Unlike some other regulations, which have do not have a defined implementation date, the Volcker Rule is specifically required within the Dodd-Frank Act to be put into place two years after President Barack Obama signed the Act into law in 2010. That has the rule slated to come into effect July 21, 2012. “That gives the Volcker Rule a sense of urgency,” Timothy Mohan, chief executive partner of Chapman & Cutler, told SI. Industry experts are still scrambling to come to grips with its real implications across the structured products market.
After the implementation date, there will be a two-year period for banks to get into compliance with the new rule. Williams said that period opens up more questions about the ways in which the Volcker Rule will really play out. Some banks might choose to exit certain markets or certain types of structures quickly, while others might take more time, making for major market shocks. “The statute says banks should come into compliance with the Volcker Rule ‘as soon as practicable’ – but is that six weeks? Six months? A year? That adds to the level of uncertainty,” Williams said.
The Volcker Rule is in the process of being jointly drafted and enacted by the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the SEC and the Commodities Futures Trading Commission. Comments on those agencies’ proposal were originally due Jan. 13, 2012, but that deadline has been pushed back by one month to give the industry more time to continue to draft constructive comment letters and feedback on exemptions and other facets of the rule, said Mohan. He is in the process of drafting the American Securitization Forum’s comment letter on the Volcker Rule.
Apart from the issue of overlap between the Volcker Rule and other various regulatory measures, Mohan said there is a concern that securitization vehicles involving banks advancing credit to transaction parties, such as an asset-backed commercial paper conduit or an residential mortgage-backed securities offering that includes a servicing advance feature, may be swept up in the new restrictions. The 23a Provision in the existing Federal Reserve Investment Act of 1940 prevents banks from entering into certain types of transactions with non-bank affiliates. The Volcker Rule creates the so-called Super 23a, Mohan said, which extends the scope of those restrictions in a way that defines “covered funds,” including ABCP conduits and others, as affiliates, restricting the ability of a bank to extend any kind of liquidity facility to them. “If the rule goes forward as proposed, people will need to rethink those structures,” he noted.
ABCP conduits, one of the structures threatened by the Volcker Rule, have already been endangered by other regulatory measures, such as the new liquidity requirements and capitalization ratios included in Basel III provisions. But another market facing a new and potentially serious threat from the Volcker Rule is the agency RMBS market.
Williams said RMBS issued by the government-sponsored enterprises could potentially take a serious blow. While agency debt is specifically excluded from the rule, there is no clarity on how far that exclusion goes. It doesn’t mention agency MBS, agency collateralized loan obligations or agency collateralized debt obligations, or the vast derivatives market based on almost entirely on agency debt, such as swaptions, Williams noted.
If the rule did sweep up agency RMBS into its purview, it might be hard for banks to make a market in the debt, as that activity would resemble the kind of proprietary trading the rule is designed to eliminate. If banks then were forced to exit the roughly $5 trillion agency MBS market, or at least dial back their activities, the market would be without dealers, leaving the government struggling to sell its product. This would likely lead to additional GSE losses and another major hit on the already beleaguered mortgage finance market.
“Should the Volcker Rule apply to agency MBS, it’s hard to imagine there would be a free-flowing agency MBS market,” said Williams. “If they don’t exclude it, it’s not necessarily cost-free for the agencies,” he added.
The Volcker Rule, named after its chief architect, former Federal Reserve Chairman Paul Volcker, was originally created to limit prop trading. But after the investigation of Goldman Sachs’ Abacus CDO in April 2010, and the subsequent Congressional hearings, Senators Jeff Merkley (D-Ore.) and Carl Levin (D-Mich.) tacked on to the Volcker Rule provisions to ban so-called “conflict of interest trading.”
Williams said he was confused by the regulators’ decision to build out the Volcker Rule, when separate conflict of interest provisions are due out from a host of regulators. Also, the risk retention rule is being crafted to specifically address banks’ and other issuers’ potential conflicts of interest in issuing risky transactions into the market and offer protection to investors. “That’s what we don’t understand,” he said. “How is it that these things don’t work together?”