Banking Entity Trading Under the Volcker Rule

The following post comes to us from Christopher Laursen, Vice President, NERA Economic Consulting and Co-Regional Director, Professional Risk Managers’ International Association’s (PRMIA) Washington, DC Chapter.

Looking back to the fall of 2007, it is clear from SEC filings that significant financial company losses resulted from proprietary positions booked in trading accounts. More specifically, a large amount of trading losses came from holdings of mortgage-backed and asset-backed bonds that had been afforded high credit ratings (e.g., AAA) by Nationally Recognized Statistical Rating Organizations (NRSROs). Rapid mark-to-market losses on these and other trading positions contributed significantly to the financial crisis and ultimately led legislators to develop the Volcker Rule, section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

With the Volcker Rule, legislators aim to reduce banking entity exposure to proprietary trading and thereby enhance bank’s ability to maintain their more traditional functions during market crises. The Rule, depending on how it is interpreted and enforced by regulators, has the potential to significantly change the scope and scale of proprietary trading within federally insured depositories and their affiliates.

This article discusses the relevant background of the Volcker Rule trading restrictions and offers insights on likely regulatory interpretations and banking entity responses. Specifically, the article addresses the designation of customer-initiated trades, increased expectations related to trading risk systems and limits, and the identification of material conflicts of interest.

The original article can be found at the following link on NERA’s website:

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