Volcker Rule Comment Letter - Sens Merkley and Levin (2010.8.3)

8/8/2019 Volcker Rule Comment Letter - Sens Merkley and Levin (2010.8.3)

1/12

1l1nited ,states ,SeHoteWASHINGTON. DC 20510 l"-..)C)J =

. c::::)q :%;h(.,? .. --- c: :-D~ T ' . c-:> ; ' j~ ~ . , , , , , ( ' -)~ , ...:: :3:,' I ,, . , , ~._;.. W ,( 'J -:-.r" j J>;c. :z -u . ~ August 3. 2010 C ) :1 :rl l U) Nc:: r'-.J.-" V).....

Hon. Ben Bemanke, Chainnan, and Hon. Sheila Bair, ChairmanHon. Daniel Tarullo, Governor Federal Deposit Insurance CommissionFederal Reserve Board 550 17th Street, NW20th Street and Constitution Avenue NW Washington, DC 20429Washington, DC 20551 Hon. John Dugan, Comptroller, andHon. Mary Shapiro, Chairman Mr. John Walsh, Acting ComptrollerSecurities and Exchange Commission designate]00 F Street, NE Office of the Comptroller of the CurrencyWashington, DC 20549 Administrator ofNational Banks

Washington, DC 20219Hon. Gary Gensler, ChairmanCommodity Futures Trading CommissionThree Lafayette Centre1155 21 st Street, NWWashington, DC 20581RE: Implementation ofMerkley-Levin ProvisionsDear Sir or Madam:Two weeks ago, President Obama signed into law the Dodd-Frank Wall Street Reform andConsumer Protection Act. The law is clear: the risky and abusive financial practices that droveour country into an economic ditch must end. Now, as you set out to implement this legislation,the American people are counting on you to fully and faithfully follow that directive. For reformto work, Wall Street cannot simply be allowed to return to business-as-usual.As essential components of the Wall Street reform effort, the Merkley-Levin provisions onproprietary trading and conflicts of interest, sections 619-621 of the Dodd-Frank Act, aredesigned to achieve five main objectives:


2/12

August 3,2010Pagel

J) Protect our economy from high-risk, conflict-ridden financial activities by barringdepository banks and their affiliates from engaging in proprietary trading and makinglarge investments in hedge funds and private equity funds.

2) Rein in dangerous risk-taking by subjecting critical nonbank financial institutions tostrict capital charges and quantitative limits on any proprietary trading andinvestments in hedge funds and private equity funds.

3) Reestablish market discipline and integrity by restricting the ability of banks andcritical nonbank financial institutions to bail out sponsored or advised hedge fundsand private equity funds.

4) Rehabilitate the traditional business of banking by conducting a significant review ofthe long-term investment activities currently permitted to banks and their affiliates.

5) End the conflicts of interest that arise when a financial firm designs an asset-backedsecurity, sells it to customers, and then bets on its failure.

If properly implemented, the impact of these provisions will be profound.We do not expect Wall Street to give up its risky and conflict-ridden trading operations without afight. But the Merkley-Levin provisions, which we drafted, are intended to give you strong toolsto protect our nation's families and small businesses from the vagaries of the Wall Street casino.We wish to help you use these tools to their fullest potential, and we write now with ourrecommendations for drafting the rules and regulations to fully and faithfully implement theseprovisions. Enclosed please find the detailed explanation that we provided during the debate onthe Senate floor, which will hopefully be helpful to you as regulators tasked with the difficult butnecessary job of making these provisions come to life.Naturally, there are many complex areas that will need to be carefully analyzed, rulesthoughtfully written, and enforcement rigorously conducted - including robust use of the stronganti-evasion authority. At this time, we would like to briefly address three issues that havealready received attention: (1) what types of activities are "market-making-related", (2) what areallowable relationships with hedge funds and private equity funds, and (3) what do the conflictsof interest provisions of sections 619(d)(2) and 621 intend to address.

Market-Making-RelatedWe have recently seen press reports suggesting that firms are responding to some of these newrestrictions by taking what amounts to two approaches: (J ) burying their proprietary trading intheir market-making accounts, and (2) reassigning their proprietary traders into assetmanagement units managing client money.


3/12

August 3,2010Page 3

The fact of these developments on their own suggests that the statutory provisions have the teeththat Congress intended. However, they also highlight the need for meaningful and faithfulimplementation. For example, banks seeking to bury their proprietary trading desks in their"market-making" operations are likely attempting to evade these restrictions, while banks whomove traders to separate asset management businesses to manage clients' funds are likely takinglaudable steps towards compliance.Done properly, market-making is not a speculative enterprise, and firms' revenues should largelyarise from bid-ask spreads and associated fees, rather than from changes in the prices of thefinancial instruments being traded. Regulations seeking to distinguish market-making fromproprietary trading activities will require routine data from banks on the volume of trading beingconducted, the size of the accumulated positions, the length oftime positions remain open,average bid-ask spreads, and the volatility of profits and losses, among other information.It is also important to note that the term "in facilitation of customer relations" was removed fromthe final version of the Merkley-Levin provisions out of the concern that the phrase was toosubjective, ambiguous, and susceptible to abuse. This means banks will have to establish thattheir market-making-related purchases and sales are not designed merely to facilitate customerrelationships, but are intended to meet the reasonably expected near term demands of clients forspecific financial instruments.Relationships with Hedge Funds and Private Equity FundsSome of the most intense negotiation over the Merkley-Levin provisions concerned the extent towhich banks that provide client asset management services would be permitted to invest in hedgeand private equity funds. The final language includes strong protections to ensure that thelimited exceptions intended to preserve asset management functions do not become backdoorproprietary trading operations. Preventing these exceptions from becoming sueh a loophole willrequire careful implementation and vigorous enforcement.The Merkley-Levin provisions limit banks to a "de minimis" amount of money that can beinvested in any given fund (at most, 3% in each fund) and in all funds in the aggregate (at most,3% ofTier I capital). This de minimis allowance is permitted only to enable banks or theiraffiliates to provide asset management services to clients, and not to open the door to proprietarytrading. However, these investments, and the banks' relationships with them, cannot be allowedto jeopardize the banks. Accordingly, regulations implementing these provisions should onlyallow for a bank investment as necessary to seed a fund or align the interests of the bank with thefund investors. Seeding funds should be limited to the minimum amount necessary to attractinvestors to the investment strategy of the fund and must not serve principally as a proprietaryinvestment. Regulators should issue rules treating hedge and private equity funds with largeinitial investments from the sponsoring bank and funds that are not effectively marketed to


4/12

August 3, 2010Page 4

investors as evasions ofthe Merkley-Levin restrictions. Similarly, co-investments designed toalign the firm with its clients must not be excessive, and should not allow for finns to evade theintent of the restrictions of this section.Further, the Merkley-Levin provisions prohibit banks from bailing out their sponsored or advisedfunds or investors in those funds, or from having relationships or engaging in transactions thatmake such bailouts more likely. For example, investments by officers and directors could crcatcinappropriate incentives to bailout funds. Similarly, maintaining lending and derivativesrelationships with sponsored funds would make such bailouts possible. Both are generallyprohibited. Regulations implementing these restrictions should be strict, and the penalties forviolations, severe.Another critical factor to minimize bank risk from hedge funds and private equity funds is torequire the bank to deduct investments in hedge funds and private equity funds on, at aminimum, a one-to-one basis from capital. As the leverage of a fund increases, the capitalcharges should be increased to reflect the greater risk of loss. Regulations implementing thesecapital charges should discourage these high-risk investments and limit them to the sizenecessary to facilitate management of clients' assets.During the crisis, banks jeopardized their financial stability, and ultimately needed taxpayerbailouts, because they bailed out the funds they managed. Our banking system, and ourtaxpayers, must never again be left holding the bag when a bank's hedge funds or private equityfunds collapse.Conflicts of InterestSection 619(d)(2) prohibits what might otherwise be pennitted activities, if such activities wouldinvolve or result in material conflicts of interest with clients, customers, or counterparties. Thisconflicts of interest prohibition seeks to restore integrity and stability to the financialmarketplace, making it safe for clients to place their investments with firms that are required towork on their behalf instead of betting against their interests. Unlike section 621, section619(d)(2) is not limited to asset-back securities, but applies to all types of pennitted tradingactivities.Regulations implementing section 619(d)(2) should pay particular attention not only to thefinancial activities of a bank's own traders, but also to the hedge funds and private equity fundsorganized and offered under subparagraph (G) to ensure that that they are not taking unfairadvantage of information on the trading flow of the banks' other clients. Hedging activitiesshould also be particularly scrutinized to ensure that infonnation about client trading is notimproperly utilized.


