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EXAMINING THE IMPACT OF THE 

VOLCKER RULE ON THE MARKETS, 

BUSINESSES, INVESTORS, 

AND JOB CREATORS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS, 

SECURITIES, AND INVESTMENT 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED FIFTEENTH CONGRESS 

FIRST SESSION 

MARCH 29, 2017 

Printed for the use of the Committee on Financial Services 

Serial No. 115–12 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

PATRICK T. MCHENRY, North Carolina, 

Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

SCOTT TIPTON, Colorado 

ROGER WILLIAMS, Texas 

BRUCE POLIQUIN, Maine 

MIA LOVE, Utah 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

LEE M. ZELDIN, New York 

DAVID A. TROTT, Michigan 

BARRY LOUDERMILK, Georgia 

ALEXANDER X. MOONEY, West Virginia 

THOMAS MacARTHUR, New Jersey 

WARREN DAVIDSON, Ohio 

TED BUDD, North Carolina 

DAVID KUSTOFF, Tennessee 

CLAUDIA TENNEY, New York 

TREY HOLLINGSWORTH, Indiana 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

WM. LACY CLAY, Missouri 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

JUAN VARGAS, California 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 

CHARLIE CRIST, Florida 

RUBEN KIHUEN, Nevada 

KIRSTEN SUTTON MORK, Staff Director 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES, AND INVESTMENT

BILL HUIZENGA, Michigan, Chairman 

RANDY HULTGREN, Illinois, Vice Chairman 

PETER T. KING, New York 

PATRICK T. MCHENRY, North Carolina 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

ANN WAGNER, Missouri 

LUKE MESSER, Indiana 

BRUCE POLIQUIN, Maine 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

ALEXANDER X. MOONEY, West Virginia 

THOMAS MacARTHUR, New Jersey 

WARREN DAVIDSON, Ohio 

TED BUDD, North Carolina 

TREY HOLLINGSWORTH, Indiana 

CAROLYN B. MALONEY, New York, 

Ranking Member 

BRAD SHERMAN, California 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

JAMES A. HIMES, Connecticut 

KEITH ELLISON, Minnesota 

BILL FOSTER, Illinois 

GREGORY W. MEEKS, New York 

KYRSTEN SINEMA, Arizona 

JUAN VARGAS, California 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

March 29, 2017 ................................................................................................. 1 

Appendix: 

March 29, 2017 ................................................................................................. 41 

WITNESSES 

WEDNESDAY, MARCH 29, 2017 

Blass, David W., General Counsel, Investment Company Institute .................... 5 

Jarsulic, Marc, Vice President, Economic Policy, Center for American 

Progress ................................................................................................................ 7 

Kruszewski, Ronald J., Chairman and Chief Executive Officer, Stifel Financial Corporation, on behalf of the Securities and Financial Markets Association (SIFMA) ......................................................................................................... 9 

Quaadman, Thomas, Executive Vice President, Center for Capital Markets 

Competitiveness, U.S. Chamber of Commerce .................................................. 11 

Whitehead, Charles K., Myron C. Taylor Alumni Professor of Business Law, 

and Director, Law, Technology, and Entrepreneurship Program, Cornell 

University ............................................................................................................. 13 

APPENDIX 

Prepared statements: 

Blass, David W. ................................................................................................ 42 

Jarsulic, Marc ................................................................................................... 56 

Kruszewski, Ronald J. ...................................................................................... 65 

Quaadman, Thomas ......................................................................................... 79 

Whitehead, Charles K. ..................................................................................... 198 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Huizenga, Hon. Bill: 

Written statement of the National Venture Capital Association ................. 216 

Slides used during the hearing by Republican Members .............................. 218 

Written responses to questions for the record submitted to Ronald J. 

Kruszewski .................................................................................................... 220 

Ellison, Hon. Keith: 

Written responses to questions for the record submitted to Marc Jarsulic . 223 

Maloney, Hon. Carolyn: 

Letter to Fed Chair Janet L. Yellen, FDIC Chair Martin J. Gruenberg, 

CFTC Chair Timothy Massad, Comptroller of the Currency Thomas 

J. Curry, and SEC Chair Mary Jo White, dated August 29, 2016 ........... 227 

(1) 

EXAMINING THE IMPACT OF THE 

VOLCKER RULE ON THE MARKETS, 

BUSINESSES, INVESTORS, 

AND JOB CREATORS 

Wednesday, March 29, 2017 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS, 

SECURITIES, AND INVESTMENT, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:05 a.m., in room 

2128, Rayburn House Office Building, Hon. Bill Huizenga [chairman of the subcommittee] presiding. 

Members present: Representatives Huizenga, Hultgren, Stivers, 

Wagner, Messer, Poliquin, Hill, Emmer, MacArthur, Davidson, Hollingsworth; Maloney, Sherman, Lynch, Scott, Himes, Foster, 

Sinema, Vargas, and Gottheimer. 

Ex officio present: Representative Hensarling. 

Chairman HUIZENGA. The Subcommittee on Capital Markets, Securities, and Investment will come to order. Without objection, the 

Chair is authorized to declare a recess of the subcommittee at any 

time. 

Today’s hearing is entitled, ‘‘Examining the Impact of the Volcker 

Rule on the Markets, Businesses, Investors, and Job Creation.’’ 

I now recognize myself for 3 minutes to give an opening statement. 

This hearing will examine the impact of the Volcker Rule on the 

U.S. capital markets broadly, including its impact, most especially, 

on the liquidity and functionality of the fixed income and 

securitization markets, the ability of U.S. and international businesses to finance their operations, and U.S. competitiveness and 

job creation. 

The Volcker Rule, or Section 619 of the Dodd-Frank Act, prohibits U.S. bank holding companies and their affiliates from engaging in ‘‘proprietary trading’’ and from sponsoring hedge funds and 

private equity funds. 

Because of the key role that market making plays in ensuring 

deep, liquid, capital markets, the framers of the Volcker Rule 

sought to exempt market-making activities from the coverage of its 

prohibition on proprietary trading. 

There is just one problem. The line between impermissible proprietary trading and permissible market making is virtually impossible to draw. As a result, banks are getting out of the marketVerDate Nov 24 2008 19:14 Apr 04, 2018 Jkt 027369 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\27369.TXT TERI
2 

making business for fear of running afoul of the Volcker Rule. This 

is a great detriment to the U.S. capital markets, in my opinion. 

The real world implications of the Volcker Rule have been higher 

borrowing costs for job creators, smaller investment returns for 

hard-working families, and less economic activity overall because of 

further regulatory restraints placed on already reduced liquidity 

margins in key fixed income markets, including the corporate bond 

market. 

Recently, both current and former regulators have finally conceded that the Volcker Rule is impacting the liquidity of corporate 

debt. Specifically, in December of 2016, staff at the Federal Reserve 

issued a report concluding that, ‘‘The illiquidity of stressed bonds 

has increased after the Volcker Rule.’’ 

Furthermore, former Federal Reserve Board Governor Jeremy 

Stein, who served during the Obama Administration, recently published a paper with his fellow Harvard colleagues, and concluded 

that the Volcker Rule should be repealed. 

They note that the Volcker Rule also discourages broker-dealer 

banks from providing liquidity during a market correction, and 

that the Rule creates a significant increase in compliance and supervisory costs. 

Market making is crucial to the modern financial system, in 

which companies raise funds by selling equity, bonds, notes, and 

commercial paper. 

Market makers also hold down the cost of credit for consumers. 

Credit card debt and mortgages are often financed by being bundled into securities, which are then bought and sold in the capital 

markets. By acting as a market maker for these kinds of securities, 

banks make it cheaper and easier for responsible consumers to use 

their credit cards and obtain mortgages. 

From its inception, the Volcker Rule has been a solution in 

search of a problem. It seeks to address activities that had nothing, 

absolutely nothing to do with the financial crisis, and its practical 

effect has been to undermine financial stability, rather than to preserve it. 

Hard-working Americans, whether they realize it or not, rely on 

capital markets to save for everything from college to retirement. 

And as their Representatives, we must act to eliminate burdensome and unnecessary regulations such as the Volcker Rule, to ensure that U.S. capital markets remain the deepest and most liquid 

of all investment so that all investors receive the greatest return 

on their investment. I look forward to hearing from our witnesses 

today. 

The Chair now recognizes the ranking member of the subcommittee, the gentlelady from New York, Mrs. Maloney, for 5 

minutes for an opening statement. 

Mrs. MALONEY. Thank you. Thank you, Mr. Chairman, for calling 

this very important hearing, and for all of our presenters here 

today. It is a very, very important topic. 

I strongly support the Volcker Rule, and I believe it stands for 

an important principle, that banks should not gamble with their 

customers’ money, especially when that money is backed by a taxpayer guarantee. We have seen too often in the past how that proVerDate Nov 24 2008 19:14 Apr 04, 2018 Jkt 027369 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 K:\DOCS\27369.TXT TERI
3 

duces a situation where all the profit is privately shared, while the 

risk is borne by the public. 

The Volcker Rule, which was named after a great New Yorker, 

former Fed Chair Paul Volcker, came into effect in July 2015. So 

this is a good time to take stock of how this rule is doing. Today 

I have some data from the Federal Reserve that will shed light on 

how the implementation of the Volcker Rule is going. 

Under the Rule, banks are required to report a series of quantitative trading metrics, in other words hard data, to the regulators, such as risk levels on each trading desk in order to help the 

regulators identify any prohibited proprietary trading or trading 

for your own account. 

Last August, I sent a letter to five agencies in charge of the 

Volcker Rule, requesting that they provide me with an analysis of 

these trading metrics which they have been collecting from the 

banks since July 2014, over 21⁄2 years. And I ask unanimous consent to place that letter into the record. 

Chairman HUIZENGA. Without objection, it is so ordered. 

Mrs. MALONEY. The Federal Reserve has been very helpful with 

my request and has provided me with an analysis of some of the 

data that they collect, so this data is limited to the data that the 

Fed collects. It does not represent any other agency’s data. 

And I want to share this data with everyone today because I 

think it is important. It is the first hard data we have on the 

Volcker Rule. It is complicated, but it is extremely important. 

As you can see on the screen, the first two charts show that risk 

levels on banks’ trading desks have been largely steady since the 

Volcker Rule took effect. All of these big downward spikes in the 

chart represent holidays, like Thanksgiving or Christmas, when 

most markets are closed. So this is not something to worry about. 

Importantly, these charts cover two periods of market stress. 

First, the Third Avenue Credit Fund’s suspension of withdrawals 

in December of 2015. A headline in Bloomberg back then read, 

‘‘Third Avenue Redemption Freeze Sends Chill Through Credit 

Market.’’ 

And second, the China growth scare, when China’s economic 

growth suddenly slowed down in January and February of 2016. A 

headline in Forbes at that time asked, ‘‘Should Markets be 

Scared?’’ 

The charts show that the banks did not pull back from the markets during these two periods. In fact, they increased their exposure during these episodes. 

Next, we have a very interesting table that shows the so-called 

Sharpe ratios on banks’ trading desks, broken out by asset class. 

What this table suggests is that banks are now making the vast 

majority of their money on trading desks from legitimate marketmaking activities, which the Volcker Rule allows, and not from inappropriate proprietary trading. 

The Sharpe ratio is a widely-accepted way of measuring risk-adjusted returns for banks. In other words, it measures the returns 

that the banks’ trading desks are getting on these asset classes relative to the amount of risk they are taking, which is important, because you can always get higher returns by taking more risks. 

4 

So we need a way to adjust for the risk level so we can compare 

performance. The higher the Sharpe ratio, the better the returns 

relative to the risk. 

Now, the most interesting thing is the difference between the 

Sharpe ratios for new positions, existing positions, and changes in 

risk factors. If banks were still doing a great deal of proprietary 

trading, then they would be getting a lot of their returns from existing positions, or possibly from changes in risk factors. 

In other words, if banks were making proprietary bets that the 

price of a particular security would increase, then they would be 

getting most of their returns from price appreciation for securities 

they already bought, which are existing positions in this table. 

But as you can see, the Sharpe ratios for existing positions, as 

well as for changes in risk factors, have averages very close to zero. 

This suggests that banks are not engaging in any amount of proprietary trading. 

Instead, the table shows that the banks are mostly profiting from 

new positions. This suggests that trading desks at banks are making most of their money by acting as legitimate market makers, 

which is exactly what Congress intended to happen under the 

Volcker Rule. 

In other words, most of the banks’ profits are coming from the 

fees, also known as the spread, that banks collect on trades they 

do with their customers. These fees are collected up-front, which is 

why most of the banks’ profits are coming from new positions. 

So I wanted to share this data with everyone here today because 

I think it is relevant to this hearing. It is important that we look 

at hard data, the facts on the Volcker Rule. And based on this 

data, I would say the Volcker Rule is working. 

I look forward to your testimony. 

Chairman HUIZENGA. The gentlelady’s time has expired. 

I now recognize the vice chairman of the subcommittee, Mr. 

Hultgren from Illinois, for 2 minutes. 

Mr. HULTGREN. Thank you, Mr. Chairman. And thank you all for 

being here. It is not a surprise that Congress needs to review one 

of the most debated provisions of the Dodd-Frank Act just a few 

years after it was implemented. 

Unfortunately, the Dodd-Frank Act and the Volcker Rule were 

sold to the American people as a way of protecting taxpayers and 

investors, when in fact they are doing, I would say, just the opposite. 

There were mixed feelings among Republicans and Democrats 

when the Volcker Rule was debated in Congress and this was probably because policymakers understood proprietary trading did not 

cause the financial crisis and that there would be real, practical 

issues for implementing the proposed restrictions on proprietary 

trading. 

In fact, Treasury Secretary Geithner, who was appointed by 

President Obama, has said, if you look at the crisis, most of the 

losses that were material for both the weak and strong institutions, 

did not come from those activities. 

The realities were so hard for Congress to address that a 10-page 

bill became a 932-page regulation with confusing and conflicting 

perspectives from multiple regulators. 

5 

And let us not forget, this does not just apply to our largest financial institutions. Compliance burdens also trickle down to community banks that have to prove to regulators what is already 

known; they were almost never engaged in activities covered by the 

Rule. 

It is impossible to measure if the Volcker Rule is making our 

markets safer, but we know it is hurting liquidity. The lack of clarity around the market making as collusion is of the most significant concern. Dealers must have flexibility to hold inventory and 

provide liquidity, especially during times of market stress. 

A December 2016 working paper from the Federal Reserve staff 

on the Volcker Rule concluded, ‘‘We find that the net effect is a less 

liquid corporate bond market.’’ 

This damage to liquidity drives up costs in our fixed income markets, makes it more difficult for companies to grow and create jobs, 

drives down returns for investors, and increases the potential for 

market shocks. All of this is very concerning. 

I look forward to the testimony today, and I yield back. 

Chairman HUIZENGA. The gentleman yields back. 

Today, we welcome the testimony of a distinguished panel. First, 

we have Mr. David Blass, the general counsel of the Investment 

Company Institute (ICI). 

Second, we have Mr. Marc Jarsulic, the vice president of economic policy at the Center for American Progress. 

Third, we have Mr. Ronald Kruszewski, the chairman and chief 

executive officer of Stifel Financial Corporation, who is testifying 

on behalf of SIFMA. 

Fourth, we have Mr. Thomas Quaadman, the vice president of 

the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce. 

And finally, we have Dr. Charles Whitehead, a business law professor from Cornell University. 

Gentlemen, thank you very much for being here. We appreciate 

your time, and you will each be recognized for 5 minutes to give 

an oral presentation of your testimony. And without objection, each 

of your written statements will be made a part of the record. 

Mr. Blass, you have 5 minutes. 

STATEMENT OF DAVID W. BLASS, GENERAL COUNSEL, 

INVESTMENT COMPANY INSTITUTE 

Mr. BLASS. Chairman Huizenga, Ranking Member Maloney, and 

members of the subcommittee, thank you very much for the opportunity to testify today. 

My name is David Blass. I am the general counsel of the Investment Company Institute. Our members are mutual funds, exchange traded funds, and other registered funds with the SEC. 

We have a very unique perspective on the Volcker Rule because 

our members are funds that are both investment vehicles that 

might be subject to the Volcker Rule, and they are investors in the 

capital markets that themselves are affected by the Rule. 

We applaud this subcommittee for reviewing the impact of the 

Volcker Rule on the capital markets, on businesses, investors, and 

job creators. We support appropriately tailored regulation that ensures a vibrant, resilient financial system. And we support revisVerDate Nov 24 2008 19:14 Apr 04, 2018 Jkt 027369 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\27369.TXT TERI
6 

iting the Rule to determine whether it is, in fact, so appropriately 

tailored. 

Based on our review, regretfully, we conclude that it is not. By 

all acknowledgements, the Volcker Rule never was meant to apply 

to ordinary stock and bond mutual funds, ETFs and other investment funds registered under the Investment Company Act of 1940. 

And there is a good reason for that. 

The Investment Company Act already provides a very comprehensive framework of regulation that serves both to protect investors and to mitigate risk to the financial system, including the 

very kinds of risks that are at the very heart of the policy rationale 

for the Volcker Rule. 

Registered funds are transparent. They are not highly leveraged. 

Their assets are held in separate custody by bank custodians, and 

transactions with affiliates are either outright prohibited or are 

highly restricted. And boards of directors, typically with a majority 

of independent boards of directors, oversee these funds. 

But registered funds and their advisors have been left to sort 

through the many consequences of the Volcker Rule and its impact 

on the capital markets, and I would like to highlight three of those 

for you today. 

First, the final regulation failed to provide a full carve-out for 

registered funds. As a result, many of these funds find themselves 

coming within the definition of a banking entity. 

This could happen in the case of a newly-launched mutual fund, 

for example, whose investment advisor is affiliated with a bank. 

Solely by reason of the advisor’s investment of start-up capital, referred to as seed money, the new fund itself could be subject to the 

Volcker Rule’s trading and investment restrictions as if the fund 

were a bank, and it is not. 

The effect is to place new restrictions on longstanding, very commonplace practices that, to the best of our knowledge, have never 

raised any regulatory concerns. It is clear to us that Congress 

never intended this result. 

Now, the agencies charged with implementing the Volcker Rule 

ultimately issued some much-needed guidance very shortly before 

the compliance date. But the 3 years it took the agencies to issue 

that guidance exposes just how cumbersome and clunky this rule 

is to administer. 

And to further compound the problem, that guidance wasn’t 

issued through a transparent rulemaking process, but rather, 

through informal agency guidance, which presumably could be 

changed at the whim of the agency’s staff. 

Second, the final regulations create competitive inequalities. And 

I will give you one example. They exclude from the Volcker Rule’s 

restrictions foreign public funds. That is an entirely appropriate exclusion. 

The problem is some U.S. firms and their affiliates also rely on 

this exclusion, and the agencies administering the Volcker Rule 

placed onerous restrictions on those U.S. firms and their affiliates. 

They didn’t apply the same restrictions for non-U.S. firms, placing 

U.S. firms at a competitive imbalance. 

Third, the Volcker Rule is overly broad and insufficiently tailored 

to its policy objectives. Regulations that sweep too broadly introVerDate Nov 24 2008 19:14 Apr 04, 2018 Jkt 027369 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 K:\DOCS\27369.TXT TERI
7 

duce friction that influences how important market participants, 

dealers in this case, access the capital markets and provide liquidity. 

The Volcker Rule’s implementing regulations are extraordinarily 

complex, and they are built upon a presumption that all short-term 

principal trading is ‘‘proprietary trading.’’ And to overcome this 

presumption, a banking entity has to be able to demonstrate that 

it qualifies for an exemption, and in most cases that is the market 

making exemption, but that is a very high bar, and it puts the 

banking entity at risk of second-guessing. 

Now, many variables affect capital markets activity and the liquidity in those markets. Clearly, however, the kind of friction created by the overly broad and ambiguous regulations included in the 

Volcker Rule can and does influence the ways in which many market participants, dealers and other trading partners, including 

funds, participate in those capital markets. 

And for these reasons, among many others, we strongly support 

the committee’s examination of the Volcker Rule and its consideration of the capital markets more broadly. 

Thank you very much for your attention this morning. I would 

be happy to answer any questions. 

[The prepared statement of Mr. Blass can be found on page 42 

of the appendix.] 

Chairman HUIZENGA. The gentleman yields back. 

Now, we go to Mr. Marc Jarsulic, vice president, Center for 

American Progress. You have 5 minutes, sir. 

STATEMENT OF MARC JARSULIC, VICE PRESIDENT, 

ECONOMIC POLICY, CENTER FOR AMERICAN PROGRESS 

Mr. JARSULIC. Thank you, Mr. Chairman, Ranking Member 

Maloney, and members of the subcommittee for the opportunity to 

testify on this important topic. 

I am Marc Jarsulic, the vice president for Economic Policy at the 

Center for American Progress. And today I will attempt to outline 

the importance of the Volcker Rule and to highlight the evidence 

that the Volcker Rule has not caused the deterioration in liquidity 

in the corporate bond market. 

First to the purpose of the Rule. The Volcker Rule was intended 

to do something very reasonable: to prevent bank holding companies and their subsidiaries from engaging in proprietary trading 

and speculative fund, hedge fund, and private equity investments. 

These activities are capable of generating high levels of risk and 

large losses, which can damage the balance sheets of even very 

large banks. 

The $6 billion lost by JPMorgan Chase in the 2012 London 

Whale incident, which involved proprietary trading-type activities, 

is illustrative of the risks that can be generated. We also know 

from historical experience that with many important financial institutions engaged in excessive risk-taking, taxpayers can be left 

bearing the burden when their bets go bad. 

During the financial crisis, large amounts of risks were shifted 

onto U.S. taxpayers, as the risks taken by large bank holding companies and other important financial market actors generated substantial losses. 

8 

Because those losses threatened asset fire sales and widespread 

panic, the Federal Reserve, the FDIC, and Treasury were forced to 

step in to support asset prices and the institutions that were 

threatened with ruinous loss. Trillions of dollars of taxpayer funds 

were put at risk to stabilize the financial sector. 

Now, let me make a few remarks about the effects of the Volcker 

Rule. I think there is little question that the post-crisis behavior 

of securities dealers collectively has changed significantly compared 

to the pre-crisis period. 

The total assets of securities brokers and dealers have declined 

from peak values of about $5 trillion in 2008 to about $3.5 trillion 

in 2016, and corporate bond holdings have fallen in a similar pattern. 

The decline in corporate inventories is attributed to the Volcker 

Rule and to other regulatory changes sometimes. However, the connection between the decline in bond inventories and the Volcker 

Rule is really not that strong. 

As analysts for Goldman Sachs have pointed out, the very large 

run-up in corporate and bond inventories pre-crisis reflects the accumulation of positions in private labeled, mortgage-backed securities, rather than in traditional corporate bonds. 

And they estimate that the declining issuance of those bonds and 

declining prices explain the decline in dealer inventories from their 

peak levels in 2007 to 2012. 

Moreover, while critics of the Volcker Rule have long forecast 

dire consequences for the corporate bond market, including declining liquidity and harm to the functioning of the capital markets, 

these negative effects have not materialized. 

Liquidity, which is usually thought of as the cost of quickly converting an asset into cash, is typically measured by a range of indicators, which include the desk spread, the price impact, and trade 

size. 

Data on these indicators do not show deterioration of corporate 

bond liquidity. The desk spread in the corporate bond market for 

both investment grade and high yield bonds has declined since hitting a peak in the financial crisis. It is now lower than in the precrisis period. 

A standard measure of price impact has declined for both investment-grade and high-yield bonds since the crisis, and is now very 

low relative to pre-crisis levels. 

Trade size has declined during the financial crisis and has not 

yet recovered to pre-crisis levels. And while by itself this might be 

taken as a measure of decreased liquidities, the declines in price 

impact are inconsistent with this explanation. 

Finally, the forecasted harm to corporate access to capital has 

also failed to appear. New issues of corporate bonds are at record 

levels, at or above the $1 trillion per year, for the period 2010 to 

2015. 

In conclusion, it seems fair to say that the exit of large banks 

from proprietary trading has not had a measurable effect on corporate bond market liquidity, liquidity risk, or the ability of corporations to raise funds in the capital market. 

With respect to these criteria, our bond markets are functioning 

at least as well, if not better than, they were in the pre-crisis peVerDate Nov 24 2008 19:14 Apr 04, 2018 Jkt 027369 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 K:\DOCS\27369.TXT TERI
9 

riod. It is important to remember, however, that there is no reason 

to expect market makers, or any other financial market participants, to act as shock absorbers in times of extreme stress. 

Market makers will buy assets if they expect to profit from their 

purchases, but in a highly uncertain environment, they will not 

step in to catch a falling knife and cushion large price declines. If 

we want to avoid the problems generated by asset bubbles and the 

crashes that follow them, we need to take preventative measures. 

The Dodd-Frank Act, which requires banks and non-banks to put 

more equity on the line when they engage in asset purchases, 

raises equity requirements when assets are funded with short-term 

runnable credit; requires the balance sheets of banks to include 

sufficient liquidity to deal with asset shock, price shocks; gets 

banks out of the business of proprietary trading; and provides 

needed protections. 

Demolition of these preventative measures is likely to be a very 

costly exercise in historical amnesia. Thank you. 

[The prepared statement of Mr. Jarsulic can be found on page 56 

of the appendix.] 

Chairman HUIZENGA. The gentleman’s time has expired. 

Mr. Kruszewski, thank you for being here today, and you have 

5 minutes. 

STATEMENT OF RONALD J. KRUSZEWSKI, CHAIRMAN AND 

CHIEF EXECUTIVE OFFICER, STIFEL FINANCIAL CORPORATION, ON BEHALF OF THE SECURITIES AND FINANCIAL 

MARKETS ASSOCIATION (SIFMA) 

Mr. KRUSZEWSKI. Chairman Huizenga and Ranking Member 

Maloney, thank you for the opportunity to testify on behalf of 

SIFMA, and as chairman and chief executive officer of Stifel Financial Corporation. 

Stifel is headquartered in St. Louis, Missouri, and we own an investment bank and a federally-insured depository. Stifel employs 

over 7,000 people, has $20 billion in assets, and manages approximately $240 billion for our clients. 

To start, I am not a proponent of the Volcker Rule. I believe it 

provides little benefit regarding its stated purpose to reduce systemic risk. However, I have the upmost respect for Mr. Volcker, 

and to be clear, my criticism of the Rule is not a criticism of him. 

I remember all too well the accomplishments of Mr. Volcker as Fed 

Chairman in fighting the rampant inflation of the 1980s. 

Let me begin with my conclusion: It is my personal view that the 

Volcker Rule needs to be repealed. If not repealed, it must be materially amended to avoid further damage to the markets my company serves. Why be so bold? It is simple cost-benefit analysis. 

Stifel serves small and middle market companies and the investors in those same companies. We, therefore, have a front row seat 

to comment on the impact of Volcker on these companies. 

Make no mistake, I do not believe deposit-taking banks should 

be making risky short-term speculative bets. And, in fact, the law 

has long prohibited such activity. 

But I believe the way to regulate risk, systemic or otherwise, is 

not by inhibiting trading or traditional market making, which proVerDate Nov 24 2008 19:14 Apr 04, 2018 Jkt 027369 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\27369.TXT TERI
10 

vides liquidity and depth to our capital markets, but rather 

through capital and liquidity rules. 

The financial crisis was rooted in the loan book, not the trading 

book. Paul Volcker himself, in a speech in 2010, acknowledged that 

proprietary trading did not cause the financial crisis or contribute 

to the failure of a bank. 

The Volcker Rule is beyond complex, covering over 950 pages and 

2,800 footnotes. You need a team of law firms, not just lawyers, to 

be able to decipher this. 

The Rule includes a provision called Reasonably Expected Near 

Term Demand (RENTD), a concept only Government could devise. 

RENTD limits market making so it does not exceed the reasonably 

expected near term demand of clients, customers, and counterparties. 

Seven years after the enactment of Dodd-Frank, I am no closer 

to understanding what that term means or how to implement 

something so amorphous. Compliance with Volcker is governed by 

five separate agencies. That is five separate agencies. This fact 

alone supports a full repeal of this rule. 

In addition, the covered funds provisions of the Volcker Rule 

reached far beyond the intended focus on the use of hedge funds 

and private equity to facilitate indirect, impermissible proprietary 

trading. The provisions are highly technical and not focused on the 

actual activities of the entities that are captured. 

But what about the cost side of this equation? The Volcker Rule 

makes our capital markets less liquid, which increases the cost of 

capital for Stifel’s clients, especially smaller companies which are 

major contributors to job creation. 

Stifel helps our clients by assisting them in raising capital from 

both the equity and debt markets. As part of this equation, Stifel 

commits to make markets, which benefits both the issuing company 

and the purchaser of the equity or the debt. 

Volcker materially impacts our ability to effectively make markets. This in turns causes the buy side to require higher compensation, reflected in lower equity valuations or higher interest rates. 

Investors now demand a significant liquidity premium for bonds 

issued by smaller firms. 

Because it is difficult to raise capital, small firms increasingly 

are finding it difficult to compete with larger firms. Instead, they 

are selling themselves to their larger competitors. In fact, a lot of 

the corporate bond issuance is from large firms financing the acquisitions of small firms, the highest share in 15 years. 

As a result, the economy is likely to see less job creation, less 

competition, less research and development in CAPEX, and frankly, less vitality overall. 

As I stated, I personally believe the Volcker Rule should be repealed. If not repealed, at a minimum, the Volcker Rule should be 

modified to: first, reverse language that assumes that all trades are 

proprietary unless proven otherwise; and second, eliminate the 

RENTD requirement. 

Prominent policymakers have also raised concern with how the 

Volcker Rule is working in practice. As noted, former Fed Governor 

Jeremy Stein co-authored a recent article which stated, ‘‘The Rule 

11 

may dissuade dealers from providing liquidity during a market correction.’’ 

The article further stated that it is difficult to enforce, while at 

the same time creating large compliance and supervisory costs. On 

balance, we believe the Rule should be repealed. Recent Fed staff 

reports say that the Volcker Rule has a deleterious effect on corporate bond liquidity. 

Federal Reserve Governor Jay Powell urged Congress to rewrite 

the Volcker Rule, stating in part that what the current law and 

Rule do is effectively force you to look into the mind and the heart 

of every trader to see what their intent is. 

We should not be debating whether or not banks should get relief 

from Volcker. Instead, we should be debating whether our economy 

benefits from this Rule. From my vantage point, based on the clients I serve, it does not. Thank you. I look forward to your questions. 

[The prepared statement of Mr. Kruszewski can be found on page 

65 of the appendix.] 

Chairman HUIZENGA. Thank you for your input. 

Mr. Quaadman, you are recognized for 5 minutes. 

STATEMENT OF THOMAS QUAADMAN, EXECUTIVE VICE PRESIDENT, CENTER FOR CAPITAL MARKETS COMPETITIVENESS, 

U.S. CHAMBER OF COMMERCE 

Mr. QUAADMAN. Thank you, Mr. Chairman, Ranking Member 

Maloney, and members of the subcommittee. Thank you again for 

holding this hearing and for the subcommittee’s continued focus on 

the Volcker Rule, as well as issues impacting the ability of businesses to raise capital. 

The Chamber first started raising concerns with the Volcker Rule 

when President Obama introduced it in February 2010. We were 

concerned that the Volcker Rule would make it difficult to delineate market making and underwriting from proprietary trading. 

The Justice Potter Stewart Rule of, ‘‘you know it when you see 

it,’’ does not lend to clarity or for the certainty needed for businesses to raise capital or for markets to be efficient. 

We were also concerned that it would lead to complex regulation, 

and it would have a chilling effect on businesses’ ability to raise 

capital. Instead, while understanding the intent of the Volcker 

Rule, the Chamber proposed a pro-growth alternative for those 

firms that would engage in proprietary trading higher capital 

standards. 

Instead, today we have both. We have a complex Volcker Rule, 

and higher capital standards that have their own OECD regulatory 

regime. Additionally, the Volcker Rule is the poster child of why 

good economic analysis is necessary for rulemaking. No economic 

analysis was performed or shared with the public while regulators 

were considering the Volcker Rule. 

The OCC belatedly, 4 months after the Rule was finalized in December 2013, issued an economic analysis that also did not look at 

the impacts of the Volcker Rule upon consumers, the consumers of 

banks, or the broader economy. 

The irony is that the Volcker Rule, which is designed to limit the 

impacts of proprietary trading on depository institutions, where the 

12 

banking regulators were required under the Riegle Act to do an 

economic analysis to understand what the impacts were on depositary institutions and their consumers; yet, it was not done. 

In 2012, we had a study done by Professor Anjan Thakor of 

Washington University to list out what the business concerns and 

issues were with the Volcker Rule. And unfortunately, those are 

coming to fruition: bond markets are stressed with less liquidity; 

we have fewer market makers; and we have poor execution and diminished price discovery. 

The Federal Reserve-authorized study that we have talked about 

today finds that corporate bond markets’ stress is attributable to 

the Volcker Rule. Additionally, we have seen increases in cash reserves by corporations, 50 percent in the S&P 500 since DoddFrank was passed in 2010, and over $100 billion just in the first 

year of the Volcker Rule. 

The one thing that the Volcker Rule, as well as other regulations, 

has done, is increasingly forced corporations to use U.S. Treasuries 

as the sole means of cash management, which is increasing risk. 

If doctors were to prescribe a series of strong drugs and not 

check on drug interactions, they would be sued for malpractice. The 

Volcker Rule doesn’t exist in a vacuum. And we have to look at it 

in conjunction with the Basel III implementation rules, the SIFI 

rules, risk retention rules, money market funds, and the like. 

All of those combine in one place, and that is the corporate treasurer’s desk. Our 2016 treasurer survey, which interviewed over 300 

treasurers, found that 79 percent of treasurers felt that financial 

regulations were adversely impacting their business’ ability to raise 

capital, that current and pending regulations were making cash 

and liquidity operations more challenging, and 1⁄3 of treasurers 

were forced to take unexpected actions because of regulations. 

Businesses are now passing higher costs on to consumers. Onethird of treasurers see the situation worsening over the next 3 

years if things do not change. And what has changed since 2013 

is that businesses are dramatically using less banks in order to 

perform their financing functions. 

The Chamber supports the repeal of the Volcker Rule. But in the 

alternative, we will make four recommendations: one, that the regulators perform an economic analysis to the Volcker Rule and to 

also determine its impacts on bank customers in the broader economy; two, a cumulative impact analysis to the Volcker Rule and 

other regulations with the same accord. three, for the regulators to 

report back to Congress on findings and then anticipate a plan of 

action to address these failures; and lastly, the Congress should require banking regulators to do an economic analysis when writing 

rules subject to public review and comment, as other agencies do 

throughout the Government. 

Thank you, Mr. Chairman. I am happy to answer any questions 

you have. 

[The prepared statement of Mr. Quaadman can be found on page 

79 of the appendix.] 

Chairman HUIZENGA. Thank you very much. 

And last, but certainly not least, Mr. Whitehead, you are recognized for 5 minutes. 

13 

STATEMENT OF CHARLES K. WHITEHEAD, MYRON C. TAYLOR 

ALUMNI PROFESSOR OF BUSINESS LAW, AND DIRECTOR, 

LAW, TECHNOLOGY, AND ENTREPRENEURSHIP PROGRAM, 

CORNELL UNIVERSITY 

Mr. WHITEHEAD. Thank you very much, Mr. Chairman, Ranking 

Member Maloney, and members of the subcommittee. Thank you 

for inviting me to testify today regarding the impact of the Volcker 

Rule on the financial markets and the general economy. 

My name is Charles Whitehead, and I am a professor at Cornell 

University. Before becoming an academic, however, I spent 17 

years in the private sector and held senior legal and business positions in the financial services industry in New York and Tokyo. 

I testify today in favor of repealing the Volcker Rule. A principal 

goal of the Volcker Rule is minimizing risky trading activities by 

banks and their affiliates and consequently enabling banks to pursue a traditional banking business in providing capital to businesses and consumers. 

What the Rule fails to reflect is change in how credit is provided 

today, moving from traditional banking to increasing participation 

by banks in the capital markets. This necessarily involves the 

banks’ use of their own balance sheets to buy and sell securities 

as part of a market making function. Artificially constraining their 

ability to do so affects the smooth operation of the capital markets. 

Now, there is certainly an argument for regulating risky trading 

activities. But as you have heard today, the Volcker Rule addresses 

the wrong problem in the wrong way. 

The Volcker Rule was sold to Congress as a response to the 2008 

financial crisis, an attempt to reduce risk in banks, principally by 

banning short-term proprietary trading directly by banks and their 

affiliates and indirectly through investments and hedge funds and 

private equity funds. 

But why was restricting short-term proprietary trading a solution to the crisis? The answer is far from apparent and is unsupported by the facts that Congress had at the time. As Treasury Secretary Geithner testified, ‘‘Most of the losses that were material did 

not come from proprietary trading activities.’’ 

