Adoption of the Volcker Rule

Today, the Commission, acting jointly with our fellow agencies, adopted a final Volcker Rule designed to significantly reduce risks to our economy and financial system while preserving the vitality of the U.S. capital markets.

The Volcker Rule is central to the framework put in place by the Dodd-Frank Act to promote the financial stability of the United States in the wake of the financial crisis.  To carry out the mandate of Section 619 of the Dodd Frank Act, the final rule seeks to focus U.S. banks and their affiliates on customer-directed activities, and to prevent the risks to U.S. taxpayers that can flow from proprietary trading and investments in private funds.  The final rule has been written to carry out these objectives while maintaining the strength and flexibility of the U.S. capital markets by allowing both domestic and foreign financial firms to continue to participate meaningfully in those markets where they are permitted to do so.

It is very important that the agencies charged with the implementation of the Volcker Rule are acting together in adopting a single rule under the Bank Holding Company Act that can be consistently applied and implemented based on continuing consultation among the agencies.  Market participants, investor advocates, and others all called for that outcome, which best achieves the specific – and very critical – statutory objectives of coordination, consistency, and comparability.

The final rule is the product of close and extensive collaboration among the agencies over the two years since the rule proposal was first issued in October 2011.  It is also the product of an open, transparent, and exhaustive public engagement process.  The Commission, like the other agencies, received and reviewed thousands of comment letters on the statutory mandate and the proposal.  Commissioners and staff met frequently with representatives of the various groups that would be affected by the rule, including those with an interest in addressing issues related to strengthening the financial stability of the United States.  Throughout this process, these groups not only shared their own perspectives, including the economic considerations supporting those perspectives, but also responded – through comments and otherwise – to the ideas and perspectives of others.

This enormous volume of public input, diverse in both source and substance, was carefully factored into the many multi-faceted policy choices presented by this mandate.  The Commission staff played a critical and constructive role from the outset in bringing to bear its expertise as a regulator of markets and market intermediaries.  The staff also applied to the inter-agency process and discussion its deep experience in regulating asset managers, investment funds, and securitization vehicles. 

In addition, the specialized economic expertise of the Commission staff was critical in assessing many of the economic issues and questions posed in public comments and in developing modifications to the final rule.  Comments on the potential economic effects of the Volcker Rule were particularly important in shaping revisions that have produced a more tailored and more effective final rule.  These comments addressed unintended consequences and offered alternatives for consideration, and these views were taken into account in formulating the final rule.

A Strong, Balanced Final Rule

The final rule faithfully and strongly implements the statutory prohibitions on proprietary trading by U.S. banks and their affiliates and the limitations on the ability of such entities to sponsor or invest in hedge funds or private equity funds – called “covered funds” in the rule.  The deliberative process leading to today’s joint rule has been informed by a careful balancing throughout the final rule of the various prudential, economic, and other factors considered over the last three years.

U.S. banks and their affiliates will no longer be able to engage in short-term proprietary trading of securities, derivatives, and other financial instruments for their own account.  In carrying out this prohibition, the final rule has benefited from a consideration of commenter views on unintended market impacts, particularly with respect to liquidity in off-exchange markets, while preserving an appropriate separation between prohibited proprietary trading and activities permitted by the statute, and taking meaningful steps to prevent evasion.

U.S. banks and their affiliates also will be restricted in how the covered funds they sponsor may be organized and offered.  In addition, firms that sponsor or advise a covered fund will be barred from, for example, purchasing assets from the fund or extending credit to it.  At the same time, the rule preserves the ability of U.S. banks and their affiliates to engage in certain activities with covered funds that the statute allows, such as asset management on behalf of customers.

Consistent with the statute, the final rule also would limit otherwise permitted activities if they involve a material conflict of interest; a material exposure to high-risk assets or high-risk trading strategies; or a threat to the safety and soundness of the banking entity or to the financial stability of the United States.

Market Making and Underwriting

The final rule takes a measured, tailored approach to market making and underwriting activities as statutory exceptions to the prohibition on proprietary trading.  Permitted market making activities can include trading in a wide variety of financial and derivative instruments, including those for which there is relatively limited liquidity, but only provided the firm is ready, willing, and able on request to provide quotes and respond to trading interest on both sides of the market.  While firms will not be required to justify permitted market making on a trade-by-trade basis, there are clear requirements regarding the maintenance and enforcement of risk and inventory limits – at the trading desk level – that are reasonably and closely tied to the nature of the instruments traded and to customer and counterparty demand.

Similarly, and consistent with the statutory objective, permitted underwriting activities include the full range of securities offerings in which underwriters participate, and encompass the various activities that they commonly undertake to facilitate distributions.  The rule requires, however, as is the case for market makers, that the trading desk maintain and enforce robust risk limits that are tied to the demand from clients, customers, and counterparties.

These carefully balanced parameters for essential permitted activities will help to ensure that market makers and underwriters can continue to contribute to the liquidity of the markets and respond to the needs of the marketplace, while appropriately limiting the financial risks that such activities may create. 

Trading by Foreign Banks

The statutory prohibition on proprietary trading does not apply to all transactions entered into by a foreign bank and their foreign affiliates.  The final rule will permit these entities to engage in certain limited proprietary trading activity with U.S. firms, but only if the risks of such trading activity are held and managed outside the United States.  Foreign banks will, for example, be able to conduct cleared transactions through U.S. exchanges and with unaffiliated, regulated U.S. market intermediaries.  This approach should help avoid unnecessary fragmentation of global financial markets and give U.S. markets access to liquidity from foreign banks, but without frustrating the fundamental objective of reducing risks to the U.S. financial system.