5/12

August 3, 20/0Page 5

Section 621 in the Merkley-Levin provisions also addresses conflicts of interest, but only in thecontext of asset-backed securities. This section prohibits finns from packaging and selling assetbacked securities to their clients and then engaging in transactions that create conflicts of interestbetween them and their clients. The Permanent Subcommittee on Investigations' hearing onGoldman Sachs highlighted a blatant example of this practice: the finn assembled asset-backedsecurities, sold those securities to clients, bet against them, and then profited from the failures.Regulations implementing section 621 should put an end to those conflict-ridden practices.The conflict of interest prohibition in section 621 is not intended to prevent firms fromsupporting an asset-backed security in the after-market. But this activity must be designed tosupport the value of the security, not undennine it. Further, the utility of disclosures must becarefully examined, and not be seen as a cure for the conflicts. We provided the Securities andExchange Commission with sufficient authority to define the contours of the rule in such a wayas to remove conflicts of interest from these transactions, while also protecting the healthyfunctioning of our capital markets.Implemented properly, the Merkley-Levin provisions on proprietary trading and conflicts ofinterest are critical elements in Congress's mandate to reestablish a financial system thatprovides capital to grow the economy while serving clients with integrity. We are ready to assistyou during the rulemaking process in any way we can, and encourage you to consult us and ourstaffs with any questions about how the rules were designed to function.

J1h A. n ~ r e l Y ' Jeffrey Merkley Cart Levin

cc: Hon. Timothy Geithner, Secretary of the TreasuryHon. Paul Vo1cker, Chairman, President's Economic Recovery Advisory Board


6/12

July 15. 2010 CONGRESSIONAL RECORD-SENATE 85893Street and In ou r financial sector havea direct Impact on Main Street and th eJIves of every American. We need to ensure that taxpayers are never againasked to ball ou t Wall Street.This financial reform legl81atlon willprevent another financial 8ector collapse. or at least wlll help prevent It. Ido not think any of U8 can say thl8 willprevent any future collapse, but It 18critically Important to helping U8 prevent another collapse. It will allow thegovernment to shut down firms thatthreaten to crater our economy and ensure that the flnanclal Industry. no ttaxpayers, Is on th e hook for an y costs.It wlll rein In rl8ky derivatives andother rlaky trading praotlces that UD-dermlned some of our largest financialInstitutions. It will help level th e playIng fleld for smaller banks and creditunlon8 by cracking down on the riskypractlce8 of Wall Street and nonbankfinancial Instltutlon8 that oaused th ennanclal orisIs.I am grateful to Senator DODD, th eBanking Committee. and members ofthe conference for work ing with me tomake certain that the final bill recognizes the special clrcumstance8 of community banka and credit unions Inrural States 8uch as mine. In particular, I appreciate the committee'smodification to the lending limitstandard8. Thl8 18 very Important tofarming communities acrou the COUD-try.The final blll also provlde8 addedfiexlblllty for rural lenders In th e newmorqrage standards as well as proVI810ns to Improve Interchange reformfor amaller financial Institutions. FInally, I am pleased th e committee InclUded a rlsk-focusecl deposl t Insurancefund asse88ment formula and modifiedrisk retention requirements for highquality loans.Especially I thank Senator DODD forhl8 extraordinary leadership. What afinal year In the Senate. What a remarkable legacy he Is leaving. I thinkthe annals of the Senate wlll show veryfew Senators have had a record of accompllahment that matche8 what Senator DODD will have done In this year.With respect to th e budget point oforder that has been ralaed against theconference report, le t me make a couple of general points. First. this budgetviolation 18 no t 81gn1ficant enough tomerit deralllng this Important legl8latlon. Second, we muat bear In mind th erisks of falling to aot. I f we ta n to protect against a future collapse and create an orderlY procesa for dealing withgiant Insolvent finanolal Institutions.It Is Inevitable that taxpayers wlllapln at aome future point be asked toball ou t the financial sector and prevent a catastrophic financial oollapse.I f one measures on any scale the differences between th e technical violation In thl8 budget point ot orderagaln8t what would happen If this legIslatlon falls. they cannot even be compared. I mean. It. Is a lDat against anelephant. So let'a keep thlnll'8 In mindhere.

second, we must bear In mind th erlak at talUng to ac t beoa.use tbatwould burden taxpayers In a way ta rbeyond anything we see wltb thl8 budget point of order. None of us wantsthat. This bill la an Insurance policyagalnat an expensive future taxpayerbailout.Th e point of order that has beenralaed 18 the long-term deflolt point oforder. a point of order I establlahed Inth e budget resolution of 2008. ThlaPOint of order problblts legislation thatworsens the deficit by more than $5 billion In any of th e four lo-year periodsfollowing 2019.CBO has determined that at least Inone of those tour lo-year periods, th econterence report would exceed thlathreshold. But this Is really just a timIng lsaue caused by the new bipartisanresolution authority created by thebill. This la the new authority given toth e government to wind down fallingfinancial firm8. Under th e re80lutlonauthority, I f a financial firm Is aboutto collapse. the government wlll usethe flrm's assets to wind It down andpu t It ou t of buslnesa. Ie tb e flrm'a &a-sets are Insurnolent. the governmentwill temporarily borrow fUnds from th eTreasury. The financial Industry willthen reimburse th e government andthe taxpayers for 100 percent of theC08t. Again, 100 percent of th e moneywill be paid back by the banks. So th ene t Impact on the deficit Is zero.Overall, th e blll savea $3.2 blllionover the first 10 years. according to th eCongreulonal Budget Office. So whiletechnically this budget point of orderlies. If you pierce the ven and look atwhat really happena. thla bill reducesthe deficit. according to th e Congresalonal Budget Ornce. which Is th e nonpartisan scorekeeper here In th e Senate. Because there Is a lag time for th egovernment to collect this money fromthe financial Industry. CBO scores thebill as Increasing the deficit In some ofthe later decades. Bu t al l at thatmoney will be paid back In enaulngyears, and that Is what matters mostIn thl8 case.So although thl8 blll does technicallyviolate th e long-term deficit point oforder, It Is In8lgnlflcant. The fact Is.thl8 bill reduce8 the deficit. accordingto th e Congreulonal Budget Ornce. SoI urge my collearues to waive th e pointof order, to support passage of this financial reform legislation. which laclearly a slgnlflcant atep In the rightdirection In preventing the Idnd of rlakto ou r Nation's economy that Is ao apparent with the current structure.Again. I thank the chairman for hlaextraordinary work no t only on thisbill bu t throughout the year and. Ithink all of ua know. throughout hlacareer.I yield the fioor.Th e PRESIDING OFFICER. The Senator from ConnecticutMr. DODD. Mr. President. before myfriend. th e chairman of the BudgetCommittee. leaves. le t me thank himImmensely tor his analysis of this

