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SIFMA Offers Ideas To Reorient Proposed Volcker Rule Regulations

Date 13/02/2012

SIFMA[i] along with several other financial services trade organizations[ii] today submitted comments to federal regulators[iii] on their proposed regulations to implement the Volcker Rule.

“The proposed regulations are unworkable, not faithful to Congressional intent, and will have negative consequences for U.S. financial markets and the economy,” said Tim Ryan, president and CEO of SIFMA.  “Investors will face decreased market liquidity and higher costs.  Companies will find it more expensive to raise capital, making it more costly to invest in plant and equipment and create jobs.  In our comments, we have offered suggestions to better implement the Volcker Rule, all in compliance with Congressional intent but without damaging the liquidity and resiliency of U.S. capital markets.”

SIFMA submitted five supporting comment letters addressing (1) the proprietary trading restrictions, (2) the provisions restricting hedge fund and private equity fund investment, (3) specific concerns for municipal securities, (4) specific concerns for securitization, and (5) a SIFMA Asset Management Group[iv] letter on the proprietary trading provisions.

Proprietary Trading Ban
SIFMA’s primary concern is that the proposed regulations will, contrary to Congressional intent, 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.  This will stifle economic growth and job creation.  In fact, Oliver Wyman has estimated[v] that the proposed regulations could cost issuers $12 to $43 billion per year in borrowing costs, and cost investors $90 to $315 billion in mark-to-market losses on their existing holdings and another $1 to $4 billion in annual transaction costs – for the corporate bond market alone.

In its letter, SIFMA outlines its specific concerns on the proprietary trading provisions (SIFMA prop letter, pgs. 2-5):

  • Permitted activity is defined far too narrowly, drawing the wrong line between proprietary trading and market making.
  • Banking entities’ abilities to hedge their own risk will be severely limited, thereby increasing, rather than decreasing systemic risk.
  • The costs of the proposed regulation, especially its overly specific and prescriptive compliance regime, cannot be justified based on its benefits.  
  • The proposed regulation does not allow for a phased-in implementation of the Volcker Rule.

SIFMA’s Asset Management Group (AMG) further highlights the adverse effect on investors and the financial system in its letter addressing the proprietary trading ban:

  • Portfolio values will decrease.  The proposed regulations are likely to shrink the savings of fund investors, retirees, pension plan beneficiaries and other investors who rely on AMG members to invest their earnings, as decreased market liquidity leads to a decrease in the demand for and price of financial instruments. (SIFMA AMG prop letter, pg. 7)
  • Transaction Costs will Increase.  Returns on AMG members’ clients’ funds will decrease as transaction costs and bid-ask spreads increase, which will ultimately decrease the value of investments of, for example, retiree 401(k) accounts.  (SIFMA AMG prop letter, pg. 7)
  • Demand For, and Price of, Corporate Issuances Will Decrease.  The price investors will pay for issued securities will decrease as secondary market liquidity decreases, reducing the amount of capital available to fund growth.  (SIFMA AMG prop letter, pg. 8)

SIFMA offers suggestions for reorienting the current approach (SIFMA prop letter, pg.5). Specifically: 

  • The proposed regulations should refocus on allowing critical financial intermediation as performed under the activities permitted by the statute.
  • The approach to market making should be replaced by one in which trading units are allowed to engage in customer-focused principal trading under the statutorily permitted activities.
  • The hard-coded factors for permitted activities should be removed from the Rule itself and become incorporated into guidance.  The Agencies should rely on quantitative metrics, policies and procedures and examinations to oversee the system.
  • The Rule should not analyze the permitted activities on a transaction-by-transaction basis.  

Private Funds Restrictions 
SIFMA’s primary concern regarding the proposed regulations’ provisions on restricting hedge fund and private equity fund investment is the Agencies’ overly broad definition of “covered fund.”  The proposed definition – which was not required by the Volcker Rule statute -- could have the unintended impact of applying the Volcker Rule’s private fund prohibitions to virtually every affiliate in a banking group.  Unless corrected, this could have the effect of: 

  • Prohibiting banking entities from entering into any new funding, risk-management or other covered transactions with a wide range of their subsidiaries or affiliates that have never been considered hedge funds or private equity funds; and
  • Requiring banking entities to divest subsidiaries and affiliates.
    The legal cloud that will hang over the permissibility of risk-mitigating and other common intercompany transactions with, and investments in, non-fund affiliates could have a serious adverse effect on the safety, soundness, efficiency and stability of the U.S. and global financial systems.  SIFMA notes a number of other meaningful concerns in its letter, and strongly urges regulators to conduct appropriate cost-benefit analysis before promulgating final rules. 

