Just days after enactment of a partial Dodd-Frank rollback that included a substantial loosening of the Volcker Rule prohibitions against proprietary trading, the Federal Reserve Board of Governors kept the ball rolling with new proposals that would further reduce Volcker Rule burdens.

What happened

As we previously reported, the Economic Growth, Regulatory Relief and Consumer Protection Act creates exemptions from past prohibitions on proprietary trading under the so-called Volcker Rule and relationships with certain investment funds for banks with (1) less than $10 billion in assets and (2) trading assets and trading liabilities less than 5% of total assets. Until the act’s passage, all banks were subject to these prohibitions, pursuant to Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. In addition, the act eases certain Volcker Rule restrictions on all bank entities, regardless of size, for simply sharing a name with hedge funds and private equity funds they organize. The Volcker Rule, named after former Federal Reserve Chair Paul Volcker, was enacted as part of the post-crisis financial reform, aimed at restricting banks from engaging in proprietary trading and from owning or controlling hedge funds or private equity funds.

But under the new proposed regulations, issued on May 30, 2018, many of those limitations could be lifted, tailoring requirements to the size of trading assets and liabilities, thereby facilitating market-making activities that fall within internal risk limits. The proposal would also ease foreign ownership rules.

The proposed changes—developed in conjunction with the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Securities and Exchange Commission and the Commodity Futures Trading Commission—will now be open for public comment. Included in the 373 pages of proposed changes is a move to divide banks into three categories based on trading activity, with varying levels of oversight. Those banks with more than $10 billion in trading assets and liabilities would be subject to the most stringent requirements, while the next tier—banks with between $1 billion and $10 billion—would face decreased compliance burdens. For banks in the final category, those with less than $1 billion in trading assets and liabilities, a presumption of compliance would be put in place.

Another key change would do away with the Volcker Rule presumption that a trading position held for fewer than 60 days is a proprietary trade, while the proposal also featured a new presumption that where a bank’s trading activity falls within appropriately developed internal risk limits, the financial institution is engaged in permissible market-making or underwriting activity.

The changes would limit the impact of the Volcker Rule on the foreign activity of foreign banks, simplify the trading activity information that banking entities are required to provide to the federal regulators, streamline the criteria applied when a bank seeks to rely on the hedging exemption from the proprietary trading prohibition, and revise the definition of “trading account” in part by relying on commonly used accounting definitions. With unanimous approval by the Federal Reserve, the Notice of Proposed Rulemaking (NPRM) will be open for public comment once it is formally published in the Federal Register.

To read the NPRM and statements from each of the Federal Reserve Board members, click here.

Why it matters

It is not altogether clear that these changes will materially increase systemic bank risk, for the simple reason that smaller banks never really engaged in proprietary trading, the largest banks are still covered by many key Volcker Rule limitations, and few covered banks are likely to engage again in the type of proprietary trading activity that gave rise to the rule in the first instance. That said, between a Republican-backed Congress, bipartisan support for these changes, universal approval at the Fed board level and new leadership appointed by the Trump administration at each of the federal banking agencies, these changes will likely become final in a form close to that proposed. “We have had almost five years of experience in applying the Volcker Rule,” Federal Reserve Board Chair Jerome Powell said in prepared remarks before the agency voted. “The agencies responsible for implementing the Rule see many opportunities to simplify and improve it in ways that will allow firms to conduct appropriate activities without undue burden and without sacrificing safety and soundness.”