Scope of Covered Funds

The final rule also fulfills the statutory goal of limiting the ability of U.S. banks and their affiliates to sponsor or invest in hedge funds and private equity funds.  The Dodd-Frank Act defined a “hedge fund” and “private equity fund” by reference to regulatory exemptions that are commonly used by such funds.  The proposal carried forward this definition of a “covered fund,” and included certain commodity pools and foreign funds as well.

The rule adopted today, drawing on the extensive comments received, refines and focuses the definition of a “covered fund.”   The final rule makes clear the exclusion of certain entities that do not present the same risks as the covered funds targeted by the statute, including:

• Entities used for general corporate – rather than investment – purposes, such as wholly-owned subsidiaries, joint ventures, and acquisition vehicles;
• Mutual funds and certain foreign funds that are publicly offered abroad; and
• Vehicles used by banks to conduct loan securitizations as permitted by the statute.

These exclusions help ensure that U.S. banks and their affiliates can continue to pursue traditional banking activities that do not raise the types of risks that the Volcker Rule was intended to address.

The Path Forward

As in any notice-and-comment rulemaking, determining whether to seek additional comment requires careful judgment, with attention to both the need to ensure full public participation and the practical reality that the process must eventually come to a close.  In my view, the full and extensive dialogue with the public and among the agencies, as well as the degree of responsiveness of the final rule to information shared in that process, makes it unnecessary to seek further comment.  Here, the interest in finality is heightened by the need to implement Congress’ mandate and to bring certainty to market participants awaiting our action.

The agencies have undertaken a long, deliberative, and constructive process.  It is critical that we now act in a uniform manner to advance these important protections for the U.S. financial system.  Acting now will provide certainty for markets and market participants and provide firms with the time necessary to make responsive business decisions and to develop and implement compliance programs.

As with any regulatory initiative of this scope and complexity, the Volcker Rule demands close attention to the nature and pace of implementation.  The final rule’s reporting and compliance program requirements will now focus both the regulatory agencies and firms on implementation.  The staged implementation of the required reporting of quantitative trading data will allow the agencies and reporting firms to benefit from early experience to evaluate whether any modifications are warranted, and what they should be.  The threshold for reporting has also been adjusted to help ensure that it will be focused on the largest trading firms.  Similarly, the compliance program requirements in the final rule are tiered, based on the consolidated size of the firms, and the schedule for compliance will be phased in over time, all in the interest of reducing unnecessary burdens and costs without compromising the objectives of the rule.

There is no doubt that, consistent with our experience in other rulemakings, questions will arise following today’s action, some of which will require clarification.  We must be alert to both unintended impacts and regulatory loopholes as we move forward.  The collaborative relationships that have developed during the rulemaking process should carry forward and allow joint and coordinated guidance as necessary during the implementation of the rule.  And, of course, as implementation is completed, we will be committed to enforcing compliance with the rule.

Our work, thus, does not end with today’s rule.  We begin a new phase of monitoring and responsive engagement to ensure that the Volcker Rule is a strong, workable framework that achieves the objectives set for us.

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On a final note, I want to express my great thanks and admiration, first, for the tireless and extraordinary efforts of the Commission’s staff over the last several years.  Important contributions have come from individuals throughout the agency, who are named on the attachment to my statement. They come from the Division of Trading and Markets, the Division of Investment Management, the Division of Economic and Risk Analysis, the Office of the General Counsel, the Division of Corporation Finance, and the Office of Compliance, Inspections, and Examinations, and were joined by colleagues from the Division of Enforcement, the Office of Municipal Securities, the Office of the Chief Accountant, and the Office of International Affairs.  I also want to sincerely thank my fellow Commissioners, both current and former, for their engagement throughout this lengthy process.

SEC Staff for the Volcker Rule

Division of Trading and Markets

Primary Drafting Team

• John Ramsay
• Jim Burns
• Catherine McGuire
• Gregg Berman
• Josephine Tao
• Angela Moudy
• John Guidroz
• Christian Sabella
• Tom Eady
• Jennifer Palmer
• Lisa Skrzycki

Additional Advice and Assistance

• David Blass
• Elizabeth Sandoe
• Michelle Danis
• Haime Workie
• Linda Sundberg
• Andrew Bernstein

Division of Investment Management 

Primary Drafting Team

• Norm Champ
• Diane Blizzard
• Danforth Townley
• Jane Kim
• Brian Johnson
• Marian Fowler

Additional Advice and Assistance

• Doug Scheidt
• Susan Nash
• Keith Carpenter
• Edward Rubenstein
• Rochelle Plesset

Division of Economic and Risk Analysis

• Craig Lewis
• Jennifer Marietta-Westberg
• Vanessa Countryman
• Adam Yonce
• Matthew Kozora
• Chuck Dale
• Maciej Szefler

Office of General Counsel

• Anne Small
• Michael Conley
• Meridith Mitchell
• Lori Price
• William Shirey
• Robert Bagnall
• Mykaila DeLesDernier
• Jill Felker
• Cynthia Ginsburg
• Maureen Johansen
• Robert Teply

Division of Corporation Finance

• Katherine Hsu
• Amy Starr
• David Beaning
• Raquel Fox
• Andrew Schoeffler
• Sirimal Mukerjee
• Karen Ubell

Office of Compliance Inspections and Examinations

• Christine Sibille