Harm to Specific Markets/Products
The proposed regulations would cause serious harm to a number of specific markets and products that are vital to a healthy economy.  SIFMA’s comment letters further outline the adverse impacts of the proposed regulations and offer suggestions for improvement, including:

  • Derivatives of U.S. Government Debt -- Permitted activity should include trading in derivatives of permitted government obligations to avoid a significant decrease in liquidity. (SIFMA prop letter, pg. A-75)
  • Sovereign Debt – Foreign sovereign debt should be included in the U.S. government securities permitted activity.  The financial stability of many countries is interlinked with that of the United States.  Decreased liquidity in foreign sovereign debt will increase risk to the U.S. markets.  Additionally, giving preferential treatment to U.S. sovereign debt may encourage other countries to respond with similar nationalist measures.  (SIFMA prop letter, pg. A-77)
    • Permitted activity should include trading in foreign sovereign debt of countries
    • Regulators and market participants from foreign jurisdictions, including Canada, Japan and the EU, have already started to weigh in on the negative affects they will face as a result of decreased liquidity under the proposed regulations
     
  • Municipal Securities – All municipal securities should be exempt.  Failure to exempt all municipal securities is inconsistent with existing securities and banking laws, and will create tremendous confusion, decrease liquidity and increase price volatility in the municipal securities market.  A wide range of government projects depend on municipal securities for financing, including essential infrastructure at the state and local level, non-profit healthcare facilities, student loan programs and affordable housing programs
    • Permitted activity should go beyond state and municipal government bonds to include state and municipal agency obligations, which make up 41% of the muni market.  All instruments that meet the definition of “municipal securities” under the Exchange Act should be permitted activity.
      o Regulators should also exempt tender option bond transactions – tender option bonds are economically similar to other arrangements that are exempt from the Volcker Rule, such as repurchase agreements or securities lending transactions
     
  • Securitized Products – The narrow way in which the Agencies have chosen to implement the Volcker Rule risks undermining U.S. and international efforts to re-establish sustainable securitization markets and restore economic growth.  The proposed regulations’ adverse impact on the vital securitization markets would significantly decrease the availability of credit and bank funding in the real economy.  Businesses need credit to grow and hire workers.  Consumers need credit to buy homes, cars, and college educations.  Economic recovery depends on this credit being available and affordable.
    • Recognizing the importance of securitization to credit availability, the Volcker statute’s Securitization Exclusion clearly states the Rule not be  “construed to limit or restrict the ability of banking entities or nonbank financial companies … to sell or securitize loans,” but the proposed regulations’ securitization exemptions are too narrowly crafted to achieve the Securitization Exclusion’s intended purpose.
    • Issuers of asset-backed securities should be excluded from the proposed regulations’ definition of “covered funds”   Deeming ABS Issuers to be “covered funds” will, as a practical matter, prevent banking entities from sponsoring ABS Issuers, in contravention of the Securitization Exclusion. Issuers of insurance-linked securities should also be excluded.
     
  • Foreign Exchange Swaps and Forwards – 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. (SIFMA prop letter, pg. A-97)
    • There is no need to disrupt a foreign exchange market that has historically and currently operates without significant risk
     

In light of the significant harm the proposed regulations will have on U.S. capital markets, and the sheer volume of questions posed by regulators, SIFMA urges regulators to conduct meaningful cost benefit analysis and revise and re-propose their rules.  SIFMA’s comments offer an alternative approach to implementation that will help regulators avoid damage to our financial system.  We remain committed to working as a productive participant throughout the rulemaking process.

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[i] The Securities Industry and Financial Markets Association (SIFMA) brings together the shared interests of hundreds of securities firms, banks and asset managers.  SIFMA's mission is to support a strong financial industry, investor opportunity, capital formation, job creation and economic growth, while building trust and confidence in the financial markets.  SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Association (GFMA).  For more information, visithttp://www.sifma.org.  

[ii] SIFMA’s letter on the proprietary trading ban and its letter on the private funds restrictions were submitted jointly with The Clearing House, Financial Services Roundtable and American Bankers Association
[iii] SIFMA’s comment letters were sent to the Commodity Futures Trading Commission, Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Securities and Exchange Commission.
[iv] SIFMA’s Asset Management Group (AMG) is the voice for the buy side within the securities industry, broader financial markets, and beyond. Collectively, members of AMG represent approximately $20 trillion of assets under management. Membership is diverse, ranging from the largest global financial players to independent, small firms across the country. 

[v] Study- The Volcker Rule: Implications for the US Corporate Bond Market, December 23, 2011 

 

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