Issue. He has It . as we saw as well, exactly right. In fact. It Is no t only reopaying 100 percent bu t with Interest.There Is an Interest requirement, thatI f we borrow from th e taxpayers Inorder to wind down SUbstantially riskyfirms. then no t only do you get paidback. bu t the Interest on the cost ofthat money Is alao part of the deal. SoIt Is 100 percent-plus coming back toth e Treasury.But his analysis and that of his commlttee--and there Is no one who hasbeen more disciplined or guarded aboutth e budgetary procesa over the yearswe have served together, and so I appreciate th e Senator's analysis of thispartiCUlar point on th e long-term defIclt.I commend the Senator for Includingthe provisions he has and trying tobuild some discipline Into the processof how we expend taxpayer moneya.colleot taxes In th e rtrst place to payfor the needed expenditures of our government. So I thank the Senator forthat.I thank him for his comments as wellabout the bill and his support and alaothe substantive contributions the Senator Crom North Dakota has made. becauae one or th e things we tried to bevery careful about.-JoN TEsTBR ofMontana. who alts on the committeewith me, has been very careful andbeen tremendously active In seeing toIt that rural America Is going to bewell served by this legislation. ADdthere are dUferences. It Is no t al l WanStreet. New York. and major nnanclalcenters. Th e Importance of the availability of credit In rural communitiesIs critical. as my oolleague from NorthDakota has Infonned me over the yearswe have served together. That abilityof a local tarmer to borrow that moneyIn th e spring. to be able to pay back Inthe fall. at harvest time. has been ossentlal. and knOWing how difficult Ithas been throughout th e country tobave access to credit Is essential.So his contributions to the legislation make sure that what we do bere IslI'olnll' to enhance th e capability ofrural America to no t only come ou t ofthis crisis we are In but to prosper Inth e years ahead with this legislation.So beyond the budgetary considerations and the points of order beforeus. I thank hi m for hla contributions toth e aUbstance of the blll. which hasmade It a tar better bill to begin with.I aee my colleague Crom Oregon Ishere. I yield th e noor.Th e PRESIDING OFFICER. The Senator from Oregon Is recognized.Mr. MERKLEY. Mr. President,thank Chairman DoDD for yielding tome and for his leadership on finanCialretorm.I yield to Senator LEVIN.Mr. LEVIN. Mr. Prealdent. SenatorMERKLEY and I. as the principal authors of sections 619. 620. an d 621 of theDodd-Frank Act. thought It might behelpful to explain In some detail thosesections. which are baaed on our bill, 8.3098. called the Protect Our Recovery

I


7/12

85894 CONGRESSIONAL RECORD-SENATE July 15, 2010Througb Oversight of Proprietary.PROP. Trading Act of 2010, and tb esubsequently flied Merkley-LevinAmendment. No. 4101, to th e Dodd-Lincoln substitute, whlcb was th e basis ofthe provision adopted by th e Conferenoe Committee.I yield th e fioor to my colJeague,Senator MBRKLEY.Mr. MERKLEY. I thank SenatorLEVIN and wlll be settlnl' forth here ou rJoint explanation of the Merkley-Levinprovisions of the Dodd-Frank Act. Sections 619, 620 and 621 do three thinp:prohibit bigh-risk proprietary tradingat banks, limit the systemic risk ofsuch activities a t systemically significant nonbank financial companies, andprohibit material conflicts of interestIn asset-backed securitizatlons.Sections 619 and 620 amend the BankHoldlnl' Company Act of 1956 to broadly prohibit proprietary trading, wbilenevertheless permitting certain activities tbat may tecbnlcally fall wltblnthe deflnitlon of proprietary tradingbu t wblcb are, In fact, safer, client-oriented flnancial services. To account forthe additional risk of proprietary tradIng among systemically critical financial flnna that are not banks, bankboldlng companies, or the like. the sections require nonbank finanCial oompanles supervised by the Federal ReserveBoard, tb e "Board". to keep additionalcapital for their proprietary tradingactivities and subject them to quantitative limits on those actiVities. Inaddition, given the unique oontrol thatfirms wbo package and sell assetbacked securities (including syntbeticASset-backed Becurltles) have overtransactions Involving those securities.section 621 protects purcbasers by prohibiting tbose firms from engaging Intransactions tbat Involve or result Inmaterial connlcts of Interest.First, it Is important to remind ou rcolleagues bow the financial crisIs ofthe past several years came to paas.Beginning In tbe 1980's, new financialproducts and significant amounts of deregulation undermined the GlassSteagall Act's separation of commercial banking from securities brokerageor "investment banking" tbat bad keptour banking system relatively safesince 1933.OVer time, commercial and Investment banks Increasingly relied on precarious short term funding sources.while at tbe same time significantlyIncreaSing their leverage. It was as I four banks and securities firms, In oompeting against one another, were racecar drivers taking th e curves ever moretightly and at ever faster speeds. Meanwhile, to matcb their short-term fundIng sources, commercial an d Investment banks drove Into inoreaslnglyrisky, short-term. and sometimes tbeoretlcally hedged, proprietary trading.When markets took unexpeoted turns,such as when Russia defaulted on it sdebt and when th e U.S. mortgagebacked securities market collapsed. li quidity evaporated, and finanCial firmsbecame Insolvent very rapidly. No

amount of oapltal could provide a sufficient buffer In sucb situations.In the face of the worst financial crisis In 60 years. the January 2009 reportby th e Group of 30, an Internationalgroup of financial experts, placedblame squarely on proprietary trading.This report, largoly authored by formerFederal Reserve System ChairmanPaul Volcker. recommended prohibiting systemically critical banking Institutions from trading In seCUritiesand other products for their own accounts. In January 2010, PresidentBarack Obama gave his full support tocommon-aense restrictions on proprietary trading and fund Investing,wblch he coined the "Volcker RUle."The "Volcker Rule." which SenatorLEVIN and I drafted and have championed in the Senate, and wblcb is embodied In section 619. embraces thespirit of the Glass-SteagalJ Ao t's separation of "commercial" Crom "Investment" banking by restoring a protective barrier around our critical financial infrastructure. It oovers not simply securities, bu t also derivatives andother financial products, I t applies notonly to banks, bu t also to nonbank flnanclal flrms whose size and functionrender them systemically slgnlflcant.While the Intent of section 619 Is torestore tbe purpose of th e GlassSteagall barrier between commercialand Investment banks. we also updatetbat barrier to renect tbe modem finanolal world and permit a broad arrayof low-risk, client-oriented financialservices. As a result, the barrier construoted In section 619 wUl no t restrictmost financial firms,Section 619 Is Intended to limit proprietary trading by banking entltiesand systemically significant nonbankfinancial companies. Properly Implemented. section 619's limits wlll tampdown on the risk to the system arisingfrom flrms competing to obtain greaterand greater returns by increasing th esize. leverage, and rlsklneBS of theirtrades. This Is a critical part of endingtoo big to fail financial flrms. In addition, section 619 seeks to reorient theU.S. banking system away from leveraged, abort-term speculation and Instead towards th e safe and sound provision of long-term credit to families andbusiness enterpriBes.We recognize tbat regulators ar e essential partners In the legislative process. Because regulatory Interpretationis so critical to the succeBS of th e rule,we wlll now se t forth, as th e principalauthors of Sections 619 to 621, ou r explanations of how tbese provisionswork.Bectlon 619's prohibitions and restrictions on proprietary trading are se tforth In a new section 13 to the BankHolding Company Act of 1956, and subsection (a), paragraph ( l ) establishesth e basic principle olearly: a bankingentity shall not "engage In proprietarytrading" or "acquire or retain . . . OWD-ership interest[s] In or sponsor a hedgefund or private equity fund". unlessotberwise proVided In tbe section.

