Tuesday, September 20, 2011

Disclosure under FDR Framework moving closer to being Volcker Rule enforcement mechanism

In an earlier post on the Volcker Rule, your humble blogger pointed out how the FDR Framework would approach the Volcker Rule and its enforcement:
[T]here is a simple regulation [regulators] could put in place that would guarantee compliance with the Volcker Rule and eliminate proprietary trading under any name by the large Wall Street firms. 
The regulators should require that the Wall Street firms disclose to all market participants at the end of each business day each and every position in their trading and investment portfolios.
As Warren Buffett would be happy to point out, this simple regulation would dramatically squash the potential profitability of proprietary trading under any name.
According to the NY Times' Dealbook article on the UBS trading scandal, it appears that regulators are leaning to adopting this approach.

As discussed in the article, the regulators are looking at creating a data warehouse to capture the trading position data.   Your humble blogger would be happy to assist in setting up and running this data warehouse.
The Delta One desks operate in a gray area, where the line is sometimes blurred between proprietary trading and client activities like market making. A bank, for example, can buy securities from one customer with the intent of selling them to another client. But if the bank holds the assets too long or lets the stake grow too large, it may look more like a proprietary trade.
“You’re never going to be able to craft a rule that permits legitimate market-making activities that our economy desperately needs while at the same time prohibiting proprietary positions,” said Mr. Seiberg of MF Global. “That’s because one man’s market making is another man’s prop trading.
Regulators are looking to make the boundaries clearer. After working on a draft of the Volcker Rule for weeks, they now agree on some of the thorniest provisions, including the definition of market making, according to a person with knowledge of the discussions.
But they are still debating how to enforce the regulation. While some are pushing for Wall Street to police itself in proprietary trading activity, the Federal Deposit Insurance Corporation and other policy makers want a tougher crackdown. The agencies could leave open the possibility of a compromise plan for banks to detail their positions to data warehouses, where regulators could keep an eye on the trading. They have also discussed whether to hold executives liable should a bank skirt the rules.
Under the proposal, the definition of market making, at least for now, largely tracks the metric laid out in an earlier report by the Financial Stability Oversight Council, according to the person close to the discussions. For example, positions held for less than 60 days would draw scrutiny, as regulators ensure that the trades are either bona fide hedges or market-making deals.
It is a tough rule to get just right. Make the regulation too broad and it could prove ineffective at keeping banks from taking on too much risk. Make it too specific, and it could crimp legitimate businesses that bolster the economy.
“The challenge for regulators is to thread that needle,” said Donald N. Lamson, a lawyer at Shearman & Sterling and a former Treasury Department official who helped write the Volcker Rule. “You have to draw a line somewhere.”
Actually, the regulators do not have to draw a line anywhere.  By requiring disclosure and sharing this data with all market participants, market discipline plus the fact that it will be harder to make money from proprietary trading when all market participants know their positions will draw the line for the regulators.

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