Following the close of the comment period on the Volker Rule proposals issued by the SEC (along with the Office of the Comptroller of the Currency, the Federal Reserve Board and the FDIC), SEC Commissioner Troy Paredes strongly criticized the proposed rulemaking. In remarks at PLI’s “SEC Speaks” conference, the commissioner stated that the rules as currently proposed “could unduly impede the competitiveness and dynamism of our financial markets and hinder the flow of capital to its most productive purposes at the expense of our country’s economic growth.” A leading industry group, the Securities Industry and Financial Markets Association (SIFMA) expressed similar reservations. According to Tim Ryan, president and CEO of SIFMA, “the proposed regulations are unworkable, not faithful to Congressional intent, and will have negative consequences for U.S. financial markets and the economy.”
Following his initial review of the comments received on the proposals, Commissioner Paredes concluded that the “most appropriate path forward” for the Commission would be a reproposal of the rules. He said that significant revisions will likely be needed so that whatever benefits might result from the rules does not come at an unacceptably high cost. Due to the extensive changes that he considers necessary, a reproposal would be appropriate to allow for another round of comment.
The commissioner anticipates that investors could be disadvantaged by higher trading costs, fewer investment options and lower returns resulting from a constriction in market-making and underwriting. Liquidity would be significantly lessened, in his view, and U.S. securities markets could become more volatile, less efficient, and marked by wider spreads. Capital formation would be frustrated, and municipal authorities could find it difficult to raise funds to finance needed public works and infrastructure projects.
The commissioner acknowledged that the statutory mandate is not a simple one for regulators to implement. He described the difficulties of implementing legislation under which “certain activity is banned, unless it is permitted, but then the activity is permitted only to the extent that it is not otherwise limited.” As an example, he said that it is not self-evident where proprietary trading ends and market making begins. Accordingly, the commissioner emphasized that it is extremely important example how regulators exercise their discretion in drawing this line. He concluded by stating that the stakes are high enough that the SEC should take advantage of another comment round to help ensure that the Volcker Rule regime “does not miss the mark a second time.”
SIFMA submitted supporting comment letters to the group of regulators, including comments on (1) the proprietary trading restrictions, (2) hedge fund and private equity fund investment restrictions, (3) municipal securities concerns and (4) securitization.
With regard to the proprietary trading ban, SIFMA stated that the proposed regulations will limit market making activity, thereby decreasing market liquidity across all asset classes, raising costs for issuers, reducing returns on investments and increasing risk to corporations wishing to hedge commercial risks. The group considers the permitted activities to be defined far too narrowly, drawing the wrong line between proprietary trading and market making. According to SIFMA, banking entities’ abilities to hedge their own risk will be severely limited, thereby increasing, rather than decreasing systemic risk. SIFMA noted that the proposed regulation does not allow for a phased-in implementation of the rules, and concluded that the costs of the proposed regulation cannot be justified based on its benefits.
SIFMA’s primary concern regarding the proposed regulations’ provisions on restricting hedge fund and private equity fund investment is what it considers to be an overly broad definition of “covered fund.” According to the industry group, the proposed definition was not required by statute and could have the unintended impact of applying the Volcker Rule’s private fund prohibitions to virtually every affiliate in a banking group. The risks presented include (1) prohibiting banking entities from entering into any new funding, risk-management or other covered transactions with a wide range of their subsidiaries or affiliates not previously considered hedge funds or private equity funds; and (2) requiring banking entities to divest subsidiaries and affiliates.
The legal uncertainty over the permissibility of risk-mitigating and other common intercompany transactions with, and investments in, non-fund affiliates could, in SIFMA’s view, have a serious adverse effect on the safety, soundness, efficiency and stability of the U.S. and global financial systems.
In the area of municipal securities, SIFMA urges that all municipal securities should be exempt. The organization sees the failure to exempt all municipal securities as inconsistent with existing securities and banking laws, with the potential to decrease liquidity and increase price volatility in the municipal securities market.
SIFMA described the proposals on securitized products as too narrow. Issuers of asset-backed securities and insurance-linked securities should be excluded from the proposed regulations’ definition of “covered funds,” according to SIFMA. The failure to exempt foreign exchange swaps and forwards from the Volcker Rule would significantly impede liquidity in foreign exchange markets, leading to significantly increased transaction costs, volatility, and currency risk for all market participants, including central banks and end users hedging risk. According to SIFMA, “there is no need to disrupt a foreign exchange market that has historically and currently operates without significant risk.”
Like Commissioner Paredes, SIFMA also called for a reproposal of the rules.