted upon, Brownback withdrew his own amendment, thus killing the Merkley-Levin amendment and the Volcker Rule as part of the Senate bill. Despite that vote, the proposal made it into the final legislation when the House–Senate conference committee passed a strengthened version of the rule that included the language prepared by Senators Merkley and Levin. The original Merkley-Levin amendment and the final legislation both covered more types of proprietary trading than the original rule proposed by the administration. It also banned conflict of interest trading. Senator Levin commented on the importance of that aspect: However, conferees changed the proprietary trading ban to allow banks to invest in hedge funds and private equity funds at the request of Senator
Scott Brown Scott Brown may refer to: Sportsmen *Scott Brown (American football), American college football coach of Kentucky State * Scott Brown (baseball) (born 1956), former Major League Baseball pitcher for the Cincinnati Reds *Scott Brown (footballer, bor ...
(R-Mass.), whose vote was needed in the Senate to pass the bill. The Volcker rule was further amended to allow banks to invest 3% of
Tier 1 capital Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view.By definition of Bank for International Settlements. It is composed of ''core capital'', which consists primarily of common stock and disclosed res ...
into hedge funds and private equity funds, an amount that would exceed $6 billion a year for Bank of America alone. Proprietary trading in Treasuries, bonds issued by government-backed entities like
Fannie Mae The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae, is a United States government-sponsored enterprise (GSE) and, since 1968, a publicly traded company. Founded in 1938 during the Great Depression as part of the N ...
and
Freddie Mac The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a publicly traded, government-sponsored enterprise (GSE), headquartered in Tysons Corner, Virginia.

