Volcker Strikes Back: Paul Volcker Defends Prohibitions & Restrictions on Proprietary Trading


By: Kirill Kan

The current proposed Volcker Rule (“Rule”), has divided regulators, threatened bank’s international competitiveness, and failed to meet Wall Street reform groups’ demands for creating substantive changes in bank practice and culture. Despite such discord, regulators are set on creating a workable provision, having posed 394 questions for the industry and the public to consider. Monday, February 13 marked the final day of the comment period throughout which representatives for the world’s largest banks commented that the prohibitions imposed by the proposal to ban proprietary trading would increase risk, raise costs for investors, and be vulnerable to legal challenge.

The Volcker rule was first proposed in 2009 when Mr. Volcker served as the chair of President Obama’s Economic Recovery Advisory Board, as section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The former Fed chairman has not left the comment period entirely to bank representatives and has recently defended the rule himself in a comment letter to federal regulators and a shortened statement published in the Wall Street Journal.

Volcker begins his defense by citing both the need for (1) a thorough understanding of management priorities at financial institutions and (2) a set of “metrics” designed to reveal evidence of deliberately concealed and recurring proprietary trading. Between these two concerns, Volcker remarks, lies the “thorny issue” of guidance with respect to defining what “market making” action is permissible for financial institutions. Specifically, this “thorny issue” is whether, and in what forms, banks can trade with their own capital (i.e. propriety trading). According to Mr. Volcker, although there may be occasions when a customer oriented purchase and subsequent sale may call for a bank to take positions lasting several days, substantial holdings of such character “should be relatively rare and limited to less liquid markets.”  Accordingly, the Volcker rule provides several exceptions to the blanket prohibition on proprietary trading. Under these exceptions, a bank is permitted to (1) make trades to mitigate risk on hedging activities (hedging) and (2) buy securities from one client so as to sell it later to another (market making). However, it remains unclear whether these exceptions provide banks with enough leeway to engage in necessary trading activity.  Finally, the comment letter concludes with the non-contentious observation that “[i]n all their complexity, our giant banks are not easy institutions to manage.”

Although Volcker makes some valid points with regard to the need to manage complex financial institutions, whether the all-encompassing Volcker Rule is the best method of doing so, remains to be seen.


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Fordham Journal of Corporate & Financial Law