Paragraph (2) establishes the principlefor nonbank financial companies supervised by th e Board by subjecting theirproprietary trading activities to quantitative restrictions and additionalcapital charges. Such quantitative limit s an d capital charges are to be se t byth e regulators to address risks similarto tbose wblch lead to tbe fiat prohibition (o r banking entitles.Subsection (h), paragraph ( l ) defines"banking entity" to be any Insured depository Institution (as otherwise defined under the Bank Holding CompanyAct), any entity that controls an Insured depository Institution. any entity that Is treated as a bank holdingcompany under section 8 of th e International Banking Act of 1978, and anyaffiliates or subsidiaries of such entities. We an d th e Congress specificallyrejected proposals to exclude tbe affiliates and subsidiaries of bank holdingcompanies and Insured depository Institutions, because i t was obvious thatrestricting a bank, but not Its affillateland subsidiaries. would ultimately beineffective in restraining tbe type ofblgh-risk proprietary trading that canundermine an Insured depository Institution.Th e provision recognizes th e modernreality tbat It Is dlCflcult to separateth e fate of a bank and Its bank holdingcompany, and that for the bank holding company to be a source oC strengthto tb e bank, It s actiVities. and those ofi t l otber subsidiaries an d affiliates.cannot be at such great risk as to ImperII tb e bank. We also note tbat notal l banks pose th e same risks. ACCOrd-Ingly. th e paragraph provides a narrowexception for Insured depository Institutions that fUnction principally fortrust purposes and do no t hold pubUcdepositor money, make loans. or accessFederal Reserve lending or paymentservices. These specialized entitiesthat offer very limited trust servicesare elsewbere carved out of the definition of "bank," so we do no t treatthem as banks for th e purposes of therestriction on proprietary trading.However, such Institutions ar e coveredby the restriction I f they quaUfy underth e provisions covering systemicallyimportant nonbank financial companies.Subsection (h), paragraph (3) definesnonbank financial companies supervised by tbe Board to be those financialcompanies whose size, Interconnectedness, or core functions are of suCfl-clently systemic significance as towarrant additional supervision, as directed by th e Financial Stability Oversight Counoll pursuant to Title I of theDodd-Frank Act. Given tb e varied nature of sucb nonbank financial companies, Cor some of which proprietarytrading Is effectively their business. anoutright statutory prohibition on suchtrading was not warranted. Instead. therisks posed by their proprietary tradIng Is addressed through robust capitalcharges and quantitative limits thatincrease with th e size. interconnectedneBS. and systemic Importance of the


8/12

July 15, 2010 CONGRESSIONAL RECORD-SENATE 85895busIness functions or the nonbank financIal firm. These restrictIons sbouldbecome strIcter as sIze, leverage, IUIdother ractors Increase. AJ! with bankingentIties, these restrlctlona should alsohelp reduce the size and rIsk or thesefinancIal firms.Naturally, the deClnltlon or "proprIetary tradIng" Is critical to the provisIon. For tbe purposes or sectIon 13.proprIetary tradIng means "engagingas a princIpal Cor tb e tradlnll' account"In transactIons to "purchase or sell. orotherwise acquIre or dIspose of" a wideranp oC traded Clnanclal products, includIng securItIes. derivatives, futures.and options. There are e88entlal)ytbree key elements to tbe definItIon:(1 ) the firm must be actIng "a s a princlpal," (2) tbe trading must be In It s"tradIng account" or another sImilaraccount, and (3) the restrictIons applyto the fun range or Ita Clnanclal Instruments.PurchasIng or selltnr "a s a principal" reCere to when the Clrm purchases or sells the relevant Clnanclallnatrument Cor Ita own account. Theprohibition on proprietary trading doesnot cover trading engaged wIth exclusively client funda,The term "trading account" Is Intended to cover an account used by afirm to make proClts from relativelysbort-term trading positions, as opposed to long-term. multi-year Investments. The admInistration's proposedVolcker Rule focused on short-termtradIng, usIng the pbrase "tradingbook" to capture that concept. Thatphrase, whlcb Is currently used bysome bank regulators was rejected,bowever. and tbe ultimate conCerenC8report language uses the term "tradingaccount" ratber than "trading book"to ensure that all types or accountsused ror proprietary trading are covered by tbe section.To ensure broad coverage of tb e prohibition on proprietary trading, paragrapb (3) of subsectIon (h) defines..trading account" as an y account used"principally for the purpose or selUngIn the near term (or otherwise with th eIntent to resell In order to proClt fromshort-term price movements)" andsucb other accounts as the regulatorsdetermine are properly covered by th eprovision to fulfill the purposes of thesection. In designing tbls definItion, wewere aware of bank regulatory capitalrules tbat dIstInguish between shortterm trading and long-term Investments, and our overall focus was to restrict high-risk proprietary tradIng.For bankIng entity subsIdiaries that donot maintain a dIstinction between atrading account and an Investment account, all accounts abould be presumedto be trading accounta and covered bytbe restrIctIon.LinkIng tbe problbltlon on proprietary trading to trading accounts permits banklDll' entIties to hold debt securities and other financial Instruments in long-term Investment portfolios. Such Investments should bemaintained with tbe appropriate cap

ltal Chal'll'88 and held for longer perloda.The definItion of proprietary tradIngIn paragraph (4) covers a wide range oCClnanclal Instruments, Including seouritles. commodities, futures, options.derivatives, and any sImilar ClnanclalInstruments. Pursuant to th e rule ofconstruotlon In subsection (11'), paragrapb (2), the deClnltlon should no tgenerally Include loana sold In th eproce88 of securItizing: however, Itcould Include such loans 1C sucb loansbecome financial Instruments traded tocapture the cbange In tbelr marketvalue.LImIting the definition of proprIetary trading to near-term holdlnlfBhas tbe advantage of permItting bankIng entities to continue to deploy credIt via long-term capital market debtInstrumenta. However, It bas tbe dlsadvlUltage or Calling to prevent th eproblems oreated by longer-term holdInp In riskIer Clnancla] Instruments,ror example, hlgbly complex oollaterallzed debt obligations and otheropaque Instruments that are no t readIly marketable. To addre88 tbe risks toth e banking system arisIng from thoselonger-term Il18truments and relatedtradIng, sectIon 620 dIrects Federalbanking regulators to s1Ct through th eaBBets, trading atrategles, and otber Investments of banking entItIes to Identity assets or actIvities tbat pose unacceptable risks to banka, even wben beldIn longer-term accounts. Regulatorsare expected to apply the 18880ns ortbat analysis to tlgbten th e range ofInvestments and activities permlSBlblefor banking entities, whether tbey areat tbe Insured deposItory institution orat an a((mate or subsidiary, andwbether tbey are short or long term Innature.

