The Volcker Rule: Mission Impossible

Politicians have given a lot of attention to the Volcker Rule in testimonies to the House and Senate in early February and even in Federal Reserve Chair Janet Yellen's first semiannual monetary policy report to Congress. Not a single politician, however, has asked recently whether any bank is ready in the near future to implement the Volcker Rule and whether the regulators, each with their distinct mandate, will be able to adequately supervise and enforce it.

For banks, the Volcker Rule represents probably the most challenging rule of any regulation from the perspective of data collection, aggregation and reporting. Part of the challenge is just figuring out how the Volcker Rule interacts with other elements of Dodd-Frank and Basel III. It is very unlikely that global systemically important banks, not to mention smaller banks, will be able to revamp their IT infrastructure, compliance processes and reporting mechanisms to comply with the Volcker Rule on time. Even though the compliance deadline is not until 2015, for some banks, some reporting requirements start this summer.

Although it has been over five years since the global financial crisis, banks are overwhelmed with a wide range of data challenges.  Key Basel Committee and Senior Supervisory Group reports in December and January highlighted how banks struggle with establishing strong data aggregation governance, architecture and processes. They even struggle with timely and accurate reporting of data related to their top counterparty exposures. 

In order to have any hopes of implementing the Volcker Rule, banks will seriously have to rethink their strategy of what types of businesses they want to be in and what types of securities and derivatives they want to trade. A number of banks have been deleveraging in the last few years in order to bolster their capital levels and avoid contravening the Volcker Rule. Of course, by deleveraging they may be lowering their risks, but they are also risking being less profitable. 

Importantly, banks will need to insure they have a strong board of directors and senior management who truly understand the Volcker Rule, since the rule imposes significant responsibility and accountability on them.  One of the elements of the Volcker Rule is for a bank's CEO to attest annually in writing to regulators that the bank has in place processes to establish, maintain, enforce, review, test and modify its compliance program. If regulators enforce this provision, CEOs will finally have to make compliance a priority.

Undeniably, banks need to create a well-thought-out Volcker Rule implementation and monitoring plan, since numerous business units are all affected by the rule. Finding the appropriate personnel to be involved in creating and implementing the plan will hardly be easy, since the people who usually should be involved are already stretched working on other elements of Dodd-Frank, not to mention Basel III. 

Banks will also need to develop a very strong compliance program and evaluate the personnel available to do so. As part of the compliance program, banks have to create compliance manuals specific to the Volcker Rule where they should provide details of the type of trading that they conduct, identification of customers, risks and risk management processes, hedging policies, and how they resolve problems when the Volcker Rule is breached. Banks will also need to pay special attention to the information that they will need to comply with market-making and underwriting exemptions granted by the Volcker Rule. Just preparing the compliance manual should force banks to think of what type of IT architecture they have in place to capture, store and maintain relevant data.

For all regulatory agencies, supervising and especially examining banks to see if they are properly implementing the Volcker Rule will be far from easy.  It is important to remember that all regulators now have even more responsibilities, thanks to new Dodd-Frank and Basel rules. Even before the Volcker Rule was finalized, all the agencies, especially the Securities and Exchange Commission and Commodity Futures Trading Commission, already operate with insufficient human and technology resources to help them do their work adequately. 

The bank regulatory agencies have had to hire additional people. Many, fortunately, are now coming in with industry experience, but they have the challenge of learning to work as regulators. Existing staff at these agencies often seriously need training in capital markets and derivatives products and in understanding the nuances of all the new regulations being written.  Unfortunately, rather than receiving more support, the staffs at these regulatory entities are all too often used as punching bags and derided by politicians and journalists who rarely have ever worked in a regulatory agency to understand the challenges.

If the goal really is to reform the financial sector, the Volcker Rule should never have been the focus for politicians or regulators. Moreover, since the U.K. and continental Europe lag in implementing similar rules to Volcker, U.S. banks may be able to find regulatory arbitrage opportunities abroad.  Now that the Volcker Rule is regulation, however, I do not expect that it will be implemented or enforced satisfactorily anytime soon.  Moreover, continued focus on it will distract bank managers and regulators from finding ways to make the global financial system healthier.

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.