Stein observed: "It's market making economically speaking, but it's unusually big and maybe a longer term position that needs to be worked off."
A Fed staffer said that the task would qualify under the market making exemption but that the bank would have to make sure to follow its pre-set limits on market making risks. Going beyond those limits would require that management make a conscious decision to breach those limits temporarily and probably should not be done without input from the bank's primary regulator. "The implementation of how it gets worked out by the firm would depend on the limit structure they imposed on themselves as market makers," the staffer said.
One SEC Republican member, Dan Gallagher, went a step further and dissented in a statement, arguing that the final rule will discourage big banks from their "market-making" obligations to provide liquidity to investors particularly in times of stress. "What we face is the prospect of banning the market making practices so central to our capital markets in order to make sure we capture every last activity that could potentially be characterized as proprietary trading," he said.
The 2011 proposal and the final rule had many differences. One key change: Bank CEOs at financial institutions with more than $50 billion in assets must attest in writing that their firms have set up processes to ensure that the institution is in compliance with the trading prohibitions. While tougher than the original proposal, critics had sought more restrictive language that would have had CEOs certify that there is no speculative proprietary trading at the firm at all. Nevertheless, even the weaker measure may have a chilling effect on banks, as executives will be less willing to allow some trading activity because there can be personal liability involved if anything goes wrong.The final rule is also tougher when it comes to how banks can hedge their risks. The new stricter wording comes after JPMorgan Chase's (JPM) so-called London Whale credit derivatives trade last year amassed losses in excess of $5.8 billion. Instead of allowing banks to hedge their risks on a "macro" or "portfolio basis," as was initially proposed, banks can hedge their risk if they can demonstrate that the trades "demonstrably reduce or otherwise significantly mitigate one or more specific, identifiable risks." Hedging of generalized risks based on models will be prohibited, as will bets on the direction of the economy or trades tied to general revenues or expectations of losses. Nevertheless, the stronger wording isn't likely to appease some critics on the left who would have preferred to have banks justify each hedge on a trade-by-trade basis, an approach they said they believe would eliminate any chance that banks engage in risky speculative trades for their own accounts. On the other side, some raised concerns about the provision's restrictiveness, arguing it would make it tougher for a bank to hedge its risks. Not all Republicans opposed the rule: One GOP FDIC member, Hoenig, suggested it didn't go far enough. Hoenig said he worries it can be "gamed," adding that he would like to see large financial institutions split their commercial banking units from their investment banking businesses as part of an effort to ensure that firms don't have access to the government safety net when engaging in risky speculative trading. Foreign governments were given some exemptions for trading of their sovereign debt. The initial version only provided relief for proprietary trading by big U.S. banks of U.S. Treasury securities. Many foreign governments were outraged by the provision because of concerns that it would result in a reduction in liquidity of trading of their sovereign debt. The final rule allows "in more limited circumstances" proprietary trading of non-U.S. foreign debt, such as Canadian and Japanese debt. U.S. banks can trade foreign sovereign debt if they qualify as a primary dealer for trading of that debt or they are using it for legitimate hedging.
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