The Volcker Rule’s Proposed Revision Could Add Liquidity To CMBS

WASHINGTON, DC–The Federal Reserve proposed revisions to the Volcker Rule on Wednesday.

The Volcker rule, which is part of the Dodd-Frank Act, prohibits banking entities from engaging in proprietary trading and from owning or controlling hedge funds or private equity funds. The Fed noted in its request for comments that the complexity of the rule has led to confusion about how to implement it. “The proposal will address some of the uncertainty and complexity that now make it difficult for firms to know how best to comply, and for supervisors to know that they are in compliance,” Chairman Jerome H. Powell said.

Constrained Market-Making

The CRE Finance Council has maintained that the the Volcker Rule is one of several regulations that has led to constrained secondary market-making. In an alert published in response to yesterday’s proposal the association noted that “in its current form, the Volcker Rule impinges upon the ability of banks to hold requisite inventories of secondary market securities, including commercial mortgage-backed securities, thereby damaging market liquidity.”

To be clear, the rule doesn’t restrict banks from trading and buying, but they have become very cautious about this activity “rather than mistakenly running afoul of the rule,” according to comments submitted to the Office of the Comptroller of the Currency last year by several trade associations that represent the commercial real estate industry. In its own separate comment, the Mortgage Bankers Association said that the rule “has hindered both market making functions necessary to ensure a healthy level of market liquidity and hedging necessary to mitigate risk.”

Executive Director of CREFC Lisa Pendergast said that the association will work with regulators and its own members “to develop a more efficient compliance regime that returns the appropriate level of liquidity to securities such as CMBS…a level that has been lacking post the enactment of the Volcker Rule.”

What The Proposal Says

Specifically, the proposed changes would:

• Tailor the rule’s compliance requirements based on the size of a firm’s trading assets and liabilities, with the most stringent requirements applied to firms with the most trading activity;
• Provide more clarity by revising the definition of “trading account” in the rule, in part by relying on commonly used accounting definitions;
• Clarify that firms that trade within appropriately developed internal risk limits are engaged in permissible market making or underwriting activity;
• Streamline the criteria that apply when a banking entity seeks to rely on the hedging exemption from the proprietary trading prohibition;
• Limit the impact of the Volcker rule on the foreign activity of foreign banks; and
• Simplify the trading activity information that banking entities are required to provide to the agencies.

“By focusing the application of the rule on those firms with the highest levels of activity covered by the statue, and by clarifying and simplifying the compliance regime, we can promote safety and soundness while reducing unnecessary burdens,” Randal K. Quarles, the Board’s Vice Chairman for Supervision, said.

What Happens Next

There are several steps that have to take place before these revisions go into effect and they are happening at a rapid pace. The Federal Deposit Insurance Corp. is voting on the rule today. The Securities Exchange Commission is holding a board meeting today and the Commodity Futures Trading Commission has one scheduled for next week, although neither has announced their agendas.

It is expected that three agencies responsible for the rule — the Office of the Comptroller of the Currency, the SEC and the CFTC — will sign onto the Fed’s revisions in the near future, CREFC said.