The US Department of Treasury proposed substantial amendments to the Volcker Rule and made other recommendations regarding the regulation of banks and credit unions, in response to President Donald Trump’s Core Principles for the federal regulation of the US financial system issued earlier this year. (Click here for background on the Core Principles in the article “Making Regulation Great Again: President Trump Requires Loss of Two Regulations for Every New One and Orders Review of All Financial Services Laws and Rules” in the February 5, 2017 edition of Bridging the Week.)

Although the Department of Treasury expressed its continued support for the principle that banks with access to the “federal safety net” (e.g., FDIC insurance and the Federal Reserve discount window) should not be permitted to engage in speculative trading for their own account, Treasury indicated that “[i]n its design and implementation … the Volcker Rule has far overshot the mark.” According to Treasury, the Volcker Rule’s definition of proprietary trading should be simplified by eliminating the subjective “purpose test” to determine whether a trade is principally for the purpose of short-term resale (and thus prohibited), and by adding increased flexibility for market-making activity.

Treasury also recommended that Congress take measures to reduce “fragmentation, overlap and duplication in the US regulatory structure.” This could include “consolidating regulators with similar missions and more clearly defining regulatory mandates.”

Additionally, Treasury recommended that a number of bank regulations implementing Dodd-Frank should be reconsidered to mitigate their negative impact on market liquidity – particularly the supplementary leverage ratio and the enhanced supplementary leverage ratio. Treasury said that measures of bank total exposure in such calculations should exclude initial margin for centrally cleared derivatives. Adoption of such relief would help make futures commission merchant activity more attractive to banks. According to Treasury, "[b]ecause of the low-margin and high-volume nature of the business of providing clients access to central clearing, high leverage ratio capital charges discourage firms from providing such services."

Treasury’s recommendations were in a report addressing the depository system, including banks and credit unions. Treasury will also issue other reports to implement the Core Principles, including one addressing capital markets, which will contain recommendations regarding debt, equity, commodities and derivatives markets as well as central clearing.

My View:​ In making a recommendation to rationalize financial regulation, Treasury echoed recommendations of the Volcker Alliance in 2015. Then, a not-for-profit think tank headed by Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, called for a substantial overhaul of the federal regulatory system that oversees US financial services, including merging the Commodity Futures Trading Commission and the Securities and Exchange Commission. Claiming that the oversight of US financial institutions “is highly fragmented, outdated, and ineffective,” the Volcker Alliance issued a report that recommended the creation of a so-called “twin-peaks” model of regulation. This paradigm would consolidate prudential oversight currently administered by a number of banking and financial regulators into one new independent federal agency—a prudential supervisory authority—and collapse the CFTC and the SEC’s investor protection and capital markets oversight functions into another new independent body. I thought this recommendation merited further consideration then and I continue to think it is worth further evaluation now. It would be critical, however, to ensure that any successor regulator is not a behemoth and is organized efficiently. (Click here for background in the article, "Volcker Alliance Calls for CFTC and SEC Merger Among Other Financial Oversight Agencies’ Reform" in the April 26, 2015 edition of Bridging the Week.)