The new Bank Holding Company Actsection 13 also restricts Investing In orsponsoring hedge funds and private eQ-uity funds. Clearly, 1C a Clnanclal firmwere able to structure Ita proprietarypositions simply as an Investment In ahedge fund or private equity fund, theproblbltlon on proprietary tradIngwould be easily avoIded, and the rIsksto th e firm and Its subsidIaries and afnllates would contInue. A flDanclal Institution that sponsors or manages ahedge fund or private eQuIty fund alsoIncurs slgnlClcant risk even when Itdoes no t Invest In the fund It managesor sponsors. AlthoulI'h piercIng th e corporate veil between a lUnd and Itssponsoring entity may be dlrrtcult, recent blstory demonstrates that a Clnanclal Clrm will often feel compelled byreputatlonal demanda and relationshippreservation concerns to ball ou t clients in a Called lUnd tbat It managed orsponsored, rather than risk litigationor lost buslneSB. Knowledge oC sucbconcerns creates a moral bazard amongclients, attracting investment Intomanaged or sponsored Cunds on th e assumption that the sponsoring bank orsYlltemlcally slgnlncant nr m will rescue them 1C markets turn south. as wasdone by a number or nrms durIng th e

2008 crisis. That Is why setting limitson Involvement In hedge funds and prIvate eQuity funds Is crItical to protecting against risks arising from assetmanagement services.Subsection (h), parall'faph (2) setafortb a broad deClnltlon of hedge fundand prIvate equIty fund. no t dlstlngulablng between the two. The definItIon Includes any company that wouldbe an Investment company under theInvestment Company Act of 1940. bu t Isexcluded from sucb coverage by theprovisions of sectIons 3(c)(1) or 3(c)(7).Although market practIce In manycases distinguishes between hedgefunda, wblch tend to be tradIng vehloles, and prIvate equIty funds. whichtend to own entIre companIes. bothtypes of funds can engage In blgh riskactIvities and It Is exceedingly dlrrtcultto limIt tbose rIsks by rocuslng on onlyone type of entity.Despite the broad prohIbition on proprIetary trading se t forth In subsection(a). th e legislatIon recognizes thatthere are a number of low-rIsk proprietary actIvities tbat do no t pose unroasonable risks and explicItly permltathose activItIes to occur. Those lowrisk proprietary trading activIties areIdenttrled In subsectIon (d), paragraph(1), subject to certaIn limitatIons se tfortb In paragraph (2), and addItionalcapItal charges required In parall'faph(3).While paragrapb (1) authorizes several permItted activities. It sImultaneously grants regulators broad authority to set further restrictIons onany of those activities and to supplement the additional capItal chargesprovided Cor by paragrapb (3).Subparagraph (d)(l)(A) authorizes thepurcbase or sale or government obligatIons, IncludIng government-sponsoredenterprIse, aSE, obligatIons, on thegrounds tbat sucb products are used aslow-rIsk, abort-term liquIdIty positionsand as low-rIsk collateral In a widerange or transactIons. and so are appropriately retaIned In a tradIng account.Allowing trading In a broad ranll'e ofaSE obligations Is also meant to recognize a market reality tbat removingth e use of these securitIes as liquidItyand collateral positIons would have slgntrlcant market Implications, IncludIng negative ImplicatIons for the housIng and farm credit markets. By authorizing trading In aBE obligations.th e language Is not meant to Imply aview as to aBE operations or structureover the long-term, and permits regulators to add restrIctions on thIs permitted activity as necessary to preventblgh-rlsk proprietary trading actlv1tlesunder paragrapb (2). When aB E reformoccurs. we expect these provisIons tobe adjusted accordlnll'ly. Moreover. asIs the case With all permitted actIvItIesunder paragrapb (1), regulators are expected to apply additional capItal reostrictlons under paragraph (3) as necessary to accoUDt for the rlaks of thetrading activIties.Subparagraph (d)(1)(B) permits underwriting and market-maklng-related


9/12

85896 CONGRESSIONAL RECORD- SENATE July 15, 2010tra.naaetlons tbat are tecbnlcally tradIng for the account of tbe Clrm but. Infact. facllltate the provision of nearterm cHent-oriented Clnanclal services.Market-making Is a customer servicewbereby a firm assists Its customers byproviding two-sided markets Cor speedyacquisition or disposition of certain Cl-nanclal Instruments. Done properly. ItIs no t a speculative enterprise. and revenues for tbe Clrm sbould largely ariseCrom tbe provision of credit provided,and no t Crom tbe capital gain earnedon the cbe.nge In the price of Instruments held In the Clrm's accounts. Academic literature sets ou t tbe distinctions between making markets for customers and boldlng speculative positions In assets. bu t In general. th e twotypes of trading are dlstlngulsbable bythe volume of trading, tbe size of th epositions. the length of time that positions remains open. and the volatllltyof proCits and 10888S. amonr otber factors. Regulations Implementing thl.permitted aotlvlty sbould focus onthese types of factors to aaslst regulators In distinguishing between Clnanclal nrms asslstlnr tbelr cUents versusthose engaged In proprietary trading.Vll'Orous and robust rerulatory overslgbt of tbls Iuue wlll be essential tothe prevent "market-making" frombeing used as a loophole In th e ban onproprietary trading.The administration's draft lanruage,the original section 619 contemplatedby tbe Senate Banking Committee. andamendment 4101 each Included theterm "In facllltation of customer relations" as a permitted activity. Theterm was removed In tb e nnal versionof the Dodd-Frank Act ou t of concernthat this phrase was too subjective.amblruous. and susceptible to abuse.At the same time, we recognize thatthe term was previously Included topermit certain legitimate cHent-orlented services. such pre-market-makIng accumulation of small positionsthat might not rise to th e level of Cully"market-making" In a security or nnanclal Instrument. but are Intendedto nonetheless meet expected nearterm client liQuidity needs. AccordIngly. while previous versions of thelegislation referenced "market-makIng", the nnal version references "market-maklng-related" to provide theregulators with limited additionalflexibility to Incorporate those types oftransactions to meet client needs.without unduly warping th e commonunderstanding of market-making.We note, however, that "marketmaking-related" Is not a term whosedeClnltlon Is without llmlts. It does no tImpUcltly cover every time a nrm bUYSan existing nnanclal Instrument withthe Intent to later sell It, nor does Itcover situations In whlcb a Clrm creates or underwrites a new securitywith the Intent to market It to a client. Testimony by Goldman SachsChairman Lloyd Blankfeln and otherGoldman executives during a bearingbefore tbe Permanent Subcommitteeon investigations &eemed to suggest

that any time tbe firm created a newmortgage related security and begansoliciting cHents to buy It. the firmwas "making a market" Cor the security. But one-sided marketing or seilIng securities Is no t equivalent to providing a two-sided market for cllentsbuying and selUng existing securities.The reality was that Goldman Sachswas creating new securities for sale toclients and building large speculativepositions In blgh-risk Instruments, Including credit default swaps. Sucbspeculative activities are the euenceof proprietary trading and cannot beproperly considered within the coverage of tb e terms "market-making"or "market-maklng-related."The subparagrapb also spectncalJyllmlts SUch underwriting and marketmaking-related activities to "reasonably expected near term demands ofcllents, customers. and counterparties." Essentially. tb e subparagrapbcreates two restrictions, one on tbe expected boldlng period and one on tb eIntent of the boldlng. These two restrictions greatly limit tbe types ofrisks and returns for market-makers.Generany, tbe revenues for marketmaking by tb e covered Clrms sbould bemade Crom the fees charged for providing a ready, two-sided market for financial Instruments, and no t Crom tb echanges In prices aCQuired and sold bytbe financial Institution. The "nearterm" requirement connects to theprovision In tbe dennltlon of tradingaccount wbereby th e account Is dennedas trading assets that are acquired"principally for tbe purpose of semngIn th e near term." The Intent Is tofocus nrms on genuinely making markets for clients, and no t taking speculative positions wltb the Clrm's capital.Put simply. a firm wlll no t satisfy thisrequirement by acquiring a position ontbe bope that the position will be ableto be sold at some unknown Cuture datefor a trading proClt.Subparagraph (d)(l)(C) permits abanking entity to engage In "risk-mitigating hedging activities In connectionwith and related to Individual or aggregated positions, contracts, or otherboldlngs of tbe banking entity that aredesigned to reduce the specific risks totbe banking entity In connection withand related to sucb positions, contracts, or otber boldlngs." This activIt y Is permitted because It s sole purpose Is to lower risk.While tbls subparagrapb Is Intendedto permit banking entities to utlllzetheir trading accounts to bedge, tb epbrase "In connection with and relatedto Individual or aggregated positions. . ." was added between amendment4101 and tbe Clnal version In tbe conference report In order to ensure thatth e hedre applied to specific, Identifiable assets, wbetber It be on an Individual or aggregate basis. Moreover.hedges must be to reduce "speclrtcrisks" to the banking entity arisingCrom these positions. This formulationIs meant to focus banklnr entities ontraditional hedges and prevent proprl

