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SIFMA Makes Concrete Recommendations to Overhaul Volcker Rule Proposal

Friday, March 2, 2012
Sima Saran Ahuja | Bloomberg LawComment Letter, Securities and Financial Markets Association (Feb. 13, 2012) The Securities Industry and Financial Markets Association (SIFMA) submitted a comment letter regarding Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), commonly referred to as the Volcker Rule, and its impact on proprietary trading. For more on SIFMA's previous comments on the Volcker Rule's impact on markets, businesses, investors, and job creation, see SIFMA Warns Congress of Volcker Rule Shortcomings, Bloomberg Law Reports® – Securities Law, Vol. 6, No. 6 (Feb. 6, 2012). In its final comment letter before the Volcker Rule comment period closed, SIFMA summarized its main criticisms of the ban on proprietary trading and specifically addressed hundreds of questions posed by regulators in the Volcker Rule Proposals (Rule Proposals). Conceptual Concerns SIFMA remained critical of the Volcker Rule and specifically faulted the Rule Proposals for failing to strike a balance between "proscribing proprietary trading while protecting financial markets and market participants." SIFMA argued that to "avoid damaging the U.S. markets," the Volcker Rule should be revised pursuant to SIFMA's detailed and lengthy comments. SIFMA began by outlining "problematic themes" of the Volcker Rule. — Artificial Distinction First, SIFMA denounced the Rule Proposals' attempt to draw a bright line between permitted activities and prohibited short-term proprietary trading. According to SIFMA, the artificial distinction is impractical, inconsistent with congressional intent, and results in an "overly narrow interpretation." — Negative Presumptions SIFMA next took exception with the Rule Proposals' negative presumptions and reliance on hard-coded criteria. In SIFMA's view, the Rule Proposals' assumption that activities are prohibited unless proven otherwise is troublesome and inconsistent with congressional intent to allow useful principal activity. To substantiate this point, SIFMA discussed congressional letters and hearings that have revealed Congress' "surprise and concern at the path the Agencies have taken." Of particular concern to SIFMA is the Rule Proposals' "reliance on hard-coded criteria to define the permitted activities, under which the failure to meet any single criterion disqualifies the trading unit from engaging in the permitted activity." Among other things, SIFMA argued that this approach does not represent the majority of markets and instead reflects a small portion of transactions. It recommended that the hard-coded criteria be removed from the Volcker Rule and, instead, be incorporated as guidance in the final rule. — Transaction-by-Transaction Approach SIFMA contended that the Rule Proposals' transaction-by-transaction approach to principal trading characterizes transactions as either market making, hedging, or underwriting and does not "accord" with how modern trading units function. According to SIFMA, rather than take a transactional approach, modern trading units "view individual positions as a bundle of characteristics that contribute to their complete portfolio." — Overly Prescriptive Compliance Regime Finally, SIFMA took aim at the Rule Proposals' compliance regime and suggested that it is "overly specific, prescriptive and impractical." Attempting to develop a scheme that identifies every instance of prohibited proprietary trading in otherwise permitted activity has contributed to this dilemma, SIFMA said. It warned that, because of compliance concerns, certain activities may no longer be affordable for banking entities to be engaged in. To mitigate against this result, SIFMA recommended that the Rule Proposals "institute a principles-based framework that provides banking entities the discretion and flexibility to customize compliance programs tailored to the actual structure and activities of their organizations." Suggestions for Reorienting the Proposal Underpinning SIFMA's recommendations is its view that the Rule Proposals should be reoriented to align more closely with Congressional intent. Such reorientation will allow banking entities to engage in critical financial intermediation. — Customer-Focused Trading To preserve customer-focused principal trading, hard-coded criteria should be "recast as guidance" on how to differentiate client-focused business from other business. SIFMA further suggested that such guidance be incorporated in policies and procedures of banking entities, with risk limits and controls to be monitored through regulatory examinations. — Phase-In To minimize disruption to the markets, SIFMA recommended that the Volcker Rule be phased in to allow banking entities a full two-year statutory conformance period. Moreover, SIFMA suggested that the Volcker Rule first should be applied to covered banking activities in the United States and phased in by asset class or business line. This will enable regulators to gauge market reaction and make appropriate changes before applying the Volcker Rule internationally. — Supervisory Confusion SIFMA reiterated earlier comments regarding "supervisory confusion" resulting from the involvement of multiple agencies. According to SIFMA, the Volcker Rule Proposals do not clarify how agencies will coordinate interpretation, examination, and enforcement of the final rule. To rectify this confusion, SIFMA recommended that the Board of Governors of the Federal System have exclusive authority to interpret the Volcker Rule and that agencies engage in coordinated examinations and enforcement actions. — Repropsal Finally, SIFMA argued that the Volcker Rule be reproposed. To accomplish this in a "nuanced and iterative way," it advocated dialogue with foreign sovereigns, Congress, and other regulators. More specifically, SIFMA appended over 150 pages of comments addressing the Volcker Rule Proposals' specific questions for comment. SIFMA provided detailed and comprehensive comments on topics such as (1) Covered Financial Position and Trading Account, (2) Market Making-Related Permitted Activity, (3) Underwriting Permitted Activity, (4) Risk-Mitigating Hedging Permitted Activity, and (5) Government Obligations Permitted Activity. 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