JPM JP Morgan Chase and Co

By Ryan Tracy and Telis Demos 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (May 31, 2018).

WASHINGTON -- The Federal Reserve proposed on Wednesday easing a rule designed to curb risky trading in the wake of the financial crisis, one of the most significant deregulatory measures for banks since President Donald Trump took office.

The proposal, unanimously advanced by the Federal Reserve and known as Volcker 2.0, means JPMorgan Chase & Co., Goldman Sachs Group Inc. and other banking behemoths would face fewer audits of individual securities and derivatives transactions. The banks wouldn't have to spend as much time proving compliance, and traders would generally have more freedom to buy and sell securities.

While financial firms have been seeking the changes for years, regulators said the proposal wouldn't bring back the highflying days before the financial crisis when Morgan Stanley and other powerhouses booked billion-dollar losses. Still, critics said the proposal gives banks too much leeway and could create loopholes that allow banks to engage in risky trading.

The proposal is part of a broader regulatory rollback that includes a recently enacted law easing rules on small banks and less aggressive leadership at the Consumer Financial Protection Bureau.

Congress told regulators to draft the rule in 2010, named for former Federal Reserve Chairman Paul Volcker, to bar big banks from hedge-fund-like speculative trading activities. That prohibition remains.

Regulators said they want to enforce the rule differently because the existing practices are costly and confusing. The Fed and other agencies wouldn't audit individual transactions as often, but they would check to see that bank managers set limits on traders aligned with expected customer demand. The law allows hedging and market-making on customers' behalf.

The proposal "will allow firms to conduct appropriate activities without undue burden and without sacrificing safety and soundness," Fed Chairman Jerome Powell said.

Citigroup Inc. Chief Executive Michael Corbat told investors on Wednesday that the bank advocates the "spirit of Volcker."

But "we're all somewhat perplexed and challenged by the implementation," Mr. Corbat said, citing the "presumption of guilt," the lack of a single regulator and the collection of trading data that the government doesn't appear to use.

Four other U.S. agencies are expected to follow the Fed in proposing the changes over the next week. They will take public comments before completing the proposal.

The proposal is drawing strong support, including the backing of banking regulators who were tapped by former President Barack Obama, a Democrat. A separate proposal on bank capital rules has sparked opposition from Obama-nominated regulators.

Fed Vice Chairman for Supervision Randal Quarles, who was nominated by Mr. Trump, said the changes were a "first effort," suggesting more could be proposed later.

"This isn't about allowing formerly banned types of proprietary trading, " said Gabriel Rosenberg, a lawyer who works with banks, referring to a bank trading for its own benefit. "This is really a rationalization of the program."

Some critics said the proposals could create loopholes.

"Sadly, this Volcker 2.0 proposed rule appears to weaken rather than advance the implementation" of the rule, said Andy Green, a former aide to Sen. Jeff Merkley (D., Ore.), an author of the Volcker rule. "The result will be more banks betting against, rather than serving, their customers."

Mr. Volcker said in a written statement that the proposal must "not undermine the core principle at stake -- that taxpayer-supported banking groups, of any size, not participate in proprietary trading at odds with the basic public and customers' interests."

The proposal would broadly loosen compliance requirements for all banks, though it would grant the most relief to firms with small trading desks.

In practice, judging whether a given trade complies with the Volcker rule has been difficult for regulators and for bankers. Banks have spent millions of dollars developing systems to measure trading activity and model future customers' demand. Wednesday's proposal wouldn't do away with those systems, but it could allow banks to simplify them.

Observers have said financial markets aren't functioning as well as they could because big banks are nervous that certain positions may violate the Volcker rule, though there is an open debate on the rule's precise effect. Mr. Quarles has said the impact on liquidity is unarguable, though hard to measure. Another Fed official on Wednesday said many factors are affecting financial markets, including new trading technologies.

Big banks have already cut back on trading businesses in search of more stable revenue sources. It isn't clear those jobs will return, even with Wednesday's proposed changes.

The current generation of top bankers, many of whom cut their teeth in businesses outside of trading, have said that whatever happened to Volcker they aren't planning for a return of proprietary trading desks.

"I'm not sure banks should put large parts of their capital at risk in proprietary trading or proprietary investing positions," James Gorman, Morgan Stanley chief executive, told analysts in April.

Wednesday's proposal would eliminate a presumption that positions held for fewer than 60 days violate the rule unless bankers prove otherwise, directly addressing Mr. Corbat's criticism. Instead, regulators would look to how positions are defined under accounting rules to determine whether they constitute short-term trading.

Regulators also would presume traders were complying with the rule if they stayed within limits set by their trading desks, but the government would regularly review those limits to make sure they were set appropriately.

If a trading desk booked gains and losses that exceed $25 million over a 90-day period, that desk would have to prove it wasn't violating the Volcker rule. But if the desk stayed under that level, regulators would presume it was in compliance.

The proposal also would reduce the burden for banks to justify hedging trades, asks for comment on potential changes to rules for banks owning investment funds and seeks to reduce the impact of the rule on foreign-owned banks' overseas activities.

There are some additional exceptions for certain types of trading contained in the rule, such as for certain kinds of currency trades used to manage a bank's cash resources and for trades that are done to unwind an earlier trade placed in error.

Some analysts said that to whatever extent Volcker allows for more risk taking, there will still be limits on how much leverage banks can use, and there are punitive capital requirements to own riskier assets. The Fed is separately reviewing capital restrictions, including the leverage limits, which could loosen for some banks.

"Without the ability to leverage, and if some of the transactions are considered to be in highly risk-weighted assets, it's really hard to see how the dynamic changes to have everybody ramp up risk," said Guy Moszkowski, an analyst at Autonomous Research.

Regulators are also proposing to create three new categories of banks. Those with more than $10 billion in trading assets and liabilities would face the highest expectations under the Volcker rule. That includes 18 firms, about half foreign-owned, representing about 95% of total U.S. bank trading activity, agency officials said.

Write to Ryan Tracy at ryan.tracy@wsj.com and Telis Demos at telis.demos@wsj.com

(END) Dow Jones Newswires

May 31, 2018 02:47 ET (06:47 GMT)

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