Volcker Rule back in the news

Reports Tuesday that Congress is considering changing some provisions of the Volcker Rule came as banks started to react to the new law.

Floyd Norris wrote about the potential changes in the New York Times:

When Zions Bank announced last month that it expected to take a big loss because of the Volcker Rule, it set off alarms all over Washington. Regulators scrambled to say they were considering changing the rule, but that was evidently not enough for some legislators.

Representative Jeb Hensarling, a Republican of Texas and chairman of the House Financial Services Committee, is expected to propose a bill that could open up a huge loophole in the rule. The proposed change could allow banks to create and own securities with many types of investments that are barred under the Volcker Rule, which is intended to prohibit speculative trading by banks while letting them both make markets for customers and hedge other investments.

Jeff Emerson, an aide to Mr. Hensarling, said on Tuesday that the chairman expected to propose the bill soon. A copy of it was provided by another congressional aide, who declined to be identified. It was that aide who raised the possibility of widespread abuse if the legislation were enacted.

Zions, based in Salt Lake City, said that it expected to post the loss because it owned a large number of collateralized debt obligations that contained trust-preferred securities, known as TruPS, issued by other banks. The bank said it would have to post the loss, which it estimated at $387 million before taxes, because it would no longer be able use an accounting rule that allowed it to keep losses on those securities off its earnings statement, although they were disclosed in footnotes.

That accounting treatment depended on the bank being able to say it expected to retain the securities until they matured, something it would not be able to do if the Volcker Rule would require the sale of the securities, even if the sales could be delayed for several years.

Stephen Gandel wrote in CNN Money that bankers were upset that they might have to show losses on the securities:

Bankers, nonetheless, cried foul. In late December, the American Banking Association sued to halt the Volcker Rule from going into effect, saying it was unfairly punishing Zions and hundreds of other small banks that had bought TruPs CDOs. Almost immediately, regulators announced they were reviewing TruPs and the Volcker Rule. And now it looks likely regulators will exempt the securities.

The retreat from regulators is understandable. The purpose of the Volcker Rule was to deter banks from making risky trades with their own money. TruPs CDOs are not actually hedge funds, or a proprietary trade. As Zions said, it planned to hold the CDOs to maturity, and that makes them more like many other bonds that banks buy and are still allowed to hold under Volcker. And they are largely held by small banks, not the large banks that threatened the economy in the financial crisis. So, not the types of things that the Volcker Rule was set up to limit.

But that doesn’t mean banning TruPs CDOs is a bad thing. TruPs are a type of debt that is sold by banks and other financial firms. The financial crisis threw into sharp relief the fact that the system was too interconnected. If one large bank were to fail, they would all go down. Banning banks from holding a type of debt could limit that risk. And banks would still be allowed to own TruPs, just not in CDOs, which makes it easier for banks to hide losses.

While regulators sort through the outcomes from the new law, Citigroup is also considering selling some private equity investments in order to comply with the new rules, Shayndi Raice wrote in the Wall Street Journal:

Citigroup Inc. is considering selling its $1 billion stake in a private-equity fund to comply with new federal rules, said a person familiar with the matter.

The move is in line with Citigroup’s strategy of shedding its private-equity and hedge-fund assets to comply with the so-called Volcker rule, part of the Dodd Frank financial overhaul, which forbids banks from investing in funds they don’t manage. It also caps the amount a bank can invest in such a fund to 3% of the fund’s assets.

Citigroup is considering selling its remaining stake in an emerging-markets fund it sold in August to the Rohatyn Group, a private-equity fund run by Nick Rohatyn, son of financier Felix Rohatyn. During meetings with the Rohatyn Group, investors expressed interest in purchasing Citigroup’s stake, said the person. A formal offer for the stake could come in the first half of 2014, the person added.

Citigroup executives have acknowledged for some time that they will need to sell the stake or ask for an extension to comply with the Volcker rule.

Reuters reported in a story by Huw Jones that the European Union’s proposal isn’t as strong as the U.S. regulations:

Banks in the European Union face limits on taking market bets with their own money under a draft EU proposal that represents a central plank of attempts to prevent a repeat of the financial crisis of 2007 to 2009.

Policymakers want to rein in excessive trading risks in the EU banking sector, whose assets total some 43 trillion euros ($59 trillion), that could threaten depositors if trades go wrong and potentially put taxpayers on the hook in a rescue.

Yet the EU proposal, seen by Reuters on Monday, has already been described as a watered-down measure designed to ensure approval across the bloc and which is less rigorous than equivalent “Volker Rule” regulations being introduced in the United States.

It seems that despite the best intentions of regulators putting the laws into practice isn’t as easy as it first appears. There are some unintended consequences for the banks and for those trying to curb their investments.