The Volcker Rule Has a People Problem

This is the second article in an eight-part series.

Banks' ability to comply with the Volcker Rule depends heavily on whether boards of directors and senior executives prioritize operational risk management. But senior management is encountering numerous challenges in understanding the Volcker Rule, developing clear, strong compliance strategies and properly communicating those strategies to all necessary parties.

Until regulators finalized the Volcker Rule, domestic and foreign bank lobbies spent thousands of hours and millions of dollars lobbying against it. Even now, lobbies continue their push to soften the rule's requirements. Ironically, all this lobbying has greatly contributed to the rule’s complexity, since even lobbyists who share a common goal often have differing demands. While lobbyists move from battling one regulation to another, they leave the daunting implementation of the Volcker Rule to risk managers, compliance officers and auditors, not to mention information technology professionals. 

While many banks are experiencing difficulty in complying with the Volcker Rule, it is not because senior management is resistant to it. In fact, most of the bankers I have met express a strong desire to comply with the Volcker Rule, if for no other reason than to "keep regulators off their backs." The real problem is that while the Volcker Rule has been in the works since 2009, the final rule is new to professionals at both banks and regulatory agencies. Everyone involved faces a steep learning curve.

The Volcker Rule is comprised of extremely data-intensive requirements that banks must meet in order to qualify for underwriting, market-making and hedging exemptions. Since banks never before had to explain whether a trade was for proprietary trading or for market-making, they never had to collect data to justify their transactions.

Under the Volcker Rule, senior managers must create projects that enable them to collect high-quality and reliable data in a consistent manner. Banks that fail to prove the purpose of a derivatives or security trade would be required to divest prohibited trades, which could in turn adversely impact earnings. But many banks are struggling to recreate a historical record of all the products that they have traded in order to come up with a framework that meets regulatory demands.

Another significant human resources challenge is that banks need legal, compliance, regulatory, auditing and technology experts among senior management and business line managers who understand both the nuances of the Volcker Rule and how the rule interacts with the major Dodd-Frank rules and the new Basel capital buffers, liquidity standard and leverage ratio. Otherwise, banks risk deciding that acquiring or divesting a given portfolio would improve Volcker compliance without realizing that doing so might weaken their ability to comply with a different rule.

As one compliance officer I know put it, "Anti-money laundering, terrorism financing and know your customer rules are forcing banks to know their activities better." She says that "if banks improve their record-keeping to meet those rules, it will help them to be in compliance with the Volcker Rule." But understanding the interconnections between the rules is a daunting task.

Senior management faces the additional challenge of deciding how many securities and derivatives desks they want to continue to implement their current business strategy while complying with the Volcker Rule. Senior managers boast about how their banks have created tons of subsidiaries and desks to suit their tax, capital and business needs. In the same breath, they complain that their subsidiary and desk structures make it difficult to comply with the Volcker Rule. My advice is that these banks take steps to simplify themselves. This would help them meet the data demands of the Volcker Rule and make writing credible living wills much easier.

The silo mentality that reigns at large banks also leads to weak operational risk management and makes Volcker Rule compliance difficult. I repeatedly hear that professionals in lending, asset management, securities and derivatives often do not share information with colleagues at their own firm — even when a firm-wide risk management effort asks them to do so. This makes it difficult for senior management to determine what strategic changes are necessary to create credible Volcker Rule compliance programs. The silo mentality is also a huge headache for the IT professionals charged with making substantial changes to existing systems so that banks can spot compliance risks in real time and promptly report metrics to multiple regulators.   

The capacity of banks' compliance and audit teams is improving. But as those professionals gain experience navigating multiple new regulations, they are poised to be recruited elsewhere. This leaves firms in the undesirable position of constantly looking for replacements, training them and figuring out how to retain them, all of which makes achieving compliance a hard task.

What has yet to improve is how traders treat these "pesky cost centers." This dismissive attitude toward compliance professionals and auditors — prevalent among boards of directors and senior management, not to mention traders — desperately needs to change. Until people at all levels understand that these teams are essential to the entire bank, middle- and back-office professionals will continue to be hindered in meeting the Volcker Rule.

Next in the series: Developing processes to comply with the Volcker Rule.

Mayra Rodríguez Valladares is managing principal at MRV Associates, a New York-based capital markets and financial regulatory consulting and training firm. She is also a faculty member at Financial Markets World. Follow her on Twitter at @MRVAssociates.