Implementation

Public comments to the Financial Stability Oversight Council on how exactly the rule should be implemented were submitted through November 5, 2010. Financial firms such as Goldman Sachs,
Bank of America The Bank of America Corporation (often abbreviated BofA or BoA) is an American multinational investment bank and financial services holding company headquartered at the Bank of America Corporate Center in Charlotte, North Carolina. The bank ...
, and JPMorgan Chase & Co. posted comments expressing concerns about the rule.
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representatives to Congress also expressed concern about the Volcker Rule, saying the rule's prohibitions may hamper the competitiveness of American banks in the global marketplace, and that they may seek to cut funding to the federal agencies responsible for its enforcement. The Chairman of the House Financial Services Committee, Representative
Spencer Bachus Spencer Thomas Bachus III (born December 28, 1947) is an American politician. He is a former U.S. Representative for the state of Alabama, serving from 1993 to 2015. A member of the Republican Party, he served as ranking member (2007–2011) an ...
(R-Alabama), stated that he was seeking to limit the effect of the Volcker Rule, although Volcker himself stated that he expected backers of the rule to prevail over such critics. Regulators presented a proposed form of the Volcker Rule regulations for public comment on October 11, 2011, which was approved by the SEC,
The Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a ...
, The
Office of the Comptroller of the Currency The Office of the Comptroller of the Currency (OCC) is an independent bureau within the United States Department of the Treasury that was established by the National Currency Act of 1863 and serves to charter, regulate, and supervise all natio ...
and the
FDIC The Federal Deposit Insurance Corporation (FDIC) is one of two agencies that supply deposit insurance to depositors in American depository institutions, the other being the National Credit Union Administration, which regulates and insures credi ...
. The proposed regulations were immediately criticized by banking groups as being too costly to implement, and by reform advocates for being weak and filled with loopholes. On January 12, 2012, the U.S. Commodity Futures Trading Commission (CFTC) issued substantially similar proposed regulations. Volcker himself stated that he would have preferred a simpler set of rules: "I'd write a much simpler bill. I'd love to see a four-page bill that bans proprietary trading and makes the board and chief executive responsible for compliance. And I'd have strong regulators. If the banks didn't comply with the spirit of the bill, they'd go after them." Regulators gave the public until February 13, 2012, to comment on the proposed draft of the regulations (over 17,000 comments were made). Under the Dodd–Frank financial reform law, the regulations went into effect on July 21, 2012. However, during his report to Congress on February 29, 2012, Federal Reserve Chairman
Ben S. Bernanke Ben Shalom Bernanke ( ; born December 13, 1953) is an American economist who served as the 14th chairman of the Federal Reserve from 2006 to 2014. After leaving the Fed, he was appointed a distinguished fellow at the Brookings Institution. Durin ...
said the central bank and other regulators would not meet that deadline. By February 26, 2013, the rule was still not implemented. Occupy the SEC filed a suit in the Eastern District Court of New York naming the Federal Reserve, the SEC, CFTC, OCC, FDIC, and the U.S. Department of the Treasury and calling for the court to set a deadline for implementation. Subsequently, it was reported that the Volcker Rule was not likely to be in effect until July 2014 and that some industry lobbyists were pushing for extension beyond that date. On December 10, 2013, the Volcker Rule regulations were approved by all five of the necessary financial regulatory agencies. It was set to go into effect April 1, 2014. The final rule had a longer compliance period and fewer metrics than earlier proposals. Furthermore, the final rule put the onus on banks to demonstrate that they are operating their trading activities in compliance with the rule and required CEO certification of the effectiveness of the compliance program. However, after a lawsuit was filed to stay the effect of the Volcker Rule regulations over whether banks could be required to sell or divest
collateralized debt obligation A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS).Le ...
s (CDOs) backed by trust-preferred securities (TruPS), on December 27, 2013, the
Federal Reserve Board The Board of Governors of the Federal Reserve System, commonly known as the Federal Reserve Board, is the main governing body of the Federal Reserve System. It is charged with overseeing the Federal Reserve Banks and with helping implement the m ...
, FDIC, OCC, CFTC and SEC all announced they were reviewing whether it would be appropriate to exempt a small subset of securities from the rule, on which they would rule by January 15, 2014, at the latest. On January 14, 2014, interim final regulations were adopted to permit certain banking entities to retain those investments. On January 14, 2014, revised final regulations were approved, and the rule came into effect on July 21, 2015. Extensions continued for banks to exit illiquid investments. On December 18, 2014, the Federal Reserve extended the Volcker Rule's conformance period for "legacy covered funds" (a defined term) until July 21, 2016, and indicated it would likely extend the period further to July 21, 2017. The extension to 2016 is the second of three possible one-year extensions the Federal Reserve may issue under the Dodd–Frank Act (regulators provided an initial one-year extension when the Volcker Rule was finalized in December 2013). Wall Street lobbyists continued to ask the Federal Reserve to extend the deadline for some banking investments in private equity and hedge funds. On January 30, 2020, the Volcker Regulators put forward a proposal to shrink the "covered funds" for which banks face investment limitations, allowing banks to invest in
venture capital Venture capital (often abbreviated as VC) is a form of private equity financing that is provided by venture capital firms or funds to start-up company, startups, early-stage, and emerging companies that have been deemed to have high growth poten ...
and securitized
loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that ...
s. Specifically, banks would be allowed to acquire or retain ownership interests in venture capital funds, or pools of investment for small businesses and start-ups. Under the existing rule, banks could make indirect investments into venture capital funds but faced restrictions on directly owning a fund. The rule change would also give banks more leeway to invest or sponsor credit funds that make loans, invest in debt securities, or extend credit. One implication of this rule change would be greater bank activity in the market for
collateralized loan obligation Collateralized loan obligations (CLOs) are a form of securitization where payments from multiple middle sized and large business loans are pooled together and passed on to different classes of owners in various tranches. A CLO is a type of coll ...
s (CLOs), where banks were previously barred from involving themselves with CLO funds that included a debt component. Federal Reserve Chairman
Jerome Powell Jerome Hayden "Jay" Powell (born February 4, 1953) is an American attorney and investment banker who has served as the 16th chair of the Federal Reserve since 2018. After earning a degree in politics from Princeton University in 1975 and a ...
called the proposed change "a simpler, clearer approach to implementing the rule
hich Ij ( fa, ايج, also Romanized as Īj; also known as Hich and Īch) is a village in Golabar Rural District, in the Central District of Ijrud County, Zanjan Province, Iran Iran, officially the Islamic Republic of Iran, and also ...
makes it easier for both banks and regulators to carry out the intent of the rule". Federal Reserve Governor
Lael Brainard Lael Brainard (born January 1, 1962) is an American economist serving as the 22nd Vice Chair of the Federal Reserve since May 23, 2022. Prior to her term as vice chair, Brainard served as a member of the Federal Reserve Board of Governors since 2 ...
voted against the proposal, arguing that "several of the proposed changes will weaken core protections in the Volcker rule and enable banking firms again to engage in high-risk activities related to covered funds" On June 25, 2020, the Volcker Regulators relaxed part of the rules involving banks investing in venture capital and for derivative trading.