Rather, many of the most significant bank losses arose from traditional extensions of credit, especially loans related to real estate. 

I believe it is fair to say that the Rule’s proponents were less interested in curing a particular cause of the financial crisis and 

more interested in championing the view that commercial banking 

should be separated from investment banking, particularly prop 

trading and principal investments. 

By barring proprietary trading by banks and their affiliates, the 

Rule’s sponsors hope that utility services, such as taking deposits 

and making loans, would once again dominate the banking business. But that view reflected more hope than experience. 

In light of the fluid and evolving nature of the financial markets, 

it was unlikely that regulation could force a return to the financial 

sector model of an earlier era when banks and bank lending were 

kept separate from the capital markets. 

What has been the result? The Volcker Rule imposes a static divide, a financial Maginot Line between short-term proprietary trading and banking, but does so within a world where capital markets 

14 

and bank loans compete for corporate lending, and fluid financial 

markets continue to evolve and can sweep around the fixed position. 

Changes in the financial markets spurred by the Volcker Rule 

still expose banks to the kinds of risks the Volcker Rule was intended to minimize or eliminate. Hedge funds and other less-regulated entities, whose activities can affect banks and bank risk-taking, picked up the proprietary trading that had exited banks and 

their affiliates. 

Moreover, in order to make up for losses in revenues, banking 

entities shifted their risk-taking activities to other businesses, increasing their risk-taking potentially through activities with which 

they were less familiar than the proprietary trading they were 

compelled to abandon. 

The problems around the Volcker Rule are exacerbated by practical difficulty in implementing the Rule itself. What is proprietary 

trading, and how is it distinguished from market making? 

When implementing the Rule, the regulators noted that it was 

difficult to define certain permitted activities because it ‘‘often involves subtle distinctions that are difficult both to describe comprehensively within regulation and to evaluate in practice.’’ 

Likewise, industry participants have complained that the lack of 

definitional bright lines make it difficult for banks to comply with 

the Rule. As a result, banking entities have had to incur substantial costs in order to implement cumbersome supervisory and compliance regimes. 

And in order to avoid stepping over the line, many have pulled 

back from permissible market making activities. The resulting increase in investors’ execution costs and the decline in market liquidity means that investors will demand higher yields on new 

bond issuances. 

And you want to note, the challenge is not how much capital is 

raised but the incremental cost to issuers of raising it, a cost that 

affects Main Street as much as it affects Wall Street. The result 

is costly regulation with limited upside and the potential for greater downside. 

There are legitimate reasons to be concerned over the risks associated with a bank’s trading operation. But those risks can be more 

effectively addressed through other means, such as imposing capital charges on a bank’s trading books and the traditional bank regulator’s focus on risk management and assessing a bank’s safety 

and soundness. 

For those reasons, I believe the Volcker Rule should be repealed. 

Thank you very much. 

[The prepared statement of Mr. Whitehead can be found on page 

198 of the appendix.] 

Chairman HUIZENGA. Thank you all very much for your testimony. And I appreciate you being here. 

I guess I will start off my line of questioning with a quick comment, and then dive into questions. I would like to note that although the slides that the ranking member put up seemed to look 

pretty impressive, it is somewhat interesting to me, as chairman of 

this subcommittee, that the Fed staff didn’t see fit to provide me 

or Majority staff with any sort of briefing on the data. 

15 

I know I am merely the chairman of the subcommittee, but I believe that also is true for the actual chairman of the full Financial 

Services Committee, Chairman Hensarling. So I look forward to 

getting that briefing at some point. I also look forward to addressing that particular issue with Chair Yellen when she is in front of 

this committee in the future. 

But I don’t feel like I can adequately comment on the slides because, again, with no real understanding of what the Fed is trying 

to get at, I don’t know that I would be able to address that. 

I believe, Professor Whitehead, you might have done some work 

on this. So I will look forward to doing that. 

But I will point out that even I understand and appreciate that 

the purpose of the value at risk (VaR) is to measure risk and not 

liquidity, which is, in fact, what we are trying to look at here 

today. And it’s easy to note that outliers on these, even on those 

charts, don’t present whether they have great risk or little risk. 

But I would also like to remind everybody that the point of the 

hearing today is what is the impact of Volcker on our capital markets? And the question is, are capital markets less liquid as a result of Volcker? 

And I think the answer is a pretty clear ‘‘yes.’’ So we are not here 

to debate whether or not banks are making money. The question 

is, are they providing liquidity into the marketplace? 

So Professor Whitehead, I believe you note in your testimony 

that none of the financial regulators have published any data or 

analysis on the metrics that they are required to provide. Is that 

correct? 

Mr. WHITEHEAD. That is correct. 

Chairman HUIZENGA. And, as you know, what has been made 

public, I guess so far, is a report issued by the staff of the Federal 

Reserve in December which concluded that, ‘‘Since Volcker affected 

deals, dealers have been the main liquidity providers. The net effect is that bonds are less liquid during times of stress due to the 

Volcker Rule.’’ 

So Professor Whitehead, can you please expand on what the Fed 

staff report might be concluding there, and why? I know you have 

some interesting research that you had referenced as well. 

Mr. WHITEHEAD. Sure. Thank you very much, Mr. Chairman. 

The Fed staff report does an analysis that I think is important to 

understand not just in terms of the results, but also the way they 

have conducted the analysis. The question is not aggregate liquidity, and the question is not aggregate bond issuance. 

The real focus here is on relative liquidity, the extent to which 

there has been an impact on liquidity as a result of the Volcker 

Rule. And that is what the study does. 

So what they do is they are taking a baseline. They look at below 

investment grade bonds, BB bonds. And they use that as kind of 

a baseline for what liquidity might be generally in the market, both 

before and after the Volcker Rule. What they then do is they take 

a look at bonds that have dropped in credit quality. 

And this is key. During times of financial stress, you are going 

to see bonds collapse. And you need to have a market maker precisely at that time. This was one of the problems during the financial crisis. There was no one there to make that market. 

16 

And what they find is, comparing both the pre- and the postVolcker Rule, and using this baseline of below investment grade 

bonds as kind of their gauge as to whether or not the Volcker Rule 

has had an impact, is that when you see a credit decline, you see 

a substantial drop relative to the pre-Volcker period of liquidity in 

the marketplace. 

And, in fact, the point that is probably the most distressing in 

the report is they find that the level of illiquidity is quite similar 

to the illiquidity for similar distressed bonds during the financial 

crisis. 

And so rather than finding no impact, they find quite a substantial impact precisely in the class of bonds that we are most concerned about, namely those bonds where you need to have a market in order to manage your risk, again, during times of financial 

crisis. 

Chairman HUIZENGA. Thank you for that. 

Mr. Kruszewski, you note in your testimony that Volcker—I 

think the quote is, ‘‘Volcker materially impacts your—and presumably, your fellow SIFMA members’ as well—ability to effectively 

make markets and that the ultimate impact is a higher cost of capital.’’ 

I would like you to explain, but I do also want to highlight that 

on page 3 of your written testimony, I think one of the best lines 

is, ‘‘A compliance expert would also need to be a psychiatrist 

trained in determining the intent of each trade by a trader.’’ So if 

you could maybe unpack that a little bit? 

Mr. KRUSZEWSKI. Yes, we do need psychiatrists on our compliance staff now to get into the minds of our traders pursuant to 

Volcker. 

I do want to just add one thing, if I may? I believe that this very 

debate and the confusion in this debate was highlighted by putting 

up charts on VaR, which is value at risk and then using that to 

make an argument about Volcker. 

I find it to be apples and oranges at best. VaR is risk on the balance sheet. What we are talking about is the mechanisms to provide liquidity in the plumbing of capital markets. And Volcker absolutely hinders that. 

And that is, to answer your question, when we raise money for 

our clients, we commit to make markets. That liquidity is needed 

for efficient raising of capital. 

The Volcker Rule, because of the way it is written and its presumption that every trade is a proprietary trade unless proven otherwise, is a hindrance and a significant hindrance on the ability to 

make markets and to make effective markets. 

That, in turn, raises the cost of capital. And I do note in my written testimony that small issuers, on average, holding for credit maturity pay 75 to 100 basis points higher because of liquidity. 

Chairman HUIZENGA. All right, thank you. My time has expired. 

With that, I recognize the ranking member for 5 minutes. 

Mrs. MALONEY. Thank you. Just to clarify, the information that 

was provided to me from the Federal Reserve was in response to 

a list of questions that I sent to them requesting this specific data. 

I am sure they would be willing to provide it to any Member of 

Congress and meet with them on it. 

17 

But I would like to ask some questions about it to Mr. Jarsulic. 

And I would like to ask you about the Volcker data that I put up 

on the screen. 

My takeaway from the two charts of risk levels on the banks’ 

trading desks is that the Volcker Rule has not caused banks to pull 

back from market making even during periods of market stress. Is 

that your interpretation as well, Mr. Jarsulic? 

Mr. JARSULIC. Looking at these graphs from a distance, it does 

appear to me that there is essentially stable VaR across the various measures. And the VaR is stable even in time periods, as you 

pointed out, where there were some shocks to the market, the failure of Third Avenue, for example. 

And that suggests to me that the market making activity of the 

firms that we are looking at here, the firms that the Fed is looking 

at here, remains relatively stable during times of stress. And that 

suggests to me that these market makers are providing liquidity 

services in a very stable fashion. 

Mrs. MALONEY. In the second slide, which shows the returns the 

banks are getting from all the different asset classes they are trading, it shows a sharp difference between the returns that banks are 

getting on new positions versus existing positions. 

Can you talk about why it is important that banks are getting 

most of their returns from new positions rather than from existing 

positions? And what does that say about how the Volcker Rule is 

working? 

Mr. JARSULIC. The positive returns from new positions and essentially zero returns from existing positions, as you describe these 

data, suggests that they are earning profits from fees and commissions, that is from the assets they take on newly into their balance 

sheet, but that the inventory costs, the hedging costs for positions 

that they hold for longer periods of time in total are not producing 

significant profits for them. 

So that does suggest to me that the model is changing, that they 

are moving toward a real market making function where market 

makers try to run essentially flat books and earn their fees or earn 

their profits from fees and commissions. 

Mrs. MALONEY. So this data basically suggests that banks are 

not engaging in a significant amount of proprietary trading—it is 

a bottom line? 

Mr. JARSULIC. These data are certainly consistent with that view, 

yes. 

Mrs. MALONEY. And I would also like to ask you, do you think 

that this kind of data on Volcker Rule compliance is helpful because it allows us to monitor how the banks are reacting to the 

Volcker Rule and the impact that the Volcker Rule is having on 

markets? And do you think the regulators should be making this 

type of data public on a regular basis? 

Mr. JARSULIC. I would certainly agree that transparency in the 

functioning of this regulation and others is certainly important. 

The Federal Reserve, through publication of Y-9s for major bank 

holding companies, provides people with a lot of information about 

how banks are conducting their business, and therefore, you have 

direct and indirect information about the functioning of regulation. 

18 

I think people are interested, and rightly so, in the effect of the 

Volcker Rule and other regulations. And to the extent that these 

data can be produced on a regular basis to make the functioning 

of the financial system and the impact of the Rules transparent 

seems like a great idea. 

Now, there may be issues about how data are presented, how frequently, whether it ought to be current or not, what level of aggregation it needs to be presented. And I am sure the Fed would have 

views on that. But in general, I think the more transparency, the 

better. 

Mrs. MALONEY. Thank you. My time has almost expired. Thank 

you. 

I have other questions if there is a second round. Thanks. 

Chairman HUIZENGA. The gentlelady yields back. 

With that, the Chair recognizes the vice chairman of the subcommittee, Mr. Hultgren, for 5 minutes. 

Mr. HULTGREN. Thank you, Mr. Chairman. 

And thank you all, again, for being here. 

I want to address my first question to Mr. Kruszewski. Your 

written testimony notes that small and midcap issuers have experienced a disproportionately negative impact under structural 

changes to our fixed income markets, including the Volcker Rule. 

Citing your written testimony, ‘‘Since 2010, the number of deals 

sized at $2 billion and above has doubled, whereas the number of 

smaller deals, below $2 billion, has fallen by nearly half.’’ Why do 

you believe these small and midcap issuers are experiencing a disproportionately negative impact? 

And, as you know, small and medium companies are the foundation of competition and growth for our economy. So I think this is 

an important question for us to understand. 

Mr. KRUSZEWSKI. It is not only in the bond markets. It is across 

the spectrum of capital raising. So you will note that, and I am 

sure there is plenty of testimony about why we don’t have very 

many IPOs anymore either. 

For the debt markets, you need liquidity to efficiently price 

bonds. And it has become increasingly difficult. And Volcker is one 

reason to provide liquidity to the buy side to buy a bond. I find 

these charts interesting, that seem to suggest that banks are complying with Volcker. They are complying with it. It is the law. 

The question is the impact of that on issuing companies. And 

what my testimony, written and oral, says, and then from my position of being a market participant, I will tell you that if the intent 

of the Volcker Rule is to raise the cost of capital on job-creating 

companies, then it is a huge success. 

If its intent is to try to reduce some systemic risk in the trading 

books, there is no need for that. The ultimate cost to the economy 

is less liquidity and higher cost for smaller companies. 

Mr. HULTGREN. Mr. Kruszewski, you probably have heard Jamie 

Dimon’s quote. He said, ‘‘If you want to be trading, you have to 

have a lawyer and a psychiatrist sitting next to you to determine 

what your intent was every time you did something.’’ Or maybe 

Governor Powell’s quote, ‘‘The Volcker Rule effectively forces you to 

look into the mind and heart of every trader on every trade to see 

what their intent is.’’ 

19 

I wonder if you could describe how the Volcker Rule’s datacenter 

compliance framework attempts to replicate this concept of mind 

reading, and what compliance challenges does it pose for companies 

like yours? 

Mr. KRUSZEWSKI. First of all, the Volcker Rule has a presumption that every trade is a proprietary trade unless otherwise shown 

and then tries to use metrics to prove that point, or at least to 

allow you to have a safe harbor to get out at that point. 

And again, this will go back to why it is hard for small companies. The very definition of liquidity requires that in times of market making and in times of stress, you will make markets that will 

be different than the RENTD requirement of Volcker. 

In times of stress, there is more demand or more supply, and 

that is when you need to step up and do that. The Rule is very interesting in that even if you have an intent to meet customer demand but do not do so in a timeframe, you are in violation of the 

Volcker Rule. 

So you put all of these things together, and from my perspective 

I obviously do not want to violate any law of the land, what we will 

do is we have compliance and try to use these metrics which, as 

I testified, significantly and materially impacts our ability to make 

markets, especially in small, illiquid issues which, again, are bearing the brunt of the Volcker Rule. 

Mr. HULTGREN. Mr. Blass, page 10 of your testimony includes a 

line from Vanguard describing how liquidity is obtained along a 

cost continuum. I wonder if you could explain how reductions in liquidity under the Volcker Rule, like we are discussing today, impact funds and those who depend on them for retirement security? 

Mr. BLASS. Thank you very much. I think if you polled our members, they would give you a disparate view of liquidity in the markets. There are some interesting data points. If you compare today’s markets in corporate fixed income compared to the markets 

10 years ago, you will see smaller transaction sizes, fewer block 

trades. It is more work to execute transactions. 

There are some other data points. The transactional volume remains robust, so across our membership they will find that liquidity is available, recognizing that there are many other market participants. 

To your question, to the extent that market liquidity is not available, or becomes less available, it certainly drives up costs to market participants seeking to access certain instruments. 

Mr. HULTGREN. Thank you. My time is winding down, so I will 

yield back. 

Chairman HUIZENGA. The gentleman yields back. 

The Chair recognizes Mr. Himes from Connecticut for 5 minutes. 

Mr. HIMES. Thank you, Mr. Chairman. And I thank you all for 

being here. This is an important and interesting topic, one I have 

looked at for a long time. And I have studied the testimony here 

closely. 

Mr. Kruszewski, I have studied your testimony particularly closely, but I keep stumbling over this line in your testimony where you 

say, ‘‘The Volcker Rule includes a provision called RENTD, a concept only the Government could devise.’’ What do you mean by, it 

is a concept only the Government could devise? 

20 

Mr. KRUSZEWSKI. From a business perspective, you can’t implement it. 

Mr. HIMES. I know, but you are pointing at the Government. 

What does it mean, ‘‘a concept only the Government could devise?’’ 

Mr. KRUSZEWSKI. I think I answered it. I did say it is a concept 

that from a business perspective—as I said, I still do not understand the concept— 

Mr. HIMES. I will get to that. I am just troubled by the derogatory quality of that. Can you tell me what the three largest banks 

in the United States are today? 

Mr. KRUSZEWSKI. Do I know the three largest banks? 

Mr. HIMES. What are the three largest by assets in the United 

States today? 

Mr. KRUSZEWSKI. JPMorgan, Wells, and Bank of America. 

Mr. HIMES. It is JPMorgan, Bank of America, and Citigroup. And 

my question for you is, would any of those three banks, all of whom 

are your members, exist in anything resembling their present form 

had they not been recipients of the Troubled Asset Relief Program 

(TARP), a Government program? 

Mr. KRUSZEWSKI. You should ask them. I don’t want to answer 

questions for them. 

Mr. HIMES. But you, in your derogatory treatment of the government, would at least acknowledge that those three banks would 

have a hard time being with us today had it not been for a government program? 

Mr. KRUSZEWSKI. To the extent you take my comment as derogatory, I did not mean it that way, so I apologize if you read it as 

derogatory. I meant it from a business perspective. 

Mr. HIMES. Okay. Well, let us go to reasonably expected nearterm demand, which is the subject here. And I actually think this 

is really interesting. I don’t actually have that much problem with 

the idea of a reasonably expected near-term depend. 

I sort of explain it in terms of small business. You know, in my 

district, if we have a Toyota dealer and the Toyota dealer sells 100 

Toyotas a month, he keeps 120 on the lot, maybe 130. He doesn’t 

keep 400, and he doesn’t keep an Aston Martin. 

If he is keeping 400 or if he is keeping an Aston Martin, something is happening there other than him keeping an inventory that 

is consistent with reasonably expected near-term demand. 

And by the way, I will stipulate that this is a complicated Rule 

and it is hard to draw those fine distinctions, but isn’t the fundamental idea that the banks ought to be able to keep enough inventory to make markets but they shouldn’t have a lot more volatile 

assets on their books? Isn’t that fundamental principle pretty reasonable? 

Mr. KRUSZEWSKI. To make markets by rules and metrics, you 

don’t have a rule that says that that dealer can only have 100 cars. 

It is up to that dealer to determine reasonable demand. He may 

or may not be wrong, and he will mark down his inventory appropriately. 

You just are creating a rule which limits liquidity. If that car 

dealer wants to make a loan, if he is a public company, the Rule 

that you put in place will raise the cost to capital for that car dealership. 

21 

Mr. HIMES. No, I understand that, and of course there is a pretty 

dramatic difference between my Toyota dealer and the bank, which 

is that the Toyota dealer is disciplined by the fact that if he keeps 

700—in my example—cars on the lot and it goes wrong, he goes out 

of business. 

And the FDIC is not there to bail him out. The TARP is not 

there to bail him out, the 1994 Peso rescue is not there to bail him 

out. So I guess my big question, and this is for the panel as a 

whole, I have heard a lot of talk about short-term proprietary trading. 

Does anybody here think that FDIC-insured institutions should 

be taking long-term proprietary bets? Okay. The silence there I am 

going to take to be a ‘‘no.’’ 

Does anybody think that the real exercise here is not so much 

making it possible for depository institutions to make proprietary 

bets of any kind, but the Holy Grail here is to make sure that they 

have enough near-term inventory to make markets? Or does somebody want to make the argument that they should be able to take 

proprietary bets? 

Mr. KRUSZEWSKI. I think the difference is that drawing a line between market making and proprietary bets, as Volcker tries to do, 

is extremely difficult when you put it into law, and will cause financial institutions not to make markets because every trade is 

presumed under Volcker to be proprietary. That is bad policy. 

Mr. HIMES. No, no, and I will grant you that. I actually think it 

is a pretty complicated rule and I understand Jamie Dimon’s comments about psychology. 

But I think this is an important point, because I think that the 

burden is not on the regulators to explain why insured institutions 

should not be able to take proprietary bets. I got total silence here 

when I asked whether those institutions should take proprietary 

bets of any kind. 

I would just point out that I think the burden is on the industry 

to come up with constructive ways, if there are more constructive 

ways, of determining a legitimate inventory as opposed to making 

the argument that we should take away the idea that proprietary 

trading is somehow permissible inside a depository institution. 

So I thank you for being here. 

And thank you, Mr. Chairman. 

Mr. HULTGREN [presiding]. The gentleman’s time has expired. 

The Chair recognizes the gentlewoman from Missouri, Mrs. Wagner, for 5 minutes. 

Mrs. WAGNER. Thank you, Mr. Chairman, and thank you all for 

appearing here today to discuss the effects that the Volcker Rule 

has had on our capital markets, specifically on market making, 

which is important for holding down the cost of credit for consumers from credit cards, mortgages, to businesses that are seeking to issue debt and raise capital. 

Additionally, it also helps savers by allowing the funds that they 

are invested in to easily sell assets at a competitive price in order 

to meet redemption calls from its investors. 

For these reasons, the Volcker Rule is not something that simply 

affects broker-dealers and traders, but it has an impact on U.S. 

22 

companies, their employees, and individuals saving for retirement 

or to send their kids to college. 

Mr. Quaadman, welcome back, and I believe the notion behind 

the Volcker Rule was that it would prevent Wall Street-sized banks 

from engaging in proprietary trading, but can you discuss how 

many other institutions that don’t conduct any proprietary trading, 

even community banks, for instance, have been affected by the 

Volcker Rule in having to prove to regulators that they are not engaged in these activities? 

Mr. QUAADMAN. Yes, thank you, Congresswoman Wagner. First 

of all, I would also just like to state, too, that in January 2012 at 

a hearing here, Governor Tarullo also mentioned that the regulators who were drafting the Volcker Rule did not understand the 

markets or the products that they were trying to regulate here. So 

I think that is important to note. 

In terms of how this impacts other institutions, there are many 

institutions, including regional banks, even sometimes joint ventures overseas that non-financial businesses are engaged in, that 

have to create Volcker compliance programs. 

So I think even if the intent was to look at a small number of 

institutions, this has actually been broadened out. And as you start 

to put that on mid-sized and regional banks, that does have liquidity impacts on Main Street. 

Mrs. WAGNER. I appreciate that. 

I have a couple more vocal questions, and I know this question 

is a bit off topic, Mr. Chairman, but I would ask your indulgence. 

I feel it is timely as we approach the April 10th applicability date 

of the Department of Labor’s fiduciary rule. 

I would like to address a question to Mr. Kruszewski, who is, by 

the way, a constituent of mine. He is chairman and CEO of Stifel 

and is very active in the community affairs in the Greater St. Louis 

area, and here on behalf of SIFMA. 

Sir, I do not find your testimony to be in the least bit derogatory. 

I find it common sense, and frankly, refreshingly honest. You deserve the respect of this committee, as do all of you. 

Mr. Kruszewski, could you please explain the effect that a lack 

of certainty in waiting on the Administration to delay the Rule has 

had on your business as we get closer to the compliance date and 

the impact this misguided rule could have on your customers? 

Mr. KRUSZEWSKI. Thank you, first of all, but there is a lot of confusion regarding the Department of Labor rule and certainly the 

implementation date, which has clients and the industry and you 

name it, very confused as to how, if, and when this will be implemented. 

As I have testified in front of the DOL in a number of cases, this 

rule, while well-intended in certain cases, will have the result, for 

my clients, and I only speak to our clients, we have tens and tens 

of thousands of clients who will either lose advice or will have their 

costs raised, and raised significantly, because we will move them 

to a fee basis to do that. 

And I find that, and I have said I have found that to be an unintended consequence of this rule and a very costly one to a significant number of our clients, tens of thousands. 

23 

Mrs. WAGNER. Tens of thousands of low- and middle-income investors. 

Mr. KRUSZEWSKI. This rule significantly impacts small savers. 

Mrs. WAGNER. Thank you very much. I appreciate it. 

Let me go back to Mr. Quaadman in my brief time. As you know, 

President Trump earlier this year issued an Executive Order on 

core principles regarding regulations affecting the US financial system to determine if laws and guidance promote fostering growth 

and enabling U.S. competitiveness. 

Do you believe the Volcker Rule can promote those principles 

outlined in the President’s Executive Order? 

Mr. QUAADMAN. No. It has made it more difficult for smaller and 

mid-sized businesses to raise the capital that they need and that 

it has not made the capital markets at all more efficient. And it 

has, in fact, built in many inefficiencies, particularly when combined with the other regulations that I was talking about as well. 

Mrs. WAGNER. Thank you very much. My time has expired. 

I yield back, Mr. Chairman. Thank you. 

Chairman HUIZENGA. The gentlelady yields back. 

With that, we recognize the gentleman from Georgia, Mr. Scott, 

for 5 minutes. 

Mr. SCOTT. Yes, and thank you very much. I really cannot stress 

enough how important the Volcker Rule is. I call to your remembrance the situation with the London Whale, I believe it was, 

where proprietary funds, banks’ customers’ funds were used for 

risky bets. That caused a problem. 

The Volcker Rule must stay in place. But that is not to say that 

we do not want to make sure that it is working as it is. One of the 

goals of the Volcker Rule was to de-risk the markets. And as we 

all know, in pre-2008 banks were, indeed, allowed to take these 

risky bets with fully federally-insured dollars, putting the taxpayers at great risk, ergo the London Whale. 

But with that said, we will never be able to fully de-risk financial 

markets because we all know that fully de-risking markets is not 

what is best for the average American because almost every bank 

in the country, big and small, will go out of business. Because 

banks, indeed, have to make money as well. 

So with that said, Mr.—I am afraid, and I do not want to mess 

up anybody’s name, but I just got here, so I didn’t have time to 

practice. But I think it is Mr. Ronald— 

Mr. KRUSZEWSKI. Kruszewski. 

Mr. SCOTT. —Kruszewski? I’m sorry. And maybe Mr. Jarsulic. I 

think you are the two that I want to ask this question. I’m sorry. 

I hope I didn’t do too badly. 

Do you agree with what I am saying? What sort of economic 

growth will we have if you completely de-risk the system? And give 

me your understanding of the Volcker Rule, from your perspective. 

Did it go too far in de-risking or did it do too little? 

Mr. JARSULIC. Congressman, I do agree with you that financial 

institutions are in the business of bearing risk, and I think there 

is no attempt with the Volcker Rule or other regulation to end that 

function. 

I think that the Volcker Rule is intended to constrain certain 

highly risky activities, at least in the part of the financial system 

24 

that has direct and indirect support from the Federal Government 

and the taxpayer. So in that regard, it is a reasonable rule. 

I think that the Volcker Rule, given a close look at the evidence, 

has done very little harm and actually seems to have left liquidity 

and market making in at least as good a shape as it was before 

the implementation of that Rule. 

Maybe I could take a moment here to speak about the 2016 Fed 

study that people have cited as evidence that under stress conditions, there is— 

Mr. SCOTT. What was that study? I’m sorry, I didn’t— 

Mr. JARSULIC. In 2016, there was a Federal Reserve staff paper 

which looked at the effect of downgrades in bond ratings and concluded that post-Volcker, the price effect of those downgrades was 

bigger. And they drew the implication from that, that markets 

were less able to react to stress. 

Mr. SCOTT. I want to get to Mr. Kruszewski, too— 

Mr. JARSULIC. Okay. 

Mr. SCOTT. —in the next 40 seconds. What is your take on this? 

Mr. KRUSZEWSKI. First of all— 

Mr. SCOTT. Where am I going right or wrong on this? 

Mr. KRUSZEWSKI. First of all, if you want to limit the risks of the 

banks, then tell them not to make loans. That is where the biggest 

risk is. Let’s look at the loan book. That is where the financial crisis has its roots was in the loan book. 

There was no trading desk at Fannie Mae and Freddie Mac or 

Countrywide. There are no trading desks. All right? What you are 

talking about here, capital rules will and are proper to limit the 

risk on the banks. 

What the Volcker Rule is trying to deal with is the short-term 

trading and the mechanism to provide liquidity so that you have 

the efficient raising of capital, primarily for small companies. 

And this rule limits my firm, and I don’t—with all due respect 

to all the studies that are going on here, I run a firm that tries 

to make markets in compliance with the Volcker Rule. And I will 

tell you that our ability to do so has been significantly impacted, 

raising the cost of capital for companies that are creating jobs in 

this country. 

Mr. SCOTT. All right. Thank you very much. 

Chairman HUIZENGA. The gentleman’s time has expired. 

The Chair recognizes the gentleman from Arkansas, Mr. Hill, for 

5 minutes. 

Mr. HILL. Thanks, Mr. Chairman. Thanks for convening this important hearing. 

And I was struck by my former colleague Governor Powell’s 

statement that what the current law and rule do is effectively force 

you to look into the mind and heart of every trader on every trade 

to see what the intent is. And so I wonder, does Stifel have Ouija 

Boards on their trading desk? Because that was one of my favorite 

games as a kid, to ascertain the intent of everyone. 

But seriously, do you believe that when you have a rule that is 

this complex that it is just almost too difficult to comply? My experience in the financial services industry is that when you have a 

rule, your compliance officer and your general counsel walk back 

25 

from that rule in order to be even more conservative so there is no 

foot fault on what has already become a super complex issue. 

So what is Stifel’s worry about that? And every day how do you 

ascertain Mr. Himes’ idea of 700 cars versus 120? How do you try 

to do that daily? 

Mr. KRUSZEWSKI. From my perspective at Stifel, you cannot do 

that, because what my compliance and general counsel tell me is 

that the evaluation of what was in the mind of the trader will be 

questioned with the benefit of hindsight. 

And so it is like going to the car dealer who wanted 100 cars and 

he only sold 30. Then he must have prop-traded on the other 60, 

but at the time that he bought the 70, he had full intentions of selling 100. 

Mr. HILL. Yes. 

Mr. KRUSZEWSKI. Any rule that tries to, as Governor Powell says, 

get into the minds of a trader, is simply not workable. 

Mr. HILL. Yes. I really think that this sort of thing of that daily 

trading work is really best handled by strict capital and liquidity 

rules and not trying to carve out something unique. I just think it 

is—Potter Stewart couldn’t figure it out, so I am sure we can’t. 

My next question is, if proprietary trading has no social good or 

value in creating liquidity and creating markets, then why does 

Congress exempt U.S. obligations and those of States and municipalities from proprietary trading? I am missing something. 

Tom Quaadman, do you want to take that question? 

Mr. QUAADMAN. That is a very good question, because if you take 

a look at the Volcker Rule, if you take a look at Basel III, if you 

take a look at a number of other rules, U.S. Treasuries are always 

exempt. And as I was talking to a corporate treasurer, he said the 

impact of all these rules, at the end of the day, to their logical outcome, is companies are going to have to put their financial resources into U.S. Treasuries. 

And what we have seen over the last several years is a chronic 

shortage in U.S. Treasuries, as well as stresses in those markets. 

Mr. HILL. I have also heard from community banks. 

And I wonder, Ron, your comments on this. Community banks 

are saying they had to sell off profitable businesses and investments because of the Volcker Rule. And I think Congress, back in 

1958, specifically said you can invest 5 percent of capital and surplus in small business investment corporations (SBICs). 

And I don’t think anyone has criticized that for almost 60 years 

now, using just a simple, ‘‘can for’’ test to invest in small and intermediate lending, to enhance net interest margin, to have some diversification at bank and bank holding companies. And yet, I think 

people are divesting similar investment funds in which they are 

not sponsoring—they are just simply a passive investor. 

Have you seen community banks divest at the holding company 

or bank level where they have just made a passive investment in, 

say, a community bank fund sponsored by your firm? 

Mr. KRUSZEWSKI. Again, it goes— 

Mr. HILL. Yes, all because of Volcker, right— 

Mr. KRUSZEWSKI. Totally. 

Mr. HILL. —because there is a perceived problem that they 

might— 

26 

Mr. KRUSZEWSKI. This deals with the complexity of the covered 

fund rule in Volcker and what is permissible or not permissible. 

Again, this is— 

Mr. HILL. Is that something that we should pay specific attention 

to in what we are doing? I know we are proposing to repeal the 

Volcker Rule. But in terms of a nuance, can you talk a little bit 

more about that for— 

Mr. KRUSZEWSKI. I think if you are going to modify Volcker, you 

need to look at the covered rule. I think, Mr. Blass, that is what 

your testimony was about in many ways. And so we have to look 

at that. 

Mr. BLASS. Yes. 

Mr. HILL. Mr. Blass? 

Mr. BLASS. I agree entirely. The covered fund definition is very 

confusing. The regulators seem to be targeting hedge fund, private 

equity-type activity. But they over-included and included some very 

different types of activity. 

I have an example in our written testimony about tender offer 

bonds, which are a very simple mechanism for holding municipal 

securities, just holding them in a bank trust. And banks have no 

longer been able to sponsor those in many different sectors. 

Mr. HILL. Good. Thank you for that testimony. 

Thank you, Mr. Chairman. 

Chairman HUIZENGA. The gentleman’s time has expired. 

With that, I don’t see any Members on the other side of the aisle, 

so I will go to Mr. Emmer from Minnesota for 5 minutes. 

Mr. EMMER. Thank you, Mr. Chairman. 

And thanks to the witnesses for being here today. I appreciate 

your time. 

Last Congress, I understand this committee received testimony 

from a number of market professionals about the current impacts 

of regulation on fixed income market liquidity. 

One of the witnesses in one in these hearings in the last Congress stated that the net effect of post-crisis regulations is to ‘‘remove productive capital out of the real economy and leave it 

stranded in government securities.’’ 

And I think I will start with Mr. Kruszewski. Do you believe the 

U.S. economy is already experiencing these impacts in this real 

economy, even though many of these regulations are still being implemented? 

Mr. KRUSZEWSKI. Yes, although I do want to say that the capital 

rules and many of the Rules that were focused on raising capital 

and liquidity in the banks were well-thought-out and done well. 

And I don’t want to suggest that that is not the case. 

But I do want to say that there are a lot of rules that need to 

be relooked at, which is what I think this committee is doing in 

looking at Dodd-Frank. And specifically, the Volcker Rule is an example where the financial system in any capitalistic society has the 

requirement to provide liquidity. And this Rule significantly hampers that. 

And when you pull capital out of an economy, you are going to— 

the U.S. Government market doesn’t need the liquidity. It is the 

largest market in the world. It has liquidity almost by definition. 

To exempt Volcker from it, I almost smiled at, because it doesn’t 

27 

need liquidity. My clients need liquidity. My clients who are trying 

to raise capital need liquidity. And Volcker sucks liquidity from 

those clients. 

Mr. EMMER. It is actually access to capital that we are talking 

about. And I go back a couple of questioners. The reason I put this 

to you first is you said it is making capital more expensive and 

harder to achieve for your clients, access to capital. 

And I go back to my question, in your experience, is this having 

an impact on our real economic growth? 

Mr. KRUSZEWSKI. Well, if you can’t raise capital, you are not 

going to invest and have CAPEX, and you are not going to create 

jobs. 

And what I see is many companies, smaller companies today— 

and I think this committee should take note that many small companies today do not go public, do not have access to the capital 

markets in an efficient manner, and ultimately exit by selling 

themselves to their larger competitors. I note that in my testimony. 

Mr. EMMER. Right. 

Mr. KRUSZEWSKI. And I believe that the health and vibrancy of 

the U.S. economy requires that our market structure and the Rules 

that we put in place, which has significantly impacted the ability 

to raise capital and has impacted job formation, needs to be looked 

at and needs to be looked at post-haste. 

Mr. EMMER. Mr. Quaadman, I want to take this a little bit further, because my colleague, French Hill, worked on the banking 

side of it. And he was making sure that he could make that accessible to his customers, his clients. 

I am on the business side of it, and you are, too. You are representing all kinds of businesses. And we have this anemic, that 

some people want to celebrate, 2 percent or less annual economic 

growth. It is pathetic. 

When you look at this situation, if you start to get five agencies 

implementing this rule that is so complex that people who are experts in it even have trouble applying it and knowing what their 

liability might be, what do you think the impact has been on the 

economic growth in this country? 

Mr. QUAADMAN. It has had a negative impact. And as we outlined in the Thacker study, this does have impacts on capital 

spending and the like. 

But let me give you one example. I talked to a corporate treasurer and he described for me a few years ago that he had to go in 

the day after Thanksgiving. He had to sell commercial paper in 

order to pay bills for the company. 

Obviously, it was a slow trading day. The bank comes back at 

the end of the day and says, we were only able to sell half the commercial paper, but here is the full amount, and we aren’t going to 

be able to sell the rest. So the bank took on the risk. His point was 

that post-Volcker, that transaction does not happen. 

