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From Banking and Finance Law Daily, February 11, 2014

Shadow Financial Regulatory Committee discusses flaws in Volcker Rule

By John M. Pachkowski, J.D.

The Shadow Financial Regulatory Committee, an independent group of experts sponsored by American Enterprise Institute, released a statement, following its Feb. 10, 2014, press luncheon (audio link), regarding the final version of the Volcker Rule.

In a statement, the Shadow Financial Regulatory Committee listed a number of flaws with the final rule.

The committee called the original proposed rule “extraordinarily complex” which “drew an avalanche of comments, emphasizing the difficulty of distinguishing underwriting, market-making and hedging from proprietary trading as well as of defining the scope across firms and the international reach of the Rule.”

Rush to regulate. Pressure from Treasury Secretary Jacob Lew calling on the Office of the Comptroller of the Currency, Federal Reserve Board, Federal Deposit Insurance Corporation, and Securities and Exchange Commission to adopt a final rule by the end of 2013 was “an example of the dangers of a rush to regulate without fully understanding the potential unintended consequences involved.”

APA requirements. The committee also noted that since the final rule “differed substantially from the original proposal, the rule adopted should, under normal Administrative Procedure Act requirements, have undergone another notice and comment review. It should also have required a second and appropriate cost-benefit analysis.”

Prior to the agencies formally adopting the final rule on Dec. 10, 2013, the Center for Capital Market Competitiveness (CCMC), and its parent organization, the U.S. Chamber of Commerce requested the agencies to re-propose the rule. In a Nov. 7, 2013, letter, the CCMC noted, among other things, that there were deficiencies in the cost-benefit analysis; ambiguity as to permissible market making and underwriting, thereby increasing risk and reducing liquidity for companies; and the danger of placing the U.S. economy at a competitive disadvantage (see Banking and Finance Law Daily, Nov. 8, 2013).

In their second letter, the CCMC and Chamber called for re-proposal in light of comments made by Fed Governor Daniel Tarullo that, “One of the key mandates to the staff from all the five agencies working on the final rule has been to ensure that London Whale, in substantive and procedural terms, couldn’t happen again.” The CCMC noted that “the London Whale incident came to light in Spring 2013 after the comment period on the proposed Volcker Rule closed” and “[a]fter-the-fact reconfiguration of such a massive regulation without public comment and input would seem to run counter to the letter and spirit of the Administrative Procedures Act.” The CCMC also wrote that “Governor Tarullo’s comments regarding this major regulatory recalibration raise substantive concerns as well.” For example, changes to the Volcker Rule that will impact portfolio hedging, an activity permitted under section 619 of the Dodd-Frank Act, could profoundly impact risk management practices within the industry and that this revision should be subject to public comment (see Banking and Finance Law Daily, Dec. 5, 2013).

Cost-benefit analysis. The committee’s call for appropriate cost-benefit analysis was also raised earlier by the U.S. Chamber of Commerce in a letter to House Financial Services Committee Chairman Rep. Jeb Hensarling (R-Texas) and Ranking Member Rep. Maxine Waters (D-Calif) which called “attention [to] regulatory process deficiencies, flaws and failures in the development” of the final rule. In that Feb. 3, 2014, letter, the Chamber asserted that the agencies asserted no economic impact on small entities and no need for economic analysis; and found that “remarkable in light of the impact that the Final Volcker Rule is having on many small financial institutions with an interest in [collateralized debt obligations];” and deemed the OCC’s regulatory impact analysis a “box-checking” exercise (see Banking and Finance Law Daily, Feb. 4, 2014).

Unintended consequences. The committee also cited a number of unintended consequences. One was the application of the final rule to collateralized debt obligations backed by trust-preferred securities, which are commonly called “TruPS-backed CDOs” and the possible need by banks to divest themselves of these instruments at possible “fire sale losses.” The committee noted that the agencies “failed to take account of the immediate accounting consequences of requiring divestment” and that the agencies “hurriedly responded to this unintended consequence” by issuing an interim final rule permitting their retention.

Another unintended consequence was the final rule’s lack of clarity. The committee noted that the agencies, in their haste to adopt the final rule, “finessed many of the subjective and contentious issues surrounding the identification of proprietary trading by transferring responsibility to the firm and its CEO, who must attest that the firm has in place policies and procedures ‘to achieve’ compliance with the Rule” that will result in a CEO unable “to make a legally safe attestation” or the agencies “to make an objective evaluation of compliance.”

Companies: American Enterprise Institute; Center for Capital Market Competitiveness; Shadow Financial Regulatory Committee; U.S. Chamber of Commerce

MainStory: TopStory BankingOperations DoddFrankAct FinancialStability SecuritiesDerivatives VolckerRule

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