etary speculation under the guise orgeneral "bedglng." Fo r example. ror abank with a significant se t or loans toa rorelgn country. a foreign excbangeswap may be an appropriate bedglngstrategy. On tbe other hand, purcbaslng commodity futures to "hedge"InOatlon risks tbat may generally Impact the banking entity may be notbIng more tban proprietary tradingunder another name. Distinguishingbetween true bedges and covert proprietary trades may be one of tbe morechallenJrlng areas for regulators. andwlll require clear Identification by financial Clrms of the speclrtc assets andrisks being hedged, research and analysis of market best practices. and reasonable regulatory judgment cans.Vigorous and robust regulatory overslgbt of this 188ue wlll be easentlal tothe prevent "hedging" Crom being usedas a loopbole In tbe ban on proprietarytrading.Subparagrapb (d)(l)(D) permits theacquisition o f tb e securities and otheraffected financial Instruments "on bebalf of customers." This permitted activity Is Intended to allow financialClrms to use Clrm Cunds to purchase a& sets on behalf of their clients, ratberthan on bebalf or tbemselves. This su'oparagrapb Is Intended, In particular. toprOVide reaB8urance tbat trading In"street name" for customers or Intrust for customers Is permitted.In general. subparagraph (d)(l)(E)provides exceptions to the prohibitionon Investing In bedge funds or privateequity ronds. I f sucb Investments advance a "public welfare" purpose. Itpermits Investments In small businessInvestment companies. which are aform of regulated venture capital CundIn Which banks have a long history orsucc888Cul participation. The subparagraph also permits Investments "of thetype" permitted under the paragraphof th e National Bank Act enablingbanks to Invest In a range of low-Inoome community development andother projects. The subparagraph alsospecifically mentions tsx credits rorblstorlcal building rehablUtatlon ad-ministered by th e National Park ServIce, bu t Is nexlble enough to permit tberegulators to Include other similar lowrisk Investments wltb a public welfarepurpose.Subparagraph (d)(l)(F) Is meant toaccommodate the normal business ofInsurance at regulated Insurance companies that are afflUated with banks.Th e Volcker Rule was never meant toaffect tb e ordinary buslne88 of Insurance: tb e collection and Investment ofpremiums. which are then used to satIsfY claims of tbe Insured. These actiVIties, while deOnl tlonally proprietarytrading, ar e heavily regulated by Stat.eInsurance regulators. and In most casesdo no t pose the same level or risk asother proprietary tradlntr.However. to prevent abuse, Clrmsseeking to rely on this Insurance-related exception must meet two essential quallflcatlons. Firat. only tradingfor the general account of th e Insurance firm would quallfy. Second, the


10/12

July 15, 2010 CONGRESSIONAL RECORD-SENATE 85897trading must be subject to adequateState-level Insurance regulation. Trading by Insurance companies or their affiliates that Is no t 8ubject to In8urancecompany Inve8tment replatlons wlllnot qualify for proteotion here.Further. where State laws and regulations do no t exist or otherwl8e fall toappropriately connect th e Insurancecompany Investments to the actualbusinesa or Insurance or are round toinadequately protect the Clrm. the subparagraph'8 conditions wlll no t be met.Subparagraph (d)(1)(G) permit8 firmsto organize and offer hedge runds orprivate equity runds a8 an asset management service to clients. It Is important to remember that nothing in section 619 otherwise prohibits a bankfrom serving as an Inve8tment adviserto an independent hedge rund or private equity fund. Yet. to serve In thatcapacity. a number of criteria mU8t bemet.First. th e Clrm must be doing so pursuant to its provision of bona nd etrust. Clduciary. or Investment adVisory services to customers. Given th efiduciary obUgatlons that come withsuch services, these requirements ensure that banking entitles ar e properlyengaged in respoDBlble rorms of a888tmanagement. Which should tamp downon the risks taken by the relevantfund.second. subparagraph (d)(1)(O) provides strong protectioDB against a firmballing out its runds. Clause (Iv) prohibits banking entities. as providedunder paragraph (1) and (2) or subsection CO. from entering Into lendingor similar transactions with relatedfunds. and olause (v) prohibits bankingentities from "directly or indirectly.guarantee(1ng]. aaaum[lng]. or otherwise lnaur(ing] the obUgatlons or perrormance of th e hedge fund or privateequity fUnd." To prevent banking entities from engaging In backdoor bailouts of their Invested runds. clause (v)extends to the hedge runds and privateequity runds In which such subparaBTaPh (0 ) hedge fUnds and private equity runds invest.Third. to prevent a banking entityrrom haVing an incentive to bailout Itslunds and also to limit conntcta of Interest. clause (v11) of subparagraph (G)restrlcta directors and employees or abanking entity from being invested inhedlle runds and private equity rundsorganized and offered by th e bankingentity. except ror directors or employees "directly engaged" in offering Investment advisory or other services tothe hedge fund or private equity fund.Fund managers oan have "skin In thegame" for tbe hedge fund or private equity rund they run. but to prevent thebank from running Ita general employee compensation through thehedge fund or private equity fund.other management and employees ma ynot.Fourth. by stating that a firm mayno t organize and offer a hedge fUnd orprivate equity rund with the firm'sname on It. clause (vi) of 8ubparagraph

(G) further restores market disciplineand supports the restriction on Clrmsbamng ou t fUnds on th e grounds ofreputatlonal rl8k. Similarly. clause(vllt) ensure8 that Investon recognizethat th e runds are 8ubject to marketdlsclpllne by requiring tbat fuDds provide prominent dlscl08ure that an y1088e8 of a hedge fund or private equityrund are borne by Investors and no t byth e Clrm. and the Clrm must also comply with any other restrictions to ensure that Investors do no t rely on thefirm. Including any of Its affiliates orsubsldlarle8. for a bailout.Firth, the firm or it s arnUates cannotmake or maintain an Inve8tment Interes t in the fund. except in compliancewith the Umlted fund seeding andaUgnment of interest provisloDB provided In paragraph (4) of subsection (d).Thi8 paragraph allows a Clrm. for theUmlted purpose or maintaining an Investment management business. toseed a new fund or make and maintaina "d e minimis" co-Inve8tment In ahedge fuDd or private equl ty fund toalign th e Intere8ts of th e rund managers and the clients. 8ubject to severalconditions. A8 a general rule. firmstaking advantage of thiS provl810nshould maintain only small 8eed rund8.Ukely to be S5 to $10 million or le88.Large runds or funds that are not ecrectlvely marketed to Inve8tors would beevasions of th e restrictions or this section. Similarly. co-Investments de81gned to aUgn the Clrm with Its cUentamust no t be exceaslve. and shOUld no tallow ror firms to evade the Intent orthe restrlctlon8 of this 8ectlon.These "de minimis" Investments areto be greatly dlsravored. and 8ubject toseveral 81gnlficant restrlctlo n8. First. afirm may only have. In the aggregate.an Immaterial amount or capital Insuch lunds. bu t In no circumstancemay suoh positions alMregate to morethan 3 percent or the Clrm's Tier 1 capItal. Second. by one year after the dateor estabUshment for any fund. the Clrmmust have no t more than a 3 percentownership Interest. Third. InvestmentsIn hedge funds and private equity rundsshall be deducted on. at a minimum. aone-to-one basis from capital. As theleverage or a fUnd Increases. th e cal)Ital charges shall be Increased to reflect the greater rl8k of lOBS. This Isspecifically Intended to diSCouragethese high-risk Inve8tments. andshould be used to limit the8e Investments to the size only neceasary to racllltate asset management businessesror clients.Subparagraphs (H) and (1) recognizerules or International regulatory comIty by permitting rorelm banks. regulated and baoked by foreign taxpayers,In the course of operating outelde orth e United States to engage in activities permitted under relevant foreignlaw. However. these subparagraphs areno t Intended to permit a U.S. bankingentity to avoid th e re8trlctlons on proprietary trading simply by setting upan orrshore subsidiary or reincorporating offshore. and regulators