Mr. EMMER. Right. 

Mr. QUAADMAN. The bank doesn’t want to engage in that. The 

company can’t engage in that capital in that way. And actually, 

that lack of sale of commercial paper takes money out of the productive economy. So they have to operate on a much longer time 

horizon and then much more inefficiently as well. 

28 

Mr. EMMER. So it has had a real impact on our economic— 

Mr. QUAADMAN. Yes. 

Mr. EMMER. —growth. Thank you very much. 

I see my time has expired. 

Chairman HUIZENGA. The gentleman’s time has nearly expired. 

With that, we will go to Mr. Davidson from Ohio for 5 minutes. 

Mr. DAVIDSON. Thank you, Mr. Chairman. 

And thanks, Mr. Quaadman. I really think Mr. Emmer asked a 

good question. It was going to be one of my first in the queue, what 

are real-world examples of how this is affecting businesses? 

And so, in the background, it is easy to see how the regulatory 

state and the regulatory environment are impacting access to capital, from what you just described in the bond market. 

I am curious if anyone on the panel has a similar example in currency markets, is a lot of the things along with the regulatory environment with Volcker combined with the currency markets has affected that. 

A lot of examples we talk about, this London Whale issue and 

things like that, but currency markets is another important way for 

things to clear. It is a highly liquid market. How is Volcker impacting it? 

Mr. QUAADMAN. I think there are a number of different impacts 

there. And, obviously currency trading is integral for the ability of 

our members to trade overseas and to do overseas deals. And that 

is much more difficult. 

And the reason why I was raising some of the other rules is 

when you also take the foreign bank operations rule, it has also retreated those banks from being a liquidity provider here in the U.S. 

and also to act as a counterpart in currency trades. 

But I think we have to also look at some of these other rules in 

conjunction with Volcker because, as I said, they do all sort of combine at the corporate treasurers’ desk and have made their life 

more difficult their ability to service the company more inefficient. 

Mr. DAVIDSON. Thank you. 

I am curious, on the bank regulatory side, when you are looking 

at how the banks are being assessed, there are four agencies that— 

or at least four as of this writing here—are charged in a 94-word 

sentence on page 247 with working together to enforce that. 

And just some real-world examples, if you could, about how well 

is that working? 

Yes, please? 

Mr. BLASS. I would be happy to volunteer one. The agencies are 

required to work together even to issue guidance that is helpful to 

the industry or needed by the industry to make the Rule work. 

In our example, we had a rule that seemed to prohibit new fund 

launches using seeding capital from fund managers that are affiliated with banks. It took the agencies 3 years to work together to 

ultimately issue that guidance just a week or two before the Rule 

went into compliance. That causes all kinds of disruption to a business, as you might imagine. 

Mr. DAVIDSON. Of course. 

Mr. BLASS. For our industry, that is a critical function, being 

able to launch new funds, so it was very disruptive. 

29 

Mr. DAVIDSON. Yes, and so you put those things together, whether it is the supply or the demand of the service that banks provide, 

how is that affecting the market today? How would the future be 

better today with or without Volcker? 

And I will just ask Mr. Jarsulic? 

Mr. JARSULIC. Sorry. If your question is how would the economy 

be functioning without Volcker, I think that if you look at the evidence on the effectiveness of market making, on the statistical 

measures of liquidity in the secondary markets, I think that the 

Volcker Rule has not done any damage. And, in fact, it has preserved the good functioning of those markets. 

And at the same time, we have managed to make our banking 

system a bit safer because we have blocked off a source of potential 

tail risks to the banks that in the past were engaging in proprietary trading. 

Mr. DAVIDSON. Okay. So thanks— 

Mr. JARSULIC. So I think that there is an overall gain from this. 

Rather than— 

Mr. DAVIDSON. Okay. So your take is is that the markets are addressing the need in other ways. And I guess I would ask, down 

the way— 

Mr. JARSULIC. No, no, I am not— 

Mr. DAVIDSON. Professor Whitehead, perhaps, your perspective 

on how accurate that is? 

Mr. WHITEHEAD. Yes, sure. The Fed report actually indicates 

that roughly 93 percent of the market making activity that was 

taking place pre-Volcker was done by large banks that are no 

longer available because of Volcker; they are now pulling back. 

And so the question is whether or not hedge funds, insurance 

companies, mutual funds, and other sort of non-Volcker broker 

dealers are stepping in. And the Fed report directly addresses this 

and suggests that it is not happening, that you are seeing a drop 

in liquidity notwithstanding the expectation that there might be 

some backfilling. 

Mr. DAVIDSON. Thank you. My time has expired. 

Chairman HUIZENGA. The gentleman’s time has expired. 

The gentleman from Illinois, Mr. Foster, is recognized for 5 minutes. 

Mr. FOSTER. Thank you, Mr. Chairman. And I would like to yield 

my time to my colleague from Connecticut, Mr. Himes. 

Mr. HIMES. I thank the gentleman from Illinois. And again, 

thank you all for being here. In my previous round of questions I 

think I can conclude that there wasn’t a lot of appetite for the idea 

of permitting depository institutions to take proprietary bets. 

I think we went through long term and short term, and I didn’t 

sense a lot of enthusiasm for that or for investment in hedge fund 

vehicles. 

A repeal of the Volcker Act, of course, would allow that to happen. So I want to get behind an issue here that I think is really 

interesting and hopefully you can help us with. There is ambiguous 

data, and we are hearing if from the panel today, about whether 

the Volcker Rule is, in fact, compromising liquidity in the markets. 

30 

There is not a lot of ambiguity around whether the markets are 

healthy. New issuance is high. We have some question about 

whether smaller issues are affected. 

But let me ask this and I will ask it of anybody. I get frustrated 

in these conversations because the premise is there is not enough 

liquidity, or there is not enough credit availability, or there are not 

enough IPOs happening. So let me just ask this as a starter question. 

Is more liquidity always good? Is there some—let me put it this 

way. Is there some optimal level of liquidity above which the system becomes risky, below which capital markets aren’t functioning 

well? 

Mr. KRUSZEWSKI. Well, I can say liquidity comes at a price on either side. So liquidity comes at a price and you can argue that too 

much liquidity isn’t good either in terms of just too much money 

flashing around. So liquidity comes at a price. 

But I do want to just say that when you talk about our long-term 

proprietary bet that we make at Stifel is to make a loan. That is 

our long-term proprietary bet. The short term that we are talking 

about here, in my opinion, is harmful. It takes away liquidity. So 

you are pricing liquidity too dearly with the Volcker role. 

Mr. HIMES. No, and I understand that. I appreciate your business. Banks are in the business of making loans. They are arguably 

not in the business of making other proprietary bets. 

And to your point, I am not dismissing your statement. There are 

others. I have a letter here from Vanguard that says that it has 

had no problem finding liquidity in counterparties in the market. 

So I guess let me come back to my question, which is a very serious question because it should inform what we are doing here. I 

think most would agree that infinite liquidity is not a good thing. 

And therefore, there is some optimal level of liquidity. 

Too little is not good. Too much is not good either. So I am looking—no one up here can say there is not enough liquidity in the 

market unless they can also say here is the optimal level. 

So I am just looking for help from anybody in terms of, how will 

we know when there is optimal market liquidity? Because if we 

don’t answer that question, none of the statements about there is 

too little or there is too much mean anything. So help us establish 

what the optimal—how we will know if we are at an optimal market liquidity level? 

Mr. KRUSZEWSKI. All I will say is that the market will get to the 

optimal level. You won’t get to the optimal level through regulation. 

Mr. HIMES. I was a banker for a long time. And oftentimes when 

the market forces have been most active, there has been too much 

liquidity and catastrophe that followed. This goes back to the South 

Sea bubble hundreds of years ago. So I am not sure I buy that 

premise. 

But, again, and let me actually single out Professor Whitehead, 

because this is a pretty academic question, none of our statements 

about whether we have too much or too little liquidity mean a darn 

thing unless you can anchor me in some concept of optimal liquidity. So how do we do that? 

31 

Mr. WHITEHEAD. Sure. So again, I will take you back to the Fed 

report, which I think tries to do just that. They are taking a look 

at the BB index. They are looking at that as the baseline. And then 

they are looking at instruments that drop in credit value down 

from whatever they were down to something that is near BB. 

And what they are doing is comparing the two. And they are saying, well, look this BB we look at it pre-Volcker and post-Volcker. 

And that is our baseline. 

Now let’s see what happens when we have this decline, which is 

really sort of a gauge for stress. And what we see in that instance? 

There is a pullback. So that is your baseline, right? Your baseline— 

Mr. HIMES. A pull back from when, though? 

Mr. WHITEHEAD. A pull back relative to what you see in terms 

of pre-Volcker versus post-Volcker. 

Mr. HIMES. Yes, yes. The pre-Volcker—none of us want to go 

back to 2008, right? Where I would argue you had a surplus of liquidity, so again— 

Mr. WHITEHEAD. What I am saying is the baseline isn’t pre-imposed. The baseline is the BB which is pre-imposed. In other 

words, they are taking a look at the stress analysis both before 

Volcker and after Volcker relative to a baseline that is a below investment grade, index, these BB instruments. 

And so the idea, as I was saying earlier, it is not a question of 

absolute. It is a question of relative liquidity. And so they are trying to judge whether or not as a result of Volcker you see this decline relative to this, again, baseline of BBs. So your baseline kind 

of would be, maybe not optimal, but certainly some sense of what 

we are looking at independent of this drop in credit quality. 

The drop in credit quality is kind of this way to estimate what 

happened during the financial crisis. And what they see is is that 

as a result of the drop relative to this baseline of BB instruments 

that you actually see a pullback in terms of liquidity. 

So I think it is hard to sort of pinpoint a number, which is what 

you are looking for, I think, or some optimal number. And I believe 

that is what the testimony before was really getting at in terms of 

the market, that you are not going to have an optimal number. 

But what I think you can do is gauge it relative to other indices 

like they do in the Fed report. And that is why they conclude that 

in times of stress you do see this problem. Or you are likely to see 

this problem, again, relative to this more standardized BB index. 

Mr. HIMES. Thank you very much. I appreciate it. 

Thank you, Mr. Chairman. 

Chairman HUIZENGA. The gentleman’s time has expired. 

I now recognize the gentleman from Indiana, Mr. Hollingsworth, 

for 5 minutes. 

Mr. HOLLINGSWORTH. Good morning. Thanks, everybody, for 

being here. I have really appreciated the testimony this morning. 

And specific to Mr. Kruszewski, I certainly appreciate your 

healthy, and I think very warranted, skepticism for government solutions being promulgated on business. 

I often think back about a quote somebody gave me which is, ‘‘If 

you think our problems are bad, just wait until you see our solutions.’’ And I frequently think of this with regard to government, 

and specifically with regard to this. 

32 

Can you help me better understand, because I think there is 

some misunderstanding about the cause of the crisis. And when I 

think about the cause of the crisis, I think about loan books. I don’t 

think about prop trading desks. I think about the risks that were 

taken on those books. So I guess for you Mr. Kruszewski, can you 

tell me a little bit about what you felt like caused the crisis? 

Mr. KRUSZEWSKI. Yes. I will add to the 100 books— 

Mr. HOLLINGSWORTH. Yes. 

Mr. KRUSZEWSKI. —that have tried to explain the crisis. The crisis is interesting. Simply, you take leverage and you take loans and 

you combine rating agencies and misconceptions of a whole bunch 

of things and you package them together. And when the house 

came apart it came apart big. And it is that simple. 

Mr. HOLLINGSWORTH. Okay. And when these banks were making 

these bets on mortgages, they are inherently taking certain risk. 

And my colleague, Mr. Himes, talks about those being of lesser 

risk. But they are inherently taking long term bets both on interest 

rate and credit risk, right? 

The typical residential mortgage is 30 years in this country. And 

so, when we talk about short-term proprietary trading versus long 

term proprietary trading, the reality is on a loan book there is real 

risk, and real long-term risk if that is not— 

Mr. KRUSZEWSKI. I think it is important that in any capitalistic 

society that when you have a crisis, the financial system will be in 

the middle of it, because the financial system is an intermediary 

and it provides loans and crises will come out of leverage and 

loans. 

And so on one hand you can simply almost eliminate that if you 

de-risk the system— 

Mr. HOLLINGSWORTH. Right. 

Mr. KRUSZEWSKI. —and just make no more loans. You are not 

going to have a crisis. But we need loans and we need good capital 

rules. 

To address, just quickly, the one question, what is too much liquidity? What I would say to that, and I think it is important, is 

that we have had a fire hose running one way for about 4 years 

where tremendous liquidity has come into the system through the 

issuance of corporate debt because interest rates are low. It is a 

policy issue. That is about to reverse. You are not going to see that. 

And you are going to see potentially the other way. 

And that is why we need the ability to have a functioning market 

to balance when the liquidity runs the other way, because issuing 

corporations are not going to buy back their debt. 

Mr. HOLLINGSWORTH. Right. 

Mr. KRUSZEWSKI. It is going to need to be replaced. 

Mr. HOLLINGSWORTH. And just one final point on that. When you 

think about crises, and especially crises where significant price 

drops are very acute, I don’t think about there being too much liquidity in those moments. 

In fact, I think about there being too little. A ready number of 

sellers and too few buyers and too few opportunities to offload it. 

That is what accounts for gaps downward in price. 

So when my friend says these crises may be on account of too 

much liquidity, I think the significant constraint in that, especially 

33 

in this momentary passing of crises, is often too little liquidity and 

an inability to find enough ready-made buyers or sellers. Is that 

generally the concept of what happens in the middle of a crisis? 

Mr. KRUSZEWSKI. You can argue that too much liquidity goes into 

the asset and there is not enough liquidity to buy it back. 

Mr. HOLLINGSWORTH. Right. 

Mr. KRUSZEWSKI. So there is—liquidity is a funny thing. 

Mr. HOLLINGSWORTH. Yes. 

Mr. KRUSZEWSKI. And I would just say that if we were sitting 

here today with 2 percent GDP growth, not even 2 percent GDP 

growth, and we were debating how to put market structure and 

regulations in place to drive economic growth, to get jobs going, 

and to do a number of things, the Volcker Rule would have no 

chance of passing under that basis. And that is why I sit here 

today is that for that same reason it needs to be repealed. 

Mr. HOLLINGSWORTH. Right. Thank you so much. I appreciate it. 

I yield back the balance of my time. 

Chairman HUIZENGA. Will the gentleman yield to the Chair? 

Mr. HOLLINGSWORTH. I will. 

Chairman HUIZENGA. All right. Because I want to actually amplify this, and Professor Whitehead, I am curious because as I was 

writing down, and I think Mr. Kruszewski had a figure of how 

many points increase that he thought that Volcker was costing in 

this environment, but I can’t recall exactly what that number was. 

But the real question I have is what happens when interest rates 

go up? And what is going to happen? Is the Volcker Rule going to 

cause an even tighter situation? 

Mr. WHITEHEAD. Well, that is the concern, that the Volcker Rule, 

because of the pullback from making a market, sort of secondary 

liquidity, is going to cause investors to be more reluctant to invest 

because they are not quite sure where to offset. 

It is the point that Mr. Kruszewski was just making a few moments ago. And as a result the cost of raising capital will go up 

as well. Not knowing what the risk is that I am going to take as 

an investor, I am going to expect a little bit more in anticipation 

of the risk of not being able to sell. 

Chairman HUIZENGA. All right. The gentlemen’s time has expired. 

With that, the Chair recognizes the gentleman from California, 

Mr. Sherman, for 5 minutes. 

Mr. SHERMAN. Mr. Chairman, as we explore the Volcker Rule, we 

have five excellent witnesses here, but I would like to bring to the 

attention to the subcommittee four witnesses who aren’t here. 

The first is President Barack Obama who said, ‘‘The Volcker 

Rule will make it illegal for firms to use government-insured 

money to make speculative bets that threaten the entire financial 

system and demand a new era of accountability from CEOs who 

must sign off on their firm’s practices. Our financial system will be 

safer, and the American people are more secure because we fought 

to include this protection in the law.’’ 

Now, the fact that President Obama would support the Volcker 

Rule is not surprising. But here are three other witnesses. Our own 

chairman of the full Financial Services Committee, Chairman Jeb 

Hensarling, in March 2013 said, ‘‘Certainly we have to do a better 

34 

job of ring-fencing, firewalling, whatever metaphor you want to use 

between an insured depository institution and a non-insured investment bank.’’ 

But the Speaker of the House was even more clear when he said, 

‘‘If you are a bank and you want to operate like some non-bank entity, like a hedge fund, then don’t be a bank. Don’t let banks use 

their customers’ money to do anything other than traditional banking.’’ That is the Speaker of the House in May 2012. 

And finally, our Treasury Secretary Steve Mnuchin, ‘‘I do support 

the Volcker Rule. I think the concept of proprietary trading does 

not belong in banks with FDIC insurance.’’ 

Perhaps it would be great to have Jeb Hensarling, Paul Ryan, 

and the Secretary of the Treasury here as witnesses to talk to us 

at this subcommittee hearing about the Volcker Rule. 

Mr.—will you pronounce your last name for me, sir? 

Mr. KRUSZEWSKI. When you stumble, I know the question is coming to me. 

[laughter] 

Ronald Kruszewski. 

Mr. SHERMAN. What? 

Mr. KRUSZEWSKI. ‘‘Kruszewski.’’ 

Mr. SHERMAN. ‘‘Kruszewski.’’ Those who authored Dodd-Frank 

gave enforcement powers to five different agencies, each with primary oversight over a different segment of the industry. 

Does your company have multiple regulators? Are they enforcing 

the Rule differently? In your experience, have the regulators coordinated with each other effectively? 

Mr. KRUSZEWSKI. I think the regulators do the best they can. But 

the fact is that the Federal Reserve comes in and they have a certain view. And the OCC comes in and they have a different view. 

They have different mandates on top of it. So obviously, you 

would expect me to say nothing other than to have five different 

agencies come in and interpret and enforce a rule, as a businessman I don’t think it is a good idea. 

So are they well-intended? Yes, but the enforcement tends to be 

a race to the bottom and which makes me have to take the most 

conservative viewpoint as to what the most conservative interpretation of Volcker may be. 

Mr. SHERMAN. Yes. You used the term, ‘‘race to the bottom.’’ In 

some spheres that means a race to lower and lower and lesser and 

lesser regulation. But I think you mean to say it is a race toward 

tougher and tougher regulation because you have to comply with 

all five. 

Mr. KRUSZEWSKI. I keep thinking in terms of liquidity availability, so I apologize. 

Mr. SHERMAN. Okay. 

Mr. Jarsulic, it has been argued that prohibiting proprietary 

trading will hurt our banks as they compete with banks overseas. 

The European Commission recommended a version of the Volcker 

Rule for its largest banks and the U.K. government is adopting a 

similar proposal that pushes risky trades into separately capitalized ring-fenced entities. 

How relevant are the competitive concerns given that our major 

competitors are moving in a similar direction? 

35 

Mr. JARSULIC. I think that the movements on the part of foreign 

regulators suggest that they, too, recognize the risks that are posed 

by proprietary trading and the effects that they can have on the 

operation of a banking system. And so I think that there is a reasonable probability that the business models of their banks will be 

similar to the business model of ours. 

But even if that were not true, I think it is important to calculate 

the risks that these kinds of activities pose to a banking system. 

And what we are looking for is a stable, sound banking system that 

doesn’t produce extreme financial events. 

And the fact that our banks aren’t participating in activities that 

other banks are, doesn’t weigh all that heavily against that consideration. 

Chairman HUIZENGA. The gentleman’s time has expired. 

With that, the Chair recognizes the gentleman from New Jersey, 

Mr. MacArthur, for 5 minutes. 

Mr. MACARTHUR. Thank you, Mr. Chairman. 

Mr. Jarsulic made a point at the beginning in his opening remarks that excessive risk-taking had caused terrible damage and 

harm to people and to our economy. I don’t think any of us would 

disagree with that. 

We watched as millions of people lost their homes, and millions 

of others lost their fortunes. Shareholders lost their fortunes, even 

modest ones. And then taxpayers ended up footing the bill. 

And unfortunately, often those three people are one and the 

same: the homeowner; the shareholder; and the taxpayer. They got 

hammered three times, and $10 trillion of wealth or more, disappeared. 

I guess the question that keeps coming back to me is—I wasn’t 

here in Congress when all this debate about Dodd-Frank went on 

and the aftermath of that—does this Rule, this particular Rule, address any of that? 

And so I want to start by asking you each just a yes-or-no question, starting with Mr. Blass. Yes or no, does the Volcker Rule, in 

your opinion, address the fundamental causes of the crisis that 

brought it about in the first place? 

Mr. BLASS. It is not clear at all to us that it does. Certainly for 

our industry it misses the mark widely. 

Mr. MACARTHUR. Mr. Blass, I am sorry because you haven’t spoken much so I am sorry to cut you off, but I have a few other questions. Just a yes or a no for this one if you would? 

Mr. BLASS. It seems to miss the mark widely. 

Mr. JARSULIC. I believe it addresses a part of the things that led 

to the financial crisis. 

Mr. MACARTHUR. You guys should run for Congress. 

Mr. JARSULIC. No. 

Mr. MACARTHUR. Yes or noes are hard to answer here, too. 

Mr. QUAADMAN. The answer is no. 

Mr. WHITEHEAD. I will do what professors never do, one word, 

no. 

Mr. MACARTHUR. Thank you. Okay. 

Professor Whitehead, I want to follow up with you on something 

that you also said. I have never been a banker. I ran an insurance 

36 

company and then I was a private equity partner. So that is sort 

of my view of some of these things. 

It seems to me that it doesn’t really matter if banks do smart or 

dumb things from my perspective, as long as they don’t do too 

many of them with other people’s money, or worse yet, with leveraged assets, because that creates certain issues. 

Do you think there is a tipping point at which too much risk, 

taking too much risk as a bank holding company, or worse yet, taking too much leveraged risk does create risk of failure that can get 

out of control? 

Mr. WHITEHEAD. I would respond in two respects. The answer is, 

yes, I do think there is a point where there is too much risk, although that tends to be addressed through things like leverage ratios and capital requirements. 

And secondly, keep in mind, the Volcker Rule extends beyond 

banks. It covers all bank affiliates as well. So a lot of the testimony, a lot of the quotes that I have heard from folks who speak 

in support of the Volcker Rule speak to the depository institutions. 

And again, you want to keep in mind, we are talking about nonbank affiliates also. 

Mr. MACARTHUR. And I think you make an excellent point. It 

seems to me that the emphasis ought to be on leverage ratios and 

capital requirements because then instead of people in government 

trying to control very fluid markets, and they are fluid; I was a 

businessman for decades. Things change by the day, and business 

people respond by the hour. 

So instead of having bureaucrats try to figure all that out and 

control it, it seems to me we would be better off creating the limitations that stop us from hitting that tipping point instead of trying 

to decide who can do what in the broadest of categories. 

And this gets to some remarks that my friend from Connecticut 

was asserting before that we are trying to march towards and manage some optimal liquidity level. 

If it exists, it doesn’t exist for more than a moment. And I am 

convinced it doesn’t exist. It is fluid. The markets are fluid. And 

what is optimal liquidity today may be different in a month. 

And so I think we have to think about this differently, and I 

would advocate, along with those that are saying this rule doesn’t 

come close to addressing the issue, it is time to re-think how to 

manage risk without shutting down the providers of liquidity. 

And again, Professor Whitehead, I think you said in the beginning, capital markets have changed. I think about how I accessed 

capital at different points of my ownership of my company, and I 

think I accessed all manner of capital other than the pubic markets. Different things worked at different times. Let us not shut 

our banks down from participating in that. 

And with that, I yield back. 

Chairman HUIZENGA. The gentleman’s time has expired. 

The Chair recognizes the gentleman from Massachusetts, Mr. 

Lynch, for 5 minutes. 

Mr. LYNCH. Thank you, Mr. Chairman, and I thank the ranking 

member as well for holding this hearing. And I want to thank all 

of the witnesses here. 

37 

Mr. Quaadman, you are here again. You spend more time before 

this committee than most of our members do. 

[laughter] 

But you are a very valuable witness, so we certainly welcome you 

again. 

Mr. Jarsulic, I read a study recently by the International Monetary Fund where the staff reported that 73 banks identified as systemically important by the Basel Committee on Banking Supervision; they said that these 73 banks account for two-thirds of global bank assets. 

And according to the study, they said these 73 institutions pose 

significant management challenges and are very difficult to regulate and supervise and would be extremely difficult to resolve in an 

orderly manner in the event of a failure. 

And so I am just wondering if Volcker went away, if the Volcker 

Rule went away, how much more difficult do you think, with this 

financial system and proprietary trading that would be brought 

back, sponsorship of hedge funds and other risky activity, how difficult would it be then operating without the Volcker Rule, in terms 

of keeping these banks out of trouble or resolving them in a tough 

situation? 

Mr. JARSULIC. I think that the Volcker Rule is intended to be a 

preventative measure, that is, to lower the probability that these 

banks are going to need to be resolved. And so from that point of 

view, I think it is positive. It contributes to lowering the difficulties 

caused by excessive risk-taking. 

Mr. LYNCH. There is the unwinding part, too, here that I want 

you to speak to. We have evidence from the London Whale trading 

incident. And it was extraordinary that JPMorgan was involved in 

that. And apparently a lot of the trading involved overseas affiliates in London, and I imagine that would occur on a fairly common 

basis. 

Mr. JARSULIC. Yes. I now see your question. Big organizations 

are—large bank holding companies are extraordinarily complex institutions. I think the Federal Reserve did a study of our larger 

banks and found that they often had subsidiaries in the thousands. 

And those subsidiaries are, of course, located across jurisdictions. 

And it has been the case, I think, in the past that a lot of trading 

activity has been located—for U.S. banks has been located in foreign jurisdictions, such as London. 

And so the more that you allow that kind of complex and potentially loss-generating activity that often creates contracts, obligations, that involve many institutions if you go across borders and 

legal institutions, it does increase the difficulty of unwinding an institution should it fail. And that it could make it a more protracted 

process. 

Mr. LYNCH. I read a Reuters article recently that Goldman Sachs 

was still seeking a 5-year extension to conform with the Volcker 

Rule for about $7 billion worth of private equity investments. 

And if Goldman Sachs can’t get rid of those illiquid assets, I 

think the average bank would have extreme difficulty. This is 6 

years now that they have been holding on to those illiquid assets. 

Let me just ask you generally, the idea that we are going to have 

insured institutions, FDIC-insured institutions out there engaged 

38 

in proprietary trading and higher risk activity, it seems like a 

moral hazard that you are insuring people and inducing them to 

engage in risky activity when you are going to end up holding the 

bag possibly if they begin to go under? 

Mr. JARSULIC. Yes, as long as you allow those kinds of activities 

inside an institution which is either insured as a commercial bank 

unit would be, or in the case of widespread calamity implicitly insured, although I think the argument is the Dodd-Frank Act reduced that implicit insurance significantly is quite strong, the more 

likely they are going to be able to engage in those kinds of activities, the greater the risk they produce, the more willing it will be 

for their counterparties and funders to help them engage in that 

kind of activity. 

Mr. LYNCH. Thank you very much, Mr. Chairman. I yield back 

the balance of my time. 

Chairman HUIZENGA. The Chair recognizes Mr. Poliquin from 

Maine for 5 minutes. 

Mr. POLIQUIN. Thank you, Mr. Chairman, very much, I appreciate the time. 

And I thank all of you gentlemen for being here today. 

Mr. Kruszewski, I know I am not pronouncing it right but it is 

close enough. Do you know who I mean? Okay? Good. I would like 

to ask you a question if I may? 

Last December, on the 22nd, the Fed released a research paper 

entitled, ‘‘The Volcker Rule in Market Making in Times of Stress.’’ 

And in that report, it states, ‘‘We document—i.e., the Fed staff— 

that the illiquidity of stressed bonds has increased after the 

Volcker Rule. 

‘‘Since Volcker-affected dealers have been the main liquidity providers, the net effect of these bonds are less liquid during times of 

stress due to the Volcker Rule.’’ And they also talked about the performance of bonds during downgrades and so forth and so on. 

So my question to you, sir, is, do you agree, since you are in the 

business, that the Volcker Rule, in fact, has caused this problem? 

Did you agree with the findings of that report? 

Mr. KRUSZEWSKI. Yes. 

Mr. POLIQUIN. Okay. What do you think that means? What are 

the implications for our economy as a result of concluding that the 

Volcker Rule does cause illiquidity during times of stress? 

Mr. KRUSZEWSKI. Again, as I have said in my written and oral 

testimony, and I will say again, to the extent that the Fed is correct, and I believe they are correct that there is less liquidity, especially for these smaller bond issues. In very simple terms that just 

equates to higher cost to capital for our companies and our economy. And it is just that simple. 

So if you cannot—buyers are going to demand more compensation in terms of bonds. That means higher interest rates for the 

issuing company. That is higher cost to capital, less money for jobs 

and development. 

Mr. POLIQUIN. So specifically at a time of stress in the economy 

when business is poor and rates are already rising, you are saying 

this could cause rates to go up even further, and further choke off 

capital to small and medium size companies that are desperately 

in need of that capital? 

39 

Mr. KRUSZEWSKI. I would not equate that report to rising interest rates per se. I think that is an economic phenomenon and that 

is what the Fed does. What they are saying, as I read that report, 

is that they see the illiquidity in times of stress. 

And what that means is, so do the people who buy those bonds 

see the illiquidity in times of stress. There will not be any buyers. 

And therefore, to compensate for that risk, they will increase the 

rates. 

Mr. POLIQUIN. Got it. 

Mr. Quaadman, if I may expand upon this please? Do you think 

as a result of this conclusion by the Fed that many of us are in 

agreement with, that that could pose the amalgamation of this 

problem on different parts of the economy—could pose systemic 

risk to the economy? 

Mr. QUAADMAN. I think it is definitely causing a drag on growth. 

The march towards stability without also having pro-growth measures in place has caused that drag. 

I do think, as I mentioned before, too, as we are seeing treasurers being forced to more and more put their cash into U.S. Treasuries, it is actually concentrating risk into another part of the financial sector. 

Mr. POLIQUIN. Mr. Whitehead, would you like to jump in here 

and comment on this, sir, before I ask another question? 

Mr. WHITEHEAD. I think it is really the same point, which is as 

investors who are concerned about liquidity assess whether or not 

to make an investment, you would expect them to receive a higher 

return. And that has a real Main Street effect. It means the cost 

of raising capital goes up and that has a knock-on effect to what 

the businesses can do. 

Mr. POLIQUIN. If a company has a problem dealing with the 

Volcker Rule because it is a 1,000-page rule where you are reporting to five different agencies, as you mentioned, sir, and that book 

of business or that part of your book of business isn’t performing 

as you expect it to, Mr. Kruszewski, could you also comment on 

what other types of activities that might be riskier might a bank 

be involved in as a result of this part of their book of business not 

performing? 

Mr. KRUSZEWSKI. I am not sure. I will try to answer your question. I believe that first of all, Stifel does not engage in proprietary 

trading. It is not something that is central to our business model. 

I am not talking my own book here. 

What I am suggesting is that the five agencies and the interpretation of the Rule, which is very complex, results in it being very 

difficult to make effective markets, especially in times of stress. 

What other firms are doing to compensate for that, I am not sure. 

Mr. POLIQUIN. Thank you, Mr. Chairman. My time has expired. 

And thank you, gentlemen, very much. 

Chairman HUIZENGA. The gentleman’s time has expired. 

With that, I would like to thank our witnesses today for your testimony. This has been, I think, a very helpful conversation. 

And without objection, I would also like to submit for the record 

a letter from the National Venture Capital Association. 

Without objection, it is so ordered. 

40 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

Mrs. MALONEY. Thank you. May I join you in thanking the witnesses? 

Chairman HUIZENGA. Please. 

Mrs. MALONEY. I also want to thank you all for your testimony 

on what I think is a critical issue. And I wanted to just end with 

the quote that Mr. Hollingsworth said, ‘‘If you think our problems 

are bad, wait until you see our solutions.’’ 

But the problem we tried to address with Volcker was the finan- cial crisis that ended up costing this country $16 trillion to $18 trillion, depending on what study you look at, thousands—millions of 

jobs and millions of homes. 

And basically Volcker just says that banks should not gamble 

with their customers’ money, especially when that money is insured by the FDIC and backed up by the taxpayers. And so— 

Chairman HUIZENGA. And somewhere in there is a thank you to 

our witnesses? 

Mrs. MALONEY. I did say— 

[laughter] 

I did say thank you, but— 

Chairman HUIZENGA. Okay. Well, with— 

Mrs. MALONEY. —I do thank you. Thank you very, very much, 

really. 

Chairman HUIZENGA. With that, I again thank our witnesses, 

and our hearing is adjourned. 

[Whereupon, at 12:08 p.m., the hearing was adjourned.] 

(41) 

A P P E N D I X 

March 29, 2017 

42 


27369.001

I I 

STATEMENT 

OF 

DAVIDW. BLASS 

GENERAL COUNSEL 

INVESTMENT COMPANY INSTITUTE 

BEFORE THE 

US HOUSE OF REPRESENTATIVES 

COMMITTEE ON Fl NANCIAL SERVICES 

SUBCOMMITTEE ON 

CAPITAL MARKETS, SECURITIES AND INVESTMENT 

ON 

EXAMINING THE IMPACTOFTHEVOLCKEI:;; RULE ON MARKETS, BUSINESSES, 

INVESTORSANDJOBCREATION 

MARCH 29, 2017 
43 


27369.002

EXECUTIVE SUMMARY 

• Congress enacted the Volcker Rule to restrict banks from using their own resources to trade for 

purposes unrelated to serving clients and to address perceived conflicts of interest in certain bank 

transactions, Tile Volcker Rule was not directed at registered funds---that is, mutual funds, 

exchange-traded funds, or other US investment companies that are subject to comprehensive 

regulation under the Investment Company Act of 1940--or at similar· non -US funds. 

Unfortunately, the final regulations implementing the Volcker Rule nonetheless resulted in a 

number of concerns for these funds and their investment advisers. Our testimony highlights three 

areas of concern. It also provides !Cl's views on structural changes in the secondary corporate bond 

markets support for the Subcommirree's examination of the Volcker Rule and its 

consideration of the capital markets more broadly, 

• A first area of concern stems from the fact that tile five agencies implementing the Volcker Rule 

failed to provide a complete carve-out for registered funds. As a result, many such 

funds found themselves treated as "banking entities." This could happen, for example, in tile case or 

a newly·launct1ed fund whose investment adviser was affiliated with a bank. Solely by reason of the 

adviser's investment of start-up capital (so-called "seed money"), the fimd itself would be subject to 

d1e Vokker Rule's trading and investment limits as if it were a tJank. It is clear that Congress did 

not intend such a result, 

• The Agencies ultimately provided some relief-only days before the July 21, 2015 compliance 

date-after months of effort fmrn IC I and other stakeholders. The task of obtaining U>is relief was 

particularly burdensome because: 

0 was apparent, and had been broughr ro rhe attention three years 

earlier during the comment period on the proposed implementing regulations, and 

o the Byzantine multi-agency process aciopted by the Agencies was never transparent, 

involving repeated meetings and calls with Agency staffs without any clear indication as to 

their thinking, progress or deliberations, 

• A second area of concern involves competitive inequalities, For example, the final regulations 

appropriately exclude "foreign public funds"-the foreign equivalents to registered funds-from 

the Volcker Rule's resrrictions. The Agencies, however, placed requirements on US firms and rheir 

affiliates that rely on this foreign public fund exclusion that clo not apply to foreign firms offering 

the same types of funds, 

• A third area of concern is that the Volcker Rule has disrupted the market for certain securities in 

which registered funds invest. To illustrate, we discuss the restructuring and contraction that has 

occurred in rhe tender option bond ("TOB") market ancl the implications for banks, investors 

registered funds), and municipalities, It is our understanding that the size of the total 
44 


27369.003

outstanding TOB market has decreased significantly since before the financial crisis, due in part to 

the Voickcr Rule, and that the demand for these securities consistently exceeds the supply. 

