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US stock market daily report (December 10, 2013, Tuesday)
Five financial regulators consisting of: Board of Governors of the Federal Reserve System, Commodity Futures Trading Commission, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency and Securities and Exchange Commission voted on final language of the "Volcker Rule" on Tuesday. The move will usher in a whole new era of tough oversight that drills to the core of Wall Street's profitable markets, trading businesses and will prevent banks from engaging in speculative trading activity. Final rules would provide exemptions for certain activities including market making, underwriting, hedging, trading in certain government obligations as well as, organizing and offering a hedge fund or private equity fund, in addition to others. The final rule would limit certain exemptions if they involve a material conflict of interest; a material exposure to high-risk assets or trading strategies; or a threat to the safety and soundness of the banking entity or U.S. financial stability.
The final rules would generally prohibit banks from - engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account; owning, sponsoring or having certain relationships with hedge funds or private equity funds referred to as ‘covered funds.’
Federal Deposit Insurance Corp and Federal Reserve Board voted unanimously to approve Volcker Rule while SEC approved it with a vote of 3-2. Ahead of the Fed's vote, Federal Reserve Chairman Ben Bernanke said in a statement, "The ultimate effectiveness of the rule will depend importantly on supervisors, who will need to find the appropriate balance while providing feedback to the Board on how the rule works in practice." Thomas Curry, Comptroller of the Currency said in a statement, "During 2014, we will develop the necessary examination procedures and training to ensure that our bank examiners have the tools they need to do the job." Gary Gensler, CFTC Chairman said in a statement ahead of the vote that the rule "permits hedging to reduce identified, specific risks from the banking entity's individual or aggregated positions" but that "hedging of the general assets and liabilities of the banking entity or a guess as to the direction of the economy will no longer be permitted."
New hurdles will now be in effect for banks that engage in market making - buying and selling securities on behalf of clients - plus will restrict compensation arrangements that encourage risky trading. While firms are expected to make "good faith" efforts to gain compliance as soon as possible, the Fed approved extension for full compliance until July 2015. The Fed will now move to apply the rule Volcker Rule to large bank holding companies it oversees. Community banks with less than $10 billion in assets will be exempt from Volcker Rule as long as they do not engage in most of the activities covered by it. The rule will permit banks to trade foreign sovereign debt. Foreign banks operating in the U.S. will face tight trading restrictions under the Volcker rule by prohibiting overseas banks with U.S. offices to buy, sell or hedge investments for its own profits.
Highlights from federal agencies “fact sheet” on the Volcker Rule:
The Final Rules
The final rules would provide key definitions and identify characteristics of prohibited and permitted activities and investments.
Proprietary Trading Prohibition
The final rules would prohibit proprietary trading by banking entities. As required by the Dodd-Frank Act, the final rules would include exemptions for.
This exemption would require that a banking entity act as an underwriter for a distribution of securities (including both public and private offerings) and that the trading desk’s underwriting position be related to that distribution. Consistent with the Dodd-Frank Act, the underwriting position must be designed not to exceed the reasonably expected near-term demands of customers.
Market Making-Related Activities
Under this exemption, a trading desk would be required to routinely stand ready to purchase and sell one or more types of financial instruments. If the rules are adopted, the trading desk’s inventory in these types of financial instruments would have to be designed not to exceed, on an ongoing basis, the reasonably expected near-term demands of customers. Under the final rules, determining customer demand would be based on such things as historical demand and consideration of market factors. A market-making desk may hedge the risks of its market-making activity under this exemption, provided it is acting in accordance with certain risk-management procedures required under the final rules.
This exemption would apply to hedging activity that is designed to reduce, and demonstrably reduces or significantly mitigates, specific, identifiable risks of individual or aggregated positions of the banking entity. The banking entity would also be required to conduct an analysis (including correlation analysis) supporting its hedging strategy, and the effectiveness of hedges must be monitored and recalibrated as necessary on an ongoing basis. The final rules also would require banking entities to document, contemporaneously with the transaction, the hedging rationale for certain transactions that present heightened compliance risks.
