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29 October 2019 Issue Brief

Volcker Rule & Proprietary Trading

The so-called Volcker Rule is a federal regulation that prohibits banks from conducting certain investment activities with their own accounts, and limits their ownership of and relationship with hedge funds and private equity funds. The Volcker Rule’s purpose is to prevent banks from making certain types of speculative investments that contributed to the 2008 financial crisis.

Named after former Federal Reserve Chairman Paul Volcker, the Volcker Rule disallows short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for banks’ own accounts under the premise that these activities do not benefit banks’ customers. In other words, banks cannot use their own funds to make these types of investments to increase their profits. The purpose is to discourage banks from taking too much risk.


Five federal agencies — the Federal Reserve Board, The Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Commodity Futures Trading Commission (CFTC), and the Securities and Exchange Commission (SEC) — approved the final regulations that make up the Volcker Rule, and the rules went in into effect April 1, 2014, with banks' full compliance required by July 21, 2015.

The rule allows banks to continue market making, underwriting, hedging, trading of government securities, insurance company activities, offering hedge funds and private equity funds, and acting as agents, brokers or custodians. Banks may continue to offer these services to their customers and generate profits from providing these services. However, banks cannot engage in these activities if doing so would create a material conflict of interest, expose the institution to high-risk assets or trading strategies, or generate instability within the bank or within the overall U.S. financial system.

The United Kingdom has also grappled with restrictions on banks engaging in proprietary trading. The Vickers Report from the Independent Commission on Banking (ICB) called for “ringfencing” of domestic retail depository institutions from global wholesale/investment banking operations. The ringfenced institutions would have separate boards of directors from the parent company and capital of as much as 20 percent.

CFA Institute Viewpoint

CFA Institute supports the general goal of the Volcker Rule — to prevent financial institutions from taking advantage of government-insured deposits and the capital of depository banking institutions to engage in proprietary trading or investing in hedge funds and private equity funds.

Affiliates within a bank holding structure should be permitted to invest in private equity funds, so long as the affiliate does not have access to either the depository institution’s insured deposits or capital.

Separately capitalized and legally separate broker/dealer affiliates of a bank holding company should be permitted to engage in trading for the purposes of market making and hedging, so long as the affiliate does not have access to either the depository institution’s insured deposits or capital.

CFA Institute has expressed concern that restrictions on market making could hurt markets for illiquid instruments like fixed-income securities and urged regulators to monitor implementation carefully to make changes quickly if the new rules are seen to significantly and negatively affect liquidity in these markets.

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