• The Subcommittee has expressed interest the impact of the Votcker Rule on the US capital 

markets, with particular focus on liquidity in the fixed income markets. Our testimony underscores 

the importance of market liquidity to r·egistered funds and tt1e continuinq complexity of the market 

making exception in the final implementing regulations. It then discusses tile significant structural 

transformations that ar·e occur-ring in the secondary corporate bond markets, and what these mean 

for liquidity in those markets, 

• To reiterate, ICI supports the Subcommittee's examination of the Volcker Rule and its 

consideration of the capital markets more broadly. Market dynamics and factors relevant to trade 

execution affect a fund's deliver on its investment mandate and, in rum, fund 

investors' to achieYe their financial investment goals. 

ii 
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I. INTRODUCTION 

My name is David Blass. I am General Counsel of the Investment Company Institute 

global association of regulotc>d funds, including mutual funds, exchange·traded funds 

a leading 

dosed· 

end funds, and unit investment trusts in the United States ("registered funds"), and similar funds 

offered to investors in jurisdictions worldwide. ICI seeks to encourage acH1erence to t1igh ethical 

standards, promote public understanding, and otherwise advance the interests of funds, their 

shareholders, directors, and advisers. As of March 1, 2017, ICI's members manage roralassers of 

US$18.9 trillion in the United States, serving more than 95 million US shareholders, and US$1 .6 

trillion in assets in other_Juris(iictions. T11ank you, Chairman Huizenga, Ranking Member Maloney, 

and members of the Subcommittee for inviting me to testify. 

ICI appreciates the opportunity to speak to the Subcommittee regarding the effect of the Volcker Rule 

on registered funds and, more broadly, capital markets, capital formation, and investors. We previously 

have hacithe opportunity to appear before t11e full Committee on Financial Services and to make 

known some of our concerns about Section 13 of the Bank Holding Company Act-commonly known 

as the Volcker Rule-which was adopted as part of the Dodd·Frank Wall Street Reform and Consumer 

Protection Act 1 As we stated then and reiterate today, tt1e registered fund 

industry 11as a unique perspective on Volcker Rule issues because funds are both issuers that, in some 

circumstances, to the Volcker Rule and "buy· side" investors in domestic and 

international financial markets that may be affecteci 11y the Volcker Rule. 

By all acknowledgements, the Volcker Rule was never intended to apply to registered funds. 

Nonetheless, IC I members have !Jeen affected by the complexities and consequences oft he Volcker 

Rule, and some have had to navigate its complicated implementing regulations and the Byzantine 

multi-agency process for obtaining guidance and interpretations under those regulations, The 

regulations implementing the Volcker Rule introduced particular uncertainties about t11e treatment of 

certain registered funds and similar funds organized outside the United States. Although the agencies 

charged with implementing the Volcker Rule ultimately issued guidance to try to ameliorate some of 

these issues, they never have been n~solved through a transparent ru!emaking process and, more 

importantly, some registered funds are now suQject to an unnecessary comp! lance burden as a result, 2 

Further, the Vo!cker Rule has disrupted the market for certain securities in whict1 registered funds 

invest, And it is one of many factors contributing to structural changes in the fixed income markets. 

In the sections that follow, we first provide background information on registered funds and their 

comprehensive regulator·y framework (Section II). We t11en discuss some of the unintended 

1 Paul Schott Stevens, ICI's President and CEO, testified before the U.S. House ofReprcscmatives' Committee on Financial 

Services during the 112u' Congress, !·11s written testimony is available at 

7 The Volcker Rule implementing agencies (the "'Agencies") are: the Federal Reserve Board, Commodity Futures Trading 

Commiss1on, Federal Deposit Insurance Corpornt1on, Office of the Comptroller of the Currency, and Securities and 

Exchange Commission, 
46 


27369.005

consequences and complexities ofU1e Vo!cker Rule that affect registered funds and their foreign 

coumerparts III). we !Cl's views ou in the secondary 

corporate bond markets and express support for the Subcommittee's examination of the Vokker Rule 

and consideration of the capital markets more broadly (Section IV). 

II. BACKGROUND ON REGISTERED FUNDS 

Registered funds and their investment advisers operate under a comprehensive framework of 

the Investment Company Act of 1940 ("Investment the 

Investment A(jvisers Act of 1940, and otr1er federal securities laws. This framework has been enhanced 

over the years, including most recently in the Dodd· Frank Act, by Congress and the Securities and 

Commission the primary regulator for registered funds and the asset management 

industry more generally. Notably, the regulatory framework serves both to protect investors and to 

mitigate risks to tr1e financial system, 

The applicable laws encompass not only disclosure and anti·fraud requirements but also substantive 

reqniremems and restrictions on funds' structures and operations. Fund investment 

advisers likewise must register with the SEC anci are suqject to SEC oversight and disclosure 

requirements. All investment advisers owe a fiduciary duty to each fund they advise, meaning that they 

have fundamental legal obligation to act in the best interests of the fund pursuant to a duty of 

undivided loyalty and utmost good faith. Actions taken on behalf of a fund by its adviser and other 

service providers are to broad oversight by rhe fund's board of directors compnsmg at 

least a majoriry of independent members) and the flmd's chief compliance officer. funds nmst have 

writtton compliance programs ciesigned to prevent violations of the federal securities laws. Fund 

directors, fund and adviser officers, and other employees all must adhere to codes of ethics. 

It is important to note that the Investment Company Act was developed in direct response to 

overreaching and self-dealing by fund sponsors in the 1920s, which caused significant losses for 

investors. That Act seeks to minimite r-isk for fund shareholders by, among other things, ensuring that 

the fund and its investments are easily understood, its investment portfolio is managed for the benefit 

of its investors and not for the benefit of invr,stment adviser, and fund assets will not be 

misappropriated. Among the most significant of these protections are the following: 

• Transactions witll affiliates: The Investment Company Act contains a number of strong and 

detailed prohibitions on transactions between the fund and fund insiders or affiliated 

organizations, such as d1e corporate parem of d1e fund's investment adviser. 

• Leverage: The Investment Company Act constrains funds' abiliry to borrow or issue any 

"senior rhar would take prioriry over the fund's shares. 

Act requires all funds to maintain strict custody 

of fund assets, separate from the assets of the adviser. Nearly all funds use a bank custodian for 

2 
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27369.006

domestic securities, and the custody agreement is typical !y far more elaborate than the 

arrangements used for other bunk clients. 

" Transparency: Under the Investment Company Act and applicable SEC regulations, funds are 

suQject to ~~xtensive disclosure requirements, Funds provide a vast array of information about 

their operations, financial conditions, contractual relationships with their advisers and other 

matters to the investing public, regulators, media, and vendors such as Morningstar, and otrmr 

interested parties-far more information than is available for· other types of investments. 

" Mark·to·market valuation offund assets: All mutual funds provide market-based valuations of 

their shares at !east daily. The valuation process results in a net asset value for the fund, which is 

the price used for all transactions in mutual fund shares. 

In recognition of the comprehensive framework that applies to registered funds, Congress deliberately 

determined to exclude registered funds from the scope of the Volcker Rule. Rather, the Rule is 

intended to apply only to certain privately offered funds that are structured in a manner that avoids 

registration and regulation under the Investment Company Act. 

Ill. UNINTENDED CONSEQUENCES AND COMPLEXITIES AFFECTING 

REGISTERED FUNDS 

Congress enacted tile Volcker Rule to restrict banks from using their own resources to trade for 

purposes unrelated to serving clients and to address perceived conflicts of interest in certain 

transactions or relationships. To accomplisi1 these goals, the Volcker Rule prohibits banks and their 

affiliates and subsidiaries to as "banking entities") from engaging in "propriera.ry 

The Volcker Rule also generally prohibits banking entities from sponsoring or investing in hedge funds, 

private equiry funds, or other similar funds to as "covered fimds"). Despite the 

recognition that the Volcker Rule was not directed registered funds, the final regulations 

implementing the Rule nonetheless resulted in a number of concerns for the registered fund industry. 

A. Hampering Organization and Sponsorst·>ip of Registered Funds 

Most significantly, many registereci funds and their advisers found themselves within the definition of a 

"banking entity" under the final regulations and, rhus, subject ro rhe Volcker Rule's trading and 

investment limits as if they were banks. For some ICI member firms, this treatment arose because tile 

fund adviser is affiliated with an insured depository institution, even though that institution not 

directly involved in the fund or asset management business. 

As a consequence, these investment advisers fonnd some of their common practices, such as 

new funds, subject to restrictions under the final regulations, even though these practices had been 

J There arc exciusions for "permitted activities," such as market making, as defined in the stature and implementing 

rcgulatiOilS. 

3 
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27369.007

longstanding and, to our knowledge, had never raised any regulatory concerns in the past. Seeding is a 

primary way for an investment adviser to launch new fund, The adviser, during an initial seeding 

period, will own all or nearly all of the shares of a fund, as the adviser attempts to establish the fund, to 

test the investment thesis of the fund, and to develop an investment record that will attract investorswith the goal being to reduce the adviser's relative ownership of the fund as investors buy fimd shares. 

As a result of the adviser's initial ownership stake, a newly seeded fund would be considered an afflliate 

of a and thereby captured needlessly so) by the final regulations implementing 

the Volcker Rule. 

ICI and other interested parties communicated this concern to tr1e Agencies during the comment 

period on t11e proposed ,-egulations to implement the Vo!cker Rule, but the final regulations offered 

only limited relief. The Agencies allowed that a sponsoring banking entity may hold 25% or more of a 

registered fund during a one-year seeding period and permitted the banking entity to apply to tile 

Federal Reserve Boarcl for an extension of tile seeding period up to two additional years. This narrow 

seeding exception did not account for prevailing industry practices and did not address seeding 

practices in a variety of contexts. 

This was a significant issue for I C I members, potentially placing affected funds at a competitive 

disadvantage. To begin with, multi··year seeding periods a1·e common for (and necessary to) the 

successful launch of registered funds in the United States; investors generally expect a demonstrated 

track record before investing in a new registered fund. The immediate effect of the wle was two-fold. 

• First, because banking entities require ce1·tainty that they will be able to avail these funds of a 

sufficient seeding period, some considered refraining from launching new funds, tt1e 

consequence of which would be to decrease investor options with respect to investment vehicles 

that the Volcker Rule was never designed to affect. That end result would diminish innovation 

and development of new funds that are important to retail investors tC? meet their retirernent, 

education, and other needs. 

" Second, and more immediate, existing funds--those that already have been formed and 

currently are in their seeding period, many of which have investors who are unaffiliated with 

the sponsoring banking entity~--.required additional time to meet the compliance deadline and 

avoid being deemed to be "banking entities" under the Volcker Rule. Absent relief, the banking 

entities would be forced to restructure the funds by selling off their stakes or by liquidating the 

funds. Either course would require advann~ planning and have evident adverse consequences 

for the third-party investors in the funds, which, again, were never intended to be reached by 

the Volcker Rule. 

Upon rhe Agencies' release of the final implementing rhe Volcker Rule, ICI and its 

members sought to engage the on rhese issnes. To our surprise and our members' 

consternation, addressing the issues--which were apparent and brought to tile attention 

from tile outset--took many months and required working thmugh the Byzantine multi-agency 

process adopted by the Agencies to implement the Volcker Rule. The process proved particularly 

4 
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27369.008

frustrating because it took so long, because it was never transparent (with ICI and other stakeholders 

writing to and meeting repeatedly with Agency staffs without any clear indication as to their thinking, 

progress, or deliberations), and because the ultimate resolution proved, in many ways, incomplete. 

Agency action on the seeding issue came in July 2015, only days before the deadline by which 

compliance with the Volcker Rule was mandated. At that time, the Agencies published fund seeding 

guidance in the form of a "frequently asked question," found on the Agencies' websites. This guidance 

provided much-needed immediate relief, in that it recognized that banking entities, during the seeding 

period, may hold more than 25% of a registered fund's shares for longer than one year without the fund 

itself being viewed as a banking enrity and subject to the Volcker Rule's restrictions. 

The "guidance," altl10ugh gready welcomed, was disappoinring for several reasons. First, it interprets 

but does not alter the legal requirements of the final regulations-such piecemeal approaches create 

needless confusion. Second, the guidance introduces other vagaries and complexities because it could 

be read to suggest that, in the ordinary course, a three-year seeding period may be the maximum 

allowed. This phraseology has left some industry participants uncertain about longer seeding strategies, 

which may be necessary and common for certain types of funds. 

To us, this process demonstrates that the complexity of the Volcker Rule is nearly unmanageable not 

only for financial entities wid1 obligations to comply witl1 the Rule's myriad requirements but also the 

Agencies themselves-they seem to struggle to administer, interpret, and implement the very regulation 

they have adopted and impose restrictions that appear untethered from the widely acknowledged 

underlying policy objectives of the Rule. Moreover, as noted, the end result leaves registered funds with 

an unexpected and unnecessary compliance burden, despite the fact that registered funds should have 

been outside of the scope of the Volcker Rule from the beginning. 

Similar challenges have been encountered by funds that are publicly offered (by both US and foreign 

banking organizations) and substantively regulated outside of the United States---essentially, the 

foreign counterparts to registered funds-despite Congressional intent to limit the extraterritorial 

impact of the Volcker Rule. The final implementing regulations appropriately provided an exclusion 

for so-called "foreign public funds" from the Volcker Rule's restrictions. Yet in much the same way as 

registered funds, these funds faced uncertainty as to what would be considered a permissible seeding 

period, such that the fund would not become subject to tt1e trading and investment limits in the 

Volcker Rule. And, like registered funds, foreign public funds did not obtain needed guidance from the 

Agencies until days before the July 2015 compliance date. In addition, foreign public funds organized 

differently from their US counterparts (for example, without a separate fund board of directors) faced 

an added layer of complexity. Without specific guidance from the Agencies, those funds might have 

been deemed robe "controlled" by tl1eir bank-affiliated adviser and thus subject to the Volcker Rule, 

despite being organized in a manner permitted under the laws of their home jurisdiction. The 

Agencies ultimately issued the needed guidance but only after the same protracted process used to issue 

seeding guidance. 

5 
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27369.009

Finally, the Volcker Rule and its implementing regulations create competitive inequalities that deserve 

to be reviewed and addressed. T nke, for example, the foreign public funds described above, which are 

excluded from the Volcker Rule's restrictions. Unfortunately, the requirements on US 

firms and their affiliates seeking to rely on this foreign public fund exclusion that do not apply to their 

competitors. In particular, US firms must ensure that fund interests are sold 

(a term that is undefined in the final to third·party retail investors, but excluding their 

affiliated persons. This restriction on sales to affiliated persons creates monitoring and other 

compliance challenges for US firms and, for no apparent reason, puts US sponsors of foreign public 

funds at a competitive disadvantage to their· foreign competitors. 

B. Hampering Investment Opportunities for Registered Funds 

In addition to tile ct1altenges described above that some of our members must grapple with, the Volcker 

Rule also has had unanticipated implications for certain securities in which many registered funds 

invest. like many investors, our members value predictability in the structure and nature of their 

investments, a predictatli I ity that has been undermined in many ways by U1e overzealous application of 

the Volcker Rule to activities that Congress did not intend to regulate when the Volcker Rule was 

enacred. One of this disruprion can be seen in the case of rhe tender option bond 

market. 

In a troditional TOB program, a bank deposits one or more investment grade municipal bonds into a 

trust that issues two classes of tax-exempt secur·it.ies: a short·term security (the "floater") that is 

supported by a liquidity and a residual floaring rate security (the "residual"). The floater is a 

variable-rate demand security that bears interest at a rate adjusted at specified intervals. The liquidity 

a "put" or conditional demand feamre, allowing the floater holder to tender rhe floater, 

wl th specified notice, and receive face value plus accrued interest, 

Floater holders shorter-term tlear limited and well-defined insolvency ancl default 

risks associated with the underlying bonds and rely upon their largely unfettered put right to manage 

these r·isks. Holders of residuals (typically longer-term investors) receive all cash flows from trlG 

underlying tlonds that are not needed to pay interest on the floaters and expenses of the trust. Residual 

holders bear all of the market risk and share the credit risk with the floater holders with respect to the 

underlying municipal bonds. 

Prior to the Volcker Rule, a bank typically performed the traditional functions of a TOB program 

sponsor·. Since the enactment of the Volcker Rule, however, a TOB trust is very likely to be considered 

a covered fund. Therefore, banks have been forced to r·estructure TOB trusts to avoici sponsoring a 

covered fund, which is prohibited under the Volcker Rule and, even when permitted under certain 

exemptions, suQjects the fund Loa variety of restrictions and tim its (such as a prohibition on receiving 

credit support from the 

There is no indication that ever inrended for the Volcker Rule to limit banks' ability to 

sponsor TOB trusts. In fact, Congress sought to avoid interfering in traditional banking activities such 

as this one. We pointed this out to the Agencies prior to the finalization of the regulations 

6 
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27369.010

implementing the Volcker Rule, but the Agencies failed to exclude these programs from the final 

definition of a covered fund. Though the worst fear ofTOB investors and sponsors-that 

cease to exist after the Volcker Rule-has not materialized, the Volcker Rule has played a 

role in the contraction of tr1e supply of TOBs4 Our memtlers report that the demand for trlese 

securities-whicll can increase the diversification and liquidity of fund portfolios-consistently exceeds 

supply, with new deals sometimes oversubscribed by three to four times. 

As a result of the Volcker· Rule, banks have been forced to change their role from sponsors to liquidity 

providers and to cede the role of sponsor to one of the trust's residual interest holders. The uncenaimy 

caused by this seemingly unnecessary regulatory shift led to disruption in the TOB market, to the 

detriment of banks and investors alike. Trm shrinkage of the TOB market also has implications for 

municipalities in that TOBs provide an important source of demand for municipal bonds, wr1ich 

benefits municipalities with funding needs. 

IV. STRUCTURAL CHANGES IN THE SECONDARY CORPORATE BOND MARKETS 

The Subcommittee has expressed interest in the impact of the Volcker Rule on the US capital markets, 

with particular focus on liquidity in the fixed income markets. We address t11is topic below. 

A. Importance of Market liquidity to Registered Funds 

For registered funds, the availability of liquidity is a critical element of efficient markets. Many banking 

entities are key participants in providing tl1is liquidity, promoting the orderly functioning of the 

markets and committing capital wr1en needed by investors to facilitate trading. 

Liquidity is particularly important in the everyday operations of mutual funds, which typically offer 

t11eir shares on a continuing basis and are required by the Investment Company Act to issue 

"rcdeernable securities. To invest cash they receive when investors purchase fund shares as well as to 

meet investor redemption requests on 3 dally basis, mutual funds must have efficient, orderly markets. 

Registered funds also rely on adequate liquidity when making investment decisions and when trading 

U1e instruments in which tr1ey invest. Important investment criteria analyzed by portfolio managers at 

registered fimds include a security's liquidity, i.e., whether a position can be sold in a timely and cost 

efficient manner. And, if registered funds are concerned about U1e possibility that the liquidity of 

particular instruments could become impaired in the future, they may be reluctant to invest in those 

instruments altogether. 

4 It is our undcrstandmg lhat the size of the total outstanding TOB market has decreased significantly from its size before 

the financml crisis. 

s :,CeScction 2(a){32) of the Investment Company Act (gencral1y defining "redeemable security" "any security ... under 

the terms of wh1ch the holder, upon its presentation to the issuer or to a person designated by the issuer, is entitled to 

receive approximately his proportionate share of the issuer's current net assets, or the cash equivalent thereof.''). 

7 
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27369.011

8, Development of Implementing Regulations and Concerns About Market Impacts 

In our December 2012 testimony, we explained that much oftt1e concern about market liquidity arose 

from the complexities of the proposed regulations to implement the Volckcr Rule. We took issue, for 

wirh rhe presumprion rhar shon-term principal trading is proprietary trading, 

unless a banking entity is able to demonstrate otherwise. Concerned that such a presumption would 

fundamentally prejudice the of a trading activity from the outset, we observed 

tt1at a banking entity in t1'1is position would have to wOI'ry about hindsight interpretations and secondguessing about key compliance decisions with respect to each financial position. Registered funds and 

other investors, in turn, would have to worry about any chilling effect this might have on a banking 

ability or willingness to engage in marker making activity, 

Tt1e final f'8gulations, regrettably, generally follow the same structure as the proposed regulations, 

and retaining the rebuttable presumption. The Agencies did 

revise the exemption for permitted market making, so that its applicability is determined based on the 

marker of a bank's trading desk and not on a transaction- by- transaction basis. 

Nevertheless, it requires, among other things, that the amount, types and risks of the financial 

instruments in the trading desk's "market maker inventory" must not to exceed, on an 

the "reasonably expected near term demands of clients, customers and counrerpartics." 

To rely on this exception, banks must maintain a robust set of risk controls for their mar·ket making 

activities, in addition to the compliance requirements generally applicable to banks under tile final 

regulations. The market making exception thus remains an area of considerable complexity, 

The final nile addressed funds' most pressing concerns about 

trading prohibition and its potential impact on the capital markets, as outlined in our December 2012 

testimony. It did ensuring tlur activities with respect ro all municipal securities 

(in addition toT reasury and federal agency securities, which were carved out from the 

would not be in1paired. As our lestirnony indicated, we were concerned that failure to exclucje these 

securities would have posed liquidity challenges for registered funds, which are significant investors in 

securities issued by state and local government entities, and made it difficult for states and localities to 

raise capitaL 

Not excluded from the Volcker Rule----and of particular interest to this Committee-ar·e the fixe<J 

income markets, including the corporate bond markets, in which registered funds are steady investors, 

\l See, M1chael Bright, J.'lckson Mueller and Phillip Swaged, FinRt.:q2r·lvfodernizing Financial Regulation for tht' 21'1 

C.fmtury, Mdkcn Institute Center for Financial Markets (Marcil 2!1, 2017) at 3, available at 

client, but cannot easily re-sell that bond and mstcad sells a the truder long a corporate note 

and short t!1c 10-ycar Treasury note. Is this a 'prop trade,' or is it simply appropriate risk management in 

market? How long can the it becomes a 'prop trade?' This is a simple trade but 

qu(ostJOn 1n ttl\:; context of the Voicker Rule. Jt seerns obv1ous that this series of events should constttute allowable 

market-making-the norma! activity of a brokcr··dca!er in carrying out trades for customers .and offsetting the resulting nsks 

on its own books-in today's financial rnarkets.") 

8 
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27369.012

Funds are investrnent vehicles tr1rougf1 which millions of Americans gnin qccess to corporate bonds, so 

ICI and its members have a strong interest in ensuring the quality and integrity of these markets. WiUl 

this in mind, we recently weighed in on an examination of liquidity in secondary corporate bond 

markets conciucted by the Board of the International Organization of Securities Commissions 

C. Secondary Corporate Bonci Markets: A Shifting Landscape 

There is considerable consensus that the secondary corporate bond markets are undergoing significant 

structural transformations caused in part by regulatory reform in the aftermath of the financial crisis as 

well as by changing economics and 

Historically, most trading in US corporate bond markets l>as been over·tt1e·counter, either between a 

dealer and a customer or between two dealers. This trading generally occurred over Hle te!ept1one or 

through electronic systems that allow a customer to negotiate or trade witll particular dealers. Often, 

dealers traded with their customers on a principal basis, using their capital to carry a large inventory of 

bonds on their books. 

After tile financial crisis and the ensuing regulatory reform, the role of dealers in these markets has 

changed, with dealers reducing inventory and acting more often in an agency capacity for their 

customers. A number of factors may explain why dealers have chosen to reduce their holdings of 

corporate bonds. These include the Volcker Rule and other regulatory requirements tl1at limit the 

ability of banks to use their balance sheets to engage in market making activities, as well as increased 

costs associated with holding corporate del)t in inventory. Given tt1e central role that dealers have 

played in corporate bond markets, it is not surprising that many participants that had become 

accustomed to dealers providing liquidity in a principal capacity now must navigate their way through 

this evolving market environment, 

Further, our members' experience suggests rhat the nature changing, as new technology has 

introduced trading protocols that did not exist in the fixed income markets even a few years ago. These 

new technologies and innovations provide market participants with additional means to trade 

cor·porate bonds, and will loe a factor both in altering the structure of the bond markets ancl in 

of market participants to to role in these markets. 

7 See Letter to IOSCO from Dan Waters, Managing Director, ICI Global, datecJ September 30, 2016, available at 

Qttps:/ /vvwti.J.ci.org/pdJ/3028llmif (commenting on IOSCO Board, Examination of Liquidity of the Secondary Corpowte 

Bond Markets, Consultation Report(August 2016). 

° For greater cletail, see genet ally! OSCO Board, Examination of Liquidity of tf;e Secondmy COrporate Bond Markets, final 

Report (Fcbrunry 2017) {"!OSCO Report"), available at ~L'ti.\Oil'\C.M£!Ltl!:ll!lLilli!rvf ubd~QfLIOSCOP[)_52fu1.<1E. 

9 See also IOSCO Report at 15· 16. 

9 
54 


27369.013

D. What About Liquidity in the Secondary Corporate Bond Markets? 

The shifting landscape does not. necessarily mean that there is a lack of liquidity in the secondary 

bond markers. Indeed, liquidity is not an "it's there or it's nor" proposition. In a recent letter 

to Vanguard-a global investment management firm offering more than 190 mutual funds in 

the United States-explained it this way: 

[L]iquidity is dynamic, subjective. and hard to define. It can change in response to shifts in 

investor risk preferences. dealer financing costs and profit opportunities. or any of the 

other variables that influence capital market activity. 

liquidity has. in effect, a price. That price corresponds to changes in the supply of and 

demand for liquidity. Or to put it another way, liquidity is obtained along a cost 

continuum, 10 

Another facet of liquidity to bear in mind is that market participants---based on their particular trading 

or investment strategies, time horizons. risk tolerances and the like-place ciifferent values on and have 

different perceptions of liquidity. As part of its recent examination of the secondary cor-porate bond 

markets. IOSCO surveyed market participants including funds, dealers. electronic trading venues and 

others. As their responses indicated, industry perceptions of the development of bond market liquidity 

over the past decade are mixed. The mejority of both buy·side and sell-side respondents the survey 

perceive market liquidity to have decreased. These perceptions were generally based on personal 

experience and not on data ana!ys!s.ll 

In addition. there is no single metric that reliahly can measure bond market liquidity. Ratl1er, a variety 

of met.rics are cornrnon!y used as indicators of liquidity. These include trading volume, turnover ratio, 

bid-ask spreads, trade immediacy (in other words, the time it takes to trade a bond), price impact 

measures and statistics related to market making. 

Some metrics, such as trading volume, indicate that liquidity has increased in ,-ecent years. Others, such 

as turnover ratio, suggest a rnodest decr·ease in liquiciity. Still ot11ers suggest potentially important 

changes in the US bond market. According to a December 2015 report by the Financial lnclustry 

tnarkct participants appear to have executed more trades in smaller 

10 Lettcrto IOSCO from T1m Buckley. Managing Director nnd Chief Investment Officer, The Vanguard Group, lnc., and 

John Hollycr, Principal and Head of Risk Management Group, The Vanguard Group, l nc., dated 30 September 2016, 

Dll~~~UQ&Q~~~~~~2LLUUK~UillUlli~~.at2. 

11 IOSCO Reportat4. 

10 
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27369.014

size. 12 The data set forth in the Fl N RA report are consistent with viewpoints expressed by some market 

participants that it requires more time and trades to transact in larger sizes in the US bond rnarket. 13 

E. What Does All of This Mean? 

Many variables affect capital markets activity and the liquidity in those rnarkets. 14 Clearly, however, 

friction created by regulatory requirements that are overbroad or insufficiently tailored to achieve the 

desired objective Is one such variable that can and does influence the ways in which various entitles--

including dealers and their trading partners such as funds--participate in the capital markets. 

I C I supports the Subcommittee's examination of the Volcker Rule and its consideration of the capital 

markets more broadly. As noted earlier, factors such as increased cost and delays in trade execution 

affect a fimd' s ability ro deliver on irs investment man dare and, in rum. on fund to 

achieve their financial investment goals, 

I appreciate the opportunity to share these views with the Subcommittee. I C I looks forward to 

continued engagement with Congress on matters of importance to registered funds and their investors. 

12 Fl N RA ~"1na(ysis of Corporate Bond L iquidHy, Rese-arch Note (December 2015), available nt 

secondary corporate bond markets). 

14 For additional discuss! on of how the corporate bond markets arc evolving, including the mixed cv1dcnce concerning 

changes m market liquidity, see Vtcwpoints, Addressing Market Liquidity A Broader Perspective on TodayS· Bond Markets, 

BlackRock (Nov. 2016), 

11 
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27369.015

Examining the Impact of the Volcker Rule on Markets, Businesses, Investors, and ,Job 

Creation 

Testimony before the U.S. House of Representatives 

Subcommittee on Capital Markets, Securities and Investment 

Marc Jarsulic 

Vice President, Economic Policy 

Center for American Progress 

Wednesday, March 29,2017 

Thank you, Chairman Huizenga and Ranking Member Maloney, for the opportunity to 

testify on this important topic. I am the Vice President for Economic Policy at the Center for 

American Progress, where I lead our Economic Policy team. Today, I will attempt to outline 

the importance of the Volcker Rule and to highlight the evidence that the Volcker Rule has 

not caused a deterioration of liquidity in the corporate bond market. 

The Purpose of the Volcker Rule 

The Volcker Rule is intended to do something very reasonable- to prevent Bank Holding 

Companies and subsidiaries from engaging in proprietary trading and speculative hedge fund 

and private equity investments. These activities arc capable of quickly generating high levels 

of risk and large losses, which can damage the balance sheets of even very large banks. 

The losses by JPMorgan Chase in the 2012 "London Whale" incident- which involved 

proprietary-trading type activities are illustrative of the risks that can be generated. In that 

incident, a single trader, who was managing patt of the bank's synthetic credit portfolio in 

London, took such large positions in credit derivatives that other market participants began to 

refer to him as the Whale. Losses mounted, and when the positions were finally unwound, 

the bank was out $6 billion. At the time the Volcker Rule was set to be finalized in late 

1 
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2013, Treasury Secretary Jack Lew explicitly stated that the final rule was intended to 

prevent London Whale-style bets. 1 

During the financial crisis, large losses were sustained by many large banks around the 

world because of failed trading strategies. In 2009 the Basel Committee on Banking 

Supervision noted that ··[s]ince the financial crisis began in mid-2007, the majority of losses 

and most of the build-up of leverage occurred in the trading book. Losses in many banks' 

trading books during the financial crisis have been significantly higher than the minimum 

capital requirements under the Pillar l market risk rulcs." 2 

We also know from historical experience that when many important financial institutions 

engage in excessive risk taking, taxpayers can be left bearing the burden when their bets go 

bad. During the financial crisis, large amounts of risk were shifted onto U.S. taxpayers as the 

risks taken by the large Bank Holding Companies and other important financial market actors 

generated substantial losses. Because those losses threatened asset fire sales and widespread 

panic, the Federal Reserve, FDIC and Treasury were forced to step in to support asset prices 

and the institutions that were threatened with ruinous losses. Trillions of dollars of taxpayer 

1 Ian Katz and Kasia Klimasinska, "Lew Says Volcker Rule to Prevent Repeat of London Whale 

Bets," Bloomberg, December 5, 2013, available at 

https://www .bloomberg.com/news/articles/20 13-12-05/lew-says-volcker-rule-meets-obama-sgoals-in-financial-oversight. 

2 Joint FSF-BCBS Working Group on Bank Capital Issues (2009). Reducing procyclicality 

arising from the bank capital framework, March 3. See also Basel Committee on Banking 

Supervision (2009). Guidelines for computing capital for incremental risk in the trading book, 

July I ("The decision was taken in light of the recent credit market turmoil where a number of 

major banking organizations have experienced large losses, most ofwhieh were sustained in the 

banks" trading books."). See also Dennis M. Kelleher, Marc Jarsulic, and David Frenk, "Re: 

Prohibition on Proprietary Trading and Certain Relationships with Hedge Funds and Private 

Equity Funds," Comment Letter, Better Markets, February 13'h, 2012, available at 

https://www.bettermarkets.com/rulemaking/better-markets-commcnt-letter-volcker-rule. 

2 
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funds were put at risk to stabilize the financial sector. 3 The federal government provided 

several temporary liquidity facilities, guaranteed debt issuance, and directly injected capital 

into financial institutions to prevent an even more devastating financial crisis. 

The Effects ofthc Volcker Rule 

There is little question that the post-crisis behavior of securities dealers collectively has 

changed significantly compared to the pre-crisis period. The total assets of securities brokers 

and dealers have declined from a peak value of about $5 trillion in 2008 to about $3.5 trillion 

in 2016, about the level they attained in 2005. Corporate bond holdings follow a similar 

pattern, peaking at over $400 billion in 2007, and declining to something above $100 billion 

in 2015.4 The decline in corporate inventories is at times attributed to the Volcker Rule and 

other regulatory change. 

However, the connection between the decline in bond inventories and the Volcker Rule is 

in reality not very strong. As analysts for Goldman Sachs have pointed out, the very large 

run-up in corporate bond inventories pre-crisis reflects the accumulation of positions in 

private label mortgage backed securities rather than traditional corporate bonds. They 

estimate that the declining issuance and collapsing prices of private mortgage backed 

securities explains the decline in dealer inventories from their peak levels in 2007 through 

20125 

3 U.S. Government Accountability Office (2013), p. 14-15 4 Adrian eta!. (2016), pp. 5, 17 5 Goldman Sachs Credit Strategy Research (2013), p. 5 

3 
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Moreover, while critics of the Volcker Rule have long forecast dire consequences for the 

corporate bond market- including declining liquidity, and harm to the functioning of the 

capital markets6 these negative effects have not materialized. 

Liquidity, which is usually thought of as the cost of quickly converting an asset into 

cash. is typically measured by a range of indicators. These include the bid-ask spread, price 

impact, and trade size. Data on each of these indicators does not show deterioration of 

corporate bond liquidity. 

Bid-ask spreads, which measure the difference between the price at which a dealer is 

willing to pay for a bond and the price for which be is willing to sell it, is considered an 

important measure of liquidity. The cost of executing a trade of limited size is generally 

calculated as one half the bid-ask spread. The spread in the corporate bond market- for 

investment grade and high-yield bonds- has declined since hitting a peak in the financial 

crisis and is now lower than in the pre-crisis period.7 

A standard measure of price impact bas declined for both investment grade and highyield bonds since the crisis, and is now very low relative to pre-crisis levcls8 

Trade size declined during the financial crisis, and has not yet recovered to pre-crisis 

levels. While by itself this might be taken as a measure of decreased liquidity- since traders 

might be avoiding larger trades because of their effect on price the declines in price impact 

are inconsistent with that explanation. 

The turnover ratio, which is measured as the percent of an issue that trades on a given 

day, has drifted downward for the most actively traded bonds since 2002. This may be a 

6 Oliver Wyman and SIFMA (2011) 7 Adrian et al. (2016), p. 24; International Organization of Securities Commissions (2017), p. 39 8 Ibid.; Mizrach (2015); IOSCO (2017) 

4 
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function of changes in market structure. First, the number of issues that are traded in the 

secondary market has risen dramatically. In 2015 more than 33,000 issues were traded, an 

increase of 12,000 issues over 2003.9 Under these conditions, the ability of investors to 

select portfolios from a broader range of issues can translate into declining turnover. In 

addition, the rising share of outstanding issues held by bond exchange traded funds, who tend 

to buy and hold. may have contributed to declining trading in the underlying bonds. 10 

Based on these and other data, the general conclusion of several studies, by Adrian ct 

a!. (20 16), Mizrach (20 15), Trebbi and Xiao (20 16) and Bessembinder et al. (20 16) is that 

there has not been a significant reduction in corporate bond liquidity between the pre-crisis 

and post-crisis periods. 11 

While on average liquidity appears be as good or better than it was pre-crisis and preVolckcr, it is still possible that the inability of big bank dealers to hold proprietary 

inventories may make the corporate bond market more vulnerable to market shocks. 

9 Mizrach (20 15), p.2 10 See h ttps://y.,ww. b lackrock .com/ corporate/ en-1 m/1 iterature/whitepa per/viewpoint-addressingmarket-liquidity-july-20 15.pdf. 11 The paper by Bao at al. (2016) is an exception. It concludes that differences in price declines 

in bonds which have been downgraded from investment grade to below investment grade before 

and after 2014 show that bond markets have become less liquid because of the Volcker Rule. 

There are, however, some methodological issues unanswered by this analysis. First, it does not 

control for the fact that many of the institutions downgraded in their post-2014 sample (at least 

19 out of 55) are tied to the oil and gas sectors, which were under considerable stress in this 

period. Hence the observed price declines may be a function of objective changes in the 

expected returns on the bonds themselves, rather than diminished market making capacity. 

Second, the study assumes that the price effects of the Volcker Rule begin with the formal 

implementation of the Volcker Rule by the Federal Reserve in 2014, However, banks took steps 

to change their trading behavior before 2014, doing things such as selling off or reducing the 

scale of named proprietary trading desks. Therefore, the smaller price declines observed before 

2014 may also reflect the impact of the Volcker Rule-induced changes in bank behavior, 

5 
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Economists at the Federal Reserve Bank of New York have looked at this possibility 

empirically. 12 They first developed a general measure of overall bond market illiquidity, 

which is a function of three measures of liquidity- the bid-ask spread. price impact. and 

price dispersion. This index is well below both crisis and pre-crisis levels. 

They then calculate the frequency of large day to day movements in market illiquidity 

to measure the changes in liquidity risk. They find that liquidity risk is well below crisis 

levels and has declined in recent years. 

