8 BYU International Law and Management Review 33 (2011)
30 Pages Posted: 5 Jun 2011 Last revised: 3 May 2012
Date Written: June 3, 2011
In the wake of the recent financial crisis, Congress has sought to regulate the proprietary trading activities of Wall Street banks. The Volcker Rule, passed into law as section 619 of the Dodd-Frank Act, bans proprietary trading for deposit-taking banks and bank holding companies with deposit-taking subsidiaries or affiliates. It nevertheless allows these institutions to continue to trade on behalf of customers, a category of transactions necessary for the healthy functioning of both the US and global financial systems. The rule proposes that regulators devise rules to distinguish between permissible, often client-facing, trades and impermissible proprietary trades. The rules themselves rely on definitions and metrics to form bright-line distinctions. The thesis of this paper is that such a system is doomed to failure.
The paper analyzes the regulation of banking entities under the Glass-Steagall Act of 1933 in order to demonstrate the successful separation of proprietary trading from deposit-taking institutions' Fed window access through a structure-based regulatory regime that separated investment banks from commercial banks. The paper acknowledges arguments that a return to a regime of discrete structures for banking entities is infeasible given the rise of modern financial institutions after the passage of the Gramm-Leach-Bliley Act of 1999, and gives this as a reason that the Volcker Rule instead focuses on transactions rather than institutional structure.
The paper concludes with the proposition of an alternative regulatory plan which would sidestep the problem-laden task of attempting to distinguish proprietary from non-proprietary trading on a bright-line basis and instead would focus on regulating all sales and trading activities together on a structural level. It would cleave trading operations from the banking entities' structures and force them into separate subsidiary entities with capitalization, ownership and other characteristics engineered to isolate traders from the moral hazard of Fed discount window access and to shackle the continuance of their client-serving operations to the risks they take in their proprietary books.
Keywords: Volcker, Volcker Rule, Dodd-Frank, Dodd Frank, proprietary trading, trading regulation, moral hazard
JEL Classification: K00, K22, K23, K29, G20, G21, G24, G28
Suggested Citation: Suggested Citation
Chatterjee, Rex, Dictionaries Fail: The Volcker Rule’s Reliance on Definitions Renders It Ineffective and a New Solution is Needed to Adequately Regulate Proprietary Trading (June 3, 2011). 8 BYU International Law and Management Review 33 (2011). Available at SSRN: https://ssrn.com/abstract=1857371 or http://dx.doi.org/10.2139/ssrn.1857371
By Andrew Tuch
By David Skeel
By Melanie Fein
By Dan Awrey
Under the 'Volcker Rule' in the United States, it is Proposed that Banks Will No Longer Be Allowed to Own, Invest in, or Sponsor Hedge Funds, Private Equity Funds, or Proprietary Trading Operations for Their Own Profit, Unrelated to Serving Their Customers: Can this Be an Effective Regulatory Response to Risk Issues Exposed During the Financial Crisis that Commenced in the Autumn of 2008?
By Ted Harding