The Volcker Rule

Overview

April 24, 2012

The Volcker Rule which is scheduled to be implemented later this year was proposed by Paul Volcker in 2010, who is the former Federal Reserve Chairman.  Introduced as a sub-section (Section 619) of the Dodd-Frank Act which was enacted on July 21, 2010, The Volcker Rule prohibits any banking entity from engaging in proprietary trading or from acquiring or retaining an ownership interest in, sponsoring, or having certain relationships with a hedge fund or private equity fund (“covered fund”), which is subject to certain exemptions. The main goal of the Volcker Rule is to prevent banks from trading or investing in securities in the short term (60 days or less) for their own accounts. The public backlash of using federally insured deposits to take positions in securities, specifically risky securities, led to the Volcker Rule.  The implementation of the Volcker Rule will result in the large broker dealers in fixed income to only be able to accept working agency orders.  There will be an inability to bid for securities on the wire that are offered for sale by fixed income accounts. Internal compliance departments are going to require burdensome documentation to position and facilitate a client sell order.  Risk based capital rules by commercial banks are going to result in higher reserves for single B credits and CCC credits.  The net result will be dramatically less liquidity in corporate debt rated B or lower which will result in higher cost of capital for issuers. Wall Street bankers are worried that they Volcker Rule may negatively impact the American Banks ability to compete with banks in the global market.

On April 19, 2012, a joint release issued by the CFTC, FDIC Office of Comptroller of the Currency , the SEC and the Federal Reserve specified that banks will have until  July 21, 2014 to become fully compliant with the Volcker Rule. Even though banks have approximately two-years to comply, the effects of the Volcker Rule are already becoming evident. The Inventories of commercial banks in corporate securities have declined by 79% since 2007.

Harch Capital has done proprietary research on the effect of The Volcker Rule in terms of cost of capital for less than investment-grade companies.