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The Volcker Rule is a federal law that forbids banks from taking part in particular speculative activities, including proprietary trading and funding hedge funds or private equity funds. In honor of Paul Volcker, a former chairman of the Federal Reserve who pushed for its adoption, the regulation was adopted in 2010 as a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The Volcker Rule's primary objective is to prohibit banks from taking unwarranted risks with their own capital and client deposits, which might endanger the stability of the financial system and subject taxpayers to potential bailouts. Along with promoting market integrity and fair competition, the rule also attempts to lessen conflicts of interest between banks and their customers.
Any banking organization that is covered by the Federal Deposit Insurance Corporation (FDIC), has access to the Federal Reserve's discount window, or receives other federal financial assistance is subject to the Volcker Rule. The requirement also applies to any affiliates or subsidiaries of such a banking company as well as international banks doing business in the US.
The Volcker Rule has five main components:
- Prohibition on proprietary trading: Trading in securities, derivatives, commodities, or other financial instruments for one's own account is not permitted for banks unless they fall under one of the rule's exceptions or exclusions.
- Prohibition on covered fund activities: Hedge funds and private equity funds, which are referred to as covered funds collectively, are not permitted for banks to buy, hold, or promote. These are organizations that rely on certain exclusions from the Investment Company Act of 1940's registration requirements.
- Permitted activities: In accordance with the Volcker Rule, banks may carry out certain operations that are deemed essential or advantageous to the performance of their primary duties, such as market-making, underwriting, hedging, liquidity management, and client service. To prevent them from posing an excessive danger or a conflict of interest, these activities are subject to a variety of restrictions and constraints.
- Compliance program: In order to ensure and monitor their compliance with the Volcker Rule, banks are required to build and maintain a compliance program. Written policies and procedures, internal controls, independent testing, training, and documentation are all required as part of the program. A CEO attestation that attests to the bank's compliance with the requirement must also be included in the program.
- Reporting and disclosure: Banks must regularly provide to their principal regulators with specific quantitative measurements of their trading and covered fund activity. These metrics are meant to help regulators keep track of and enforce the Volcker Rule. Banks must also tell investors and other counterparties of certain information regarding the activities of their covered funds.
Five federal agencies work together to enforce the Volcker Rule: the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodities Futures Trading Commission (CFTC). For the entities under its control, each agency has released its own regulations and instructions on how to apply and interpret the Volcker Rule.
Since it was implemented, the Volcker Rule has drawn numerous complaints and debates. Critics claim that the rule is excessively ambiguous and convoluted, which leaves banks and regulators in the dark. Others claim that the regulation is overly onerous and expensive, which lowers banks' profitability and competitiveness and restricts their capacity to provide for clients and promote economic growth. The rule's effectiveness and importance are defended by some of its proponents, who argue that it lowers systemic risk and moral hazard, safeguards taxpayers and consumers, and rebuilds public confidence in the financial system.