The forecasted harm to corporate access to capital has also failed to appear. New 

issues of corporate bonds are at record levels, at or above $1 trillion for the period 20 l 0-

20\5_13 

Conclusion 

fn conclusion, it seems fair to say that the exit of large banks from proprietary trading 

has not had a measurable effect on corporate bond market liquidity, liquidity risk, or the 

ability of corporations to raise funds in the capital market. With respect to these criteria. our 

bond markets are functioning at least as well as, if not better than, they were in the pre-crisis 

period. 

It is important to remember, however, that there is no reason to expect market 

makers, or any other financial market participants. to act as shock absorbers at times of 

extreme stress. Market makers will buy assets if they expect to profit from their purchases. 

fn a highly uncertain environment, they will not step in to catch a falling knife and cushion 

12hlli~~~~~~~~~~~~~~UQ~~l~Wx~~~~~~~ 

bond-market-increased.htm I. 13 Mizrach (20 1 5), p. I. 

6 
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large price declines. If we want to avoid the problems generated by asset bubbles, and the 

crashes that follow them, we need to take preventative measures. 

The Dodd Frank Act- which requires banks and nonbanks to put more equity on the 

line when they engage in asset purchases, raises the equity requirements when assets are 

funded with short-term runnable credit, requires that balance sheets include sufficient liquid 

assets to deal with shocks, and gets banks out of the business of proprietary trading 

provides needed protections. Demolition of these preventative measures is likely to be a very 

costly exercise in historical amnesia. 

7 
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References 

Adrian, Tobias and others. 2015. "Has Liquidity Risk in the Corporate Bond Market Increased?" 

Liberty Street Economics, Federal Reserve Bank of New York. October 6. 

(http://! ibertystreeteconomics.newyorkfed.org/20 15/1 0/has-l i quid it y-risk-in-the-corporate-bondmarket-increased.html [March 28, 2017]). 

Adrian, Tobias and others. 2016. "Market Liquidity after the Financial Crisis." Federal Reserve 

Bank of New York Staff Reports. October. 

(https://;vww.newyorkfcd.org/medialibrary/media/research/staff_reports/sr796.pdf?la=cn [March 

28,2017]). 

Bao, Jack, Maureen O'Hara, and Alex Zhou. 2016. "The Volcker Rule and Market-Making in 

Times of Stress." Finance and Economics Discussion Series, Division of Research & Statistics 

and Monetary Affairs, Federal Reserve Board. December. 

(https:/ /'www.federalreserve.gov/econresdata/feds/20 I 6/files/20 161 02pap.pdf [March 28, 20 17]). 

Basel Committee on Banking Supervision. 2009. "Guidelines for computing capital for 

incremental risk in the trading book." July I. (http://www.bis.org/publ/bcbsl59.htm [March 28, 

20 !7]). 

Bessembinder, Hendrik and others. 20 I 6. "Capital Commitment and Illiquidity in Corporate 

Bonds." Working Paper. Arizona State University and Southern Methodist University. 

(http:/ /tlnance. bus.utk.edu/UTSMC/documents/B il!Maxwel1Papertopresent0420 16.pdf (March 

28, 2017)). 

BlackRock. 2015. "Addressing Market Liquidity." Viewpoint. July. 

(https :/ /www. b lackrock.com/ corporate/ en -lm/1 i terature/wh itepa per/viewpoint -addressingmarket-liquidity-july-2015.pdf [March 28, 20I 7]). 

Goldman Sachs Credit Strategy Research. 2013. "Primary dealer data overstate decline in 

corporate bond inventories." The Credit Line. March 17. 

International Organization of Securities Commissions. 20 l 7. "Examination of Liquidity of the 

Secondary Corporate Bond Markets.'' February . 

.Joint FSF-BCBS Working Group on Bank Capital Issues. 2009. '"Reducing procyclicality arising 

from the bank capital framework." March 3. (http://www.fsb.org/wpcontent!uploads/r _ 0904f.pdf!page _moved= I [March 28, 20 17]). 

Katz, fan, and Kasia Klimasinska. 2013. "Lew Says Volcker Rule to Prevent Repeat of London 

Whale Bets.'' Bloomberg. December 5. (https://www.bloomberg.com/news/articles/20 13-12-

05/lew-sa ys-volcker-rule-meets-obama-s-goals-in-financial-oversight [March 28, 20 17]). 

Kelleher, Dennis M., Marc .Tarsulic, and David Frenk. 20I2. ""Re: Prohibition on Proprietary 

Trading and Certain Relationships with Hedge Funds and Private Equity Funds." Better Markets. 

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February 13. (https://www.bettennarkets.com/rulemaking/bctter -markets-comment -lettervolcker-rule [March 28, 2017]). 

Mizrach, Bruce. 2015. "Analysis of Corporate Bond Liquidity." F1NRA Office of the Chief 

Economist Research Note. December. 

(https://www.finra.org/sites/dcfault/files/OCE _researchnote _liquidity_ 2015 _12.pdf [March 28, 

2017]). 

Oliver Wyman and SIFMA. 2011. '-The Volcker Rule restrictions on proprietary trading: 

Implications for the US corporate bond market." December 23. 

(http://www.sifma.org/issues/item.aspx?id=8589936887 [March 28, 201 7]). 

Trebbi, Francesco and Kairong Xiao. 2016. "Regulation and Market Liquidity." Working Paper. 

University of British Columbia. (http://faculty .arts.ubc.ca/ftrebbi/research/tx.pdf [March 28, 

2016]). 

U.S. Government Accountability Office. 2013. "Government Support For Bank Holding 

Companies: Statutory Changes to Limit Future Support Arc Not Yet Fully Implemented." Report 

to Congressional Requesters. November 14. (http://www.gao.gov/products/GA0-14-18 [March 

28, 201 7]). 

9 
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\~~fVla· Invested in America 

Written Testimony of Ronald J. Kruszewski, Chairman and CEO, Stifel 

On behalf of the Securities Industry and Financial Markets Association 

before the U.S. House of Representatives 

Committee on Financial Services 

Subcommittee on Capital Markets, Securities, and Investment 

Hearing entitled "Examining the Impact of the Volcker Rule on the 

Markets, Businesses, Investors, and Job Creators" 

March 29, 2017 
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Chairman .Huizenga, Ranking Member 1\faloney, and distinguished members of the 

Subcommittee, thank you for providing me the opportunity to testify today on behalf of the 

Securities Indnstry and Financial Markets Association (SlFMA) 1 and to share our views on the 

market effects of the V olcker Rule. SIFJ\1A represents a broad range of financial sen·ices firms 

active in the capital markets and dedicated to promoting investor opportunity, access to capital, and 

an efficient market system that stimulates economic growth and job creation. 

I have been CEO of Stifel Financial Corp. (Stifel) since 1997, and haYe oYer 30 years' 

experience in the securities industry. As Chairman and Chief Executive Officer of Srifel, I appreciate 

the opportunity to bring my company's experience with tllis law to the Conmlittee. For those of 

you who don't know Stifel, we are a tlnancial services holding company headquartered in St. Louis, 

Missonri. Stifel was founded in 1890 and, as such, this year marks our company's 127'' anniversary. 

Stifel's affiliates are primarily engaged in wealth management, Investment Banking, Institutional 

Services and traditional banking conducted through a federally insured depository. As to our size, 

Stifcl has revenue of approximately $2.6 billion, $20 billion in assets, and manages approximately 

$240 billion for our clients. Stifel employs over 7,000 people and enjoys a market cap of nearly $4 

billion. 

First, l must say, I sincerely wish the Volcker Rule had another name. \\l'hy? \\icll, as my 

testimony will illustrate, T am not a proponent of this rule. I believe the Volcker Rule provides little 

benefit regarding its purpose when enacted which was to reduce systemic financial risk by banning 

proprietary trading. 

1 SIF~L\ is the voice of the U.S. securitie~ industry. \X'e represent the broker-dealers, banks and asset managers whose 

nearly 1 million employees provide access to the capital markets, raising over $2.5 trillion for businesses and 

municipalities in the U.S., sef\"ing clients with over $18.5 triliion in assets and more than $67 trillion in assets 

for individual and institutional clients including mutual funds and retirement plans. with offices in New York 

and \V'ashington, is the U.S. regional member of the Global Financial.i\Iarkds Association (GI"''1L\). For more 

information, 

2 
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On the other hand, I have the utmost respect for Mr. Volcker and want to be clear that my 

criticism of a rule which bears his name is not a criticism of Mr. Volcker. l remember all too well 

the accomplishments of Mr. V olcker, as Fed Chaim1an, in lighting the rampant inflation of the early 

1980s. 

Thus, let me begin with my conclusion. It is my personal view that the Volckcr Rule needs 

to be taken off the books, repealed. But if repeal is not possible, it must be materially amended to 

avoid further damage to the markets my company serves. 

The V olcker Rule is the product of years of statutory and regulatory wrangling, involving the 

Congress, the Department of the Treasury, and live independent regulatory agencies. As many 

stakeholders and policymakcrs predicted, the rule as formulated, implemented, and enforced has had 

a deleterious impact on the ability of American businesses to raise capital and grow the economy. 

Put simply, the V olcker Rule discourages legitimate and needed customer-supporting market-making 

activities by imposing an overly complex and intent-based compliance regime. To determine 

whether an activity was proprietary trading or legitimate market making, a compliance expert would 

also need to be a psychiatrist trained in determining the intent of each trade by a trader. The Rule 

has raised the cost of capital for businesses and enconraged pro-cyclical effects on liquidity in 

financial markets.2 

I know that saying the V olcker Rule should be repealed is a bold statement. \'Vby be so bold? 

Simple cost/benefit analysis. Before I discuss the cost/bcnellt of V olckcr, allow me to provide you 

"~th Stifel's perspective and whether my testimony is merely "talking my own book". 

2 A paper from Anjan Thakor from \XIashington University in St I..ouis noted that previous scholarship on the cost of 

capital for businesses found a relationship between higher bid-ask spreads and a higher cost of capitaL Because ilLiquidity 

due to constrained market-making will likely drive up bid-ask spreads, Thakor concluded businesses will likely face 

higher costs of capital due to\' olckcr. Darrell Duffie (from Stanford Universjty) came to a similar conclusion in a 2012 

paper, U.S. corporate bonds and non-agency mortgage-backed securities will face higher costs of capital 

because Volcker Rule, due to ]0\vcr liquidity in secondary markets. 
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As previously stated, Stifel has beeu around for over 125 years. We did not take TARP 

during the linancial crisis and are not looking at betting the proverbial ranch on any one strategy. 

Said another way, Stifel does not directly and materially benefit from a proprietary trading model. 

Importantly for today's testimony, Stifd serves small and middle-market companies and the 

investors in these same companies. \X7e therefore have a front row seat to comment on the impact 

ofVolcker on these companies. As l already stated, the purported benefit of the Volcker Rule is to 

reduce the systemic risk to our economy caused by proprietary trading. 

Make no mistake, I do not believe deposit taking banks should be making risky short tem1, 

spcculati,·e bets, and in fact the law has long prohibited such activity. But I do not believe the way 

to regulate risk, systemic or otherwise, is by inhibiting trading or traditional market making, which 

provides liquidity and depth to our capital markets, but rather through capital and liquidity rules 

addressing the balance sheet of our financial institutions. 

r tis important to note that the financial crisis was rooted in the loan book, not the trading 

book, of our tlnancial institutions. 

Since the financial crisis, several rules have been implemented which have significantly 

increased the quantity and quality of capital and increased internal liquidity of our financial 

ins6tutions, most n1ore stringent than internationally agreed standards. But the Volcker Rule 

doesn't do anything to increase capital or internal liquidity at firms, but it does impact firms' ability 

to make markets and provide liquidity, particularly in times of stress, as the Federal Reserve itself has 

written. 

As to the V olcker Rule itself, let me make three observations: 

1) The Rule is beyond complex. While only 11 pages of the Statute, the regulatory rule text 

is over 950 pages and included 2800 footnotes. You need a team of law firms- not just 

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lawyers- to be able to decipher it, and even then, many times the answer is rhat there is 

no clear answer. 

2) The Volcker Rule includes a pnwision called "RENT-D," a concept only the 

government could devise. RENT-D limits market making so it does not exceed the 

'reaJonably e.'<fxded near ter7!1 dema11d' of clients, customers and counter-parties. Seven years 

after the cnacunent of Dodd-Frank, I am no closer to understanding what that term 

means or how to implement something so amorphous. The ability to provide market 

liquidity requires an anticipation of supply or demand, which if proven wrong with the 

benefit of hindsight, would ,-iolate the V olcker Rule. 

3) Compliance 'W-ith Volcker is governed by five separate agencies. 

The fi,-e separate agency construct, each with their own congressional mandate, their own 

philosophy and own approach, creates an uncertain and um,~cldy bureaucracy. In turn, this leads to 

numerous and overlapping exams and inquiries. Furthermore, this has resulted in an utter lack of 

guidance, under an ovcrlv complex rule that is screaming out for interpretations and FAQs. 

History of the Volckcr Rule 

Controversy has surrounded the Volckcr Rule before~ during, and after its inclusion in the 

Dodd-Frank ,\ct. The Rule was not part of the first Treasury Department or Obama Administration 

blueprints, nor was it found in the initial versions of the financial reform efforts that became DoddFrank. l ts eleventh -hour inclusion in the Senate version of the bill was criticized by members of 

both parties, and even within the Obama Administration there were major disagreements over its 

necessity. Treasury Secretary Geithner testified before the Congressional Oversight Panel in 2009 

that in the financial crisis "most of the losses that were material ... did not come from [proprietary 

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trading] activities." Paul Volcker himself even conceded in March 2010 that proprietary trading was 

"not central" to the crisis. 3 Simply put, it was the loan book, not the trading book, that fueled the 

crtsts. 

\' olcker's proponents assured the public that the rule would prohibit only certain activities 

that put taxpayers at risk while preserving beneficial customer-supporting market making. llowe,·er, 

the distinction between proprietary trading -the purchasing and reselling of financial instruments to 

profit from short-term price changes -and market making- the purchase and reselling of financial 

instmments as a service to customers- has turned out to be very difficult to determine in practice. 

Unt(Jrtunately, the rule's current overly-broad definition of proprietary trading, its negative 

presumption that activity is prohibited and its complex, intent based compliance structure 

constrains, and will continue to constrain, legitimate market making whose costs will be felt 

throughout the economy. 

Bad Policy 

Looking at the benefit side of the cost-benefit tradeoff, I believe there is little incremental 

benefit provided by the Volckcr Rule. What about the cost side of this equation? Simply put, the 

Volcker Rule makes our capital markets less liquid which increases the cost of capital for Stifel's 

clients, especially smaller companies which arc the major contributors to job-creation. 

Stifd helps our clients by assisting them raise growth capital in both the equity and debt 

markets. As part of this equation, Stifel commits to make markets, which bcnctits both the issuing 

company and the purchaser of the equity or debt. Volckcr materially impacts our ability to 

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effectively make markets. This in turn causes the buy··side to demand higher compensation, 

reflected in lower equity valuations or higher interest rates. And, higher cost of capital. 

Market liquidity is critical for a well-functioning, high growth economy that continues to 

create jobs as it gives businesses of all shapes and sizes the ability to access capital in a timely and 

efficient manner. Ivfarket makers, such as bank affiliated broker-dealers, provide liquidity by buying, 

selling and holding infrequently traded financial products in their inventory, granting buyers and 

sellers immediacy in transactions that may not be otherwise available. This immediacy is especially 

important for financial products that arc traded over-the counter (OTC) and the overwhelming 

majority of bond trading is done in this manner. 

The Volcker Rule threatens market liquidity by making the trading of OTC financial 

products both slower and costlier for issuers and investors. The current regulatory framework limits 

some trading that is connected to customer acti,,ity by relying on a broad definition of proprietary 

trading and providing prescriptive, conditional exemptions for allowed market making activities. The 

narrow set of pennissible activities and the prescriptive conditions for engaging in those activities 

has led many financial institutions subject to the Volckcr Rule to scale back their trading operations 

as well as their inventories of financial assets to remain within the Rule's strict guidelines.' Financial 

institutions subject to the Rule arc forced to take a conservative approach even to permitted 

activities in order to remain within the confusing and complex parameters of the Rule. Taken 

together, these changes reduce liquidity in financial markets broadly, and have resulted in higher 

market execution costs and delays for would-be issuers and investors. A recent Federal Reserve staff 

paper found that the Rule has negatively affected liquidity in corporate bond markets, quantifies this 

effect and notes that this effect may be stronger in times of market stress when liquidity may be 
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most essential to maintain financial market stability and eftlciency.' This potentially pro-cyclical 

impact on market liquidity for corporate debt could cause problems in one part of the financial 

sector to spread quickly to the broader economy, exacerbating any crisis. 

I would note that while manv of the studies of market liquidity have focused on aggregate 

conditions, my experience indicates that small cap and mid-cap issuers appear to have experienced a 

disproportionately negative impact from a number of the stmctural and regulatory changes meant to 

improve transparency in markets and financial stability in our financial system, including the Volcker 

Rule. In addition, the significant increase in the size of the corporate bond market, \vith a relatively 

smaller secondary market, has increased the liquidity premium for smaller issuers. Investors now 

demand a significant liquidity premium for bonds issued by smaller firms. Despite the fact that the 

corporate bond market has seen record issuance in recent years, most of this has been in large deals. 

The number of smaller new debt issues coming to the market has fallen, illustrated by the fact that 

the average size of new debt issuance has steadily increased. My analysis shows: 

1) As of mid-"\pril2016, the average new investment grade deal size was $921 million, 

the highest on record and more than 2.5 times the average seen in just 2013. 

2) Since 2010, the number of deals sized at $2 billion and above has doubled, whereas 

the number of smaller deals (below $2 billion) has fallen by nearly half. 

5The paper compared the illiquidity of corporate bonds that were downgraded from investment-grade to spt:culatrvcgrade, both before and after the Volcker Rule was implemented. The paper concluded that «bond liquidity dcttertoroJton 

around rating downgrades has worsened follmving rhc implementation of the Volcker Rule." The paper also found that 

"the rdati\"C deterioration in liquidity around these stress events is as high during the posr-\~olcker period as during the 

Financial Crisis. GiYen how badly liquidity deteriorated during the financial crisis, rhis finding su,!Ze,csts that the \yolcker 

Rule have serious consequences for bond market functioning in stress times." The full study is available 

8 
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3) Credit spreads for small-cap issuers arc on average 75 to 100 basis points wider than 

large-cap issuers, controlling for credit rating and maturity, due to the liquidity 

differences perceived by investors-' 

The fact that smaller firms are challenged in effectively financing thcmseh-es in the debt 

market has many potential implications for the economy -all of them negative. Because it is 

difficult to raise capital, small firms increasingly are finding it difficult to compete with larger firms. 

Instead, they are selling themselves to their larger competitors. Much of the increased corporate 

bond issuance is from large firms financing the acquisitions of small firms the highest share in 15 

years. As a result, the likclv risk to the economy is less job creation, less competition, less research 

and development and capex - and less dynamism overall. 

Indeed, prominent voices in the regulatory community have recognized the negative impact 

of the Rule and called for an examination of its effects. For example, the president of the Federal 

Reserve Bank of New York, William Dudley, addressed his concern about liquidity in remarks in 

February: 

"You could probably do the Volcker Rule in a more efficient wav to achieve the same 

objectiv-es vv-ithout the burden of regulation that you have right now. You know, right now, if 

you're an equity trading desk and the equity market falls very violently, vou really aren't 

supposed to go in and buy equities unless you actua1ly haYe customer orders. So, you actually 

have this crazy situation where the equity desk can't actually buy equities to support the 

market. 

So, I'd like to see the Volcker Rule looked at to see if there's a way of doing it in a way that 

if you're a client-facing business, and you're trading your own asset class, you have a little bit 

more freedom to buy and sell when markets arc volatile and maybe prm~ide actually a little 

liquidity support in the market. But also make it a lot easier, 1 think, to enforce the Volcker 

Rule."' 

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ln addition, former Federal Resence Covernor Jeremy Stein co-authored an article which 

noted that: 

"There are reasons to be skeptical about the usefulness of the Volcker Rule. 

By discouraging "speculation" at broker-dealer banks, the rule may dissuade 

dealers from providing liquidity during a market correction. Most 

fundamentally, market-making and proprietary trading are almost 

impossible to distinguish in practice, making the rule difficult to enforce, 

while at the same time creating large compliance and supervisory costs. 'Ibis 

is not to say that concerns about the risks associated with bank trading 

operations are unfounded. However, these risks can be more effecti\·ely 

addressed by imposing stiff capital charges on banks' trading books, "'~thout 

attempting to divine whether the underlying trades themselves are driven by 

market-making or speculative motives. ·rhus, on balance, we believe that 

the Volcker Rule should be repealed."' 

Burdens of the Volcker Rule's Covered Funds Provisions 

The covered funds provisions of the Volcker Rule result in a scope far beyond the intended 

focns on the use of hedge funds and private equity funds to facilitate indirect, impermissible 

proprietary trading. The provisions are highly technical and are not focused on the actual activities 

of the entities that are captured. Some of the issues these rules have created include, but are not 

limited to: 

1) Challenges in identifYing what is, and what is not, a covered fund. The status of tens 

of thousands of transactions executed prior to the implementation of the Volcker Rule is 

unclear. The result for banks has been the expenditure of significant resources on internal 

and external counsel to review transactions and structures, and impacts to market 

making. The industry has come together to develop electronic identiiication tools at great 

in 2017 ,"Robin Greenwood, Samuel G. Hanson, Jeremy Stein, ~\c.li 

on Behavioral Finance and Financial Stability, aYail~able af 

10 
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expense, but these are incomplete at best. The bottom line is that banks have had to spend 

(and continue to spend) millions of dollars annually to unnecessarily prove a negative with 

these products which are neither hedge funds nor private equity funds. 

2) Impacts to ordinary-course relationships with clients. For covered fnnds, many 

transactions that are provided as part of normal client service are prohibited hy the Volcker 

Rnle, including: ordinary checking and transaction accounts with overdraft protection, 

custodial services, family wealth \Thicles, clearing and settlement, providing margin and 

other intraday extensions of credit, and plain vanilla extensions of credit. 

3) Funds that are not covered funds but become subject to proprietary trading 

restrictions. Certain foreign funds, which are expressly not covered funds, may instead be 

categorized as banking entities and thus subject to the V olckcr Rule's proprietarv trading 

restrictions. 

4) Requirements to Change the Name of Existing Funds. The Rule includes a number of 

limitations on the ability of a banking organizations to sponsor a fund which includes its 

name or the name of its affiliates. In practice these requirements are more form on·r 

function, as they do not go to the core issue V olckcr was intended to address. 

The covered funds provisions of the V olcker Rule should be amended to limit the definition 

of covered fund only to funds that engage in proprietary trading. This would achieve the goal of 

prohibiting indirect, impermissible proprietary trading through a fund without sweeping in core asset 

management and related activities that are far removed from the policy goal. 

Poorly Implemented 

11 
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Beyond its bumpy legislative history and Hawed concept, interpretation and enforcement of 

the Rule is overly complicated and requires the involvement of five regulators, creating significant 

compliance challenges. The Secudties and Exchange Commission (SEC), the Office of the 

Comptroller of the Currency (OCC), the Commodities Futures Trading Commission (CFI'C), the 

Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve must jointly determine 

Volcker compliance, and while they have assured the public they will cooperate on enforcement and 

supervision, we believe it '-Vill be very difficult, if not impossible, for five different, independent 

regulators to jointly enforce a rule this complex. Recent anecdotes from SIFiVL\ 's membership 

indeed confirm a lack of coordination. 

Additionally, regulators are relying on quantitative metrics to calculate the purpose and 

market risk of trades to determine which trades are proprietary and which trades arc not essentially 

using fom1ulas to determine the intent of indi,·idual traders who usc firm principal to take positions. 

The inherent difficulty in operationalizing an intent-based prohibition has resulted in regulations that 

are overly complex, require an outsized compliance infrastmcture and mctrics, and often capture 

beneficial activities beyond the professed goals of the Rule. Federal Reserve Governor Jerome 

Powell recognized this difficulty. When asked about the Volckcr Rule and echoing the concerns of 

market participants, Governor Powell noted that "[wJhat the current law and rule do is effectively 

force you to look into the mind and heart of every trader on every trade to see what the intent is." 

[ Je highlighted the difficulties in determining what is permitted and what is restricted under the 

Rule: "Is it propriety trading or something else) If that is the test you set yourself, you arc going to 

\\~nd up with tremendous expense and burden." Finally, he suggested that "Congress should take 

another look at it."9 

12 
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Most absurd is the fact that rcgulatmy mctrics for calculating intent \Vill penalize traders who 

are unable to sell inventory in a certain time frame, even if the trader i11tended to sell the product 

within the Volcker approved window. The entire implementation regime of the Volckcr Rule has 

been poorly thought out and e\·cn the rule's hypothetical benefits are being drowned in a flood of 

unnecessary costs. 

Principles for Change 

As I stated, I personally believe the V olcker rule should be repealed. If not repealed, at a 

minimum, the V olcker Rule should be modified to: 

1) Reverse language that assumes all trades are proprietary unless proven othcn\~se. 

2) Eliminate the "reasonable expected near term demand" requirement. 

Any changes should he consistent with the following fundamental principles: 

1) the Rule should not impede market liquiditv and capital formation; 

2) the restriction on proprietary trading should be plainly written and not based on 

trader intent; 

3) restricted proprietary trading should limit only trading wholly unrelated to customer 

activity or risk management; 

4) the regulatory regime should be rationalized ''~th a single agency responsible for 

implementing, interpreting and enforcing the Rule; 

5) the restrictions on covered funds should target indirect, impermissible proprietary 

trading. 

These principles recognize the clear benefits of market making activity to the capital markets but 

also to the entities that access these markets in order to grow their businesses and invest in future 

job growth. 

13 
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Conclusion 

Our economy has now had enough experience with the V olcker Rule to reasonably conclude 

that its existence has needlessly impeded beneficial market ttmctions without producing any 

measurable improvement to the safety of our system. Its true impact has been felt on Main Street in 

the form of higher costs of capital and diminished liquidity. SIFM:A and Stifel were opposed to the 

Volcker Rule when it was first proposed and have consistently questioned the need for its existence 

ever since. SIFM1\ is committed to assisting policymakers in the Administration, the agencies, and 

the Congress, as they study the effects of Volcker and what do to next. 

In summary, the Volckcr Rule is a solution in search of a problem. We should not be 

debating whether or not the banks should get relief from Volcker. Instead, we should be debating 

whether our economy benefits from this rule. From my vantage point based on the clients I setTe, it 

does not. 

### 

14 
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27369.038

ON: Examining the Impact of the Volcker Rule on 

Markets, Businesses, Investors, and Job Creation 

TO: House Committee on Financial Services, 

Subcommittee on Capital Markets, Securities, and 

Investment 

BY: Thomas Quaadman, Executive Vice President, Center 

for Capital Markets Competitiveness, U.S. Chamber of 

Commerce 

DATE: March 29, 2017 

1615 H Street NW I Washington, DC I 20062 

The Chamber's mission is to advance human through an economic, 

political and social system based on freedom, 

incentive, initiative, opportunity and responsibility. 
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27369.039

The U.S. Chamber of Commerce is the world's largest business federation, 

representing the interests of more than three million businesses of all sizes, sectors, 

and regions, as well as state and local chambers and industry associations. The 

Chamber is dedicated to promoting, protecting, and defencling "\merica's free 

enterprise system. 

More than 96% of Chamber member companies have fewer than 100 

employees, and many of the nation's largest companies are also active members. We 

are therefore cognizant not only of the challenges facing smaller businesses, but also 

those facing the business community at large. 

Besides representing a cross-section of the American business community \vith 

respect to the number of employees, major classifications of American business---e.g., 

manufacturing, retailing, services, construction, wholesalers, and finance-are 

represented. The Chamber has membership in all 50 states. 

The Chamber's international reach is substantial as well. We believe that global 

interdependence provides opportunities, not threats. In addi1jon to the American 

Chambers of Commerce abroad, an increasing number of our members engage in the 

export and import of both goods and services and have ongoing inyestment activities. 

The Chamber favors strengthened international competitiYeness and opposes artificial 

U.S. and foreign barriers to international business. 

2 
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27369.040

Good morning Chairman Huizenga, Ranking Member Maloney and members 

of the Subcommittee on Capital Markets, Securities and Investments. My name is 

Tom Quaadman, executive vice president of the Center for Capital Markets 

Competitiveness ("CCMC") at the U.S. Chamber of Commerce ("Chamber"). The 

Chamber is the world's largest business federation, representing the interests of more 

than d1ree million businesses and organizations of every size, sector, and region. I 

appreciate the invitation to testify today on behalf of the businesses that the Chamber 

represents. 

It is an honor to be invited and testify at today's hearing: Examining tbe 

Impact of tbe Volcker Rule on Markets, Businesses, Investors and Job 

Creadon. This is the latest in a series of hearings on the impact of the Volcker Rule 

upon the financial system and the broader economy. 

The Chamber opposed the Volcker Rule at the outset because of the 

foreseeable negative consequences of the rule, such as restricting market-making and 

underwriting activities, which in turn impact the ability of businesses to obtain d1e 

financing needed for short-tenn operations and long-term growth. Instead d1e 

Chamber proposed higher capital standards as an alternative means to achieve the 

intent of the Volcker Rule-more fmancial stability but without the regulatory 

complexity that can harm ~:,>rowth. 

Today we have both-the Volcker Rule and higher capital standards. The 

Volcker Rule has imposed upon financial institutions a complex web of regulatory 

compliance. Basel III and systemic risk rules have created higher capital standards 

through opaque processes that make it difficult for the public to truly understand the 

strength of those firms. This has created incentives whereby firms do not provide the 

financing they have in the past. 

The Volcker Rule has, in combination wid1 other initiatives such as the Basel 

HI Capital 1\ccords, systemic risk rules, the foreign bank operation rules, risk 

retention rules and new money market fund rules harmed the ability of businesses to 

affordably raise the fmancial resources needed to operate on a daily basis and grow. 

Business financing is now more inefticient. Furthermore, the lack of economic 

analysis by the regulators in drafting the Volcker Rule is aprimafade instance of why 

evidentiaty analysis, subject to public scrutiny and comment, is necessary for the 

drafting and implementation of regulations that may promote stability and growth. 

3 
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It is important that policy makers review all of these rules individually and on a 

cumulative basis to determine the impact it has on stability and growth. Moreover, 

under President Trump's Executive Order on Core Primiple.rfor R~gulatinci\ the United 

J tate.r Financial System, laws and guidance to determine if they promote the core 

principles of fostering growth and enabling U.S. competitiveness, the Volcker Rule 

should be thoroughly examined. Following such a review action should be taken to 

address the unintended consequences of the Volcker Rule by repealing it, or 

undertaking the efforts necessary to amend it. We believe that tius hearing is an 

important first step in starting that process. 

Background 

Proprietary trading occurs when a financial finn buys and sells stocks, bonds, 

or other financial instruments, on its own trading account, with the purpose of 

profiting from market movements. It has been widely acknowledged, including by 

financial regulators themselves, that proprietary trading was not a cause of the 2008-

2009 financial crisis. Nevertheless, some commentators, including former Federal 

Reserve Chair Paul Volcker were uneasy that banks were engaging in what they felt 

\vere not traditional banking activities that they felt might implicate the banks insured 

deposits. On January 21, 2010, President Barack Obama proposed a ban on 

proprietary trading and named it after former Federal Reserve Chairman Paul Volcker, 

its chief architect. The Obama Administration reguested other nations to follow suit, 

which was universally rejected. 1 The Obama ;\dministration supported the Rule's 

enactment despite the universally recognized fact that it would be exceedingly difficult 

to demarcate the lines between proprietary trading and other important bank activities 

like market making and underwriting. 

The Volcker Rule was incorporated into the Dodd-Frank \'Vall Street Reform 

and Consumer Protection Act (Dodd-Frank Act) at the 11th hour. There was exactly 

one hearing on the Volcker Rule. During that hearing, in the Senate Banking 

Committee, serious doubts were voiced on a bipartisan basis as to how this Rule 

could be implemented. Mr. Volcker, one of the two witnesses at that hearing, was 

unable to articulate a method for delineating proprietary trading and other trading 

activities such as market making. Despite the lack of a hearing record establishing the 

need for the Rule, it was incorporated in the Senate version of the Dodd-Frank Act 

and became law. 

1 See E.U. j\ii.nistcrs to Resist Ohama's Proposal for Banking Overhaul, Bloomberg News. Feb. 16,2010. 

4 
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27369.042

Section 619 of the Dodd-Frank Act prohibits financial finns from engaging in 

proprietary trading and acquiring or retaining any ownership interest or sponsorship 

of a hedge fund or private equity fund. Additionally, Section 619 included exemptions 

for market-making and underwriting activities, risk-mitigating hedging and the sale or 

disposition of financial obligations of the United States. 

On October 11, 2011, the Board of Governors of the Federal Reserve 

("Federal Reserve"), Federal Deposit Insurance Corporation ("FDIC"), Securities and 

Exchange Commission ("SEC"), Office of the Comptroller of tl1e Currency ("OCC") 

(also collectively as the "regulators") voted to release a joint Volcker Rule Proposal. 

This joint rulemaking, encompassing 298 pages and over 1,000 questions, was 

published in the Federal Re,gi.rteron November 7, 2011. The Commodity Futures 

Trading Commission ("CFTC") voted to release its version of the Volcker Rule 

Proposal on January 11, 2012, almost 90 days after the other regulators. The agencies 

approved and promulgated the Volcker Rule on December 9, 2013. The deadline for 

covered firms to comply with the Volcker Rule was july 21, 2015. 

Since that time we have witnessed a tightening of debt markets whereby 

traditional buyers of debt and securities have failed to come forth. 

Chamber Concerns with the Volcker Rule 

The Chamber opposed the Volcker Rule at its inception because of its potential 

to negatively impact d1e market-making and underwriting activ:irjes needed for 

businesses to access liquid debt and equity markets. In the alternative the Chamber 

proposed higher capital standards as a means to promote financial stability if a 

covered fmancial institution chose to engage in proprietary trading. 

Market makers play an essential role in fmancial markets, acting as a source of 

liquidity that keep markets vibrant and make investing feasible. As market makers, 

banks must hold inventories of the financial instruments in which they make markets. 

For example, corporations rely upon the "market making" activities of banks in order 

to secure affordable funding in the bond market. \'Vithout d1ese "market making" 

activi6es, banks would be unable to underwrite d1ese bonds. Thus, if banks can no 

longer hold inventory, it will be much more difficult for businesses to raise the 

amount of capital needed. Typically, banks \viii hold bonds in inventory that aren't 

sold in d1e marketplace on day one but later in the week. as under the Volcker Rule, 

however, this temporary inventory build-up is considered proprietary trading and 

therefore deprives issuers from raising the total amount of capital needed. 

5 
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It is very difficult to distinguish between market making and proprietary trading 

without arbitrarily imposing a demarcation. The Volcker Rule significantly constrains 

their ability by dictating how banks should manage their inventory. This \vill reduce 

the depth and liquidity of our capital markets. 

Bank trading activities arc what create market liquidity and enable the market to 

provide an efficient clearing price. Without these activities, markets take a giant step 

back-ward toward individually negotiated bilateral 'deals'. Investors would no longer 

be willing to risk their capital in securities that in exigent circumstances would have to 

be sold at fire sale prices. 

The Chamber submitted 14 lettcrs2 to the regulators and other agencies to raise 

our concerns with the Volckcr Rule. Those concerns highlighted process irregularities 

especially the failure to conduct an economic analysis subject to public review and 

conduct, and sought post-promulgation action to address adverse consequences witl1 

trust preferred securities ("TRUUPS") and collateralized loan obligations ("CLOs"). 

In summary tl1e Chamber expressed seven major concerns regarding the Volcker Rule 

implementation proposed by tl1c regulators: 

1) The Chamber was concerned how the Volcker Rule proposals were released 

and believed that comment process has been compromised as a rcsult;3 

2) The Chamber believed that serious issues and deficiencies exist with the 

economic and cost benefit analysis used by the regulators;4 

3) In releasing the proposed V olcker Rule, regulators failed to take into 

consideration the adverse impacts the proposal vvill have on the ability of 

companies to raise capital; 

2 See comment letters of October 11,2011, November 17,2011, December 15,201 17,2012, 

2012. February 14, 2012. April 16. 2012. November 16, 2012. September 25, 2013. 7, 2013. 25. 

2013, December 4, 2013,January 14,2014 and I\farch 4, 2014 from the U.S. Chamber of Commerce to the regulators 

and FSOC. 

