The final draft of the Volcker Rule released by the five regulatory agencies is not as bad as feared earlier, believes Citi.
Keith Horowitz and Christopher Larmoyeux of Citi point out the initial read of the Volcker rule is not going to limit proprietary trading in U.S. government, agency, state and municipal obligations. Further foreign government debt would also be excluded from the Volcker rule.
Earlier it was feared a new version of the Volcker rule may force U.S. banks to cede their capital market share in credit, sovereign and emerging market sectors to European capital market banks. It was feared a unilateral prohibition by U.S. regulators regarding OTC market making would radically change the global market shares and competitive positions of the leading U.S. fixed income participants.
Won’t restrict market making abilities
Citi analysts believe the final rule doesn’t seem like it will severely restrict market making abilities. However they point out there will be more clarity and interpretation from regulators in the future.
Brennan Hawken and the team at UBS point out that the exception for market making appears to be more focused on appropriate controls and design over trading operations, rather than overly prescriptive in preventing anything close to prop trading. In their opinion, the final draft seems less ‘in the weeds’ and less likely to restrict liquidity and allow for more flexibility for regulators.
Hedging exception in line with expectation
UBS analysts point out banks are still permitted to hedge risks, but must clearly document the structure and design of such hedges and design sufficient monitoring. They believe the oversight is likely to put moderate pressure on expenses, though that seems a far better outcome than very restrictive rules on market making and underwriting.
On the other hand, Citi analysts note banks will have to hedge targeted and identifiable risks in their trading books and will have to constantly re-test these hedge assumptions to ensure no additional risk is being created. They point out the rule prohibits rewarding traders through compensation for any banned proprietary trading.
The final Volcker rule only requires CEOs to guarantee
Citi analysts point out that, contrary to earlier expectation, the final Volcker rule only requires CEOs to guarantee that the firm has adequate controls in place to comply with the rule instead of guaranteeing compliance with the rule.
Further UBS analysts believe Goldman Sachs’ Investing and Lending business doesn’t seem to be incrementally impacted by the final draft of the rule, as restricted prop trading limits positions held fewer than 60 days.
The Volcker rule implementation will be delayed by one year until July 2015, though there are near-term requirements to be complied with.
Citi analysts thus conclude the final rule looks to be manageable but banks may incur additional compliance costs.