Finally! The Volcker Rule is Finalized and Good Regulation (Looks to Have) Won Out

The much-anticipated final regulations implementing the Volcker Rule will be released today and, almost miraculously, it seems to be significantly stronger than the proposed text publicized more than a year ago. We will all have to await the actual wording since this is an area in which the devil is truly in the details.

But the all-important limitation on insured banks betting on the trading markets with depositors’ money is rumored to do a few key things:

• Prohibit the perversion of the concept of “risk mitigating hedging” (as JP Morgan Chase did in the “London Whale” fiasco in which they lost more than $6 billion).

• Eliminate loopholes that could allow evasion through the use of offshore branches and affiliates.

• Require high-level management to stand behind compliance through periodic certifications. 

No doubt, there will be other improvements and changes that weaken the rules.

But for now, how were the regulators able to resist the tremendously powerful bank lobbyists in this area of regulation? One reason is that the administration finally got focused on getting this job done—partly because it is a good thing, and partly because it wants to be seen as being effective at governing.

But there are also some unlikely heroes. The Volcker Rule regulations have to be adopted by five separate Federal agencies, including the Fed, the Comptroller of the Currency, the FDIC and the Securities Exchange Commission. The fifth is the Commodities Futures Trading Commission or CFTC. The CFTC was somewhat on the sidelines during the proposed rule drafting. It was the smallest of the agencies involved and had been given the massive task of crafting the regulations governing the mammoth and devilishly complex derivatives markets. As a practical matter, the CFTC had limited resources to devote to the Volcker proposed regs.

But, unlike the rest of the bureaucracy, the CFTC did its work efficiently and promptly. In the last few months, as the final Volcker regulations were worked out, the CFTC has asserted its views, and it appears that the American people are better off for it. CFTC Chairman, Gary Gensler, is in the last weeks of his tenure. Similarly, another Democratic appointee, Bart Chilton, has announced that he is departing soon. The timing is important, these two became critical to the Administration’s announced intention for prompt adoption of the regulations. The CFTC had to adopt the rules and Gensler’s and Chilton’s votes could make it so.

Chairman Gensler is said to have become very active in the process, particularly on the subject of the coverage of extraterritorial activities of US banks operating abroad and foreign banks operating in the U.S. He had just been through a bruising fight over the extraterritoriality coverage of the general derivatives regulations and had been required to make some compromises that he did not like. By successfully negotiating with other agencies over the Volcker regulations, he was able to both improve them and to bolster the effects of the derivatives jurisdiction by the combined effects of the two rulemaking areas.

Commissioner Chilton had his hand on the door to retirement when key members of Congress intervened urging him to stay on just to vote on the Volcker regulations. Because his imminent departure created such a problem, he found himself in a position of great leverage. He let it be known that he would not be able to vote for the Volcker regulations unless the all-important hedging exception provisions were made strict and they were.

No none knows for certain what conversations happened. The important thing is that we may just have a Volcker Rule that works. In a year’s time, when we see how the banks shrink, we will know for sure.