Banking

The Federal Reserve Board on October 11 requested public comment on a proposal that would implement the so-called "Volcker Rule," part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Volcker Rule, named for its chief backer and former Federal Reserve Board Chairman Paul Volcker, generally bars financial institutions from doing two things. First, it prohibits insured depository institutions, bank holding companies, and their subsidiaries or affiliates from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for the banking company's own account. Second, it bans owning, sponsoring, or having certain relationships with a hedge fund or private equity fund.

Some activities would be exempted
Transactions in certain instruments are exempt from the Volcker Rule. Those include obligations of the U.S. government or a U.S. government agency, government-sponsored enterprises, and state and local governments. Consistent with the statute, other activities exempted include market making, underwriting, and risk-mitigating hedging. The statute also permits banking entities to organize, offer, and invest in a hedge fund or private equity fund subject to a number of conditions.

However, the proposed rule requires companies that engage in the exempted activities to establish an internal program to ensure and monitor compliance with the Volcker Rule. The proposed rule includes commentary to help banking companies distinguish permitted market making-related activities from prohibited proprietary trading activities.

The Volcker Rule would also prohibit banking firms from engaging in an exempted transaction or activity if it would involve or result in a material conflict of interest between the firm and its customers or counterparties or that would result in a material exposure to high-risk assets or trading strategies, as defined by the rule. The act similarly prohibits banks from exempted activity that poses a threat to the safety and soundness of the institution or to the financial stability of the United States.

Proposed regulation jointly developed
The Federal Reserve developed the proposed regulation jointly with the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Securities and Exchange Commission, and the Commodity Futures Trading Commission. The regulation is designed to clarify the scope of the Dodd-Frank Act's prohibitions and, consistent with statutory authority, provides certain exemptions to these prohibitions.

October 31, 2011