The Volker Rule: An Overview of Issues

Introduction
Guy Dempsey of Katten Muchin Rosenman LLP was in keeping with Christmas spirit when he suggested that ‘I don’t think anybody but Santa has enough elves to read that rule’.

The Volker Rule, which has been looming over banks for almost three years, has finally landed. The rule bans lucrative practices that deposit taking banks undertake, namely proprietary trading: which is the act of banks trading with their own money.

The rule serves a simple enough purpose: to avoid another systemic financial crash that must be borne out by the taxpayer. The rule itself, however, is far from simple. In fact, the senior editor at large at CNN Money has been quick to point out that it is ‘half again as long as the Greek version of the New Testament,’ which brings with it problems of complexity and ambiguity.

This ‘problem’ for banks, is big business for law firms. Furthermore, and slightly more relevant for those readers studying a banking and financial regulation law module, is that it gives an interesting comparison between different forms of regulation in the US and the UK.

‘One Man’s Loss is Another Man’s Gain’

This idiom can be clearly applied here with respect to banks and law firms.

Banks must make trades for their clients if they are to be profitable. Yet this rule will restrict their ability to do so on the huge pre-crash scale they used to operate on. This will force some securities and non-banking firms who can no longer compete to leave the market.

This is not only a problem for banks, but for the economy as a whole. If banks stop conducting transactions for their clients then the markets become less liquid, and this means higher transaction costs leading to sluggish growth in the financial system. Whilst this might prevent a crash, it will slow down the US economy.

As any macroeconomist will tell you, this will have a negative effect on businesses in the US as aggregate demand begins to slow and people spend less, leading to widespread issues ranging from unemployment to less tax revenue. With China’s economy ever on the offensive, this is the last scenario the US needs.

What does this mean for law firms?

‘Compliance, compliance, compliance’ is the name of the game for banks according to Shearman & Sterling partner Donald Lamson, and this means huge amounts of work for the lawyers advising banks.

The high levels of complexity coupled with the regulators lack of appetite to provide interpretive guidance means a huge volume of interpretive work for law firms, who will be looking to establish models for compliance and find new strategies for securities firms to stay competitive in the market, whilst ensuring they adhere to the golden rule of ‘compliance.’ Law firms can afford to charge astronomical fees for such advice, as banks cannot afford to get on the wrong side of the regulator.

Furthermore, the forced exit of some securities firms creates an opportunity for new ones to enter the market, meaning new clients for law firms.

What will Law Firms be doing?

Many law firms have already started receiving correspondence from their clients asking for the difference between proprietary trading, market making and hedging. This kind of work will form the bulk of their hours; interpretation of the rule.

The job, generally, for law firms is to make their client’s lives easier. By looking for exploitable loopholes in the long and complicated rule through different forms of interpretation, this is exactly what they will be doing.

For example, finding out the scope of the exemptions on market making or what metrics must be complied and reported are all details that are vital to banks and are sure to have various degrees of answers based on different interpretations. It is estimated that such paperwork will run into millions of hours, costing the banks billions, and profiting law firms hugely.

The work is not restricted to the US either. Jones Day have reportedly 200 lawyers across the world reviewing the rule, illustrating the opportunity for trans-border work for lawyers in the banking groups of their respective firms.

Overall, the rule provides lawyers with a fresh new problem to solve with the opportunity for inventive solutions, and for clients willing to pay huge amounts of money to ensure they comply with the rule in the least onerous way possible.

An Effective form of Regulation?

As mentioned before, this new regulation in the US provides an interesting comparison to the changes in the UK. It is suggested however, that the UK’s system is a much easier form of regulation as it ‘ring-fences’ conglomerate banks.

What this means is that, even if investment bankers fail, the other parts of the bank such as retail are safe. More importantly however, is the fact that UK regulators do not have the almost impossible task of deciding what types of trades are socially beneficial, as the US regulators must do under the Volker rule.

Summary

The Volker rule is now in full fledge. It is an onerous and complicated rule for banks to comply with, and presents them with serious concerns given the American regulators precedent of setting huge fines to banks lately.

For lawyers however, it presents a fantastic opportunity for them to do what they do best; interpret, find loopholes and advise. There is no better time for law firms to start devoting resources to their banking and finance practices, as banks start piling on the questions they need to ensure compliance.