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The Volcker rule restricts US insured depository institutions from engaging in proprietary trading of securities, derivatives and commodity futures, or options on any of these instruments. Banks have to prove that all positions are needed to meet reasonably expected near-term demand (RENTD) from clients.
The rule also limits banks’ investments in “covered funds”: hedge funds and private equity funds. The rule, named after its originator, former Federal Reserve chair Paul Volcker, is one of the most controversial pieces of the Dodd-Frank Act.
Volcker intended the rule to restrict US banks (and some foreign banks with US operations) from making speculative investments with their own funds that do not benefit the banks’ customers and, he argued, contributed to the 2008 financial crisis. Volcker had hoped to re-establish the divide between commercial banking and investment banking imposed by the Glass-Steagall Act, which was repealed in 1999. The Volcker rule went into full effect in July 2015, with extensions for banks to exit illiquid investments. Critics of the rule say it has reduced banks’ market-making activities, diminishing liquidity and the competitiveness of US firms, and compelled firms to create an overly complex and burdensome compliance regime.
When US president Donald Trump ordered a review of financial regulation in 2017, Volcker’s critics hoped to see the rule repealed. However, pursuant to Trump’s order, the Treasury Department published a report in which it says it “supports in principle the Volcker rule’s limitations on proprietary trading and does not recommend its repeal”. Treasury did agree that the scope and complexity of the Volcker rule was excessive and made recommendations to exempt smaller or well-capitalised firms from the rule, improve co-ordination between the five regulatory agencies responsible for oversight under the rule and offer banks more flexibility around RENTD determinations.
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