should enforce them accordingly. In addition. the subparagraphs seek tomaintain a level playing field by prohibiting a foreign bank rrom Improperly orferlng Ita hedge fund and privateequity fund services to U.S. personswhen such ofrerlng could no t be madein th e United States.Subparagraph (J) permlte the regulators to add additional exceptions aaneoessary to "promote and protect thesarety and soundness of the bankingentity and the financial stablllty of theUnited States." This general exceptionpower Is intended to ensure that someunforeseen. low-risk activity Is not Inadvertently swept In by th e prohibitionon proprietary trading. However. thesubparagraph sets an extremely highbar: th e activity must be "neceBBary topromote and protect tho saroty andsoundness or the banking entity andth e financial stablllty or the UnitedStates. and no t simply pose a competitive disadvantage or a threat to firms'profitablUty.Paragraph (2) or section (d) adds expUclt statutory limits to the permittedactivities under paragraph ( I) . Specifically. It preventa an activity fromquallCying as a permitted activity I f Itwould "Involve or result In a materialconmct of Interest." "result directlyor Indirectly In a material exposure. . . to high-risk assets or high-risktrading strateB'les" or otherwise pose athreat to the sarety and soundness orthe firm or th e Clnanclal stablllty orthe United States. Regulators are directed to define th e key terms In theparagraph an d Implement the restrictions as part or th e rulemaklng proceBB. Regulators should pay particularattention to th e hedge runds and private equity funds organized an d offeredunder subparagraph (0 ) to ensure thatsuch activities have 8ufflclent distancefrom other parts or th e firm. especiallythose with windows Into th e tradingfiow of other clients. Hedging activities should also be particularly scrutinized to ensure that Information aboutclient trading Is no t Improperly utilized.The limitation on proprietary tradInB' activities that "Involve or result Ina material conmct or Interest" Is acompanion to the confitcte or interestprohibition In section 621. bu t appliesto all types or activities rather thanjust a888t-backed securltlzatlons.With respect to the definition ofhigh-risk auets and high-risk tradlnB'strategies, regulators should pay closeattention to the characteristics of asaets and trading strategies that havecontributed to substantial nnanclal1088. bank rallures. bankruptcies. orth e conapee or financial firms or financial markete In the past. Including bu tnot limited to the crisis or 2008 and thefinancial crisis or 1998. In 88sesslnghigh-risk assete an d high-risk tradingstrategies, partloular attention shouldbe paid to th e transparency or the markets. th e avallablllty of consistentprlolJllr Information. the depth of themarkets. and the risk characteristics


11/12

85898 CONGRESSIONAL RECORD-SENATE . July 15, 2010or the assets and strategies themselves.Including any embedded leverage. Further. these characteristics should beevaluated In times or extreme marketstreu. such as those experienced recently. With respect to trading strategies. attention should be paid to therole that certain types or trading strategies play In times or relative marketcalm. as well as times or extreme market streu. While Investment advisorsmay freely deploy hlgb-rlsk strategiesfor their clients. attention 8hould bepaid to en8ure that firms do no t ut1l1zetbem ror their own proprietary activities. Barring high rl8k strategies maybe particularly orltlcal when poJlclngmarket-maklng-related and hedgingactivities, as weJl as trading otherwisepermitted under subparagraph(d)(1)(A). In this context. however. It IsIrrelevant whether or not a firm provides market liquidity: high-risk assetsand high-risk trading strategies arenever permitted.Subsection (d). paragraph (3) directsthe regulators to se t appropriate additional capital charges and quantitativelimits ror permitted activities. Theserestrictions apply to both banking entities and nonbank financial companiessupervised by the Board. It Is lert toregulators to determine IC those restrictions should apply equally to both.or wbether there may appropriately bea distinction between banking entitiesand non-bank ftnanclal companies supervised by the Board. The paragraphalso mandates dlvers1flcatlon requirements where appropriate. ror example,to ensure that banking entities do no tdeploy their entire permitted amountor de minimis Investments Into a smallnumber or hedge fUnds or private equity funds. or tha.t they dangerouslyover-conoentrate In specific produotsor types or financial products.Subsection (e) provides vigorousantl-evaslon authority, Includingrecord-keeping requirements. This authority Is designed to aUow regulatorsto appropriately assess the trading offinns, and aggressively enrorce th e textand Intent or section 619.The restrictions on proprietary tradIng and relationships with prlva.tefunds seek to break the Internal connection between a bank's ba.lance sheetand taking risk In the markets. with aview towards reestablishing marketdlsclpJlne and refocusing the bank onIts credit extension function and clientservices. In the recent financial crisis.when funds advised by banks surreredsllfDlOcant losses. thoae orr-balancesheet funds came back onto th e banks'balance sheets. At times. the banksballed ou t the funds because the Investors In tbe funds had other Importantbusiness with the banks. In some cases.the Investors were also key personnelat the banks. Regardleu or th e motivations. In far too many cases. the banksthat balled ou t their funds ultimatelyrelied on taxpayers to ball them out. I tIs preolsely ror' this reason that th epermitted activities under sUbparagraph (d)(l)(G) are so narrowly defined.

Indeed, a large part or protecting that a banking entity should no t befirms from ba1l1ng ou t their afrnlated prohibited. under proper restrictions.runds Is by Jlmltlng the lending. asset from providing limited services to unpurcbases and sales, derivatives trad- a.rr1l1a.ted funds. but In which It s ownIng. and other relationships that a advised fund ma y Invest. Accordingly.banking entity or nonbank Onanclal paragraph (3) Is Intended to only covercompany supervised by the Board may third-party runds. and should no t bemaintain With th e hedge fUnds and prl- used as a means or evading th e generalvate equity funds It advises. The rela- prohibition provided In paragrapb (1).tlonshlps that a banking entity maln- Put simply, a firm may no t createtalns With and services It furnishes to tiered structures and rely upon paraIt s advised funds can provide reasons graph (3) to provide these types Of servwhy and the means through which a Ices to funds ror which It serves as Infirm will ball ou t an advised fund. be It vestment advisor.through a direct loan. an asset acquisition, or through writing a derivative. Further, In recognition of the riskSFurther. providing advtsory services to that are created by allowing ror thesea hedge rund or private equity fund cre- services to unarrtliated funds, severalates a confilct or Interest and risk be- additional criteria must also be metcause when a banking entity Is ltaelC for th e banking entity to take advandetermining the Investment strategy or tage or this exception. Most notably,a fund. It no longer can make a rully on top or the Oat prohibitions on ballIndependent credit evaluation or the outs. the statute requires the chler exhedge fund or private equity fund bor- ecutlve orrtcer or firms taking advanrower. These bailout protections will tage or this paragraph to alsO certlCy81gntncantly benefit Independent hedge that these services are not used dlfunds and private equity funds. and rectly or Indirectly to ball ou t a fundalso Improve U.S. financial stab1l1ty. advised by the firm.