Trading in Certain Government Obligations
The final rules would permit a banking entity to continue to engage in proprietary trading in U.S. government, agency, state, and municipal obligations. They also would permit, in more limited circumstances, proprietary trading in the obligations of a foreign sovereign or its political subdivisions.
Certain Trading Activities of Foreign Banking Entities
The final rules generally would not prohibit trading by foreign banking entities, provided the trading decisions and principal risks of the foreign banking entity occur and are held outside of the United States. Such transactions may involve U.S. entities only under certain circumstances. Specifically, an exempt transaction may occur a) with the foreign operations of U.S. entities; b) in cleared transactions with an unaffiliated market intermediary acting as principal; or c) in cleared transactions through an unaffiliated market intermediary acting as agent, conducted anonymously on an exchange or similar trading facility.
Other Permitted Activities
The final rules would exempt, provided certain requirements are met, trading on behalf of a customer in a fiduciary capacity or in riskless principal trades and activities of an insurance company for its general or separate account.
The final rules would clarify which activities are not considered proprietary trading, provided certain requirements are met, including trading solely as an agent, broker, or custodian; through a deferred compensation or similar plan; to satisfy a debt previously contracted; under certain repurchase and securities lending agreements; for liquidity management in accordance with a documented liquidity plan; in connection with certain clearing activities; or to satisfy certain existing legal obligations.
Covered Fund Prohibitions
The final rules would prohibit banking entities from owning and sponsoring hedge funds and private equity funds, referred to as “covered funds.” Under the final rules, the definition of covered funds encompasses any issuer that would be an investment company under the Investment Company Act if it were not otherwise excluded by two provisions of that Act, section 3(c)(1) or 3(c)(7). The final rules also would include in the definition of covered funds certain foreign funds and commodity pools, but defined in a more limited manner than under the proposed rule.
The final rules would exclude from the definition of covered fund certain entities with more general corporate purposes such as wholly-owned subsidiaries, joint ventures, and acquisition vehicles, as well as SEC-registered investment companies and business development companies. Other exclusions would apply to certain foreign funds publicly offered abroad, loan securitizations, insurance company separate accounts, and small business investment company and public welfare investments.
As provided by the Dodd-Frank Act, the final rules would permit a banking entity, subject to appropriate conditions, to invest in or sponsor a covered fund in connection with: organizing and offering the covered fund; underwriting or market making-related activities; certain types of risk- mitigating hedging activities; activities that occur solely outside of the United States and insurance company activities.
The final rules would clarify that, provided certain requirements are met, a banking entity is not engaging in prohibited covered fund activities or investments when it acts on behalf of customers as an agent, broker, custodian, or trustee or similar fiduciary capacity; through a deferred compensation or similar plan; or in the ordinary course of collecting a debt previously contracted.
The final rules would provide compliance requirements that vary based on the size of the banking entity and the amount of activities conducted, reducing the burden on smaller, less complex entities. Banking entities that do not engage in activities covered by the final rules would have no compliance program requirements.
The final rules generally would require banking entities to establish an internal compliance program reasonably designed to ensure and monitor compliance with the final rules. Larger banking entities would have to establish a more detailed compliance program, including a required CEO attestation; smaller entities engaged in modest activities would be subject to a simplified compliance regime. Banking entities that do not engage in any activity subject to the final rules, other than trading in exempt government and municipal obligations, would not be required to establish a compliance program.
The final rules would require the banking entities to maintain documentation so that the agencies can monitor their activities for instances of evasion.
The final rules would require banking entities with significant trading operations to report certain quantitative measurements designed to monitor certain trading activities. The reporting requirements would be phased in based on the type and size of the firm’s trading activities.
The final rules would become effective April 1, 2014. The Federal Reserve Board has extended the conformance period until July 21, 2015. Beginning June 30, 2014, banking entities with $50 billion or more in consolidated trading assets and liabilities would be required to report quantitative measurements. Banking entities with at least $25 billion, but less than $50 billion, in consolidated trading assets and liabilities would become subject to this requirement on April 30, 2016. Those with at least $10 billion, but less than $25 billion, in consolidated trading assets and liabilities would become subject to the requirement on Dec. 31, 2016. The agencies will review the data collected prior to Sept. 30, 2015, and revise the collection requirement as appropriate.
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