3 See October 11,2011 letter from the CC~fC to Treasury Secretary Geithncr requesting that the Financial 

Stability Oversight Council use its authority to reconcile differences in the Rule Proposals issued by the 

regulators; November 17, 2011 letter from CCf\IC to the regulators requesting a withdrawal and of the 

\"'dcker Rule because of the failure of the Cl•TC to issue its proposed rule in with the 1 Set~ December 15,2011 letter from the CC!\fC to the regulators citing flaws the cost hencfit and economic 

of the Y olcker Rule Proposal, requesting that the proposal be submitted for enhanced economic 

review, that it be considered an cconomicaHy significant rulcmaking and that the regulators coordinate 

efforts under Executive Orders 13563 and 13579. This letter also re'Yuested that the cumulative impact of other 

initiatives. such as Basel I1l, he taken into account when determining the economic impacts of the Volcker Rule 

Proposal. 

6 
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27369.044

4) The Volcker Rule will force commercial companies d1at own banks to build 

and maintain compliance programs though they have never engaged in 

proprietary trading; 

5) The Volcker Rule creates ambiguity as to pennissible market making and 

underwriting, thereby increasing risk and reducing liquidity for companies; 

6) The Volcker Rule places the American economy at a competitive 

disadvantage and may in fact violate existing trade at,>reements; and 

7) The Volcker Rule Proposal may endanger infrastructure projects and the 

businesses that work on them by impacting the ability of State and 

Municipal governments and agencies to raise capital. 

Issues before the Promulgation of the Volcker Rule 

a. Failure to Perform an Economic Analysis, Chamber Survey of Members 

In proposing the Volcker Rule the regulators did not conduct an economic 

analysis. The OCC issued an economic analysis over 4 months ajtertbe Volcker Rule 

was promulgated, fmding that the costs to 46 OCC regulated institutions could be as 

high as $4.3 billion dollars. Despite the Chamber's request, as is discussed in greater 

detail below, the regulators did not study the impacts of the Volcker Rule upon the 

broader business community nor was it treated as a major rulcmaking decision. 

An economic analysis of the costs and benefits of a proposed regulation on 

those affected by it is a critical tool in a regulator's tool box. 5 Cost-benefit analysis 

provides discipline to rulemaking so that rules are narrowly tailored to the problem 

they are designed to address. It also encourages the consideration of less costly 

alternative approaches. 

"-\n agency's failure to undertake economic analysis is more tl1an a missed 

opportunity. The lack of adherence to express congressional instructions to consider 

certain costs and benefits is itself a violation of tl1e "\dministrative Procedure Act, and 

it increases the possibility that the resulting rule will be found arbitrary and 

capricious.6 For example, in 1996, Congress amended the Securities Exchange .Act to 

require tl1e SEC to consider a proposed rule's economic impact on efficiency, 

5 Sec Paul Rose and Christopher]. \X1

alker, The lmpmta!lce ofCo.rt~Bm~fi! Anab·sis in Pinandal Regulation, U.S. Chamber of 

Commerce 

6 Sec 5 

7 
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27369.045

competition, and capital formation, in addition to its preexisting duty to consider the 

impact on investor protection.7 In the years that followed, the SEC failed to take that 

mandate seriously, often claiming in a perfunctory way that it had "considered" the 

costs and benefits of a proposed rule and thus satisfied the statute even though it did 

not publish its analysis. It was not until a series of decisions by the United States 

Court of Appeals for the District of Columbia that the SEC began to undertake and 

publish its economic analysis when it proposes a rule.8 

Despite the clear language of d1e Riegle Community Development and 

Regulatory Improyement Act of 1994 (the "Riegle Act"), the banking regulators did 

not perform an economic analysis of the Volcker Rule. Like the SEC, the Federal 

Banking Agencies are required to consider the costs and benefits of their proposed 

rules, albeit \v-ith respect to different mettics. Section 302 of the Riegle r\ct proYides: 

[i]n determining the effective date and administrative 

compliance requirements for new regulations that impose 

additional reporting, disclosure, or other requirements on 

insured depository institutions, each Federal banking 

agency shall consider, consistent with the principles of 

safety and soundness and the public interest: (1) any 

administrative burdens that such regulations would place 

on depository institutions, including small depository 

imtimtions and customers of depository institutions; and 

(2) the benefits of such rq,'11lations.9 

In implementing the Volcker Rule, which is designed to minimize the risks of 

proprietary trading on the federally insured deposits of a financial institutions, the 

banking regulators failed to undertake a legally mandated a cost-benefit analysis 

re~1uired of a proposed rule that may negatively impact the insured depository 

institutions that the tule is intended to protect. 

f .. W:h,.o, ... "' pursuant to tllis subchapter the Comm:.ission is engaged in rulemaking and is required 

to consider whether an action is necessary or appropria!e in the public interest, the Commission shall also 

consider, in addition to the protection of investors, whether the action will promote competition, and capital 

formation. accord !5 U.S.C. 78c(t) (same); 15 U.S.C. 15 U.S.C. 

'Sec Bus. v. SEC, F.3d 1144, 1148 (D.C. 

as it did most recently in American 

assess the cconotnic effects of a new 

Chamber of Commerce v, SEC, 412 F.3d 

'12 u.s.c. § 4802. 

Investment . . and before that in 

:\m. Eguity Jnv. Life Ins. Co. v. SEC, 613 F.3d 166 (D.C. Cir. 

(D.C Cir. 2005). 

8 
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27369.046

On December 15, 2011, the Chamber wrote to the regulators asking that a cost 

benefit analysis of the Volckcr Rule be undertaken for public review and comment. 

The Chamber letter requested that the Volckcr Rule: 

• Be considered under the requirements of Executive Orders 13563 and 13579 

in order to coordinate different requirements for economic analysis and 

finalization of rules; 

• Be considered an economically significant rulcmaking and the public 

provided ·with a qualitative and quantitative analysis of the impacts upon the 

economy as required by the Unfunded Mandates Reform Act of 1995 

("Unfunded Mandates Reform Act"); 

• Be subject to an enhanced Office of Information and Regulatory /\ffairs 

("OIRA") regulatory review process; and 

• Be considered in the context of other initiatives, such as Rase! III, and other 

pertinent Dodd-Frank Act rulemakings, when determining the economic 

impacts 

This letter also included a survey of Chamber members demonstrating the 

impacts of the proposed Volcker Rule upon non-financial businesses (see appendix 

F\). The letter stated in part: 

While much of the focus of the Volcker Rule Proposal has 

been on fmancial institutions, there arc significant costs to 

non-financial companies that have not: been contemplated 

by the regulators. To illustrate these impacts, included as an 

appendi.x to this letter is a survey that uses 2010-2011 

historic data, of select US financing companies that 

provide services for non-financial businesses. It appears 

that the Volcker Rule \vill impose at least a five basis point 

increase in bid-ask spreads. In a confidential survey of five 

large U.S. borrowers, it estimates that under the Volckcr 

Rule Proposal increase in the bid-ask spreads will be closer 

to 25-50 basis points increasing lending costs from between 

$742 million and $1.483 billion. In reviewing Volcker Rule 

impacts upon potential lending strategies for smaller less 

frequent borrowers, hypothetical scenarios suggest an 

mcrcase 111 bid-ask spreads will be closer to 50 and 100 

9 
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27369.047

basis points leading to increased lending costs of between 

$106 million and $211 million. 

1\lso, in discussions with our membership it appears that 

there \Vill be an impact upon switching transactions-the 

process whereby a financial institution buys back some of 

an issuer's older bonds as part of the process for a new 

issuance. For example, a 10 basis point increase caused by 

the Volcker Rule would increase the costs of S\vitching 

transactions by $2.8 million per billion -.vhile a 50 basis 

point increase would drive up costs by nearly $14 rnillion 

per billion. 

Taken together, by extension, with $8 trillion of corporate 

debt outstanding and that approximately $7 trillion trades 

in a year, the incremental transaction costs for investors 

and fillancing costs for U.S. companies could total into the 

tens of billions of dollars. 

These discussions with our members provide a snap shot 

of potential costs facing non-financial companies because 

of just one prov-ision of the Volcker Rule Proposal. Other 

provisions will also markedly affect liquidity in the financial 

markets and will increase the costs associated with raising 

funds for both financial and non-financial firms throughout 

the economy. 

Had the regulators conducted such an analysis and heeded the information 

the Chamber provided, some of the consequences of the Volcker Rule and other 

regulations currently interacting with it may have been avoided. 

b. Chamber Study: Consequences of the Volcker Rule 

In 2012 the Chamber a1so released a study, The Economic Consequences of 

the Volcker Rule ("Thakor study"), authored by Professor ..r\njan Thakor of the Olin 

School of Business, Washington University in St. Louis. (Attached as 1\ppendix B). 

The study had four major findings: 

1. The V olcker Rule will have a negative effect on market making and liquidity 

prov-isions for many securities. 

10 
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2. The V olcker Rule will reduce network benefits of market making for 

financial institutions and businesses. 

3. The Volcker Rule is likely to lead to higher costs of capital for businesses 

and potentially lead to lower capital investments by borrowers creating 

greater potential focus on short-term investments. 

4. The Volcker Rule Vv'ill make bank risk management less efficient, adversely 

impact the structure of financial institutions and harm the ability of 

businesses to raise capital. 

The Thakor study found that financial firms were expected to retrench their 

market making activities away from smaller issuances. Businesses were expected to 

find a lower level of financial services activity and less liquidity. Market makers in 

securities operate in networks and any retrenchment will harm the general network 

benefits that all for the sale of securities. The reduction of those network benefits 

would be felt even if other non-Volcker regulated entities undertook market making 

acti·vities. Reductions in liquidity and regulatory uncertainty will lead to higher costs 

of capital. Therefore, capital expenditures by businesses are of a shorter duration for 

a quicker payoff. Failure to have longer-term capital investment could lead to jobs 

loses. By artificially constraining the instruments a financial firm may hold, banks may 

have to accept more risk or operate with more cash. This will hann the diversification 

of frnancial flrtils and hatm the ability of businesses to raise capital. 

Unfortunately, many of the findings of the Thakor study are coming to fruition 

as the Volcker Rule has become fully operational. 

Issues Arising Since the Promulgation of the Volckcr Rule 

In 2016, the Chamber released a survey of more than 300 corporate finance 

professionals. The report, Financing Growth: The Impact of Financial 

Regulation ("SmTey"), (attached as AppendLx C) found that 79'% of treasurers felt 

that financial services regulation had impacted their business. One-third of treasurers 

expect the regulatory impact to worsen over the next three years. Treasurers believe 

that current and pending regulations will make their cash flow and liquidity operations 

more challenging. One third of these companies are being forced to take 

unanticipated steps in response to regulatory challenges and businesses are being 

forced to pass the impact of those costs on to their customers. This survey also 

II 
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found that businesses had dramatically reduced the number of financial institutions 

they have used since 2013. 

Treasurers stated that the regulations most negatively impacting them were the 

Volcker Rule, Basel IH, SIFl regulations and SEC money market fund reforms. 

In previous testimony the Chamber warned that one of the responses to the 

Volcker Rule would be an increase in the cash reserves that American businesses feel 

compelled to hold. American businesses have traditionally benefitted from liquid 

financial markets that enable them to put capital to work rather than holding 

excessiYe, dormant reserves. It has given American businesses a competitive 

advantage over their counterparts in the European Union. Recent regulatory 

developments have forced American businesses to take more of a European Union 

approach to finance. While U.S. cash reserves have not hit the ratios held by rl1eir 

European counterparts, U.S. corporate cash resen-cs rose by $100 billion since the 

Volcker Rule has been implemented. Cash at the S&P 500 has risen by m-er 50%, 

hitting all-time highs since the Dodd-Frank Act was passed. 

Even though corporate bond issuances have increased, bond market liquidity 

has decreased with fewer dealers and less market making activity. This has led to 

unexplained stresses in the marketplace. A 2016 CPA Institute found that over a five 

year period liquidity in high yield investment grade corporate bonds had decreased, 

there were fewer dealers in the market place, there has been an increase in the time 

needed to execute a trade, trades are smaller in volume and there was an increase in 

unfilled orders. The CPA study also found that no liquidity issues existed for 

government bonds. 

A 2016 Federal Reserve study (attached as 1\ppendix D) looked at stress events 

in ilie corporate bond market. This study found that bond dealers regulated by cl1e 

Volcker Rule had changed their behavior by decreasing their market making behavior. 

Because those dealers make up the preponderance of the marketplace, ilie Volcker 

Rule was found to have caused less liquid bond markets during times of stress. 

Accordingly, businesses arc forced to deal with a longer time horizon in 

meeting their needs and use a more inefficient marketplace which also creates the 

incentive to use alternative means of financing including the use of cash resen,es. 

This also has an impact on the overall economy as less cash is deployed for 

productive purposes. 

Ivlany of these issues may have multiple causes, but the Volcker Rule is 

undoubtedly a contributory and exacerbating factor. In failing to use evidentiary tools 

12 
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available to them to write the regulation, financial services regulators missed the 

opportunity to discover these problems before the rule was implemented. That is why 

the Chamber proposed using the conformance period as a ti:tne to "war game" these 

issues. Unfortunately, this was not done. 

These impacts of the Volcker Rule as still working their way through the 

system and there is time to fn, them. 

Chamber Recommendations 

The confluence of the V olcker Rule and other uncoordinated rule-makings 

such as those implementing Basel III, the risk retention provisions of the Dodd-Frank 

Act, systemic risk policies and money market reforms have created stress \v-:ithin the 

financing mechanisms for businesses. Financial firms now must deal with complex 

compliance structures that make the deployment of capital either more clifficult or 

more expensive. For smaller companies, certain financial products or services may be 

unaffordable or altogether unavailable. 

While the Chamber still believes that the Volcker Rule should be repealed, we 

also recognize that there are those who would like to see some form of the Volcker 

Rule remain in place. Additionally, we must have a better and clearer understanding 

of these major initiatives and how they interact with each other. Simply put, the 

Volcker Rule cannot be viewed in a vacuum; it must also be viewed in conjunction 

\v-:ith other major rulemakings. 

Accordingly, the Chamber recommends the following as a threshold to 

determine if an outright repeal of the Volcker Rule or a modification of it is the right 

course of action: 

1. Conduct an economic analysis of d1e Volcker Rule to include the impacts 

on business financing as well as the consequences for financial institutions. 

1 t is important that the regulators understand how the Volcl.;:er Rule is 

affecting the customers of those financial firms. This analysis should also 

factor in d1e influences dut the Volcker Rule may have on economic 

growth. 

2. Conduct an analysis of major regulatory initiatives undertaken since the 

financial crisis to determine how they interact with each other and the 

economic consequences of those actions. This analysis should include, but 

not be limited, to: the Volcker Rule, risk retention mles, money market fund 

13 
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regulations, Liquidity Coverage Ratio Rule, Net Stable Funding Ratio Rule, 

Total Loss Absorbency Coverage Rule, the Foreign Bank Operations Rule 

and capital rules and other rules promulgated under section 165 of the 

Dodd-Frank Act. 

3. Following these studies, the regulators should report to Congress if the 

Volcker Rule and others should be repealed outright or amended. 

Regulators should then proceed with appropriate rulemaking to achieve 

those goals. 

4. Congress and the 1\dministration should t.ake steps to ensure that banking 

regulators conduct an economic analysis >,vith all rulemakings as required 

under the Riegle Act and the ;\dministrative Procedures Act. 

Conclusion 

I appreciate the opportunity to appear before the subcommittee on such an 

important topic. The V olcker Rule, though well intentioned, has harmed the ability of 

non-fmancial businesses to operate and grow. These adverse impacts are exacerbated 

when combined ,-virh other initiatives. Additionally, the manner in which the V olcker 

Rule was written demonstrates flaws in the rule-writing process. Indeed this is an 

example of why a data driven, evidentiary based, transparent rule-writing process is 

needed to achieve the goals outlined by Congress in the least burdensome manner 

possible. 

Our recommendations are common sense solutions to get tl1e facts necessary 

to determine the path forward-repealing the Volcker Rule or at the very least a 

holistic and wholesale revision of the Volcker Rule as well as Basel III, the risk 

retention rules, systemic risk policies, the Foreign Bank Operations Rule and money 

market fund reforms. Such an exercise can develop policies that will promote both 

financial stability and economic growth. We look forward to working with all parties 

and stakeholder in achieving those goals. 

I am delighted to discuss these issues further and answer any questions you 

may have. 

14 
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27369.052

THE ECONOMIC CONSEQUENCES 

OFTHEVOLCKER RULE 

by 

Anjan V Thakor 

John E. Simon Professor of Finance 

Olin School of Business 

Vhshington University in St. Lonis 

Snrnmer 2012 
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Since its the US Chamber's Center for Capital Markets Competitiveness (CCMC) has led a 

bipartisan modernize and the outmoded regulatory systems that have governed our 

capital markets. Ensuring an effective robust capital formation system is essential to every business 

from the smallest start-up to the largest enterprise. 
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Executive Summary . 

Introduction .. 

Impact of the Volcker Rule on Businesses ... 

Impact of the Volcker Rule on Financial Institutions ... 

'I11e Volcker Rule as One Part of Overall Regulation 

and Alternatives to the Ruk ... 

Conclusion. 

References . 

. ........ 3 

. B 

13 

. .. 22 

. ..... 32 

. 34 

. . 36 
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This pJper pl\widt>~ a analy<..is of the potenti,ll Cetlllomic cou~eqtH'nce~ 

the Vokker Ruk, -.,v-hich i) '' p,lrt of the l )odd--Fnnk \V"lll :::.rn:ct Ref('l'lll And Comumer 

ProtectwnAct (Dodd-Frank). fhis ruk pHtS re~tnctlon) on hanJ.-..,- ,1b1liry tn en~-1ge in 

in propnctary todms, ~ome t)f 

The analysi~ the~eliquidity provision f()r numy securities. TheVokkn Rule will induce b:mks 

l\.' retrench more Crom nurket making in smJllcr ,md nskwr ~ccurities where large and 

uncx_pectt'd ~upply-dem:md ~hocks ,ne more likely. thereby redtKing market nukmg iu tlh' 

\'(.'ry secunti,·s where it b mo<.t \'<lhuble. The ~<-'l"UrHie~ l'i\UlT~ .md the \\'lll fed 

th~· 

There will aho be other adw:r<;e comequen.::cs fOr bank cmtnmc:rs. ~-xperiencc' 

nf financnl \lTVH"\'\ prnvtdcd by b,mb. k\\ liqmdity J(w the \L'CuritJCS that 

h;:mb l>~uc, and mort• di~torted price~ ofb.lllk securities tlut rcnum di,tortl'd f(lr longer 

before. Moreover. h,mk CU)h>rnt'r~ ,tlw hkdv to be ti)fn;d to nxord mJrk-tom.nkct lo'~t'\ on the \Ccuritie~ they hold 

oper<ltc m networks, :md the retrenchment of bank) in market makmg: \vill reduce the 

nluc oftlw !kt\vork c'Wn 1funrcgubted (non-h,mk) cnnties.tnow m ro fill the ncuum 

ue.1ted hy t!w of hank). Tlm will ewnt11allv hurt hank cmtomer-, 

Thin!, the Vokkcr Rule is likely to lead to hig:h\'r costs 

husine-;ses and potentially 1mv1?"r capital inYestnwnts hy tlwse 

along "vi:th a possibly greater focu.;; on riskier or mor(' short-tt'rnloriented investm.cnts. Due to redwed liquidity Jnd gre.ltcr pt'rn'ived re:,~nlatory 

uncert:nnty, borrower\ wi!l be contfonted with higher cost~ of capital. Thi\ i~ likely to 

reduce at;gregatt' mve>tment ,md J!so make ri\kJCr inn''itmcng more attracnve_ Moreover. 

finm will fi11d it nwn: ,lrtraz-tiv(' tu itW\'"t in pn~Jt.'C\\ rlut pAy ntff.ISt~T.Thc rcduct10n m 

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institutions, harming the ability of bnslnesses to raise capital. By :mificL111y 

constrammg \ecunty holding'i tlut banks em h;we in tlwir inventories for market 

making or proprietary tr;HJing purpose~, the Volcker Rule will make hank ri~k management 

lc~s ctftcicnt, ll1rcmg lunk<; w ctthn Jcccpr nwrc n<,k or npcr.ltt' with more o~h. Mon'O\'\'r, 

it ru.ry advcn.dy nnpxt rb,- dn'cnificd-tin,mci.ll-\ervic~-~ husinc>-, model of b;mks, ,md 

tlwnJorc Atfut tht c:xtt_'llt to \dlich IMnk~ ,md l'<lpiu] mc~rkcts co-evolve in,, mutually 

lwudicul m.mncr. 

Although main go,tl of the \'okker Rnle----to n:duce over.lll ri<..k in h:mkin~ and limi( 

tl11~ go.ll em k <tthKvcd wHh 

hqtttdity requirement,_ 

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INTRODUCTION 

In the '\\\tke oftbt' :?007-.()9 tinmci,1l cmi.<., there ln;; been ,l grot dc,1! ofintcn:.;,t -in lmpo.;;mg 

rt'~tri~·tinn'- on the Jctivirks ofhmb to cmurc tlut they do en~,1ge m tlut m,1y JtKJ"e,lSC 

the fi·agllity of the fnwtnJ! 'Y'>tcm. On July 2L 20li\ the Dodd-FrJ.nk \X':lll Street Rd(m1l J.nd Con\nmcr 

PmrcnlnH t\ct t'ILlctCd to pur ltl pL1C'..' S\VC;:pmg 11\'W rcguLnory ch,mp:n Ill the rln,mn:ll \\TVicn 

indthtry: lnduded in ])odd-Frank (§(lllJ) tmpo~t'~ re~tnct10m on 

actlYittC\ ofh,mb snd their JtfiliJ.k.,_TJm \t'ctwn h,t\ cnmc tn bt' kno\\'ll a\ the ''Vnkkcr H.uk."! lw 

prmcipal ohjrcti\·e ~;f thi~ p.1per 1'- to cx,uniu,, the l'COtl\11l1tc '-·otw.:qw:tKl''> of the Volcka Rule. 

The Vokker Rule 

The Vokkcr Rule prohibits ,my lw1king entity, including; b,mk JflilLue-,, froml) Spon~oring. or invc\ting in, a hedge fund, priv,tt~· eqnit>· tim d. and other 

ofit·red funds and pookd vduclc'>. 1 

E\Ytplit!l!s: l unds 

lnng .1~---

bJllk 0\Vll~ JlO lliOrt' t!uu -~ lWfCt"llt of the timd: 

No more tlun -~ percent of the h.mk \ TR't··One capiral i~ inv<'\ted in the fimd: ;Hhi 

( )tbn rcqtnrcnwnt~ <;Jtl~ficd tlut pcrtnn to the run~e oftlw tlmzL -tnd .tfiilut,·r! 

1 r.::u h;lltJOn~. 

2) in J'!Opritt<~l")' tr,lliiH."f, ·whidt j, ddlncd ~hotl·fl'rm trsdmg (th.c purrh«v' wd 

qk of fin.mculHutruBwnt~) with the intcm to profit ti·om the difiCr,·ncc hct\\TCil thl' 

pn~<::h,l'"': .md ~.de 

1:-:..:rcption\: l:x~-mpt fi:om thi~ p1·ohihirion tr:lt!ing .Ktivitic~-

ln :m1mcip,1l bond~. if tlwy ,\rc i.'-'>Ued b\- .1 '>t.lte. county or political subd1Ylsion ('mch a~ 

amullKJp:dity):' 

lo ronncctwn \Yith "llurkct Jlt.c~king''; 

In ClHl!H'ction with ,·z·rt.l!!l !wdgillr ,\ctivitJe~ inkmkd to rl'dll(t< ri~k: ,md 

Condnctl'd on bcblf of ;:mtomcrs. 

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It no tin?: that nurket making h pwprid.1ry tLhling tbdt i.;; designed to pnwide 

"immethxy" to mn'\tOJ<:.. One (lf tlw go,\h of m,u-kcr m,1kmg 1~ to pro\·ide hqmd!ty f(x inw~ton. so 

they em be .munxl of tr.1ding .lt pn'YJiling nurht rJthcr tlun bcmg concerned about moving 

the advcr<:.dy a> a rc5nlt ofth-c!r own trade. A nurket maker can fanlit.ltt' this <;Jtuation hy tr.1ding 

om of lh own !11\'t'nlory of holdint,l"\ o( that \ecurity. ntlwr tlun rd~cmg 'SOlely on ,l CC'-ncurrent nppoqte 

tramaction by .mother invcqnr to the trade 

Rmkm&: cntltll"i .m· requin·d to he in <·nmpliancc l~y dw end of tlw Vnkkn Ruk \ dfi·cmY r!:tt<.'. 

"l"he rnle it\elf \\"Jll come mto fiw,_::c m July 2(11."2, hu1 the ultint.lte cumpliatKc zbtc i~ ,mticip:!tcd to be 

three to fi:mr yeJ.r\ f!-om the bill\ cn,lCtmcnt cbte ofjuly 21, 2Pl!l. w1th the pm~ll.>Jhty that the Fcdcr.1l 

Rco.erve \Ytl! 1ssne fmth<-·r extcmiom.' Sever;ll f(:dera! ,1~cncit'~. mduding the h•dnal Reservt\ ~)ther ft-derat 

bank:.iug Jgcncie>, the Secunlit's and F.xdungt" Comnn~sion (SEC), :mJ the Commodity Fntun'sTradmg 

Cnmmi\~ion (CfTC). an:- curr~~ntly cng.tged the ~pccific ruk) by whKh they \Yillnnr!cnwnt 

tlwVokkcr Rult' .<gctKics will determine the deotb n.·btcd to the 1mplement.1ti\m of the m.trh•t 

nuking excmpion 

Historical Perspective the Origins 

In a\~essmg the econonnc con~('qncncc\ of the Volckcr R llle. 1t l'> to he cogniz,mt nf the 

lH\tOric:l! roots o( ~HCh fH\~\<.T1pt101l' ,m,J umkrst.md both they \\\'IT i·int ,tduptcd ,lt)(\ why they 

Lncr disnuntled. Tlm section prm ides a bnef <Yonotn!c per,pectl\·e. 

In IQ:'\3, thl' Secmitie~ An of !9]3 ,tml th~~ (;tb~-Stc,1g,lll An \'\Tf\' ('tlXted wirhin th<.' three 

month~ of President Fr:wklin n ROO\l'Wlt\ New fkal.Tiw C!J~'>-Stc,Jg,tll Act l~fO\'Jdcd iOr the kgal ,md 

reguLttory \t:p:lr.<tlnll of comm<.Tci,ll banking fi·om im-e"tment h;mkmg (indudmg 5t'ctmties tmticnHitm~. 

market m,1kmg. and other c.1p1ta! Jnarket acti\·tt!e~) and 1murance.This cn::,lt<.'d a US bankmg modd 

th,lt was quite di,tinct tfnm the "univcr$Jl banbng" model in m.my othet countrit"' tht' world, mn~t 

rwt,1hly thow in Europe. One of th(' princip~tl go<tl" oC tlw Cb~~· Stc<<g,<ll Act w,\'> to t!ut the U.S. 

h:mking indn~try. which h,1d yu~t bcnl provid<.·d with Ceder.tl del'o~it in~tu\mn:, "\.V(}uld h(· \sft: <10d ~ound 

Jwl protected from "non ~bankmg" capital market ri~b. Tht• 1dc.l th:tt ft:deral deposit mmrance 

,l coming~.·nt li:J.b1lily f()r lJ.S. t,lxp.rycr~.mcduni~lm h:1d to in pLln:' to rnnt.1in th\' ~iZ1' oCtlm li,lbility. 

{)m' ~uch mechanmn tht: ;~doption ofre~tncunm on the penni,~ihle ofm~un::d hanks. and the 

1he ),lfE•t)· ,md ~omHlnt>>~ of,\mcnon commercial bankmg. 1 One of the cornerstone> of tlw C!a)~~ 

Ste,1g.1ll Act w:~~ the di~tincuon het\wcn ,\ /ot111 ,md a B.mks allowed to onginatt>!make 

,t]]ownJ to \Hl(knHit(' \('Cntitii'S. ror 

buth conceptually and 

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operationally mclul. I-10\Vt'ver, in the 19BOs ,md Y>O~. srmriri:::<~li<'ll emerged in bdnking 

Sl·cnritil,\tlon i~ ,\ pmce~~ wlwreby ,t puol ot'Jlliqmd .1s~~'N hke mortg,1gcs or crcd1t t·.mlln.ms (n:-cciv"1bk.,) 

.m· pooled top. ether m a ponf()lio and placed in a tnv;t. and then daim\ are is~ucd ag.1inst thi~ portf()lio th:\t 

,m· .,old tn capital market inw,tor<;. 6 flw...,c daint~ ;ne gin·n Llting<:. by the n'¢dit rating .1gcnne\, ,m· tr.dt·d 

dw c.1pit,1l ma1kct Mld hJY(' m,lrket-tktt:rmiucd 

Sumitu.:ninn. wlnch h,l, been h;ukd nne of the LmdnMrk firVIKi,\l innovdtil)ll~ of the tw.cnticth 

h,mks 

to dJV('rsit)• more etit-cnvdy :~rro~s Ydnou~ sector_;, nfthe economy by purcha,ing rtums agJuht lo,ul~ 

nngm:~te,J by mhcr hauks .md ;;z:llmg off ~umc (\f their own lo,nh. Thts t~Kihtar''' tlw man,tg,'nWnt of Ct'1'dit 

ri\k by han b. Second, ~ecuntJLttion conwrt5 previously 1lliqmd ](WlS mto liquid tndcd 

n:dunng banb' hqmdity ri~LThinL 11 \hlft, p.nt of the funding of),l~lll' f!um depoqtors to c.tpital-marh'r 

mw~tor~ who able to avail themsdn~s of trading opportunnie~ in ,lliquid m.Hkct.This rcdtKC\ rh..: 

cvnJtu,ll cost offin,mcing tlw'c loam ffom tht' \Lmdpnmt ofb,mk<;, wh1ch comcquent!y reduces horrmving 

cmt\ fix b,mk nNom<.T'.. Founh, ,h .1 rc~ulr oflmwr fin,mcing cow; ,l!ld imprO\nllK]Uhilty, h,<nb arc abk 

w proflubly provillc credit to crcdJt '.eckcr~ who prc\·wus!y t~xcludcd fi·om rL'CCJVHif:; kmk 

necht. 7 Bcumc Pflhc.~e C'COlWlllh. !lcndit~.~Z"cnritiation grew hoth m vohmH.' and ~cope, md by .?:1\().:) the 

m.nket fnr aN't·h1ch•d !ud grown to :~hno\t .$:?. tnllion (r:1gme !).~ 

c 

0 

~ soot-~~~~~~-~~~~-~,-,-~--,,-,,~-~, ____ , ___ ~ 

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 

Year 

S,l!ll(t: Crecnb.nnn ,md Tbkor (2007) 

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One of th<' comeguence~ of the ri~e of <;ennitization was that blurrC'd the hound;n·y hC't\veen 

loan~ :md secunties. Because '>ccuritizJtion j, :1 pron-~" of convcrtmg loam int{> secunt1es. b.mb \\TT<: 

df0c·tJvcly lnvo!v,:d m tlw procc~' o( >ccontie~ undcnxrinng \Yhen thz·y were p,lrrici}utmg m .,ecuntlution. 

Yt.'t. ro!!mg hack 'itYuritiz:~tion jmt to \tlck to the "letter of the bw"' of the Gbs~~Ste,tg.lll i\ct ~ecmcd 

economic,!lly ~il!y m hg-ht of all of tlw pnTJomly di,un~cd ccorwnnc hcncfit'i. ThU\, during rhc 19XPs 

(t~pedally after 1985, \\'hen U.S. comm ... ·rcia! h:mking truly embraced ~ccurinnnon) and tlw l91J(ls, the 

ecmwnnc~ r>f rhe finanrul 5lTVHTs mdu~try gndna!ly bur mexonhly eroded tlw dc.fi1(1o, ,!lthou(.!:h not de 

jure. separ,1tion lwtwen1 !o,m ()rigination ,md ~ecuntie\ underwriting that \\\l~ at the heJrt uf ( ;!as~~Stcagall. 

Banks contmued to pby a pivotal and incrc,t\ing role in not only urigin:tting the y;Jriou~ loam th,ll 

\Yerc :;.ecuritized but abo Ul makmg ,1 market m the daim<> ,tg,oin~t lo,m pool' th:~t were ,nJd to invc:.tors. 

J() a large extent, this rclentk<;<> \Yeakenlng of the ~t'pJr:ltion prov1~ion~ of ()L\~,,-StcJgJ.ll WJS a 

direct comcqucncc <.lf 1turkct f"on·c~ And the Lmderlynlg ~hift in t!w cnmumics of the finanCJ,ll <;en·ice\ 

mdustry, rather than lobbying dT(wts or pohtlClli(!!TCS. Ewnma!ly. the c;Jas~-Stcaga!l .J\ct W.l~ f(mn:dly 

d!<;mdntll'd m J999 with thl' p;t<;'i.lf';t' (\f the Cr:tmm~Lc.Kh~Bliky Act, ,1ho called the r:inancd Stn"JCCs 

Modernization Act. act repealed Sections .~0 and of the (;Jass-Ste,lpll .'\ct. and ,ltlthorind b.mk 

holdmg conJp,mic' ,md foreign lunk' th,Jt meet chgihility nitcn.l to become /inanci,d holJH1g comtunic,, 

thm ,d!;w.-mg them to engage m ;l hrn:rd r,mgc: of fin,mnally n:Lllt'd ,\01\'itlc,.'' 

The Vokker Rtde ,Jttempt.-:. to bring tlll~ situ,ttion "fi1l! nrcle." in ,l nwmer of,peakillg.The 

Dodd-Fr.mk Act doe5 not th(' Cb~'i-Steag:tl! Act, 1

" hut it doe'> reviw some of it\ ft·atures through 

litllltAtion~ m1pmcd Pn the ,1biliry of conHncrn,ll b,1nb And ,<tfihatcd compJnlt'<; to enpge in tr,tdmg 

''unrelated tu cmtomer JH'('(h' .md inve~tmg m and \pomoring hedge ftmth or pnvate eqmty fimd~, 

Sunnnary 

With this h:Kkdrop, this report examim'" the potential implicltJom of the Vokker Ruk t~w banb 

Summary, .lre th.lr the Vokker 

Rule hJ., i''*'mi.dly <-lgnifinnt economic <.'<Hl"'qU<'rH-<''· It n•ill ,\dvn~L-Iy .ttfcct liLtrket m.1kmg .md 

liq\lldHy provt,iou in tlw fin;mn,ll m,n·k,'t. Bnrrown-; (1.e., bank customer~) \YllllLlYC lower market hquidny 

thClr 'ecunlH'~, luglwr llnancmg (·osts, po~qbly duwm-;hl·d ncd1t ,lnT\~. lower over;!!! mvcqmcnt<-, ,md 

potentiJ!Iy !0\vt:r nnp!oynwnt. rnr reguLa or~ mtl'rt'\ted m the qft·ty ;md 'oundn('\5 of tfw !irnnnal 

it t> likely th,n the xt1vities that b.mb wlll be t\.>rccd 10 giw up will nHgr.ltl' to dw nnregubtt.'d ~t'"gnwnt 

of the flnann,l! 'ocrvi,cs indmtry. And po~'1bly k,ld to ;1 pcrvcr<.(' incrc-,l<;z' i11 ovcLlll ri~k. For bnk~, the 

reduction in market nuking will impede rd:, HLHl,tgi'llWnt, ohtrw.::t the ,tbility to :-ignal the quality of the 

lo,m~ they h,1vc ~ecunnzcd, reduce the nlne of fin,lnn.tl <;crvin·s <.)ff~'rcd to ctbtomcr~, ,1dwrsdy mlp.Kt rlH' 

"hll\inc~~ nwdd"" ofb.mk1ng. ,uld pn.<.~lhly h,unpcr the cconomiolly-bendicnl co-cvolut1(1!l ofhanb ,md 

fitunnal m,1rkct~. 

The rc>t of thi'> report is orp:anized :1' fi1llows. Section !I examines the impact of the Vokker Rule 

<.lll the economit:: flmct1ons of Jll,trkct nuking and liquidity prn\"l'iion. SectlO!l !!I cxanuncs the potential 

rq:::uL1tor'- Ill 

10 Sec the dJ'o\'ll''oJ0!1 m Cupcntcr .md Nlurphy 

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irnpact of tll\~ Vokkcr Rule on hank cmtomer~. Sect1nn JV t'X:nnitw> the impJCl of the Vokker Rnh.· on 

b,tnk'>. Section V point that the Vokker R nle 1~ not being contemrLned in J reguLttory v:tcuum, 

lllllllL'rOth other re~ruLltwn.> m.1y <nnphfy \OflK of Jt~ potenti.dly SJgniticmt dekrerion~ crt~·U>. Tln~ 

.tlso mdude a d1~cm~ion ofaltematnws to theVolckcr Rule t{)r containing bank n'>k, ~uch AS C.lpHJl 

reqmrements. Sect1on V! cont.m1:. concluding thoughts. 

