Regular readers know that there are two components to every regulations: the rule and how it is enforced.
Regular readers also know that enforcement for the Volcker Rule is simple: require every bank to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.
With this information, market participants can assess every trading position and see if it is simply there for market making or is there as a proprietary bet.
If it is a proprietary bet, the bet is subject to every trader's worse nightmare. The market can now trade against the position to minimize its upside while maximizing its downside. Traders know this and it acts as discipline so that the traders don't engage in proprietary betting.
As for the Vicker's Rule which separates investment (casino banking) from retail banking, it too needs an enforcement mechanism. Again, the best enforcement mechanism is requiring the banks to provide ultra transparency.
With this information, market participants, including the financial regulators, can see if the banks are taking risks they are not suppose to inside the ring-fence.
Please note that in the absence of requiring the banks to provide ultra transparency so the rules can be enforced, we are left with the combination of complex rules and regulatory oversight.
The combination of complex rules and regulatory oversight is known to increase the risk of future financial crises. This lesson was learned with our current crisis where the combination of complex rules and regulatory oversight failed to prevent a bank solvency led financial crisis.
U.K. banks shouldn’t be restricted from proprietary trading in a way similar to the U.S.’s so- called Volcker rule because it would be too complicated to police, said John Vickers, chairman of Britain’s Independent Commission on Banking.
The distinction between market making and a bank trading with its own money is ill-understood and would sap too much time from regulators, Vickers, 54, told the U.K.’s Parliamentary Commission on Banking Standards today.With ultra transparency, there is no need to make the Volcker Rule complex nor to sap too much time from regulators. The Volcker Rule could stay as it currently is: banks are prohibited from making proprietary trades.
With ultra transparency, market participants can decide what is market making and what is a proprietary trade.
Shielding banks’ consumer units from their investment banking operations as recommended by the ICB is preferable, he said.
Federal Reserve Chairman Paul Volcker, 85, who helped devise the U.S. rules, told Parliament in October that Vickers’s own proposals will be difficult to maintain and financial institutions will seek to unwind separations over time....The Vicker's Rule also needs ultra transparency for enforcement. There is no reason to believe that the financial regulators can do a good job of enforcing the separation as Glass-Steagall collapsed in the face of bank lobbying.
“If one had ring fencing and Volcker there would be two boundaries to police,” Vickers said. “Volcker draws the line in a very difficult, almost excruciatingly difficult, place.”
If proprietary trading is banned from banking, it could “move elsewhere” where there may be fewer rules to govern it, Vickers said.
Banks holding bonds and shares to sell to clients, so-called market making, is indistinguishable from proprietary trading, where a firm takes its own positions in securities for its own gain, he said.
It would be “very difficult” for a regulator to tell the difference between market making and proprietary trading, Vickers said. “People at the top of banks themselves have not known what was going on in terms of the kind of trading, and the regulator is at a disadvantage even relative to them.”Mr. Vickers makes a strong case for ultra transparency. Market participants like traders at other large global banks and hedge funds don't have trouble distinguishing between market making activities and proprietary bets.