Volcker rule finally gets revised, but Wall Street is different now

Wall Street spent the better part of a decade battling for regulators to reshape the Volcker rule, which contained a ban on banks making speculative investments. When the changes finally landed Tuesday, the win felt more symbolic.

The Federal Deposit Insurance Corp. and other regulators rolled out tweaks that clarify which trades are prohibited and lay out limits for banks to follow in their market-making units. Although those are some of the revisions that banks had pushed for, they’re far from transformational changes that will spark a trading revival.

“Reports of the demise of the Volcker rule are premature,” said Jai Massari, a partner at law firm Davis Polk & Wardwell. “It will be more clear whether activities will be scoped in or out of the rule, but the overall impact is not yet clear.”

Bank trading divisions have been totally reshaped since the Volcker rule was passed as part of the 2010 Dodd-Frank Act, the changes spurred by the new rules as well as technological advancements and a multiyear revenue slump. Global banks’ stock and bond desks are coming off their worst collective first half of a year since before the financial crisis a decade ago. Goldman Sachs Group Inc. — once the king of proprietary trading — just launched a credit card.

The Volcker rule targeted banks’ trading operations under the rationale that FDIC-insured lenders shouldn’t act like hedge funds. Proprietary-trading desks racked up billions of dollars in losses during the financial crisis and contributed to the need for taxpayer bailouts that sparked furor on both sides of the political aisle.

The low-hanging fruit was a series of standalone proprietary-trading units that were producing almost $5 billion a year for the biggest banks. Firms fairly quickly spun out or shut down legendary money-making teams including Goldman Sachs Principal Strategies and Morgan Stanley’s Process Driven Trading.

The trickier part was crafting regulations that wouldn’t allow banks to carry on proprietary trading within their client-facing desks. Wall Street firms have long argued that the rule went too far in that effort, limiting activities that are legitimately aimed at facilitating buying and selling illiquid bonds for customers or hedging the bank’s own risk. Traders also grumbled that the rules’ “guilty until proven innocent” approach curbed the risk appetite needed in the market, on top of the costs and headaches from compliance efforts and paperwork.

Bank critics pointed to traders who continued to rack up hundreds of millions of dollars in gains in a single year to note that Wall Street desks were far from riskless matchmakers.

“The big banks could already do risky trading by pretending to be market making — these changes will give them more leeway to do so,” said Mayra Rodriguez Valladares, managing principal at New York-based MRV Associates, which trains bank examiners and finance executives.

Harsher capital and liquidity requirements introduced after the crisis have been even more restraining on the trading risks the big banks can take. They will continue to exert pressure even under a softer Volcker rule, Rodriguez Valladares said.

“If they start taking more risk, capital rules should kick in and force them to have more capital backing that risk, so that’s the backup control mechanism,” she said. “We’ll see if that will work as it should.”

The latest revision drops the much-hated “intent” prong for the largest firms. That had forced banks to include all trades that they intended to be short-term to be covered under the rule and required an explanation for each one. JPMorgan Chase & Co. Chief Executive Jamie Dimon famously quipped that each trader would need a psychologist and a lawyer by his side to comply.

As far as regulators are concerned, removing the intent element of the rule won’t have any material effect on which trades are covered. That element was created as a way to distinguish trades that smaller banks carried out, and it now will be applicable only to those smaller banks. The largest lenders already have trades covered under market-risk rules that are connected to their capital requirements.

For years, banks’ complaints fell largely on deaf ears. When President Trump took office in 2017, his administration vowed to relax the complex web of financial rules. That hasn’t always gone smoothly.

The original proposal for Volcker rule changes in 2018 would have expanded the reach of the rule even further, and the big banks pushed back. Several bank officials involved in the discussions said in recent months that they wished the regulators would just drop the revision effort altogether, since more complication seemed just as likely as a big victory.

Even the regulators’ attempt to simplify compliance is unlikely to bring significant cost savings, said the officials, asking not to be identified discussing regulatory matters. The largest Wall Street firms have hired thousands of compliance officers in the last decade in response to tightened regulation following the 2008 crisis, and the Volcker rule is only one of dozens that require more manpower.

Yet there are critics who denounced the changes, saying the softening of the rule gives banks a free hand to increase risk. FDIC board member Martin Gruenberg, a Democrat who ran the agency until a year ago, said the rule has been defanged because many types of financial assets will no longer be covered.

“Gutting the Volcker rule will generate more risk in the banking system,” the Center for American Progress, an advocacy group, said in a statement. “Taxpayers, workers and families will again foot the bill when this toxic mix goes south.”