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POTENTIAL IMPACT OF THE VOLCKER RULE ON 

MARKET MAKING AND PROVISION 

In cvaluatin~ the potential imp.wt of tlw Vokker Rule on marke1 making .and liquidity provi~iom, 

this ~ection i" organi?cd in thn't' part<:: the efonomics l)f market nuking .md liquidity provi~ion. the 

nurb:t m:~king, .md the hkcly unp.Kt of the Vokhr Rule on nLtrk\'t nukmg. 

The Econon1ics of .\.1arkct Making and Liquidity Provision 

M:~rh•t nuh'r" "erve an imporunt t'nmomic fuuctton in St'rmitie~ markets, :mJ proprietary tnding 

allow~ banb to be maker~ m :1 v.lricty Marh·t maker'\ handle most t)f tlu~ 

trading in gowrmnent bow. h. mumcipal bomh, and corporate bonds, on::rAhe~countet ((Yl"( :) denntiw\, 

currencies. commoditie<, of Vdriou~ \OltS. mortg.1ge-backed ~ccurilles, :llld equities trJJed in L1rge block\ 12 

M.l.rket making ism important p:1rt of etFuring tlut tht•re is a liquid market in the 'eoJrity.An investor 

who w,mt' to sell a ::.ennity can call a m;nkt>t nuker, whn would then pnrchJ~t' the ,;enuity immediately on 

it<> mvn account :md add 1t to it<; inventory. Smn!J.rly. ;m inw~tor who wishe~ to 1-~urch,he a security c:~ll 

.1 m,nh·t m:tkcr, which would then t,tke the (('Curity fwm its o-wn inventory and sel! it.T!m provide-> 

nluJhle econonuc fimniom. One 1S ''imnwdJ,\cy'': a~ a buyer of,, 'ecurity, f need not \V,lit ,, -;elJer to 

nmu: along nght JWJ.Y for the tLUhlction to be expcdniomly executed, and J'> a seller 1 nn·d not wait tOr 

,, buyer to .1ppear rigbt :tway. The nurket nuker ~crve\ ,v; ,m intnmedury to make tim happen. The other 

ecnnornic tlmctinn i~ hquidiry, which rdCrs to rhe ,1bility purdw;e or sdl or scruriry without movmg 

th<..' price ,lg,limt you tfyou are pLKing a purch.<\e order, prit'l' dne~ not rJ\t: much, and if you 

pbcing a \ell {~rdcr, the does not f~1ll). It the market m.1h·r\ c:xecutinn from its own im\'ntory dur 

hdp'i mimm17t' dw prKc impan of ind1vJdual tr:tdt·~. 

Thi\ (h~;·u.:;sron pninr'i om an imporum dift('tTtKl' henV\'t'll .\ fm,kcr and a marb·t m,1krr. A broker 

sirnply rnatdw~ buyers and sellers of sccuritic~, \Vhl'n.\1\ a market niJkcr ,lh'>orb'i <;upply .m~l ckmand 
104 


27369.063

a market maker a "qualitative .1N't tr:msi\xnwr" (QAT). 11 Thi~ Qi\T finKtion in<port,mt bt•c:tu~c 

inn~~tor alwsy~ tic."' unccrtJinty ;lbont how m:my other mve~top, .are prq1arcd biLl competitively fi:n· h1~ 

trade The mw~tor 1' thcrd1_)t\' wdling ro uff{:r .1 (,,m,1l1) pncc di<.count w the llLlr"ket m,tkn m orJn w !uw 

l'XpeJitiomly ,md \Ylthout :.ignitlc'Jllt (,;dwr,<) price mlpact. 

Th.c \',\'it m:~jority ofOTC tr,msJctiom ,1re conducted with m;n:kct maker:;. Almost .11! bond trading 

io. conduct<:d in the OTC rmrkct. Tlu" indude'i {'Urpor.ltt' honds. municipal ,md US bomh, and 

~OY<."rct)~ll bonds is<:uni hy t{neip;n gnwrnnwnts. Aho, the m:t)nrity of the nut~tmJing !Lltmn,ll ,nnotmt of 

1\ rnded in the OTC nurket.Tlws, nurkct nukcrs provide immedi.Ky k)r many ~e-cuntks th,lt 

,m' JHlt tr.Jtbi on org.mized exdung:~·s. Alth(lugh cxdungc-h·Mkd .l'>Sl'IS .1bo h,n-e the h.:nctlr ofinnnnliKy~ 

there i;;. the putl'lltt:tl tClr :m .1dvcrse price impact J{n Ltrge trade~, ,md thi~ imp..1ct grows larger with 

the ~izc of the trade./\ market 1\l,lker on oftl'll h;1ndle Lngt' blod·;. trAde-; ·with J. \lluller price illlpact 

In pr,Ktire, then' JS comklt'rabk h:.·terogeneJty in the demand filr inmiedi,Jcy from custonwr~. 

Dui"lie (21112) proYtde\ :-.ome indic:won of hem: Llq::;l' ,, role a nurk,·t nuker on ~~by in ,1{',\rtlct!l,Jr o;tock.A<:. 

J.n Ilhl\tr.Jtion, he provide\ inft)rmation Jbont the actual {bity US. dollar inventory of the common slurc" 

of1\ppk hdd by a particuhr bmker~..Ie:ller dunng a cont1guou<; period from .~O!ll to 2011. The'<' cbt,l ~ho'l..v 

th.1t the nurket nuktr\ inwntory ()(thi\ senmry rC\'t'rl\, on .tvcr.1gc, ,tpproxinutl·ly 20 percent of the w,ry 

tmnrd norma! each cby. implymg .1pproximatdy a thret·-day expected half lite unhatmet'). 

The datA ,\bo rt'W,ll ~ub~umial CH)\S-\ettll)!l,t! ht·terop:eneity xros\ indtvJdu.ll equities h,mdlt>d by tlk ),tnk' 

market m-tkcr. 1v1th dw cxpened ldf lifi.· of inventory nnbALmn·~ bcmg t!w highc(t t{)r (leJ.st liquid) \tocb 

\nth tlw highnt-bid··a\k )pread~ J.lld tlw lowt"•t tr.Hling Yolum~. 

L1rge h.mk~ t,•nd to be mo~t promin<.'nt ,1\ m,uket m,1kns t\)r s~·curitie\ \Y]Wrl:' trade• ffcqucncy 

is relatively low and trade rebtivdy t1rge. Thc~c the \ecuritJes f{H" whtch of immedi,Ky and 

hqmthty ,n-c !ikdy to b..: mo-;t f'l\'S~mg, snd1 J~ locvcr-rat~·d bonds ,md credit ddJult \\\",l!'-'·1 )utile (20 l ":) 

report~ <111 indiYidtul broker ·dealer's p<.bitwm lll ,m illVt'~tlllt'!lt··grade COf!'OLltt' bt~nd, ~htl\V1tl~ t}ut the 

m:~rket makmg fnnCtH)n omt•d thi~ broker-de.1lcr\ mvcntorv to hecorne 111'\!<ltir·e. An indJCatJOn 

]loli'nlia/Jlliquiduy in the corporatl' bond market i~ tlut the l':..pected lnlf lif0 of inventory imh:d.ltKl'' 

l\ rypi,·,1lly much longer than that f(w a typK<ll'>t<xL In the JlJu\lLlllon proYJdd hy Duilic (2012). d;c• 

C:":j.Wcted h,tl\, hfe of inventory unh,lbtKl'~ 1'\ ,1bout two wecb. 1

·

1 

Like other QAT nuklllg impmc~ tlw !fl,trkd nuker.Thi~ ri~k ~tem~ 

fiom the that pnce~ of \t'Ctlntle~ in n~ nwentory n1.Ty 6ll, (>r pncc' nuy n\e !tS tnn,·nt~>ry 1~ 

This rbk 1' ,thorhed hy th~· market m.1ker\ opiu!, .md the higher the ,tmomlt of capiul tlt<t rlw 

m,lrkct m,tkn h.1s, the it\ .1hibty to ,tbsorb ri\lz and !wncc the mon' v<~luJb!e the market-nuking 

functwn f()r inve~ton. 

Ll 

~,j Anot!wr imhc.ltlon of potential 

(;o](htr111.l{otchkls'<:md 

,\bond \V\<' 

hon<h <11ld 
105 


27369.064

any otlwr ri>k 

ht':lriug thi:, ri,k.Tlw greater the mventory n\k fKed by the nurket m,tk(·r, t!w h1ghcr th~· r\'turn 

(comtwm,ltion) th.lt the market m.1ker need).Th1\ expected returllJS not only cnmpemation f()r hearing 

risk, but al"o implicit rew;ml f,)r the ;..pn.:iali?Jtion ,f..ilh that the nLnln nuker develops as it lt'.lrm about 

ckmge\ in nurket c~mdttion' .md '"'Jut cJ.rly indicator' imply about the pos>ibk dircctiom of future price 

mnV<::\.Thm, ,\ nurkn nukcr can profit by antidp,1ting '>-vhen Jt nukn \l'mt' to let Jh mvcntory diwrgc 

'Hb<.t,UJti,llly hom .1 "urget" or "norm,lr· kwl m order t\) pnwide m1.mediacy to a dlL'llt who wis]w, to 

phcc a large buy or ,dJ order f(x J secmity. Fm example, the nurkct m:tker nuy ~mticip.lte that ,t 

price j, likely to t:lllm the future. aml nuy thus bt· wilhng to ~Ml\~V a Ltq,;~· purcba<.c order .lt thl· current 

pri~·e tTcn though it m.1kc~ the market m:Jker\ inventory in th,lt S\Yurity neg.llwe. 

The nurkct mdkt'r\ willmgnc<>~ to ab,orb supply and demJnd imhal:mce.<. in 

J. compcmatin!l: n.'lllrn produ<e\ ccnnomic bene tits, which h,!V<.' b,·cn di;..cu~,;,cJ m the 

and empinc-1l rt'S{',uch on thi'i- sul:JCCL Exam ph:; are p,1pers by Adrian and Shm (.'2007); Brunnennei('r 

.md 1\:dCr\;,'!\ (2009); And Comcrtnn~fordc. 1-kndcnhott,Jom'\, Mc•ulton, .md Se.dwk" (20lll).cl'lw bJ<;ic 

of this rec.earch J:S t!ut. m the ab<;encc nf m.nket m.1kers, tlw pri,·e Hll]XKt\ ot" tr-1d\'S would be 

btg~cr ,md more JWr\i\tl'llt. In ,1 nut~htll. bquidtty \\·onld he ~~r~niticmtly ,\d\·cndy 

J', .1 "network nurket nukn m ,my \ccurity do\'~ not nper,ltl' JH A V.lC'HUm. R,ltlwr, in providmg 

imml·di.~ey. a m,nkct m:th'r relic~ nn hemg ,<bk to unwmd Jt> po~ttion' .<t opportmw time~ by trading 

,lrhcr market maker~. These nurkct maker' m,Jy pm\C\~ kno-wledge .1b(.\ut 1mpcnding orders !Tom their 

own cmtomer~ thJtnuy iudun' them to nBkc tT,<dc\ with a uurkct nukt'r 1hat twcds to do ~o in order 

tn n·b,tLmt~' it~ im·entory. ·n111s. the cxi~tence of :1 network of market makers r.Ypands 1 he upacity of any 

individtBl nurket maker to proYidc- immediacy. 

Thi>. !Wt"'-'-'<->rk i~ ,-rnci,tl in undcr~tandin)!: the pot,•nti,Jl imp:~ct nf the Vokker R111t'. 1t ha, h•en 

mg.sc,tcd tlut the lns\ of market rn.lking due to the <'Xit ofb;mks \vould not he proble-mAtiC .l~ othe-rs will 

rmh m t(l fill the v.1nnmL Althongh ;;udt nurkd-·nukm,e; rcpLtcctncnb m,ty occur, the tH't\H)rk etfl'ct 

mdicltC\ tlut thi~ l\ unlikely to be withnut ecnnomJC romequenn· 

\Vho are the m:~jor member~ of thl\ nct<vork? T:1bk 1 prm·1de\ (Llt,l on the hank\ t!ut \vould he 

,llh·(tcd by the \'nicker Ruk. 

Page iU , l HE LU)i\\),\11(: Z ON'J[(/l'ENCL:i \)f· Hif· VOU'KER RUU: 
106 


27369.065

Making 

the !)odd-Frank pn)hJbiti(\11 

prnpri<:tary trading.1t .1ppea!"'> th.lt the rule \\TJting proct~\ of the n:guLJtory a~encie<> \Yillmzked inhibit 

!11Jrket mabng by banb in a tlut h to h: dNupt1vc tin m.lrkct !iquid1ty. Dodd--h;mk requires 

rcgnL1tors to nukt~ ,l cbtinctJon bet\veen tr;1ding acti-..-1\H.'\ tlut mtcnded to ~CrYt' m,1rket nuking 

pmpme\ .md thmt• tlut ,m· proh1bitezt Flow (kws Utlt' go .1bout 1nakmg tim d1stiuction, 1' whkh h quite 

(htficu!t n1:1.kc m pucticc? App.m::ntly~ the intent h rome quJnutatwc nwtric~ to ll\(',l~nrc the ri<.k uh·n 

by the m,ll ket m.1ker ;md \h<:' thi<. mt',l'ureuwnt a<: .m indiotor of wlwtlwr the propricun· trading \\":1~ of 

rlK prnhihit('d form. for c-:,unple. dw Af:;t•nci''·' dnii-ing rhc tlrul rule 

Jhc_;l,gnu/C.I 

i11{\mnali,,n 

htrthcr, 1t ~~~rated: 

ih<l! lhc..;c rca/i.:of.·ri_lk w1d n'i'Cil!lc-rcit!liw~to-;cldi,:-cd-risk !llCasurnnO!I U\ndd J'H'I'idc 

wht'thn tmdi11g <Jail'itir_, <~rc' J11(>durinJ; !H't'!lllc_, t!wt arc r,,H;:ist('Jit, in toms ~:f 

.drtomine whc!licr rlwsc ,/cli!'iti;'S hn'\'IPc pMitibitcd prorrictmy /r,ulirt,(! brnmN rhc rracling acfiFity Fithtr is 

inn'll<istm! witlt pctmitt<·d mar/.:('{ milkill,'(-lciili!'d attiJ'itifS or fliC'iCJ/fS a n;,Jtcriaf cxpcsurc 1i' h('<h-risk 

or lu);h-risk flwiing :cnattxic,_ 

"]f you \vanr to h\' rr.Jdmg, wm h.Jn' U' 

did 

"\V\Yw.(:c-ntcrfor( .tp!t«ltvbrkct~.com I !)age !l 
107 


27369.066

PageL' 

And then: 

S(~n[fit<~nf, <Jbnipf N illtllJhi-:tmt rh,ll~(!i'S f,\ key risk m,//h~'(Cil!CIIf IIH\1.'1/rts, .wth J' l·;,R, tlut mt· iucmLq'<;tcm 

with prior t'xperieniC, the expcricwc ,:{similarly situated lrd1liug 1JI1its a11d /Hilll<li~cmcllt5 staled e.vratatioR' 

m.1y indicate i111ptrmissibk propricuny tradiug 

R egul,ttor<; are ,1bn likely to .l. host of metrK~ to re.Kh their condmiom :~bout \Yiwther 

include JYWnne-·bascd ntccnc~ tlut llW.t\ure d.1ily tr.\(h!l~ n·wnue~ and prot "it> compared with histnnol 

rC\Tlltll''> .md protir~ fl-om total tLldll\~ activny: rn-eone-tn-n~k mctnn t!ut m~,hurc the Jmount ofn_'Vl'llu~· 

the h.mk g~'nentes Jnd. eanm11-." \'oLlt!lity n.J:uive to th~· ri~b J·;~umed: mvenwry metnn; and cu'itonwr 

flow nwtrics. 

lt ~> unknnwn ,lt thi~ time whnhcr the· rnk will haY<.' this .tpproKh. If it due~. there lih·ly 

to b,· ~crious Ct\Jbequencn f()r rlw nurk1·t m,lking ruk J!T impknwnted 

in the nunncr di>dl'M'd aboYe, m;1rkct makers will be Jblc to >YJth only modcr:~te ~npply-dt·nund 

imbalance~. ,md thm pnwide immeJi,Ky only lll limited nrdllTl\tances. Any market whu "d,J.re~·· to 

qep m and .1b~orh n:·bti\Yly large supply-demand imh.tlance~ .m expected return ,·ommemunh' with 

nwtnc\ and an HlC\T:l\L' Hl profit~ tlur could ~1goJ! tiLl( H lud cng,1ged m hannul propnct.try lr;tdmg. It 

would therefinc ~''\flO~l· lt,eJfto rqtubtury qnLtlmlO or pcru!t!C<,.Thb will dunim<-h tlw \Vi!lingm::s<. ofh:mb 

to prr-.vHk nLHkt·t nukmg pnxi>ely those '>itn,1tJOm m which H produce\ rlw l'{·onom!c h·nd"il. 

namely tlH sm.:dk·,-, k~'> liquid iN1es tlut .lrt.• mo'>t hkely to be subjected to Lu~e mH'X}XI"tl'd '>opp}y- dennnd 

\Wing'> and hence large imbal.mct.') kJr market nvkcr~Y'The withdr.l\1./Al <>ftunb fi·om nurkct 

HLlking in nuny ~ecuritie~ '' illluve cons,·quenfe<- f(w both borrO\'-\'r~ ,md invc<.tur,<,. Tbc~e 

dt~cu,scd in the next ~ect10n 

dtifictJlt-tn-JnticipAtc 

con,t'<JllCJJCC,, \dnd1 could be ;t\ ~onw \~·gmenl~ of the n1~{rkc( ti-c<"7ing up. An ex.nnple of sttdl ;\ 

up 1s provtdcd by the reacuon of ned it r.ttlng Jgencic\ the p.t\qg-e of the ])odd-hank l\ct and 

the ~ubscquent market cnmeqm•nc<'~. ln :20 Jn.l he 11\Cft.',\<;ed !eg,ll liabllity for r.ltlng agennn led Stambrd & 

P~lor\ (S&P), Milody\ ltlw,tnr SerYICr.'<., ,111d !.1.._,1tings to ,1~k -;ome born>wero~~ including those who 

h,Hl :!ln.>.Hly nhtainc>d r:ltmg\-·-- to rcfi·,nn fi·om U"lll,D; their r.Hnlf~· Sllh"{.' tlw 

10 luve talmt.'"' 1fthey wante,l to debt secuntw~. the lll.lrb::t sccuntJe\ 

until dw to temporau!y the r.tting'> reqmrement 

16. 

Lt~ON0,\1H: l;()I\:SEQULN(:L\ {)!· fHE\/l)l {'KU\ l<..t:LE 
108 


27369.067

Volcker 

Rule 

Effects on Customers of Banks 

Reduced 

Liquidity 

Mark-to-Market 

Losses 

Capital 

Distorted 

Security 

Prices 

It 'llwuld he cmph,hucd t!ur dw dfcct;; dcpnnl ,\bon:: do nor wpn·\cnt ,\ll cxlun:.tiv\' 

of the imtr(,)ll!Jc>tttd ILttun· of thL' finctnculm.lrkct (~c'' Th,Jkor (20{ 1)), It is d1fficult to predict 'econd-

<md third-ordn ctl-L'ct'>. Tf1<' d-'iLYt~ 'llwwn in hgun~ 2 \Villlw dis{ m-;ul Hl the Jol!owing 'iCCtJOlh. 

ivLnk\'t nuh·r<, prn\·id.c liquidity hy \r.tnrling re.lrly to <lb~orh \upply Jlld dcnund <:hocb. Sornt:tinte\ 

.'hock' ,lr\' tdimyncntlc; tllJt ),, they from -,,mwthmg '>fwntlc pcrtainmg to the 

i1l qLK~tWlLAt ntlwr nnl<.'~, thcc,c ~hncb nuy be 'Y~kndc, pcrLlliHn~ ro m.1rknvvnk cvem>.! )uffi~· (:?0! ::1 

pmv1Je., of,uch .1 market-wide ddetion of'>onw equitwc, Jfmn the S&P SilO 

iwh-·x. An eTnt hkt' th,1t em fi>rn' b()th indrv1dn~l 11)"\T~tor~ ,md instituttO!l) tlut employ mdt>>.:>tr,1cking 

)tntq>;lC\ to ~dl their hnldmgs nf the deleted \ecuntw), nften in brgt' bloch. If market !nakep; Jre ,1\',ul.<hle 

to pnrcha\t' the'>e sen1rities And add them to the1r mvc!lt(1nes, 1' then the pncc impJct of these tr,1dcs w1ll 

be muller th:m \\hat would l->c in the absence of the'e market makn'i. JV1on'ovcr. without the Jmnwdi,Ky 

JWO\'Hln! l1y nurker m.1kns, tt wuuld ukc lnnf':l'l" t(,r tlw priCe\ of ~(·tuntKS .1t'fi:ct"d by 'IJ("h t1rhc tr.Jdc;; tn 

return ttl lcn.'ls dJCtJtnl by ilmrLmwntd~ 
109 


27369.068

This th,lt the Vol, kcT Rule '"ill ,ltkct HLtrkct liqnidity !11 two Y\':rJh.'Tb tmdcr<.tand this, it 

u>eli1l to note that 1hc_·n· two dmwmion~ ofnurket hqHidity: (1) tht• re,.pomivent"\<; of price t<) tht: order 

tiow. ,md (:?l the h1d-.hk 'PH'Jd. Th-:: Vnlckcr Rule em both dimcminn~ 

\Vhen think of price rcspGmlWJHC~\, what i<; being comidered i' the extent to which on:kr of 

a p,1rticuLtr si?e muw~ the price.Tlw more liquid dw lll.ltb·t in which a given tr:1dcs, the smaller the 

price 1mp;~ct will be t(H· any 

brgc bank' tlut are willmg to comrmt ~uh,tantiJl ctpital to support their market making xtivnies, le,ltis t() ,, 

sm,tlkr pnce 1mpa1'l of tndes b~·cws;~ market nuh>r~ are \villing to ''ahorb" tr,Jde\ hy Mlrling m subtractmg; 

fi·om their inwntoryThth, hy reducinp; the number ofJ.vAibhle nurket makers. thcVokker R11h' em reduct' 

bid~,tsk sprcJd i~ the diHCrencl' hctv;ccn rhc price ,Jt \Yhich 

one em immediately purcha~e a fi1.)m the m;Jrket maker\ inventory and the price at which one 

\ell the to the market maker. The l11ghcr the hld·-,hk ~preMt the lower the liqmdity.Tlm\. wry 

hqmLl imtrument~ hke money lu\·e no btd-,Jsk spread-. (unle~s one i~ de:~ling in f(weign ClllT\~nclt'~), \dwre,l~ 

rcLttn:dy illiqHid inw~tnwnl~ hke hou~e~ hJ.\T fJirly ~prnds. As tht-' Vnlcker Rule wlll ('.tme .<t kt~t some 

retn:nchnwnt ofbanb fi:om m,trket making, tl1<.· munber nfm,lrkct m,tker~ in m,my \CCuritics will decline, 

lc,1dmg to k~~ cnmpetltton. St.uhbrd economic ncasoning would '>ll) .. ;g:est tlur ,1 comequence oftlns i~ hkdy 

to he l11~her hid-a'>k .;preJd:,, and hence lower hqmdity :l(TOS'> a wide spectrum of .~~~ct da\<.C<.. When hld-ask 

'-pre,l.d'i mcrea'~' i(•r ;m ,\\\et. tcKling inth.1t :l'-St't !,!:O<'<; d<'wn. For inst:mce, when th~· tenm oftlw connni;;;<.ion 

J-Mid to ,l rnl ('\Ute broker ro scH ,1 hNl~(' i~ J p.trt of tlw bid·-,lsk ~pn',Hi Pn the house, 1t h cnmidcr.<hly rm~re 

,HtrM'tlH' finmcia\Jy tn -,eJ] the homt' lftbt' U111llllb\101l h 1 percent lh,ll) if it is 7 f'el""Cl'll\ 

'l hu~, both dnm:miml'> llfhqmdity hkdy to !w Jdvcndy .di('ctd hy the Vokker Rule. Thi<. 

\Vlll be potenti.tlly the m the bond ,md OTC derivative~ markt'l'>, \VhtTc m,lrkl't nukt'rs qt1sf~r ,1lmost 

JIJ the dcnund f(w 1mme(bacy. hgurc J summdrizv.<. the 1mpact ofthcVo!ckcr Rnll' on liqllldity. 

Volcker 

Rule 

Bid-Ask 

Spreads 

liquidity • 
110 


27369.069

WlHt imp,Kt d01.\~ rduad hqui{hry h,lW Oll firms? Amihud Jnd rvtcnddson (19tl(J) hAY<.' dew loped ,l 

thl'Ot\'tiol model that \hm\·s hn\Y liqunlity .1Jl~cts .b~cl pncc~.Tlw modeluSL'S trJm.Ktwm CO\h Lo clur.tctcnzc 

J.'&'h and inn·.,tmcnt hori.wm to ch.Jracterizc inw::,tors. In\"e\!on nuximin· !lw expected present n.htt• of the 

c~>h flmv~ thnr ,ty;;et<. tt''llt'Lltt'. mdudmg th(' n''" oftr:ln'>JC\Hlp:. ln \"qudihrium, tfw n.;p<'rted n:turn ou an 

markeb uc not all t!ut Llr)..';(\ ,1hout A dlfticult-ro-dnnnmw imp.1n of the \!_,kkn Ruk on 

LhC.'>t' Nott>, an ll1\."t'\tor that 1<. tr:tding <.ecunty w!ll need mcur the 

illiqUidity (or more approj'n.ltdy, pntul l!quidity) OYt'r :tnd nver 

rhm, tlw~c costs .Hid up, and may re'>l!lt in 

!\"1endel-.on (2flOh) 

inve->tor dcm,mding a nontrivi,ll premiwn, Amihud ,1nd 

price (li1r @1.>/ puh/if·ly traded 

it i~ ilj!,J(fiou (:( ,, pNa:ur). then nuJml,<tJuc l(ifi'il ,,n g!{w' is !.nf!i' bt1'w't llu'}" <11e nuHncd rt1>cdtedlr 

wcr the l{k. "!7ms, rht iJ!Ip,1tl 4 illiquidity '.:!i<'U!d 1''7t1<1f <1/ ftvq Il1c prcsml Flfl11e ,11! 

mmrrcd u/l'rt'll;/y .md 111 thtj!Jtmc. A 

the e-xtent to whid1 the f(wmne\ exh1b1t co·mtKcmcllt wirh the hm:Kl 

en'ryrhmg ('],~, tiwd. ,1n !11\T\tlil" ·will demAnd,\ lower hqllldlty prl·nmHll, .md 

pril.'E, {(lr a more hqmd '<'Cnriry tlun fi)f ,\ les<; hqmd 01w.Tb tlw t'Xtent that the pre~encc ofhanb J~ markl't 

m:1ker; enhance\ liquidity, 1lw retrt'nchmcnt ofh.lllb w1ll dimini\h liqmdity. In re,pon~e. yield-; on bond'> .md 

cxpc~·h·d rcrnrm ()ll ;;c·urmn m guwr.tl \Ylll ro rdkn iughn hzp.1Hhty pn'mnmh. ( :omcqucnt!;.: pnn."' 

w1l1 drop, \\·lw:h "1-vdl lead to imn~edutc !o-..\e~ l\:1r mn·~tOr'• who nn;,i to ''m.lrk to nnrkct.'. 

E\tinl,lH"' oftlw ~J7t' nfthest• pott•ntLlllo<ws \".iry~ ,tnd :idnuttcdly are serNtin· to the 

,1pproxh mt:d.The Olrver\Xiym.m (201 J) ~tudy {'~tim,lte\ tblV' kw;c, to k $90~S3l:i hil\iun,.md it h.1<. 

be,·n cntln!cd r(lr rdying on z'stnn.lt''' hJ~cd on rondmons dunng the depth of the i)runcul 

The pnYi~t- nugnirudc of the~\' t''>tim,lk> l\ le~\ import«nt th,m the ge1wr.1l pri11npk th,\t rcgul.\t~wy ,lCtion~ 

tlut ,ldv..·r~ely H1lpmgc on market liquidity un impose lO\\C~ on mwstor>. What more th.m the 

preose of these lossc~ b the th,lt inve\tor'> nmv hav(' a hc1g:htened .lWJ.renes" of the potenti,11 

i1npJct·of n:>:i!latNy U11t1'rt,1iiHy on tlwir ".,,,dth. WJth dh: '-trokc of:t pen. the t;rAernmen\ can take actwm 

tklt impo't' Jlnnwdi,lte Jos,l''> on inv~·<.ton.Thi\ ]., u,Jf J dJY\.T~1ti,1hk ri\k. 'lo 1t i~ n:.honablc rn a~~nmc that 

111\'t:~ton will now HKn',lSt' the risk prcmium they need to be compt'n~.H~·d f()l· dB~ unccrt.1inty. It ~~ imkeJ 

a ''double wlummy" f()r the i->\tlfT'> ohecuriritv""-not only doe~ the hquid.Ity prcmwm go up due to the 

Vnkker R1de, hut 'u dne'> thl'' rq;uL1!ory moctcrt.timy pncmnmL" 
111 


27369.070

Page 

\X/hen liquicbry in a market gut:'> down, ~co:nrity prin·s nuy rem,lin di~torted. -t\>ny tl:om th~·lr 

fi.md,nncnul (\:)r !onga periods. nurtic (2.<)1 2) prndJc<, .m cx.unp!c holll Ncwm,m ,md RllTWll (2003), 

who <;tudy the p:lttern nfy1dd nnpach an.mnd the time of a corpor,ltt' bond h~ue. The nnpKt that 1'> 

~twl!ed 1~ for the bon,b offtrlll\ (lthn tlun th\' bStk:r th,H m llH' \,llnl' iudu-..try ,\\the i~~uer. Spen(ic,llly, 

·when ,\ Europnn te!cnmt tirm lud .1 bond 1\\tWlt"C fi·om 19')') through .'?.0() l. ,d! Europt'<Hl tclecom 

firms n:pnKJK~'d h1ghcr bond yKhkThe lwh,1vior ofpchh through tune \Vel$ ,d~o interc,ring.Tlw yield~ 

increa~ed 3" the 1\Stunce ~.:btc approached, .md then to normallevds. \Vh:1t determine~ the 

of diwr[.;<'llC<.' fi·om norm,ll kveh .<~\\··ell ,\S the ~pt·ed of.tlljmtment b,Kk to r)l)rnJJl i~ the market liquidity. If 

market their nsk linuts or the sin's uf snpply ckm,md imluLmo.'~ they ,lre willing to "tep ,md 

mtcrmedi,\U.'\ the yidd imp,tct\ of e-vents like brge sccunty iNunces will be 

EmpincallTidcncc on thi~ JS provided hy Mitchell :md Pulvino (~!1\19), who ~how how 

"ip;11ifiontly corpont<.' bond yw]d, dJ\tortt'd during the financi-1! rri,Js . .'-\peotiolly, .tctlU! 

\'orpootl' bond ykkh mnch higher th,m tho..;t' nnplied hy the pnce-: of the \"n'dit ckbnlt S\Y<lf'~ 

written on the'e bonds. :md thi~ trend occurred aero\\ a broad ongtc of inve-.tmcnt--gtJde And high-yield 

bon,k ;\ \\"I<kmng of the y1cld <ipreMl tfm !lldllllcr IS .1 tcll-uk qgn of hqmchty df("C\~-~~ The tTJ"Oll 

for thi~ INide 'pn:.KI during the \H'> that c1piullcn:l~ ,llmornully low ,lt Lblkr b,mkcl\\ a 

conwqucnce. even corporatiom i.;;,uing inve.;;tnwnt-grJtic hnnd~ m Ltte 2001) !ud to mterc\t rates tlnt 

\Wre 200 ba~1~ pllint~ higher hcou;;e of th1s nurh.:t tl-ictJOn.-'" 

Snch distortiom will be t'>::Kt'rbatl·d by the V('kker Ruk not ouly hecm~c ofhanb retrenching 

from nukmg, but :t!~o the of iudi!'idud trMier,\ mvolved in m.1rht m.<kmg v.-il1 

be ,1tlCncd:' 1 lm!~l\'m"·nution oftheVolt"kcr Rule will came the compematinn ofthc>e to resemble 

tb.tt ofbrokl'r.lge ,tgt'!lb. Add tht\ L<l the rcpuunon,ll n\k ofvioLHing tlw rcguLnory nurht··makm):.': nornl\ 

thJt m,nket nuking to lw rebtiwly low to quahf)' penni-;qbJe tradiJJg, and mJkcrs 

likely to l~econw highly Indeed, the pn;po<;ed tn be lhed 

w nnph·nlcnting tlw Vnkkcr Ruk \\dl o,nffi( H'tldy ln!Ahly profir.1hk tr:uk~ ,1\ ltllpn!llJ>~lbk prop!WlMY 

trading: '>!ll( ~- \l!Ch tudt·~ typl,·,,!ly ,t\~u, i,tt~·d w1th llHTttng Ltrge dnnamb inmwtli,H-y_ mdividtul 

traders mvo]Yed in nurkd making arc liheh- to '>hun them. 

rlw pn'ttding chscm'>ion m.1kes it ckar thJt t!wVokker Rul~.: j, likely to mcreA'iL' t!w co~t 

for corporJtiom.Thc ,unount of the i~ noton~m'-ly lht1\ndr tn \'~tun.lt\', hut the dfL·n on the 

(apird w1l! be m:unf(.·,ted m ,1\l mcrc.t<.e in tlw w.;;t of both debt ,md equity. Hoth cost~ w1l1 go up be<:A\1\t' nC ;1 
112 


27369.071

higher liquidity pn•mium dt-manded hy invc~tm·.;, ,Js wdl as a higher premium 

he Llrgcr t(w ~m,tlkr and nski~-r 1\\lK'rS, the finn\ fiw wlnch llLlrb·t liqmd1ty nutkF tlw nwst. 

c,1rlivr.Amihud .md Ml·ndchon (:2006) me brgc-~.lmplc LbU tn show how Jlliqtw3itv,J.~ nw,lstu-cd by the 

hid-Jsk "Pn',d on J the expt·ctcd of the ~rt)tk Jnd hcnn:: the tirm's ((.1\t nfopiu! 

(hgnn· -l).The ;\Urhon te~ted the rNnrn-illiquidity rdttinn<.hlp on NYSf>AMEX \tnck' tl:om JfJ60 to 

19;-JO_ They di\·idt'd their sample into 

portfolio they rank-ed the ~tocb bJ~ed (IH cad1 'itock 's bet<~ (a of the of the qock, b.1scd on the 

Clptt.tl As~et Pricmg Modd).Ttw11 rhcy l'Stimatcd the cro'>~-~enioml \"Jri,nwn of tlw 

''JCh portfOlio '-Ylth the hid-Jsk sprod. Figure 4 >mnmJrlzcs their tinding~. 

Sow:rc: Am!lmd :~nd Mt'tHlchon (200(}), 

return on 
113 


27369.072

The tJkcaway ti-mn is th;lt rnunn (which expected 

n:tttrns) higher t(w ~rock~ \'.:Jth lughcr bnl-,t~k ~prcad~.Thcy pnn'idc :1 mathenLmol rcbuomhip 

between the ,mJ 1t~ bid-J.~k ~pn~,1d, wh1ch 'how\ tlut ~to..::k retnru innt'.\<:t'~ 

pwrortwn to the lng.mthm ot'it; bid<l.Sk spn:.-ad. 

return nn a stock p; ~ynonyllloth with the equity co\t of c·,\pitd on the 

\tock.Thll~. the rt'~e.m:h dhLU~\ed ,1hove indiot<."~ that a potential inne,\<;t' m the l'nd-,bk ~pn:-.td cm~ed 

llwVnkkcr Ruk V·all kJd to a poknti,l! mcrc;!'.c m the ('(hL\ ofoplt.<l for firms 

A !ll~:';hcr cmt of upttal f(w firms has pok'llt!.dly sJgmti.cJnl comeqm·nn·~ for corpor,ttc inw<Tm<:nt<; 

and l:'Conomic grnwth. It lS \VUrth noting that the ide,\ th.lt all th.tt the Vokker Rule ·w1ll do is to 

an nnp.1ct on lHnk profi.ts ,nhl ,t mJJllnurgin,!l tmp.ll't oH lHlmdity t\ d..:cply fLrwcd. Fr>r ~-x,unpk 

R<:'pn·scnL\tJve H.mH.'Y h.mk 

J/11' notion Ih.ll rmrthin.Jt tfun adniHrcs liquidity is thi!(Q, fl'it/tllll/ ,my n:card to stahility, is 1hc 

pnoblc1;1, ,\lwh t;rrltis liquidity U'il>~t'tj(Jr Otl·r,)nu·r,.;, hHj(Jr the h,mk_;; ron~<Ikc ttli'flf')')i'r !htmstlr•cs. 

