The Volcker Rule, part of last year’s Dodd-Frank financial regulation law, which debars banks from participating in risky proprietary trading, has drawn stiff opposition from finance ministers from around the globe. A specific tenant of the rule that says that U.S. banks, and possibly some foreign banks that do business in America, would be restricted from trading in foreign government bonds, has left many foreign governments unhappy.
The move, critics say, will drastically reduce the liquidity of foreign sovereign bonds, and increase the borrowing costs of governments in need of capital. The rule however does not prevent banks from trading in U.S. government bonds.
Japan, U.K., and Canada have been particularly critical of the Volcker Rule. George Osborne, the Chancellor of the Exchequer in Britain, in a letter to Ben Bernanke, chairman of the Federal Reserve, has voiced concern that the regulations could significantly impact the market for sovereign bonds. Mr. Osborne proposed that U.S. and U.K. “launch a more active dialogue” on the Volcker rule and its potential impact on global financial markets.
Japanese officials are equally skeptical of the implications of the rule, which they feel would raise the operational and transactional costs of trading in Japanese government bonds. This consequently, could lead to the exodus of the Japanese subsidiaries of U.S. banks, from Tokyo.
Mark Carney, governor of the Bank of Canada, has also voiced his concerns about the rule. The five largest banks in Canada are so anxious about the rule that they have sent a letter to the Federal Reserve and four other agencies, arguing that the rule may be illegal under the North American Free Trade Agreement.
The Volcker rule, named after former U.S. Federal Reserve Chairman Paul Volcker, seeks to prevent regulated banks that receive government support from making risky bets with their own money, and among the many elements of the 2010 Dodd-Frank financial overhaul law, has been the most criticized. Critics point out that the scale of foreign protests could force the U.S. financial regulators to make some changes to the draft rule they released in October.
The defenders of the Volcker rule point out to the collapse of MF Global, which they say was caused by the excessive trading in foreign sovereign bonds. They also argue that if large banks stop trading in government bonds, smaller firms will step in and fill the gap, thereby addressing the concern of market volatility.
U.S. Treasury Department also conducted a study on the impact the Volcker Rule would have on liquidity across markets, and came to the conclusion that it would be limited.