Banks' Volcker Headaches Limitless

NEW YORK ( TheStreet) -- The Federal Reserve on Thursday announced that large bank holding companies would need to comply with the Volcker Rule's ban on proprietary trading by July 21, 2014.

That gives the industry, regulators and Congress plenty of time to continue hash-out what the rule actually prohibits -- and what it allows -- as compliance headaches are sure to continue.
Paul Volcker

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act -- signed into law by President Obama in July 2010 -- the Volcker Rule prohibits bank holding companies from engaging in most forms of proprietary trading while severely limiting banks' investments in private equity funds and hedge funds. The rule was proposed by the president and supported by former Federal Reserve Chairman Paul Volcker.

Investment banks Goldman Sachs ( GS) and Morgan Stanley ( MS) and the "big four" bank holding companies, including Bank of America ( BAC), JPMorgan Chase ( JPM), Wells Fargo ( WFC) and Citigroup ( C) are already in the midst of a major transition in order to eventually comply with the rule, and an exodus of investment talent from the large banks has already begun, with analysts and portfolio managers starting their own hedge funds.

Foreign bank are also scrambling over Volcker. Deutsche Bank ( DB), for example, in March reorganized its U.S. subsidiary Taunus Corp. so that it would no longer be considered a bank holding company, thus avoiding Federal Reserve supervision and escaping the Volcker Rule.

In its 2011 10-K report filed in late February, Morgan Stanley said that it's "business and operations are expected to be impacted" way before the July 2014 deadline, "as operating models, investments and legal structures must be reviewed and gradually adjusted to the new legal environment."

Kevin Petrasic -- a partner in the Paul Hastings Global Banking practice in the firm's Washington, D.C. office -- says that "Volcker is one more reason for foreign banks to reconsider their commitment to US interests, both operationally and on the investment/capital side of the equation," which "could have significant longer term implications for US capital markets and growth, as well as US jobs -- in the capital market arena and expanding outward from there."

Frank Mayer -- a partner in the Financial Services Practice Group of Pepper Hamilton LLP, in the firm's Philadelphia office -- said that "financial institutions are trying to understand exactly what the regulators think congress meant," when banning short-term proprietary trading, but making exceptions for certain risk management activities," and that "this period of time will allow the regulators, the industry and perhaps congress to hold hearings to establish congressional intent on this provision."

This is absolutely key, Mayer said, "because we do not want the U.S. financial industry to be prejudiced by losing business to off-shore liquidity providers, seeking the proverbial, regulatory arbitrage."

When asked if Congress may take another look at the Volcker Rule and make changes with new legislation, Mayer said "there has to be a congressional decision on whether or not an enterprise itself can engage in enterprise-level risk hedging. The law that was passed would suggest that that's prohibited and that the hedging must be done on a deal-by-deal basis."

"Dodd-Frank was passed quickly amidst serious global atmospherics, and having hearings to have Volcker more closely aligned with international financial institutions would be worthy, so that U.S financial institutions are not art a competitive disadvantage," he said," adding that "Congress needs to have a full and robust discussion with the industry to avoid unintended consequences."

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.