FAQ: How would Volcker Rule regulations affect compliance programs?

FAQ: How would Volcker Rule regulations affect compliance programs?

The Volcker Rule is a section of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act that aims to rein in banks' high-risk, speculative trading. Initiated by former Federal Reserve Chairman Paul Volcker in the wake of the 2007 financial crisis, the main goal of the Volcker Rule regulations was to avoid another taxpayer-funded bailout of Wall Street. Volcker was chairman of the White House Economic Recovery Advisory Board from February 2009 to January 2011.

The Dodd-Frank Act created the Financial Stability Oversight Council to study and make recommendations about how regulators should implement the law. The Volcker Rule was originally conceived as a simple idea to prohibit banks from proprietary trading and investing in hedge funds or private equity funds. However, the rule morphed into a 298-page set of proposed regulations that included hundreds of questions for which regulators sought feedback.

The public is invited to submit comments through Feb. 13, 2012, and the rule is scheduled to go into effect July 21.

This FAQ is part of SearchCompliance.com's IT Compliance FAQ series.

Table of contents:

What is covered under the Volcker Rule, and who implements and enforces it?

The Volcker Rule generally applies to federally insured, deposit-taking banks (as well as institutions that own this type of bank) and credit unions. Smaller banks with less complicated transactions are given less extensive requirements under the proposed regulations because regulators sought to lessen their compliance burden.

Responsibility for implementing the Volcker Rule is shared by the Office of the Comptroller of the Currency at the U.S. Department of the Treasury, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the U.S. Securities and Exchange Commission (SEC). Agencies enforce the rule according to the type of financial firm they regulate. For example, the SEC will enforce the rule as it applies to publicly traded firms, and the Office of the Comptroller of the Currency will enforce it as it applies to nationally registered banks.

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What is so complicated about the Volcker Rule's proposed regulations?

The Volcker Rule's proposed regulations carve out numerous exemptions to general trading and investing prohibitions, and by all accounts, these exemptions are complicated. Market making, underwriting and risk-mitigating hedging would be exempt from the proprietary trading ban, as would some transactions involving government obligations. The ban on investing in hedge funds and private equity funds would not apply to "[o]rganizing and offering a hedge fund or private equity funds under certain conditions, including limiting investments in such funds to a de minimis amount; making risk-mitigating hedging investments; and making investments in certain non-U.S. funds," according to the SEC's proposal.

Distinguishing between prohibited activities and those exempted from the prohibition is expected to be challenging in some cases. In the SEC's proposal, regulations included comments to help banks make the distinction.

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What concerns have Volcker Rule critics raised?

From the outset, banks have voiced concerns that the Volcker Rule could impede American financial firms' global competitiveness. Proprietary trading was highly profitable for many banks in the lead-up to the financial crisis. The Volcker Rule would force them to forgo some of these profits and would raise the cost of regulatory compliance, critics said.

On the other side of the debate are consumer advocates, who maintain that the proposed regulations are too weak to be effective. The proposed exemptions to the trading and investment bans create loopholes that banks will exploit, they argue. Americans for Financial Reform, which is made up of more than 250 national, state and local organizations, called the proposal "vague" and questioned whether the trading ban exemptions would render the rule ineffective.

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What new compliance and reporting requirements would exist under the Volcker Rule?

Under the proposal, banks would be required to set up internal compliance programs subject to supervisory oversight by regulatory agencies. The programs would aim not only to ensure compliance with the trading bans and restrictions, but also to monitor compliance activities.

The compliance program would include a minimum of six elements:

  1. Internal policies and procedures designed "to document, describe and monitor the covered trading activities and covered fund activities and investments of the banking entity to ensure" compliance.
  2. Internal controls designed to monitor and identify potential areas of noncompliance.
  3. A management framework that designates who is responsible for compliance.
  4. Independent testing of the program.
  5. Training for appropriate personnel.
  6. Record-keeping to demonstrate compliance and to turn over to a requesting agency.

If a banking entity has "significant covered trading activities or covered fund activities and investments," its compliance program also is subject to a set of detailed standards. If a bank has less-complex activities that are covered under the prohibitions, it is not subject to the additional detailed standards.

A banking entity with large trading operations also would have to report quantitative measurements to their appropriate regulatory agency to make it easier for the regulators to identify trading activity that might call for additional scrutiny. The proposal spells out those quantitative measurements.

Entities with "large trading operations" are defined as those that have "together with affiliates and subsidiaries, trading assets and liabilities the average gross sum of which (on a worldwide consolidated basis) is, as measured as of the last day of each of the four prior calendar quarters, equal to or greater than $1 billion."

These larger operations would have to submit periodic reports to their regulatory agency and hold on to the records that document how the reports were prepared. The requirements would vary according to the size and scope of the trading activity covered under the rule.

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How would the Volcker Rule affect information technology?

Implementing the required compliance program under Volcker Rule regulations probably would mean significant changes to many banks' IT infrastructure, data processes and record-keeping procedures. New internal policies would have to be developed to document, describe and track the trading and investment fund activities covered under the rule. New internal controls would likely have to be established to detect possible areas of noncompliance. Records would have to be maintained to demonstrate compliance and to submit to regulators upon request.

One of the biggest IT challenges could be in implementing a system for distinguishing between prohibited activities and those that are exempted from the prohibitions, cautioned Deloitte Development LLC in a report outlining the potential impact of the Volcker Rule on banks' infrastructure.

Reporting quantitative measurements -- which the proposal requires of larger banks -- would likely mean that new controls would have to be added, Deloitte warned. Although other financial regulations implemented in recent years are spurring banks to add new controls, the Volcker Rule, as proposed, would make a number of changes more urgent. These changes include improving data quality, reducing the use of end-user-developed applications and spreadsheets, and improving front-office systems, the consultants cautioned.

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