As you may have heard, the U.K. is putting the FSA out to pasture at the end of the month. In its place on April 1 will sit the Prudential Regulation Authority—success guaranteed by the name alone—and the Financial Conduct Authority. Read more »

We’ve talked a bit before about the Volcker Rule and how it’s going to have creepy unintended consequences because it is really hard to distinguish “market making,” which is what bank-broker-dealers are supposed to do, from “proprietary trading,” which is evil and destroyed the world. Today we have an excuse to talk about it again because (1) Uncle Vikram sort of shrugged off a question or two on it on this morning’s Citi earnings call, though he’s not quite in the Jamie Dimon camp of “I can’t hear you there will never be a Volcker Rule shut up shut up SHUT UP”; and more relevantly (2) Stanford finance professor Darrell Duffie just put out a study saying that the Volcker Rule is going to have creepy unintended consequences because it is really hard to distinguish “market making,” which is what bank-broker-dealers are supposed to do, from “proprietary trading.” Don’t be distracted from the rightness of this study (obvs!) by the fact that securities industry trade organization SIFMA paid Duffie to write it.* Instead, let’s focus on the important questions, like: where is my $50k check from SIFMA?

Much of this paper is a full-throated, conventional defense of Grossman-Miller market-making, which is nice and will bring a tear to your eye if you’re a market maker: Read more »

The Volcker Rule As Price-Setting

Today in Volcker Rule coverage: now you can read the whole thing. Get on that. Many people find it confusing.

Much of the meat of the rule is a bunch of qualitative and quantitative information that banks must collect and hand over to regulators, each piece of which tends to indicate whether a trading desk is more prop-y or flow-y. So if 90% of your trades face customers, that looks like market-making; if 90% of your trades face other dealers, that looks like prop. But there are no bright lines on what is and is not allowed – you just report statistics and hope that the regulators are okay with it.

One important complex of tests involves the distinction between revenues that come from “portfolio profit and loss,” i.e. securities going up or down in value, and “fee” and “spread” income. Fees and spreads are okay. Portfolio is not okay. Or okay only in moderation. Unspecified amounts of moderation.

I continue to have an unhealthy fascination with exactly how the regulators draw those lines. Read more »

Apparently lawyers at Davis Polk pulled an all-nighter reading and summarizing the Volcker Rule draft that was published yesterday. And they’re not the only people annoyed by the regulators’ refusal to get to the point:

As people drilled down into the details of the draft, many were concerned that it appeared to require very granular policing of individual traders at banks as part of the stringent, multilevel compliance regime described in the document.

“They have chosen the most burdensome way of doing it,” said Tim Ryan, chief executive of the Securities Industry and Financial Markets Association, a Wall Street trade association, in an interview.

While last night’s rule-summarizing festivities undoubtedly distracted some young lawyers from the Yankees game / general yearning for death, there may be other more consequential distractions. Read more »

The draft Volcker Rule proposal memo that American Banker got its hands on and published today is a pretty impressive piece of work. As a reminder, people thought that a reason 2008 was so unpleasant was that banks engaged in too much risky proprietary trading. So the testudinal gentleman to the right suggested, and Congress passed, a rule to rein in risk by banning FDIC-insured banks from proprietary trading.

But that’s hard to do, since the basic securities functions of a bank – making markets for customers, and hedging risks in its market-making book or in its regular old deposits-and-loans banking activities – require trading for its own account. So the agencies implementing the rule came up with a rule proposal that sets out, in 200 pages with lots of Q&A in case you have better ideas, to figure out how to distinguish bad “proprietary trading” from good “permitted trading.”

On a first read, er, skim, it’s really smart. It looks at a bunch of different metrics to distinguish market making from prop trading, like:
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Volcker Rule To Go After Your Moneys

The rulemaking process for implementing the Volcker rule, which will ban proprietary trading by banks, seems to be proceeding by periodic leaks to the media about the draft rules – which are always described as having 174 pages but also always discussed one small bit at a time. Today’s leak is from Bloomberg and is about pay:

The rule, which aims to ban most proprietary trading by banks with federally insured deposits, would exempt trades related to market-making as long as the activity met at least seven standards, or principles. One principle would be that traders get paid from fees and the spread of the transactions rather than the appreciation or profit from their positions, according to a copy of the draft reviewed by Bloomberg News.

As a quick aside, I don’t really know what a “spread” is in this context. If you buy $10MM bonds from Client X at 101 and sell $10MM of the same bonds to Client Y at 101.25 a second later, then your spread is pretty clearly a quarter on $10MM bonds. Easy enough. If however you wait 3 days and sell the bonds at 103, is the 2 points “spread” or “price appreciation” or a combination that the payroll department would have to disaggregate?

That quibble aside, though, this is actually quite clever and diabolical. It is difficult to separate “permitted” inventory and hedging activities from “not permitted” proprietary position-taking. But if you just tell traders “all you can do is get paid on volume of transactions times commission that you can charge,” then there’s no incentive to do anything but flow transactions. Making money on hedges, inventory, etc. can’t help the trader and so almost by definition is irrelevant to him.

It is predictably easy to find someone to say “people who aren’t paid giant gobs of money will quit and go to hedge funds and do dark evil things in unregulated corners of the world.” Specifically: Read more »

Jamie Dimon of JPMorgan Chase launched a tirade at Mark Carney, Bank of Canada governor, in a closed-door meeting in front of more than two dozen bankers and finance officials, underscoring mounting tensions between bankers and officials over financial regulation. The JPMorgan chief executive’s remarks to Mr Carney, who is touted as a potential next head of the Financial Stability Forum, the international group of regulators, were focused on a capital surcharge for the largest banks, according to several people who attended the meeting of about 30 bank chiefs…Mr Dimon told Mr Carney that many of the rules discriminated against US banks and he was going to continue to use the phrase “anti-American” because it seemed to resonate with people who might be able to modify the reforms. The atmosphere was so bad after the meeting that Lloyd Blankfein, chief executive of Goldman Sachs and head of the Financial Services Forum bankers’ group which arranged the session, emailed the central banker to try to smooth relations, people familiar with the matter said. [FT via BI]

Paul Volcker has made himself surprisingly relevant recently as an enemy of both (1) inflation/whatever Paul Krugman might be up to and (2) proprietary trading/whatever Kweku Adoboli might be up to. As for the second category, on Friday I guessed that I was not alone in being confused by the Volcker rule, which would ban “proprietary” trading by big banks while still allowing not-“proprietary” (“flow”? “customer facilitation”? “market making”?) trading. So I was pleased to learn today that the regulators designing the Volcker rule seem to be equally confused:
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