Of all the complicated and controversial provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act, perhaps none can top the Volcker Rule. The financial regulators’ proposal implementing the rule runs to nearly 300 pages and features hundreds of questions designed to help the regulators understand how their proposal would affect financial institutions and the economy.

Two House subcommittees held a joint hearing on January 18 to review the proposal. Subcommittee members split on whether or not the Volcker Rule should be repealed, but offered little help to the regulators, who must adopt implementing regulations by July 21, when the statutory provisions take effect.

Requirements

The Volcker Rule, section 619 of the Dodd-Frank Act, generally prohibits banks and their affiliates from engaging in short-term proprietary trading of securities and from owning or sponsoring a hedge fund or private equity fund. There are limited exceptions to these provisions, but the exception could not be applied to a transaction that creates a conflict of interest or result in material exposure to high-risk assets or trading strategies.

As Federal Reserve Board Governor Daniel K. Tarullo told the subcommittees, the agencies have proposed a framework for implementation of the Volcker Rule that combines:

• An explanation of the factors the agencies expect to use to differentiate prohibited activities from permitted activities,

• A requirement that banking entities with significant trading activities implement a program to monitor their activities to ensure compliance with the statute, and

• Data collection and reporting requirements, to facilitate both compliance monitoring and the development of more specific guidance over time.

Tarullo emphasized that the data collection and reporting requirements are designed to assist the agencies and the banks in identifying the risks and characteristics of activities that are prohibited and those that are permitted. For now, the agencies are not proposing specific thresholds that would trigger further scrutiny; however, they expect to do so at some time in the future.

The Rule also includes a number of elements intended to reduce the burden of the proposal on smaller, less-complex banking entities. For example, the proposal limits the extent to which smaller banking entities are required to report data on their activities.

However, under the current proposal, banks of any size that engage in trading activities or covered fund investments must meet certain minimum compliance standards. Banks that do not engage in any covered trading or fund activities, which would include most small banks, would have to make sure the bank completely avoids engaging in covered activities unless it first adopts an appropriate compliance program.

The regulators rejected a more user-friendly proposal by former FDIC Chairman Sheila Bair, who had suggested looking to the source of profits on a transaction. If the profit came from fees, the transaction would be legal; if the profit depended on market movements, it would be illegal. But that was deemed too simple.