Ongoing regulatory debate in the US and the European Union

European scholars and lawmakers also discussed the necessity of banking reform in light of the crisis, recommending the adoption of specific regulations limiting proprietary trading by banks and their affiliates, notably in France where
SFAF The French Society of Financial Analysts (french: Société Française des Analystes Financiers (SFAF)) is the main professional organisation representing members of the French financial industry. It was created in 1961 and currently has over 1500 ...
and
World Pensions Council The World Pensions & Investments Forum is a research and policy oriented conference organised by the World Pensions Council (WPC), also known as the International Association of Pension Funds (IAPF), in partnership with regional and supranational ...
banking experts argued that, beyond fragmented national legislations, such rules should be adopted and implemented within the broader context of
statutory law Statutory law or statute law is written law passed by a body of legislature. This is opposed to oral or customary law; or regulatory law promulgated by the executive or common law of the judiciary. Statutes may originate with national, state legi ...
s valid across the
European Union The European Union (EU) is a supranational political and economic union of member states that are located primarily in Europe. The union has a total area of and an estimated total population of about 447million. The EU has often been des ...
. The
Liikanen Report The Liikanen Report or "Report of the European Commission’s High-level Expert Group on Bank Structural Reform" (known as the "Liikanen Group") is a set of recommendations published in October 2012 by a group of experts led by Erkki Liikanen, gover ...
, or "Report of the European Commission's High-level Expert Group on Bank Structural Reform", is a set of recommendations published in October 2012 by a group of experts led by
Erkki Liikanen Erkki Antero Liikanen (born 19 September 1950) is a Finnish social democratic politician and a former Governor of the Bank of Finland. Early life and education Erkki Antero Liikanen obtained a bachelor’s degree in Political Science (Economic ...
, governor of the Bank of Finland and ECB council member. The "Liikanen Group" was molded after the UK's Independent Commission on Banking and the President's Council on Jobs and Competitiveness: it was established in Brussels by EU Commissioner
Michel Barnier Michel Barnier (born 9 January 1951) is a French politician who served as the European Commission's Head of Task Force for Relations with the United Kingdom (UK Task Force/UKTF) from 2019 to 2021. He previously served as Chief Negotiator, Task ...
in February 2012. On July 25, 2012, former Citigroup Chairman and CEO
Sandy Weill Sandy may refer to: People and fictional characters *Sandy (given name), including a list of people and fictional characters * Sandy (surname), a list of people *Sandy (singer), Brazilian singer and actress Sandy Leah Lima (born 1983) *(Sandy) A ...
, considered one of the driving forces behind the considerable financial
deregulation Deregulation is the process of removing or reducing state regulations, typically in the economic sphere. It is the repeal of governmental regulation of the economy. It became common in advanced industrial economies in the 1970s and 1980s, as a ...
and "mega-
merger Mergers and acquisitions (M&A) are business transactions in which the ownership of companies, other business organizations, or their operating units are transferred to or consolidated with another company or business organization. As an aspect ...
s" of the 1990s, surprised financial analysts in Europe and North America by "calling for splitting up the commercial banks from the investment banks. He called for the return of the Glass-Steagall Act of 1933, which he said had effectively led to half a century free of financial crises. Quoting interview on CNBC's Squawk-Box. On October 24, 2017, citing "no foreseeable agreement" in sight on criteria, the
European Commission The European Commission (EC) is the executive of the European Union (EU). It operates as a cabinet government, with 27 members of the Commission (informally known as "Commissioners") headed by a President. It includes an administrative body o ...
scrapped the draft legislation that would have permitted the EBA regulator to order "
too big to fail "Too big to fail" (TBTF) and "too big to jail" is a theory in banking and finance that asserts that certain corporations, particularly financial institutions, are so large and so interconnected that their failure would be disastrous to the great ...
" banks to split off their trading activities. The draft was supposed to be the EU's answer to the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territorie ...
' Volcker Rule.


