And just like that, after a ten year hiatus, prop traders are about to become the most desired job on Wall Street (now that hedge funds are replacing their trading desks with algos).
As a reminder, the main component of Volcker Rule which was implemented in 2010 in response to perceived shortcoming from the financial crisis to limit risk-taking by commercial bank trading desks, had banned prop trading, which contrary to “flow”, allowed banks to trade for their own accounts rather than for clients.
Well, as Bloomberg reports, Wall Street is set to win the biggest reprieve since the implementation of the Volcker Rule nearly a decade ago, as U.S. regulators are set to scrap the key restrictive presumption that most short-term trades violate the post-crisis regulation. Specifically, as part of the anticipated overhaul of Volcker, the Fed and other regulators will drop an assumption written into the original rule that positions held by banks for less than 60 days are speculative, and therefore banned.
Instead, it will be up to banks to determine and conclude that their trades comply with the rule, putting the onus on regulators to challenge such judgments; the architect? A former Goldman banker of course: Steven Mnuchin.
Many of the Volcker revisions under consideration adhere to a blueprint issued last year by Trump’s Treasury Department, which advised doing away with many of the rule’s more subjective demands. Asking banks to figure out the purpose of each purchase or sale of an asset “effectively requires an inquiry into the trader’s intent at the time of the transaction, which introduces considerable complexity and subjectivity,” Treasury argued. Its report said the rule’s complexity had caused banks to be overly conservative in their trading activity, a contention also made by industry lobbyists.
Of course, banks had previously found numerous loopholes to engage in prop trading, the most infamous of which was JPM’s 2012 “London Whale” fiasco, when billions in prop CDS trades masked as “hedges” went spectacularly wrong, resulting in huge losses for the bank, numerous terminations, lawsuits, and even Jamie Dimon appearing in Congress. JP Morgan was eventually slapped on the wrist with a token fine.
Fast forward 6 years, when while banks will still be allowed to prop trade, at least they won’t have to come up with silly ways to pretend they aren’t.
The result: banks are delighted and as the American Bankers Association said in a Sept. 21 comment letter to the OCC, presuming all short-term trades are prohibited transactions “has undercut banks’ ability to serve customers, out of concern that such services would be deemed proprietary trading.”
To be sure, opinions were mixed about the Volcker ban: while on one hand the rule was meant to limit excessive risk-taking by restricting speculative trading by banks, and curtailing lenders’ investments in hedge funds and private-equity firms, the offset was a collapse in liquidity across Wall Street, as banks no longer held securities in inventory making procurement problematic and costly, while expanding bid/ask spreads; all this in addition to being overly complex and is difficult to comply with.
Meanwhile, demonstrating just how political every financial regulation really is, the same Fed which led the implementation of Volcker, was just as fast in undoing it: and while the Fed led the rewrite, there is broad agreement among all five agencies responsible for Volcker on how to proceed. Accoridng to Bloomberg, the other watchdogs involved in the process are the Securities and Exchange Commission, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Commodity Futures Trading Commission.
Additional changes the regulators intend to propose include making it easier for banks to stockpile assets that their customers may want to buy in the near term and dialing back compliance burdens for smaller lenders, the people said. The agencies expect to release the proposal by the end of the month — a timeline confirmed publicly by Joseph Otting, the former banker who leads the OCC. Spokesmen for the five agencies declined to comment.
It’s not just the big banks’ trading floors that will benefit from the revision: a separate objective that’s also making headway in Congress is to easy life for smaller banks. The Senate passed a bill earlier this year that would exempt all lenders with less than $10 billion from Volcker and the legislation is expected to clear the House as soon as next week.
As Bloomberg notes, criticism of Volcker hasn’t been limited to Republican regulators nominated by Trump. Former Fed Governor Daniel Tarullo, who frequently battled with Wall Street over post-crisis rules, said before he stepped down last year that it was “too complicated” and may hurt banks’ ability to make markets for customers. And Martin Gruenberg, the current head of the FDIC who was appointed by former President Barack Obama, has cited Volcker as an example of a good place to start simplifying regulations.
The best news, however, is for junior hedge fund traders and PMs, who have become disenchanted with the buyside: instead of having to do something actually socially constructive with their lives, traders and portfolio managers will be given one last chance to make a killing by investing deposits in the latest and greatest super risky investment, with the hopes that it either soars, or if it crashes, that enough banks are invested in it that another government bailout will follow.
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