Statement of
Martin J. Gruenberg, Chairman,
Federal Deposit Insurance Corporation
on
"Volcker Rule Implementation"
before the
Committee on Financial Services,
United States House of Representatives
2128 Rayburn House
Office Building
February 5, 2014
Chairman Hensarling, Ranking Member Waters and members of the Committee, I
appreciate the opportunity to testify today on behalf of the Federal Deposit Insurance
Corporation (FDIC) on the regulations to implement section 619 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank Act), also known as "the
Volcker Rule."
On December 10, 2014, the FDIC, along with the Federal Reserve Board (FRB), the
Office of the Comptroller of the Currency (OCC), the Securities and Exchange
Commission (SEC), and the Commodity Futures Trading Commission (CFTC), adopted
a final rule implementing the Volcker Rule requirements of the Dodd-Frank Act.1
My testimony today will include a brief overview of the statutory provisions and an
overview of the final rule.
Overview of the Volcker Rule Statutory Provisions
Section 619 of the Dodd-Frank Act is designed to strengthen the financial system and
constrain the level of risk undertaken by firms that benefit, directly or indirectly, from the
federal safety net provided by federal insurance on customer deposits or access to the
Federal Reserve's discount window. Section 619 added a new section 13 of the Bank
Holding Company Act (BHC Act) to prohibit banking entities from engaging in
proprietary trading activities and to limit the ability of banking entities to invest in, or
have certain relationships with, hedge funds and private equity funds. In general terms,
proprietary trading occurs when an entity places its own capital at risk to engage in the
short-term buying and selling of securities primarily to profit from short-term price
movements, or enters into derivative products for similar purposes.
Section 619 of the Dodd-Frank Act generally places prohibitions and limitations on the
ability of banking entities to:
engage in short-term proprietary trading of securities or derivatives for their own
account and
Martin J. Gruenberg, Chairman,
Federal Deposit Insurance Corporation
on
"Volcker Rule Implementation"
before the
Committee on Financial Services,
United States House of Representatives
2128 Rayburn House
Office Building
February 5, 2014
Chairman Hensarling, Ranking Member Waters and members of the Committee, I
appreciate the opportunity to testify today on behalf of the Federal Deposit Insurance
Corporation (FDIC) on the regulations to implement section 619 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank Act), also known as "the
Volcker Rule."
On December 10, 2014, the FDIC, along with the Federal Reserve Board (FRB), the
Office of the Comptroller of the Currency (OCC), the Securities and Exchange
Commission (SEC), and the Commodity Futures Trading Commission (CFTC), adopted
a final rule implementing the Volcker Rule requirements of the Dodd-Frank Act.1
My testimony today will include a brief overview of the statutory provisions and an
overview of the final rule.
Overview of the Volcker Rule Statutory Provisions
Section 619 of the Dodd-Frank Act is designed to strengthen the financial system and
constrain the level of risk undertaken by firms that benefit, directly or indirectly, from the
federal safety net provided by federal insurance on customer deposits or access to the
Federal Reserve's discount window. Section 619 added a new section 13 of the Bank
Holding Company Act (BHC Act) to prohibit banking entities from engaging in
proprietary trading activities and to limit the ability of banking entities to invest in, or
have certain relationships with, hedge funds and private equity funds. In general terms,
proprietary trading occurs when an entity places its own capital at risk to engage in the
short-term buying and selling of securities primarily to profit from short-term price
movements, or enters into derivative products for similar purposes.
Section 619 of the Dodd-Frank Act generally places prohibitions and limitations on the
ability of banking entities to:
engage in short-term proprietary trading of securities or derivatives for their own
account and
own, sponsor, or have certain relationships with hedge funds or private equity
funds, referred to as "covered funds."
The challenge to the agencies in implementing the Volcker Rule was to prohibit the
types of proprietary trading and investment activity that Congress intended to limit, while
allowing banking organizations to provide legitimate intermediation in the capital
markets.
While section 619 broadly prohibits proprietary trading, it provides several "permitted
activities" exemptions that allow banking entities to continue to provide important
financial intermediation services and to promote robust and liquid capital markets. Most
notably, section 619 allows banking entities to take principal risk in securities or
derivatives, to the extent necessary to engage in bona fide market making and
underwriting activities, risk-mitigating hedging, and trading activities on behalf of
customers. Other permitted activities include trading in certain domestic government
obligations; investments in small business investment companies and those that
promote the public welfare; trading for the general account of insurance companies;
organizing and offering a covered fund (including limited investments in such funds);
foreign markets trading by non-U.S. banking entities; and foreign covered fund activities
by non-U.S. banking entities.
