RiskTech Forum

Wolters Kluwer: Lawyers, compliance officers, doctors and shrinks – the Volcker Rule works its way through the Asia-Pacific

Posted: 6 January 2016  |  Author: Selwyn Parker   |  Source: Wolters Kluwer

The governor of the Bank of Japan is worried. Senior figures in the Asia-Pacific branch of the International Capital Markets Association are worried. And no less than 11 governors of the most important central banks in the Asia-Pacific region including Australia are worried.

The object of their concern? It’s the Volcker Rule, that most challenging element of America’s Dodd Frank financial-sector reforms that ban banks from proprietary trading.

Bank of Japan governor Haruhiko Kuroda expressed his latest concerns as recently as early December during a conference in Paris. In his remarks he said “Volcker”, as it’s popular known, needed to be closely monitored along with other US-inspired financial regulation that was overhauling the rest of the world.

“Looking at individual countries, large-scale financial and structural reforms are under way, as typified by the Volcker Rule in the US,” he said. “The extent of the effects and impact of these regulatory reforms on international financial intermediation and flow of funds in the financial sector as a whole remains unknown, and therefore requires close monitoring.”

The main fear of Mr. Kuroda, whose increasingly successful revival of the Japanese economy makes him an influential figure, is that ever-tightening financial regulation may throttle economic growth.

So it’s fair to say that Volcker isn’t exactly the most popular regulatory initiative in the region. In fact, in the last two years the groundswell of opinion expressed at most echelons of the financial sector has been running heavily against the rules, albeit while approving of the general principles that lie behind them. Reading the tea leaves, they are seen as an American fix for an American problem that has been foisted on a region that doesn’t need them, at least not at this level of complexity.

Typically, senior figures in the Asia-Pacific branch of the International Capital Markets Association attribute a worrying decline in liquidity – essentially, intra-bank financial flows – to the rules as well as to other tough regulatory initiatives.


A decline in liquidity is clearly a legitimate area of concern, but the rules are also seen as a nightmare in terms of compliance. Most institutions are reportedly feeling their way through a minefield of regulation that few compliance officers can be expected to understand.

And that’s official. Late last year the 11 governors took the practically unprecedented step of writing a joint letter to the America’s five main regulators including US Treasury to express what amounts to their perplexity at some aspects of Volcker – and urging a stay of execution while important concerns were resolved.

The governors were mainly preoccupied with the cross-border impacts of the rules on the region. Citing the need to “collaborate and coordinate with affected jurisdictions,” the letter warned: “Given the extensive extra-territorial reach of the Final Regulation and potentially single counterparty credit limit, we believe [Volcker] would have serious negative impacts on the financial stability and smooth functioning of financial markets in the EMEAP region.”

By any standards that’s a big claim. Among other unforeseen effects, the governors feared problems with US dollar funding in the region, and with less liquid and resilient sovereign debt markets. In themselves that would be serious enough. But the letter also predicted a compliance black hole: “Besides, the Final Regulation constitutes an extremely complex set of rules which contains several elements where it is not clear how compliance can be achieved.”

In the absence of “clear and detailed” guidance from the American authorities, the letter went on to say that institutions in the region would be obliged to make excessively conservative compliance choices at a high cost. In short, compliance officers would have to err on the side of caution with a detrimental effect on capital markets.

In other words, please tell us how compliance officers can comply.

And this letter followed earlier objections from non-US authorities including the Asia-Pacific region’s central banks, only some of which had been addressed to their satisfaction.


Thus the compliance issue underpins how the rules will work. If compliance officers interpret them too strictly and give instructions accordingly, this will adversely affect the market-making that banks do as a matter of routine. But if they interpret them too freely, institutions could run into penalties and sanctions.

Three years ago JP Morgan’s outspoken chief executive Jamie Dimon famously expressed his own concerns about Volcker. “For every trader, we’re going to have to have a lawyer, compliance officer, a doctor to see what their testosterone levels are, and a shrink [asking] what’s your intent?” he told an interviewer.

Dimon, who actually supports the principles behind the rules, was referring to how difficult it would be for financial firms to distinguish between proprietary trading – that is, banks taking risks with depositors’ funds while enjoying government guarantees – and the vital bread-and-butter business of market making, or intermediation. Essentially, intermediation is the way banks oil the financial markets in corporate bonds, foreign exchange, interest rates and other products that have long been the staple of the global giants.


But what in more detail is the Volcker Rule? As Bloomberg points out in a briefing, it was designed to limit the high-risk bets that banks were making for their own gain rather than for their customers. Proprietary trading, in short. The rules apply to federally insured banks with assets of $50bn or more as well as to US branches and agencies of banks based outside America.

And, controversially, they also apply to many foreign-based investment funds that meet US regulators’ strict ownership criteria. By effectively classifying these funds as “banking entities”, this has long been a sticking point in negotiations. By common agreement the application of the rules places a heavy compliance burden in terms of identifying the precise nature of any security that is traded, as Jamie Dimon colorfully pointed out.

Cross border

The difficulties of applying a made-in-America regulation in other jurisdictions is under debate at the highest level. In its latest report, issued in September 2015, the International Organization of Securities Commissions (IOSCO) that regulates the world’s securities and futures markets, highlighted this very issue.

“IOSCO is seeking to promote consistent – but not necessarily identical – regulatory approaches to securities market activities across borders, on the basis that the removal of regulatory impediments across borders should contribute to global economic growth,” the report noted. It also referred to reservations against regulation being “outsourced to a foreign jurisdiction.”

Yet the latter is what the region, with its different (and largely effective) regulatory systems, is seeing in the case of Volcker. As Ashley Alder, chief executive of the Hong Kong Securities and Futures Commission – and head of IOSCO’s task force on cross-border regulation, told an IOSCO conference in Madrid in September, “promoting consistent regulatory approaches for cross-border marketing activities is challenging, not least because it must take into account existing differences in markets, regulatory philosophies and other domestic considerations.”

As such, the Volcker Rule looks like a test case for cross-border regulation. And it would not be surprising if in time it was heavily modified by the region’s regulators to suit their own “existing markets, regulatory philosophies and other domestic considerations.”