Effects

The proposal of the Volcker Rule led to an exodus of top proprietary traders from large banks to form their own
hedge funds A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as shor ...
or join existing hedge funds including Todd Edgar and Roger Jones from
Barclays Barclays () is a British multinational universal bank, headquartered in London, England. Barclays operates as two divisions, Barclays UK and Barclays International, supported by a service company, Barclays Execution Services. Barclays traces ...
, Sutesh Sharma from
Citigroup Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
, George "Beau" Taylor and Trevor Woods from
Credit Suisse Credit Suisse Group AG is a global investment bank and financial services firm founded and based in Switzerland. Headquartered in Zürich, it maintains offices in all major financial centers around the world and is one of the nine global " ...
, Pablo Calderini,
Nelson Saiers Nelson Saiers is an American mathematical artist and former hedge fund manager. Before 2014, he worked in finance as a Managing Director at Deutsche Bank AG and as the Chief Investment Officer at Saiers Capital, LLC (formerly Alphabet Management, ...
and
Boaz Weinstein Boaz Weinstein (born 1973) is an American hedge fund manager and founder of Saba Capital Management. He rose to prominence at Deutsche Bank in the early and mid 2000s with his credit default swap and capital structure arbitrage trading strategi ...
from
Deutsche Bank Deutsche Bank AG (), sometimes referred to simply as Deutsche, is a German multinational investment bank and financial services company headquartered in Frankfurt, Germany, and dual-listed on the Frankfurt Stock Exchange and the New York Sto ...
, Pierre-Henri Flamand, Bob Howard, Morgan Sze, Darren Wong and Mathew McClean from
Goldman Sachs Goldman Sachs () is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Warsaw, Bangalore, H ...
, Deepak Gulati and Mike Stewart from
JP Morgan JPMorgan Chase & Co. is an American multinational investment bank and financial services holding company headquartered in New York City and incorporated in Delaware. As of 2022, JPMorgan Chase is the largest bank in the United States, the wo ...
, Peter Muller from
Morgan Stanley Morgan Stanley is an American multinational investment management and financial services company headquartered at 1585 Broadway in Midtown Manhattan, New York City. With offices in more than 41 countries and more than 75,000 employees, the fir ...
, and Jean Bourlet from
UBS UBS Group AG is a multinational Investment banking, investment bank and financial services company founded and based in Switzerland. Co-headquartered in the cities of Zürich and Basel, it maintains a presence in all major financial centres ...
. Critics of the rule pointed to the subsequent brain drain of top talent, however the trading expertise thus lost would only relate to the activity to be curtailed by the new framework, and would only be lost to the banks rather than the economy as a whole, and may be understood as precisely the sort of cultural change within taxpayer-supported banks that the rule was intended to achieve.


Historical antecedents

The Volcker Rule has been compared to, and contrasted with, the Glass–Steagall Act of 1933. Its core differences from the Glass–Steagall Act have been cited by one scholar as being at the center of the rule's identified weaknesses.


See also

* 2008–2010 bank failures in the United States * 2008–09 Keynesian resurgence * Brown–Kaufman amendment *
Principal–agent problem The principal–agent problem refers to the conflict in interests and priorities that arises when one person or entity (the "agent") takes actions on behalf of another person or entity (the " principal"). The problem worsens when there is a gre ...


References

{{Reflist


External links


Examining the Impact of the Volcker Rule on Markets, Businesses, Investors, and Job Creation: Joint Hearing before the Subcommittee on Financial Institutions and Consumer Credit and the Subcommittee on Capital Markets and Government Sponsored Enterprises of the Committee on Financial Services, U.S. House of Representatives, One Hundred Twelfth Congress, Second Session, January 18, 2012

Final regulations
from the OCC, Federal Reserve, FDIC, and SEC in the
Federal Register The ''Federal Register'' (FR or sometimes Fed. Reg.) is the official journal of the federal government of the United States that contains government agency rules, proposed rules, and public notices. It is published every weekday, except on feder ...

Final regulations
from the CFTC in the Federal Register Bank regulation in the United States Separation of investment and retail banking Systemic risk