In addition, Section 619 contains two quantitative limits on the amount a banking entity
may invest in covered funds organized and offered by the banking entity or an affiliate.
First, for any particular covered fund, a banking entity may not own directly, and/or
indirectly, more than 3 percent of the value or ownership interests of that fund. Second,
a banking entity's aggregate direct and/or indirect ownership in all covered funds may
not exceed 3 percent of the banking entity's Tier 1 capital. In addition, any ownership
interest in a covered fund that is held by a banking entity must be deducted from the
banking entity's Tier 1 capital, including ownership amounts that fall within the
limitations described above.
To prevent banking organizations from engaging in otherwise prohibited proprietary
trading through one or more of the permissible activity exemptions described above,
section 619 provides at least three prudential safeguards. First, section 619 requires the
federal banking agencies, the SEC, and the CFTC to issue regulations that may include
restrictions or limitations on the permitted activities if appropriate. Second, section 619
states that no transaction, class of transactions, or activity may be a permitted activity if
it would: involve or result in a material conflict of interest between the banking entity and
its clients, customers, or counterparties; result, directly or indirectly, in a material
exposure by the banking entity to a high-risk asset or high-risk trading strategy; or pose
a threat to the safety and soundness of the banking entity or the financial stability of the
United States. Third, section 619 contains anti-evasion provisions that, in part, require
the Agencies to include internal controls and recordkeeping requirements as part of
their implementing regulations. In addition, the appropriate federal agency has the
authority to order a banking entity to terminate any activity or dispose of any investment,
after due notice and opportunity for hearing, if the agency has reasonable cause to
funds, referred to as "covered funds."
The challenge to the agencies in implementing the Volcker Rule was to prohibit the
types of proprietary trading and investment activity that Congress intended to limit, while
allowing banking organizations to provide legitimate intermediation in the capital
markets.
While section 619 broadly prohibits proprietary trading, it provides several "permitted
activities" exemptions that allow banking entities to continue to provide important
financial intermediation services and to promote robust and liquid capital markets. Most
notably, section 619 allows banking entities to take principal risk in securities or
derivatives, to the extent necessary to engage in bona fide market making and
underwriting activities, risk-mitigating hedging, and trading activities on behalf of
customers. Other permitted activities include trading in certain domestic government
obligations; investments in small business investment companies and those that
promote the public welfare; trading for the general account of insurance companies;
organizing and offering a covered fund (including limited investments in such funds);
foreign markets trading by non-U.S. banking entities; and foreign covered fund activities
by non-U.S. banking entities.
In addition, Section 619 contains two quantitative limits on the amount a banking entity
may invest in covered funds organized and offered by the banking entity or an affiliate.
First, for any particular covered fund, a banking entity may not own directly, and/or
indirectly, more than 3 percent of the value or ownership interests of that fund. Second,
a banking entity's aggregate direct and/or indirect ownership in all covered funds may
not exceed 3 percent of the banking entity's Tier 1 capital. In addition, any ownership
interest in a covered fund that is held by a banking entity must be deducted from the
banking entity's Tier 1 capital, including ownership amounts that fall within the
limitations described above.
To prevent banking organizations from engaging in otherwise prohibited proprietary
trading through one or more of the permissible activity exemptions described above,
section 619 provides at least three prudential safeguards. First, section 619 requires the
federal banking agencies, the SEC, and the CFTC to issue regulations that may include
restrictions or limitations on the permitted activities if appropriate. Second, section 619
states that no transaction, class of transactions, or activity may be a permitted activity if
it would: involve or result in a material conflict of interest between the banking entity and
its clients, customers, or counterparties; result, directly or indirectly, in a material
exposure by the banking entity to a high-risk asset or high-risk trading strategy; or pose
a threat to the safety and soundness of the banking entity or the financial stability of the
United States. Third, section 619 contains anti-evasion provisions that, in part, require
the Agencies to include internal controls and recordkeeping requirements as part of
their implementing regulations. In addition, the appropriate federal agency has the
authority to order a banking entity to terminate any activity or dispose of any investment,
after due notice and opportunity for hearing, if the agency has reasonable cause to