Congress Likely to Toughen Volcker Rule in Reform Bill

WASHINGTON — Like it or not, and most large banks don't, the Volcker Rule to ban proprietary trading is now all but certain to be enacted in regulatory reform.

If anything, despite efforts to weaken the provision, it is only likely to get tougher.

"The dialogue seems to be shifting from whether there would be a Volcker Rule at all a month ago, to now what form it will take," said Satish Kini, co-chair of the banking group at Debevoise & Plimpton LLP. "So really you can see the ground shifting in the way these amendments are coming up. It doesn't seem simply deleting the Volcker Rule in the Dodd bill is going to happen now."

When the proposal was first endorsed by President Obama in January, most lawmakers said it had come too late in the reform debate. Still, Senate Banking Committee Chairman Chris Dodd included a form of the plan in his reform bill, giving regulators wide latitude to craft and implement a ban.

As the Senate prepares to continue voting on reform next week, amendments trying to change the provision are likely to dominate much of the debate.

Of the three measures relevant to the Volcker Rule, the one by Sens. Carl Levin, D-Mich., and Jeff Merkley, D-Ore., is looking most likely to pass. It won an endorsement this week from Volcker himself, who said it should be made part of the bill.

"We have had several communications with the Merkley-Levin folks, and Mr. Volcker appreciates the hard work they are doing to preserve the intent of the Volcker Rule," a spokesman for Volcker said. "With the strong support of the Treasury, White House and Senator Dodd as well, Chairman Volcker feels very confident that these provisions will make it through the process intact and become law."

It has also been helped by Levin's recent hearings on fraud allegations at Goldman Sachs Group Inc.

"The amendment I'm working on with Sen. Merkley would try to end the conflict of interest that was highlighted in the Goldman Sachs hearing, where firms create financial instruments, sell them to their clients and then bet on their failure," Levin said.

While Levin is still in the process of drafting his amendment in consultation with the White House, it would go beyond the Dodd bill by putting the Volcker Rule into statute by adding a prohibition on proprietary trading to the Bank Holding Company Act and superseding existing authority governing such activities.

Like the Dodd bill, Levin's version would direct the proposed systemic-risk council to conduct a study on the issue, but they would not have as much leeway in how they implemented it.

It also would broaden the definition of proprietary trading by eliminating an exception for activities conducted "in connection with or in facilitation of customer relationships."

Rather than giving banks five years to implement the ban, Levin's amendment would shrink that period to two years. Levin's amendment would also ban underwriters from betting against a security or any activity that would undermine the security's value.

Both the Dodd bill and Levin amendment would also restrict banks' investments with hedge funds and private-equity firms.

Levin's amendment "would really make a bad situation worse, so I would expect there would be some significant support for it," said Ed Yingling, the president and chief executive of the American Bankers Association. "The strongest argument is you have to take in what other countries are doing … and second you should not write these rules without some flexibility because you cannot anticipate what the market will look like in the future."

The industry is supporting two amendments from Sen. Scott Brown, R-Mass., designed to loosen the provision. One amendment by Brown and Sen. Kay Hagan, D-N.C., would allow more flexibility for working with hedge funds and private-equity firms by allowing such investing up to 10% of Tier 1 capital of a bank into any particular fund.

Another by Brown would exclude limited-purpose banks and thrifts from the Volcker Rule.

But Yingling admits the industry is at a disadvantage in fighting Levin after he led a day-long grueling hearing of Goldman Sachs.

"That's why it's a more dangerous amendment because he sat in the chair in those hearings," Yingling said.

Brian Gardner, a political analyst for KBW Inc., said of the amendments, the Levin measure is most likely to pass. "It looks like that Volcker in some way, shape or form is going to make it into the final Senate bill," he said. "Any changes to the Volcker Rule will be to toughen it. I think the Levin amendment has the best chance of passing."

Paul Miller, a managing director of Friedman Billings Ramsey & Co., agreed. "What we believe at the end of the day is it's the Dodd language or tougher," Miller said. "The bill has moved to the left and it's going to stay to the left."

Oliver Ireland, a partner at Morrison & Foerster LLP, said the proposal is so technical the vote could signal other changes to come.

"The vote on this will be an interesting bellwether," he said. "If they vote for the Levin version, it's a very bad sign for everything else in the bill because it seems people are just voting against the financial services industry. They were willing to adopt things that they probably don't understand just because they 'rein in the financial sector industry.' And if they will do that here, they probably will do that elsewhere."

While the industry appears to be losing the fight over the Volcker provision, the former Fed chief did help them this week in their battle against another reform measure that would require banks to spin off their swaps desks.

In a letter dated Thursday to Dodd, Volcker said he agreed with regulators who warned it could drive derivatives trading to less-regulated parts of the economy.

"I am also aware of, and share, the concerns about the extensive reach of Sen. Lincoln's proposed amendment," Volcker wrote. "The provision of derivatives by commercial banks to their customers in the usual course of a banking relationship should not be prohibited."

The provision is championed by Agriculture Committee Chairman Blanche Lincoln, who is fighting efforts to remove it from the bill.

Volcker said he sympathized with the intent of the provision, but said the Levin-Merkley amendment would better address the issue.

In response, Lincoln issued a statement that said her provision was essential to protecting the banking system. "My provision begins to cut down the size of these institutions by moving this risky activity into fully regulated entities, protecting American taxpayers," she said.

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