Accordingly, subsection (0 . para- Subsection


12/12

July 15, 2010 CONGRESSIONAL RECORD-SENATE 85899also continue to honor certain contractual commitments durinll' the transltlon period. The purpose of this extended wind-down period Is to minimize market disruption while stilisteadily moving nrms away from therisks of the restrloted activities.Tbe definition of "illiquid runds" se tforth In subsection (h) paragraph (7) 18meant to cover. In general, very il liquid private equity funds that havedeployed capital to illiquid assets suchas portfolio companies and real estatewith a projected Investment holdingperiod of several years. The Board. Inconsultation with th e SEC. shouldtherefore adopt rules to donne th e contours of an illiquid fund as appropriateto capture the Intent of the prOVision.To facilitate certainty In th e marketwith respect to divestiture. th e BoardIs to conduct a special expedited rulemaking regarding these conformanceand wind-down periods. The Board Isalso to se t capital rules and any additional restrictions to protect the bankIng entities and the U.S. financial system during this wind-down period.We noted above that the purpose ofsection 620 Is to review the long-termInvestments and other activities ofbanks. The concerns renected In thissection arise out of losses that have appeared In the long-term Investmentportfolios In traditional depOsitory Institutions.Over time. various banking regulators have displayed expansive viewsand conflicting Judgments about perml88lble Investments for banking entities. Some of those actiVities. IncludIng particular trading strategies andInvestment assets. pOse slgnlncantrisks. While section 619 provides numerous restrictions to proprietarytrading and relationships to hedge

funds and private equity runds. It doesno t seek to significantly alter the traditional buslnesa of banking.Section 620 Is an attempt to reevaluate banking aB88ts and strategies andsee what types of restrictions are mostappropriate. The Federal banking agencies should closely review the riskscontained In the types of assets retained In the Investment portfolio ofdepository Institutions, as well as risksIn affiliates' actiVities such as merchant banking. The review shoulddovetail with the determination ofwhat constitutes "high-risk auets"and "hlgb risk trading strategies"under paragraph (d)(2).At this pOint. I yield to SenatorLBVIN to discuss an Issue that Is of particular Interest to blm Involving section 62l's conflict of Interest provisions.Mr. LEVIN. I thank my colleague forthe detailed explanation be has provided of sections 619 and 620. and Cullyconcur in It. I would like to add ou rJoint explanation of section 621. whichaddre88es tbe blatant conntcts of Interes t In the underwriting of aB88t-backedsecuritIes highlighted In a hearing withGoldman Sachs before the PermanentSubcommittee on Investigations.which I chair.

The Intent of section 621 Is to problblt underwriters, spOnsors. and otbers who assemble asset-backed securities, from packaging and selling tboseseourltles and profiting from tb e securities' failures. This praotlce has beenlikened to selling someone a ca r withno brakes and then taking out a life Insurance pOlicy on the purchaser. In tb easset-baoked securities context. th esponsors and underwriters of the assetbacked securities are the parties whoseleot and understand the underlying&alIets. and who are best positioned todesign a security to succeed or fan.They. like the mechanic servicing acar, would know I f the vehicle has beendesigned to fall. And so they must beprevented from securing handsome rewards for designing and selling malfunctioning veblcles tbat undermineth e asset-backed securities markets. ItIs for that reason that we prohibitthose entities from engaging In transaotlons that would Involve or result Inmaterial conflicts of Interest wltb thepurohasers of their produots.Section 621 Is no t Intended to limitth e ability of an underwriter to support tbe value of a security In theaftermarket by providing liquidity anda ready two-sided market for It. Nordoes It restrict a nrm from creating asynthetic asset-backed seourlty. whichInherently contains both long andshort pOsitions wltb respect to seourlties It previously created. so long asth e firm does not take the short position. Bu t a firm that underwrites anasset-backed security would run afoulof the provision If It also takes th esbort position In a syntbetlc assetbacked security that references th esame assets It created. In such an Instance, oven a disclosure to the purchaser of the underlying asset-backedsecurity that the underwriter has ormight In the future bet against the security will no t cure the material conflict of Interest.We believe that tbe Securities andExchange Commission has surnctentauthority to denne the contours of therule In such a way as to remove thevast majority of conntcts of Interestfrom these tranJlaotlons, while alsoprotectlnr the healthy fUnctioning ofou r capital markets.In conclusion. we would like to acknowledge al l our supporters. co-sponsors, and advisers who assisted usgreatly In bringing this lerlslatlon tofruition. From the time PresidentObama announced his support for th eVolcker Rule, a diverse and collaborative effort has emerged. uniting community bankers to old school financiers to reformers. Senator MERK ...EYand I further extend special tbanks toth e original cosponsors of the PROPTradln8' Act. Senators TED KAUFMAN.SHERROD BROWN. and JEANNE SHAHEEN.who hAve been with us since th e beginning.Senator JAOK REED and his staff didyeoman's work In advancing thiscause. We further tip our ha t to ourtireless and vocal colleague. Senator

BYRON DORGAN. who opposed tho repealof Olass-Steagall and has been speakIng about the risks from proprietarytrading for a number of years. Aboveall. we pay tribute to the tremendouslabors of Chairman CHRIS DoDD and hisentire team and starr on the SenateBanking Committee. as well as the support of Chairman BARNBY FRANK andRepresentative PAUL KANJORSKI. Weoxtend our deep gratitude to our staffs.Including th e entire team and staff atthe Permanent Subcommittee on Investigations. for their outstandingwork. And last but not least. we highlight th e visionary leadership of PaulVolcker and bls staff. Without th e support of all of them and many others.the Merkley-Levin language would no thave 'oeen Included In tbe ConferenceReport.We believe this prOVision will standthe test of time. We hope that ou r regulators have learned with Congressthat tearing down regulatory wallswithout erecting new ones underminesour financial stability and threatenseconomic growth. We have legislatedto the best of our ability. It Is now upto our regulators to funy and faithfullyImplement tbese strong provisions.I yield the noor to Senator MERKLBY.Mr. MERKLEY. I thank my colleaguefor his remarks and concur In al l respects.Mr. DODD. Mr. President. I said soyesterday. and I will say It again: Ithank Senator MERKLBY. I guess thereare four new Members of th e Senateserving on th e Banking Committee.Senator MERKLEY. Senator WARNER.Senator TBSTER. and senator B E N ~ E T are al l new Members of the Senatefrom their respective States of Oregon.Virginia. Montana. and Colorado. To bethrown Into wbat has been the largestundertaking of th e Banking Committee. certainly In my tbree decadeshere-and many have alVUed goingback almost 100 years-was certainlyan awful lo t to ask.I have already pointed ou t the contributlon Senator WARNER has made tothis bill. Bu t I must say as well thatSenator BBNNET of Colorado has beenInvaluable In his contributions. I justmentioned Senator TESTER a momentago for his contribution on talkingabout rural America and the ImpOrtance of those Issues. And SenatorMBRKLEY. as a member of the committee, on matters we Included beredeallnr particularly with th e mortgagereforms. th e underwriting standards.th e protections people have to gothrough, and credit cards as well-wepassed th e credit card bill-again. I twas Senator JEFF MERKLEY of Oregonwho played a critical role In that wholedebate not to mention. of course. workIng with CARL LEVIN, one of the moresenior Members here. having served formany years In th e Senate. But theMerkley-Levin. Levin-Merkley provisions In this bill have added substantial contributions to this effort. So Ithank bl m for his contribution.I see my colleague from North Dakota Is here. I suggest th e absence of a

Volcker Rule Comment Letter - Sens Merkley and Levin (2010.8.3)

Documents

Transcript of Volcker Rule Comment Letter - Sens Merkley and Levin (2010.8.3)