Volcker Rule, or Not

WASHINGTON — As the two chambers of Congress begin to hammer out a single financial regulatory reform bill over the next several weeks, industry groups have mixed views about a provision in the Senate bill that would prohibit banks from engaging in proprietary trading but exclude municipal, Treasury and federal agency securities from the ban.

Click here for a side-by-side comparison of the House and Senate bills' muni provisions.

“The Regional Bond Dealers Association is supportive of this exemption and would encourage Senate language to come out of the conference agreement,” said Michael Nicholas, RBDA’s chief executive officer, referring to the lawmakers from both chambers that are expected to be named this week to resolve differences between the Senate and House language.

But the Securities Industry and Financial Markets Association opposes the Senate provision.

“The Volcker rule remains highly problematic and is likely to have the unintended consequence of constricting market liquidity, as evidenced by the fact that Treasuries, agencies and munis are exempted,” said Michael Decker, managing director and co-head of municipal securities at SIFMA.

“These exemptions show the originators of this rule believe it will constrict liquidity, which raises the question of what else don’t we know about this rule’s affects.”

The Senate’s language is more detailed than what was originally floated in late January, when the Obama administrative embraced the so-called Volcker rule, after former Federal Reserve chairman Paul Volcker, who has been pushing American and European regulators to restrict the proprietary trading activities of commercial banks.

The goal of the measure generally is to prevent banks and their holding companies from using their deposits to make financial bets that are unrelated to serving their customers.

Originally panned by market participants who warned it was way too broad, the proposal also was cited as having a potential adverse impact on the re-emergence of tender option bond ­programs, which historically have been important and have bought large bond deals that have lower ratings and higher yields through banks’ proprietary desks.

The Obama administration proposed the measure a month after the House passed a separate financial regulatory reform package that would authorize, but not mandate, the Federal Reserve Board to impose such trading restrictions.

Nicholas said that while his group was originally opposed the Volcker rule when it was first announced because it was unclear what type of trading would be defined as “proprietary,” RBDA’s members have become more comfortable with it because of the proposed carve-outs.

“What we don’t want is for it to be very broad, and kicked to the regulators to decide what’s proprietary,” he said.

In a letter to lawmakers late last month, RBDA said there remain “deficient” issues with the proposal and called for definitions of important terms, such as “trading book” or targeted “financial instruments.”

Market participants said yesterday that the Senate’s proposal would pose very little impact on the municipal market.

“If the Senate exempts munis, then it’s really not a matter of concern for the market,” said Matt Fabian, managing director at Municipal Market Advisors.

Dealers’ ability to at least temporarily buy munis from their prop desks has been important for managing the primary market, and a limitation on that ability would probably have led to slightly higher yields, he said.

At the same time, Fabian said extending the ban to municipals would avert a return to the risk that the market was carrying when proprietary TOB programs were using a lot of leverage to hold munis for incremental return.

“But it’s unlikely that we’re going to get back there,” he said, noting that the programs, which suffered losses and contracted dramatically during the credit crisis, have not yet taken flight again even though the market has recovered.

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