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May 1, 2012

Brokers Want Changes to Volcker

By John D'Antona Jr.

Big banks and broker-dealers are seeking changes to the Volcker rule that will make it easier for them to comply with its requirements and still allow them to execute for their clients.

After the SEC received 15,000-plus comment letters asking for revisions and clarification, the proposed Volcker rule will likely be delayed from its July 21 deadline, though no official announcement has been made. The brokers want changes to the language regarding what are permissible market-making activities and what metrics will be used to measure compliance.

James Brigagliano, partner at Sidley Austin LLC in the securities and futures group and former deputy director of the Division of Trading and Markets at the SEC, told Traders Magazine that broker-dealers wanted changes to the Volcker rule that would make it easier for them to do business and conduct the customer-oriented businesses the statute endorses-like underwriting and market making. He expects the regulators working on Volcker to make changes in the coming months.

"We are likely to see the timetable for Volcker rule's completion further extended," Brigagliano said, noting that the SEC wants more time to analyze and incorporate input from comment letters. He explained that the SEC historically has focused on how the business of trading is conducted, not on what trading businesses are allowed.

Jamie Brigagliano

The Volcker rule, named for former Federal Reserve Chairman Paul Volcker, seeks to limit risky trading practices by banks.

The final Volcker rule included in the Dodd-Frank Act, which was signed into law in 2010, prohibits banks from proprietary trading and restricts investments in hedge funds and private equity by commercial banks and their affiliates. However, the rule exempts certain activities of banks such as market making, hedging, securitization and risk management.

"Volcker is a different kind of animal," said Brigagliano. The SEC, he said, normally focuses on preventing market manipulation and transparency. Volcker strays from that focus and into restricting the ability of banks to conduct certain activities-such as prop trading.

First, the brokers want an expansion of the language that defines market making. The more generous language would allow "market-making-related" activities, which would be broader than the current rule permits.

"The agency model is used in equities and doesn't always work," said one bulge executive. "This model really doesn't work in fixed income at all. We want broader latitude in making markets."

Alongside tweaks to the definition of market making, the exec also said his firm wants to see a clearer definition of what constitutes proprietary trading. That is, broker-dealers want a broader interpretation of the rules so they can build up inventories and hold them longer than 60 days. Under the rule's current language, holding a position for more than 60 days is considered proprietary trading.

The brokers are also looking for more latitude in how they hedge positions. As written, the rule says once a brokerage carries a position, it must be hedged with a near exact instrument on a one-for-one basis. This makes it harder and more costly for the brokers to carry positions, another exec said.

"It's going to be very hard to find similar size hedges for positions that have a similar yield and duration," he said.

Lastly, Brigagliano said the brokerages wanted simplicity in the compliance process in meeting the Volcker rule's mandates. The rule as written requires brokers to perform upward of 17 separate tests to measure compliance in some instances.

"Brokers hope to pare this back to a more manageable and less costly number," he said.

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