The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act was created to prevent a repeat of the financial crisis that occurred in 2008. The “Volcker Rule” is a component of this legislation, and was drafted as part of the financial overhaul. Named after the former chairman of the Federal Reserve Paul Volcker, its purpose is to prevent banks from extreme risk-taking that can have detrimental effects on the economy and tax payers.
Greater Transparency
The Volcker Rule was recently approved by all five US regulatory agencies – the Federal Reserve, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission (SEC), Commodities Futures Trading Commission, and the Office of the Comptroller. The rule places restrictions on bank propriety trading, essentially preventing banks from trading for their own gain; however, banks are still allowed to trade, as long as those activities are linked to clients’ needs and demands. For instance, Western Central Banks trade to keep gold prices down for their clients to support their fiat currency, which is closely linked to the price of gold. Enforcing the rule is bound to be complex, as distinguishing between speculative trading and hedging may be difficult at times.
Potential Consequences
The implementation of this rule is bound to impact banks significantly, as many rely on trading for a significant percentage of their revenue. According to the Wall Street Journal, “Goldman generates about 50% of its revenue from trading.” Furthermore, in most cases “bank executive compensation depends on the profits they reap from speculative trading” (Forbes).
Even so, as the banks have been aware for some time that the Volcker rule would be implemented, pre-emptive planning and preparations might mean that there will be no real impact on the market. Additionally, the Volcker rule is reportedly rife with grey areas and loopholes, potentially leaving room for banks to find creative ways around it to result in an unchanged trading landscape (Forbes).
Although there has been no explicit mention of the consequences of non-compliance, lawyers for financial groups have expressed some concern over the highly subjective nature of the Volcker rule (Financial Times). Legal departments will certainly have some work ahead simply determining what it means to meet compliance criteria. The rule was written to leave room for interpretation in order to provide the regulatory agencies with adequate discretion – but this tactic could easily backfire as it creates more confusion.
Market Impact
This new legislation will not come into effect until April 2014 but some banks have already begun to shut down their proprietary trading desks (Reuters). It is likely that in the coming months, banks will already be much more cautious when making trades. However, as the details of the Volcker Rule have only recently been released, the impact on the commodities market will remain somewhat uncertain until the arrival of the second quarter of the upcoming year.
Nonetheless, it is safe to say that market participants will need to be aware of the new regulations imposed by the Volcker Rule, and keep track of trading activity to monitor compliance. ZEMA provides powerful auditing and reporting tools for companies, and covers a comprehensive list of commodities data to track market movements. ZEMA is the enterprise data management solution that allows businesses to capture and analyze the data needed to make strategic decisions.