!'he tLm·~ m tht$ «~Sl'rtwn th,lt the Vdch·r Ruk \vill atlt:n nnly b,mb and not the hquidlt)' of 

tlnm, ,Hid th,tt thi' ctkct c.m h: ipwrcd. 

In'liCSttncn.ts: Lo"\VE;~r 

£nvestn1ents 

well ~·~tabll'-.hnl in <lC.hlcmic rc\carch. :md well 

pnctlCl', tlut ,1 firm'~ co~t ('fc.lpttcd goc-; up, it 1\WC\t~ lc>'>.Tiw rC:l\Oll 1'> -;impk.A firm 

wlll inw\t c.q>tt.l! only if Join~t '0 hd' net pre<>ent nlue (i.e., when the internal of r\'turn oft he 

the cost the cmt of L,lpital ri'le", there ,tre mvestmell\ JXOjt'z·p; w1th 

Hltcnu! r,\tc~ of n:·turn h1gh enough to ckJr tlw hnrdk ofcxcculing the 1·ost uf Clptul, .md the firm mv:.-~tS 

h:·<;~. rit-,'llre 5 illu"lr,tres dm n::Lltl~m"hip bet\YCen tlw pre~ent V,lhlC (NPV) of J prn.Jel"t and the CO\t of 

LlplU! needed to tin,nl<·e it. 

+ I~ Cost of Capital 
114 


27369.073

3 -,ho;,vs dvt then:: .1 decrc,1sing And cnnwx reLttwmhip between th'-· \',lluc ot' .1 projc·n to .1 finn 

,md lt'- cmt nf c.:~piu!. /\ proycr t!ut b ,Kccpuhlc to thz' firm Jt A 10 percent co'r of opJtal not be 

.1~·ceptahk ,Jt 15 percent. Thm, a~ rhc n>~t nf capltalmcrc:J:,e-.. tl·wcr and ft>wt•r p<oj<-'ct' h,rvt' p()'>ltJW: 0-!PV 

t<> the firm, Jnd 11 end~ up lll\Y~tmg k~<-. 

An empiric1l te~t of the rebtionshlp bt't\'>ten inn·\tnll'nt .md the cost of opttal 

Cikhn<.t and Z,Jkr.lj<.ck {2(HJ7). They find th,H mvc<.tmcnt 

.md 'Utl'-tJCllly. to ckmg('' m tlw tirm \ co~t of cap1t1l TIKy 

in the cmt of op1tal percent (1 percent in the long· 

nm) rcducuon in tht' r.uc ofinve~tmcnt ~pendmg. .1() pH thc~e e"tml::ttt''> in per~pcctiv-e, comidn ho-\v 

nnl(h U.S. finm 111\T~t ;umu.tl!y. !n 2010. U.S. nont:mn bu.;;inc'~"' inw~tt'd htllwn lllllt.'\V ,md 

u<:ed <.tructures .md equipment, up ~lightly hom the 2iJ09 h•vd of$1 ,090.1 () billion. Figure (, prm·idcs a 

bre,tkdown by ye;n Cwm 2000 to 2009, .md 7 hre,tk~ tlm infmuwitm down further hy mdm.try. 

UJ10 

8 

c 1,000 

! 

3 800 

600 c 

0 

;;; 400 

200 

2006 20(!7 2008 2009 

.\\,wre. U.S. Censu' nuw.1u 

A one pern·nt the cnsr nfnpir:J.l would therd~'">rC lead to a to Stn.:; billion decline In 

-'P:i-'YCg:,nc ;mnm! ctpit:ll \}''-'lld1ll;2: by L:.\, nonf:lrln firm.<., .md m the lnng nm t1w could lw .J~ much .t\ ,1 10 

blllmn Jtmu.t1 declmc. mo\l iumJedi;Jte and tr,tn\p:m•nt com~·qm:nce ofthi~ i<- lower ecnnomi1.' g:rowth. 

Htm:evn, then· other ctKYt\ ,1\ '.-vdL \'(·'ith lom:r e,.·unnmi1- growth come\ lower cmploym,'nt. 

'itudy~ Beard, Ford, and Kim (2010) estinutc tb,· lYLltion\hit' hetwcen employml'nt :md <-'<lpiul 
115 


27369.074

2SO.OOO 

~ 200,000 

~ 0 

c 150,000 $ 

t: 

~ 

() 

'0 100,000 w 

g 

~ SO,OOO 

2000 :?001 2002 2003 200~ 200:) 2006 2001 2008 2009 

s(ll/f(l' ll.S_ ( ~t'll'>U~ Bure,l\l 

,"xp,·n,lJttm'\ h; f1nm m the Jnf(ll·nution ~~'d(lr.Thc;/ ntrm,ltl' th.tt .1 10 percent ncgJtlVc \hock tn ctprul 

hh-ludmg indirect job<;. the\c job ]o<;>t"' could be .t\ high a> :l21.600job~. l.o,t <'.trnillf;'> c\rim,\ted to 

be SJO(l bilhon over the rivl'-Y(',lr pcriod.Tlwy .1!vo c~tlt11.ltc tll~· "employment mu!tiphcr·· to ,l los\ 

\\l mf()lll1Jtwn ·\('rtor jnh f<.)r J r('ductwn of$ 1 mdlion m opit.ll e-xpenditur~·~- i\(\'<.)rding to Fignr~· 7, 

opit.ll expenditme in tlw mflwnurion ~ector in 20(Jl) \\\lS :1 little ovt'r billion. down fi·om 

well owr $200 btihon m e.trlicr Yl'<ll'\. r\ 11X• 11Krose m the Uht nfnp1tal m thi\ "l\'ctor would ll1lj'ly A 

reduction in c.tritJl >pendmg of~750 milhon to blllion thing the C1khri't and Z.1kr:~j>C'l-. (7.0\l7) 

c>tmu\l'\. B.1~cd on llw Beard, Ford. ,md Kn11 (~:l!lO) e<;tl!HJJt'~- thi' would !l1l',H1 ,, Jo,~ ofvm1ndww 

httwn·n 7,.soo .md IS, nou job' .Jnnw1!ir. 

(:omidcr ,m cx.u11ple ti-orn the mtOrmation '\ector. AT&T lMs J '''~'ll:ll \'xpenditnrc of aronnd 

${, billinn_/\ I llliTC:'I'-C Ill m CP\t nr C1pll:~l \\onld reduce tfm <."\pendllurc hy SJO to ShP millmn. 
116 


27369.075

Job lo~w<; would be 

ext1 JP<)Llte 1he inform.1tion-~cctor e~tinute~ on job lm~es to all the •wctor~.a simple extrapolation wonltl 

imply that J 1 percent mcn'":Jse in the co\t of capital could lnd to job lm<:.e~ nf 'nl1lt\Yhere bet\nx·n 

:)~n,nnn and 1.1 mdlwn pn ye,n in the nonCmn ~CCh'r of the '-'con,,my. It would be thHlntlt tn 

prcciv'ly estinutc by how much the Vokkcr Rule \Yill the co<,t ofctpiul f()r firm~:'' but thest 

c~nm,1tn Me large and '>ignific:nn cnouf.dl to be .1!annmg in tcnm nfthe potcnti;ll dllxt they 11Hhore fix 

tlw m·erall o:cnnomv. 

lntncstingly. r!t<: dt(yt of the co,~t of cJp!t,t1 on inw~tmcnt ,tpp;.•,tn tn be Y)'HlOl<'tri\· in ,1 qn,<ht-tri\'c 

~cmc. (;Jlchn~t, Hlnunelhcrg, and Hnbt•rnutJ (.:2(105) document that a •cduuiol! m the cost ofcap1t,d kJd~ tP 

l1ltTl':hC lll lllVt'\tltl<:'HL 

!mpan on Risk t!f Inrcstmcnts: Thal' l'> abn ,mnthcr dl~Yt. which tlut the Cll'-t ofclptt.tl ri,c-;, the firm 

cx,unpk. :1 tinn nuy !uvc an opportu1llty to cxpJnd it\ dome~t1c opl'Lltion~ ,md rhc nlternal of n'turn 

fi-om domg- ~o i\ 10 percent. lfit; ethf uf c1pital i'i bdmv 10 pcnxnt, the NPV 11f'thh expamion will he 

po)itl\'C and the will nuke the mYntmcnt. But, 1f the ~-o~t o( cJpiul 

will pJs\ up thJS opportnnity and look tOr sonk'thillg with J higher return, <..lld1 ,m opportumty to build 

,1 phnt in ,m ClllL'tging m,trkct. cr, hnus thu~ nuy t'ither mvc't lc~~, rc~ort to n~kwr imT~tmcnt'i, or bNh.l\~ 

'hown m Th,1kor (/(!1!), reductiom m mvc)ttllent\, mduced l11ghcr tlnancmg co>ts, un haw· a multttude 

of '-p1l!ovcr m Jll imcrcontJCct{'d economy_ 2

• !t 1'- dJtticult to t\tm<,ttc <Ill nf the gencr,\ted by 

thi<> tlut Jrt' perninou.;; to economK f!rowth. 

lmpan on th1' Durath1n vfPn)jetts lnrcsud in: An incn',!St' m the Ul\t of1'.1pit.ll .d~o nnkt''> the f1nn J1~pby 

prd('n::nn.' tbr Ct:-tn··pxyhM'k prn_Juts (u:: __ project~ un \Vhirh the finu em recover its inwsllll<.'ll( 

more qull"kly'). Corporatwm Ml' often .Kcused of''slwrt tenm\m." 'x nuking- im·estmcnt' that <.eek to 

capture )lwrtAerm profit, ,u rh~: c'XjWll\t oflonp;-t{'rll\ \·.1luc. But wlut J h1ghcr coot nfopJt,tl may 

loollwh.lvior;~lly <.imihr to ~nch ;l 

mve>tments_·rhc rCJ\Oll i> th:tt the 

comp.m1e<. .lre 'in1ply lllAling v.J!ue·tll,\Xltninng 

imp:Kl of .m m the cmr of cq>1Lll i> /n:~scr f(w moredt'>t,l!lt C.!\h flow~.Thm. pn:Fn~ \V!th lonp,n p.1yhgk pcrwd\ dedmc mor(' Hl \\dnc t!un thn'c \YHil 'horta 

j'l'flOlh. 
117 


27369.076

IMPACT OF THE VOLCKER RULE ON 

FINANCIAL INSTITUTIONS 

The Impact H3sk l\:1anage1nent Banks 

Jn \'nlu,ltmg the potenti,ll impact oftheVokker Rule on b.mk~. this Sl'Ctiou mg.minxl in f{,ur 

p<trt.s: ri~k m,Hugemcnt, lo,m qu:diry ~1gruling in 'i\'Cuntusnon. nduction in dw Ya!uc ot'ti.Iuncial 

pnwidccL lnljHct nn the hu:;.incs'i Hlodd ofh,mb, and tlw dkn on the CN'Y<1lunou of hJnb. ,md market~. 

Bauks haw to m.mage a Yariety nf t+,b. The mo~t pmminent among the'e an· cred1t rhk, intt•rc't 

r:tte ri,k, and hquid1ty ri'ik. A .t'iptYt of ri\k m.mJgenwnt is th.1t it is nor dficwm to nLungt' th~·"c ri~h 

if each n~k i~ a tub on it\ own bottom. lntegc1tcd management, commonly rd~>rwd to a'i cnt<:rpn~e n\k 

nvnagenwnt. JS cs.-;eutJal to cope \Vlth tbc'e 

As dbdh'-t'd eArlier. <,ennitiz.nion t~Kiht.lte<, b,mk nn/tl n:'t..' mmwi<tmcnl. A b:mk would like tn f(xu:> 

ib lo,m origm:ttlon acti\1t1t'~ in ~ector~ when' 1t has credit scrct•ning e>..pertN: th,lt i~ ·where it lS mmt 

likely lo be ,1ble to idcntif\· ,md >Cn:'t'!\ out b.1d credit lT>k~ with the grc1te't preci~inu. Howewr. tlw do\\·mide 

ofthi~ i> that 1t lods to credit concentration ri~k.Thi) c.&; f{x the bank to dl\-TNI)'. lkt(m.· the advent ot 

''Yuritt<4lt!On, divcT~lfic.nion \\\l\ \Tl)-' cmtly hcc,n!\C 1t requm:d dut tlw h.mk \<len fin: Jt~ ~\1 tg-Hution 

Jnd nuke lo;m~ in -;ector\ tlut lcs> fmulur to it than it~ 

otET\ the b.mk the lw't of both wm·ld~. ft em ongill,\te lo,m" in it;.. '-<'Ctors of ,·xpcrthe .mJ then n'J11cc 

acd1t <J)!lccntr.ltlon by \<.Yuritump: thc~z· lo,uh .tllll ,cJhng utf ~omc of!hcm tu nrlh'r bJnks .wd !1011-h.mk 

i\·k•remTr.Jt on purcha\c ~c~unliLHinn clJmJ~ ag.umt porrf{)lio~ ofloam in other ~c-ctors th~t 

Ol"lf!:!lJ,Jtnl by h.mb tfut ~J'('fl,lli7e m thm~_· \ccton.Tlnl'i, dt\'l't\Jficmon .HHl cn·tllt ri-;k conn:tlfrAtmn 

rcdncr10n Jn' :1xhiewd wirhont h.wmg ro ongin.1tc lo.ws in unfunili.u ~t.'ctors. 

Bcoth(' '-\'Curit\7,\Hnn nT,lt\'~ n·JnclH·<: wH.h difl~·n.·nt nutunrie<:, b.mk' on ,tl'>o unpnwe then 

m;ungement of in!rrt'! mrc risk by JUdiciomly of loJm 

thai are secnntJZed). /\ m.uor ~ource of mten~>t r,1te .1 much 

longer maturity th:m the1r depo<:it<> Th1' m.1111rity nmnurch me;m\ th.1t hank<: ~t;md to mJke lm"e~ during 

1ime> nf rkug inlvre~t rate\.;" t\ tr> redtK<' inter~·st nte ri~k j, to ~horr-en the ,r,·cr.lgc nutunty of the 

-;ide nfthc slwn . .A hank em do tlm l--ry pnrr!u~mg ,l\,ct-b,lckul '>Ccuntlt"i th,llluw 

dur,tt!om'1 th,m the J\Tragc dur.l!Jon \lftlw lo,m~ it lus onguuted. \' 

Jl. 
118 


27369.077

Secnriti/Jtion J!\o r:nahks a h;mk t() mon' ctfcniwly nmuge liquidity n\{', /\ cl,1\~ic probkm in 

hmking 1~ th,lt loam ,tre inn.1tely ilhquid~~tllt'y cmnot be exped1tiuu\ly ~old without incurnng a ~uht:mti:tl 

lo'~ m the f(wm of a pnce di~count rebtiYc to true Y:JhH'"·····whereJ'> dcpo~ib, C"lxci;tlly demand deposlt~, 

rcpre~ent iiqmd 

dficient l>,nlk n'>k nunJgc·nwm_t\ 

bank that !'i holdmg ,m inventorv of ~e .. ·untvt:d lo,1m \Vould haw to _imtt!}' to reguhtor'> t!ut it l~ holdmg 

tlm fix (proh1bitcd) rropnctJry trading. A' Frel, N:1tLlukL ,md Stul? (.~\J 11) docunwnt h.mk~ wnh 

large tndmg portfi)hos lud holdm~;" ofhighly-nted ,l'>~ct-b,wkcd '>LYUntic~ >{)times: g-rcJter than the 

holdin~"' oft he typiolt~JnLThi' that there m,1y be complemental it~t:s or \yncrgic' bctwC\'n market 

nukmg ;md mtrabank n.;k management .... vhen Jt t:OillL'\ tn holdm~ daJm'> producccl \t>cununtion. In ntht'r 

wonk h,win~ ,Ul inventory nf;;ecuritJzed claim~ nuy t:tnlit.ttc h'rli n'>k nwl.lgt.•nwnt an,/ m.1r~ct makmg. Hy 

crcatmg a etwironnwnt m which b,mb J.rt' pn'~'urcd to n•dnn· then holding> of,ccnritized d.1imo. 

nuy llLtdvcrtcndy lower tlH' crl'tctivcllt'~' ofh,mk ri~k nun,tgenKnt. 

llo\v .lre lMnks bkdy lo re~pnnd tc• 

\vill repbc::e the hcltmlity pnl\"Hkd by ~ccunti;cd danns by the liquidity provided lw 'innw otllcr :l\,Ct, ~nch 

cbh_Thu<;, instc,Kl ofhohling .m inventory of,e~.-uriti?Td cbinh tlut em m:tkmg. banb may 

www.CcntcJforC.lpitaUvb.rkch.com I P:tgL" 
119 


27369.078

hold c;:p;h ino.tcld. Thcrl' i.;; con<.idcrabk con<:tern,ltion at present about banks holding exces\in• amotmts of 

ca'h .md not l~·ndmg enough.Thi~ \lttL<tion ·will only ,lppnr to lw (~XX('rklted 1fhanb ,ne iudnct'd tt) hold 

more u~h prt of the c!nngt' in n\k man.1gemcJ1t precip1Uted by the Vokker Ruk 

One mig:ht ohject to the argument tlut n:~tricnom on proprietwy tradmg m,ly interll·n· with the 

,1bility nfb,mb to pruckmly lll<HMge then own nsk exposure,_/\ffcr alL the purpose of the re,trict1on 1' to 

limit bank ri\k,dlkl the motivation ofthcVold.t-r Rule that unl)lidkd nsk-t.tkmg through 

'>fll'lltlfil ev1dcncc dut pmpnctAry tr.tding h.Hl a c.m'i,ll dE·ct on dw fltwh·ul c1·1,i'i.As VV'hirdw.td 

(21111) point\ out. rh1' nukes 1t fir fi-om ,1pp,m:m why proprie1,1ry tr,dmg ~~ re~tnnvd m the !)odd· h:mk 

/\ct rhe tin.r plHc, bTJl Cluirnun Volckcr \Lltcd tlut "l'roprieury trading in nmmKrci,1l b,mb, 

not centLtl' 

Jo\<;C\C:!111l' traditionalextemiom of b,mk credit, ntlwr than prop1 iet<1ry trading: '' 

Loan QuaHty Signaling 

Wh('n a l•ank ~ecurit1zcs J. pool oflo::m<;, there J<; ,l potential credihihty problem. The b:mk k1' 

inceotn-es to dcvot~' re<;onrn.c:~ to 'crecning Jo,m Applu:,mt\ .md invc>ting 111 the' :1.ppropriste dtlt' 

chhg:ence i.f tt ;wtinp,lt\,S th,tt the,,· loam will be sccuritin·d th,m if it klw\v' tlut the ln:Hh will be held on 

the hank\ booh. rhe i'i th,1t hank hear" ,1 cmt h-om makmg a bad loan if the loJ.n 

on the ba11k \ boob than if the loan i'> ~old. Of cour~c, mvcstor~ th,lt purcha'>t' the- ,\s~et-b,tckcd ~ecmitie~ 

that ,tre cbtnh the ponfolw of securitized kMns r,ttiotl:dly :nJt1np.l!l' the~e Hlt"\'!ltlH':> <Uld ,H1)tht 

the price .Jccordmgly. 1'' Th1~ result in ,1\~et-luckcd cbim\ \el!mg rcLltlvcly low pnce\, which in 

\H)U]d tnlJ() $0ll\C Ofi\W lO\\"t'!"--CO\t--()f ... fitLUlC!llf( benefit Of \(YUnti7,l\H)tl 

em he re~olved. ( )ne way to the ~:~roh!cm JS through "\igruling" 

dz'aler <;clling .1 u~eJ or "pre-owned" or n'COgJI\?c"; that rott'llti.<l hnyers Y\-J!l h,l\T dnuht~ :1hnHt the qu:1hty nf 

the or. A (coc;tly) \l)!:lHl tlut c,m thew doubt, \\nnld pro\'Jdcd by rlw de,1.kr.Tlw 

v,-nnld >ign.tl to ,\ potentul huy'--r dLlt the dt·.1ler lwlie\·es the c<r bJ~ lngh qtMhty ~ince t!K C\.1'-t of pnwicling the 

h1gher [()r a lower qu.1lity or."ll1e ~r:curitint10n nw·ket Jl\o U\t.'~ \l)-.';!l:lhn(-'; '' 

By keeping on Jts hook\ ~onw of the tr:mchc' of the loam it ~::>nuiti?e\, a hank em \if.,'l1,ll to 

1t lwlww~ th,lt tht: loMl~ arl' ufhigh qu,lhty. Re~'ent \'mpinnlt'\'idenct' rrovickd hy EreL 0J.1dauld, and Stulz: 

many b,mk~, to nrymg ,kgrce,. held on lo tht' 

,]lowed rlu1 en dw bhor nurket. mcliY1lhu], 

dun t'mployep, do on qpLd dw; 
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27369.079

:ts<-ct-h:Kkcd ~ccurities that "\Verc as~onarcd with the loam they had originated. During the ~ubprime cri'i'. nuny 

of thc-.;e ~ccuritic> bccume ''toxK'' and 1mpo.;;ed lm.\c~ (In these hmb. Mmt of the~e <;ecunnes \Vere h1ghly rned, 

and mcludcdAAA,Af\, .md A tr,wdw~ of,l,~et·lu(h·d ~LYlllilie~ .md colLJteralizcd dtht oblig.ttiom.Tlw ]O\\l'~ 

tlBt h:mk\ i11currcd aro'e fl·om declines in the v,thws of thc<.e <.t'CuntJe\ dunng the crisl\ and the bet tlut hmb 

had to ren)(2:1117t' m.nkt't··to -market ]i)\~t"\ ;l'''k'i,lll'd ·with the,e decline~. for ex,1mpk·. Cioh.mk cxpencnced 

\\TJtc-dnwns 1•CSl8 htlhon dw ;'nunh qtw·tcr of2(l((/ ,done. The figure hdow <-hnw' how the 

holdint-."' of highly r::u-.·d -><.'cuntintioll tr:mches Y,\ncd through time durmg the p:~nod fi:nm t1w t(lttrth qtMrtcr 

of20il2 to th~· funrth l]ll.lrter ot':200f\.A~ flh'llre 9 '.hO\\-'S, th~~L' holdmgs :<mounted to about $.100 billion. 

Holdings of Highly-Rated Tranche; 

Na(Ltud,,md Stul;; (:?.011) 

hpm· 9 plot> the .tggrq.;:~te, nonun,tl U.S. d()lL1r anlo..)tiUt l)fholdmf);' ofh1~hly~rated tLlHdiL''> throngh 

tim'-'-The qmple mn~ tfnm :2002 tc> 201Ji·S ,md indndt'\ alllTS puhhcly- tnded b,mk hnlding comp,mlt''-

plot!\ Cr<.:,Hd! li'•WS the ''!nghJy Llh'lllT>Hhu!" llll'A\1\l'C nf[nghly··f.lf('(J hoJdm;~'-, ddincd ,1'. the \\JlH o( 

nongovernment or non,tguKy mortgage-bAcked <:.ecuntJe\; J\'iCt- b,1cked ~ecuntic~ rated 111 the h1ght>~t thn'L' 

H1\-L'\\nwnt (AAA. AA. or A) cnegone~; and nongowmnwnt, non,ty;t'nc~ '>C\'Ur1tJcs 

m tr,1ding <.enmtie~. The lllt\1\Un: nl(ludes held~ to, matunty .md JQtbbk- t():r--~,lh' ~ccuntic~ \Vith 21) pel( l'llt 

or SO percen1 1 i~k wnght mmm \t'nlntil'\ in 20 percent or S(l percent n~k- \\,l'Jght category tlut J~'>ued 

gn;trantced by the govenuncnt or s:ow'rnmt'nt-~p01h<Jtl'd ,1getKtC\./\ll nlm'~ ,trc A! ;anorti7vd z:tht_~;, t'Xl't'p! 

mortr:Jge~h,Kkcd '.t:YuritJc'> fi·om trading ;w.cl'. that J.re :reconkd .n tan v:1!ue\. 

on f<.) the mo~t lnghly r.H;'d ~auntinuon trandtc\ n:L1ted ro the lrHn\ tlut they migm.tt;·d.Thcy r'in,lllw 

empn·ic1l \Hpport f(n· tlw hyt'ntheq;-,. fn rw·tn uL1r. they iind th,Jt, fi)r !1\(l<.t !unb, the 

holdings of highly rated tranche-; JS .1 pt-rn·nt,lge of ,b~Cb \H'rt' le\\ tlun l pen.::t'nt, hut hank\ with brge 

txaclmg po\itwn' had hold in~"'> that were. on .1verage, .30 time<> brgcr tlBn the holdmg" of the typiol h.mk, 

;1~ mentioned t\lther. Thnr ('Vtdence make~ H deAr th,\t bank> w1th tr,uling ,llloote more of t!wir 

holding'~ to h1ghly otcd tranche,, ,1~ slwwn Flt!ure 

ww\v.CcnterforC:<ptalMarkcts.com j Jlagc 
121 


27369.080

holding- nnnpJme\.Thc ).nnple indud1'\ All ~ecuririz,nion-J.ctiw h.mk lwldin[.!: comp;mit''> Jnd ,\ "-W> hJ.~t·d 

hsnk holding cowp.mics. lhnb Arc ckcnwd '\ecuritintinn 

Tl'\"PU1V~ cred1t -enh:mn.·ments l" gn·.1ter tlun any qn:lrter between the 

200.1 ,md 20(1(, 

H(· find, lMI'f"!"<'r, rlha hank- 11ilin J/1 .I"(Yllllli~,lfJOil held !!i<'IC h(~h!y-!;ltrd IIW!tlvs. _\"u,!J" n'>nlt 1.111 be 

,o!lsL>tmt l<'ith n:;;ufdlilr)' arhitm,>;<" ,H JJ"tlf as wirh scmriti.;:;:/1.~ h,mks !wlrlin.\! h(~hft mtcd mmrhcs w 

iln'l'ilcJr,.; d the ,pwlity ~~r these scmritics. ()w <'l'idmi"c 'IIJ>J!C'II\ the lllffcr lqp:•thcoi> 

rlw impliouon of tlm n·oc,m::h is th.tt h:mb m.1y con~ider it important to hold in their portfl,lio\ 

a5sct-backcd \CC\lrltlc\ rcbte\t to the lo.ms tlwy ori~itult' and '>l'l'Urittl'e in oder to \ign,ll the qu,llity nf thl' 

lo.m.\ lwtnp; wcuritized. \X/ithnut thi' to qt;n,1l, ,\ b,mk may h,n-c to Accept a large "l<.:mon~ 

the hvndit {>f>rnmtJtJtmn, p:~rncuLdy 

the co~t-of-fnndmg J.dvanr<~gt' commonly ,t,socuted \nlh rJJ\ing fi.mch thnmy;h \t:cunti?,ltion rather than 

dcpO\Jt\. The comeqnence m.1y not ody be dinnni,Jwd. >ecurituation hy lnnb. hnt al'<o .1 highn cost of 

fin,mcmg for theN' who borrow :ii·nm hdnks. 

r!U'. l.t;()0i():'\1!C ('ONSI:QUENCLS 0! n !I. VOl ('KrR lUH.E 
122 


27369.081

.trl~ctcd by 

tht' Vt)kkt'f Rule. M,trker !Jl.lklllf!: p; one :,nch ~t'lTKt', and it \\',1~ di~cus-.ed CJrlier. rhere ,lfl', ho"\n~ver. ntbtT 

-•~ \Yell that f:1ll undt•r tht' gen.:ul umhrelb of'",tdvbory E'..::,uupk'> :1re aJuce on what 

)Ccuritit"'' tn j,~ue in the secomLlry aud the timing of ~enn ity i'>'>tUJKt'S. Advice on whether to do ;;n m1thl 

pubhc orft·ring .md ,n what price, trad1ng .dncc. nsk m.l!l,ll:-(Cllll'nt ;hl\·tn· .md ~o on 11 ~how~ tlw 

wide tlnt inve-.tmcnt hank>, f(1r example, prondc 

cmt(llnt:T~. Thi~ knowledge is r;aincd in a varie-ty (lf ways, one of whKh ~~ nurkct 111.1king. l11 pJrtiCtlhr, the 

th,tt Hurkct nMking involve',, network. ,t, ('xpLtincd earher, mc:~m th.!t the L1rger the number oftLHk~ 

th,lt the h;mk 1.'< invo!n:d in,,~:< m.ukt't m.1ker, 1hc more it k-1rns ,1hnw mJrb:t concht10n~ ,md th(' mon' 

a nwm!wr of t!w uct\\'Ork 11 become\. Tlw, knnwkdge llwn not un!y enh,mces 1t~ 
123 


27369.082

market mab:L but .<hn in('n'<l\CS the \",lluc it pnwide\ .Kro~s a wide rJ.!1f':l:' thow sho'\vn in 

Fi~tm' l l.Tlu~ kno\vkdge lu~ been referred a'> the "cro~s-'>ectJOnal n:::m.1b1lny ofinf(mn.nion.""' 

Re~trictiom on propriew-y tTJding th:~tlinut the role thJ.t bank~ play a~ nurkct makers also rhmini~h 

the ,nnonnt ofinl(xnution that b,mks. em g,11her about markn nmditlOlb :111d lmver<- the \'.Jlue of the ~;:rvi~-"' 

that provide ro thnr cn~tomers. Some haw arf!:ued that cl,1irm about the potcnti:tl harm done by lhe 

rl'Lluced role ofb,mk' ,1, market nukcrs ,1rc on:'rhlown, became 1fb:mks e-ng:~ge m ks\ nurkct nukmg tht'll 

otiKr' (non-h,mh) \Vlll stt'p ,md fi.!l dw \\lnnun. The argument tlMt JH111-hwk~ 111<1}' fill the '>p.ln' vac.w:d 

by b,mks m,:ry be 'i.·,;lid, but \dut i-;. 1101 \'":.tlid ~~ tlw ,\~sertiuu tbdt tfm would h· \Yithuut Jd•:er~e ccononm 

co;oc;cqucuce> rlm dj>cm>ion reveal, th:Jt nne or the c,,mcquenet''- wdl bt:' ,l lower v,1luc provitkd 

to dw cmlonKr' ofhmks. In the end, it i'i- the bank msf('IIH'r' who nLl}' lw Jdn:r\dy 

hnpact on Structure Institutions 

As dJ<:cu,sed nrlier, bank> h,lH' e\-dved ,l hminc-ss. m.odd over the iMst few decade~ that invoh>e~ 

prodding J thW'r\iticd of ti.nauci.1l th,u includr commercial ,md imT)tnlent bankmg, including 

of the b.mking hmilW\~ model O\'t'nrred Jii'l lwcwse l)f change:; m rq;oLltwn hut becm~e ot'the ine-xorable 

nBrch o(nurket f(wce,'>.Thc of the fin;mna! mdmtry JU,ldc lt cconominl!y bcndin,ll 

b,mk' to cxp.md thc1r busmc~\ modcl11\ pYovJdc ,1 dlYt'r\lfinl \l't nf fln,mcul -;cn·H ·~-As ~lwwn in hglln' 

tht\ enllvmg bu\ine~'> model provllkd numewm economic ,llh-.mugc~ 

Business 

Model 

of 

Diversified 

Set of 

Financial 

Services 

Morertficient 

UseofliQUidJty 

Lcr U\ cxh bcndir 111 tun1. 

MoreFff1cient 

UseotCapital 

Pag; n !!·. l C(Y!'-iC\I\1lC CON~U)l!F.NCT~ OfTHE\'Ol.OZER RUU~ 

Benefits 

To Customers 

More Profitable 

andSater8anks 
124 


27369.083

(:{Liquiditr: Keeping more liquid aw.'b. lih· chh. on the haLmce sheet i'> one \V,ry 

for banks to m;uuge liqmdtty ri'ik. t lowever. keeping liquHhty like this l'< co,tJy t(>r b,mk~ beon"e liquid 

!ike ca\h thJt nrn little by \Y,lY ot" rcrunl. HJnb tlwrdl)rc fKe ,\ trJ.d<-·ott: keep 

tied np JJl low~n·turn liquid "h;.ct\ m nrder to reduce liqmdity n~k. or inve~! in h1glwr·y1eldmg ,l,sets ,md. 

,tcLept more Jiqulliity ri\k.This induce~ b.mb to be ~_-ttiucm Wtth their m~· ofliqui,lity, kc(•ping ,1, little of it 

to meet their 

make' then· liquidity ri\k m~map:cmcnt JllOTt' 

"\hocb" {;x the dJtJl·rcnt actJ\.'llKS arc 11clf pert(:nly correLn;·d with e.Kh other. Th,lt i'<, when more liquidity 

J\ nel·ded t{lr the hank\ markeHnakmg acunty.less liquithty may h· needed fi)r it\ cnmnwrciaJ bJnkmg 

;lcti\-t1y. Such impnft:~-cly correbted lH]uHhty <;}lO..::b ,llhm· the h,mk to anil ofintcrn,l.l "opccnioruJ" 

<ltwr\ific.ltion :md keep le~s liquidity to adm·n: the s.JnK kvd of orrcrpri<:c liquidity ri\k thm if it l.ld;l•d 

!"his mt\lllS th.1t ;t Volckcr Rule that C<lmes bank~ to from making\vill the 

etllficncy of the h,mk\ hquid1ty n~k D\.ltus;cnwnt. H.mh ,m.' likely to rnpond by kapm)~ mor;;' liqmdHy 

nn the balance sheet Tlus, 10 turn, \\-Jllmcre,l\C the b,mk'~ co.'lt ofpW\'Jdin(l. y;mons 

pd<-~cd on to the b,mk \ cmtomcr\. 

L1kc hqmdlt)\ <'-<piul ,l]-;n present~ bank' \\"Jth ,l tndcotf { )n the mw 

h,ud. keeplllb mnr<:' c,1pital tlw owr,lll ~.1t\·ty oft he h,mk. On tlw ntlwr h,md, upltal i' C\>~tly f(\r 

b,mk. 11 TlHl~, b,mh Will ::tttempr to optimi:rc thclt" IN' of caplt;ll. u~ing logic ~mnLll" to tb,lt f(lr hquidity. 

tbJt bAnks w1ll be ,1hlc to u<,c c1piul more ,.,.·hen they z·ng~gc m more .H"tlvlflc\.\X'hcn 

find' itself m tnrbuk·nt \'1-".ltc'r' ,l!\d tW\'(h more opto! tn buffn dw :-.hocb to dw hu,uw\'\. 

:mother Ktl\'ity m.ry rwed le'<~ ClpltJI hecame it rs dt>ing wdLThi~ way. the hank .1chJevc ,l dc-,tred 

\Vlth k'\\ Clf'it.ll tll:mif Jt 1ud ,l Je,, dtwP,ificd bu~int''' 

t)rw t'COl\OtnK l~)r thi~ tlut ~~ \Vorth mcntrontng 1s tlu1 ,dthough the lunk\ <;]Urcholdcr~ ~.k) 

not ore sbom whether the h.mk h (>pcratwnally div;.-r'ltled (lwcnl\L' sktrcho!dn, c.m divep;if)' tlwn own 

hold1ng ,1\T(l\\ (iJllh ,\1 ncgligthk Ol>t), the l'snk\ l'!llployz'c''-, cu't<>nwr..,, ,md ot!w1 ~ukch()ldt'r\ do 

,rbout dJ\TT'ilf"icnwn. b.mk'' !in.uKul dJ~trn<, or Lnlun C\!l .tJl(:n nnplnyc('S (whn h,l\T to h~' Llid 

nt1) .md ,·mwnwr~ (who may cxpcrwuce dt<>ruptwn' m the pron~JOn t)C\t.TV\('t'\ to <hcm)_·nw hank \Vlll 

take these com1deratiom mto m determining hmY much to hold oo it~ b.1lance <,hcet 

m:mage it~ bmine'' than ,l. b:mk ,J nJrrowcr ,,·ore, 'inch .1 hank will also be ,n·erse to meetmg 

lnghcr regulatory cap1Ul r~'quin.'lllt'llC\. Tlw ''pohnul economy'' of rq~uLll<wy opir,d requirement<; rctJc,"g 

an ongoing temmn between the d.esm: of regubtors charged w1th rmnoprudenti,<l reguLltion to impo'c' 

h1ghn minimum capital reqmrcments and the dt~sm' ofh::tnb to opcrJte w1th lower upttal reqmremcnt~. 

~I One!"l\lSOn 

!:,qmry 
125 


27369.084

cndor<.Jng higher oplt,!l rcquin'nH'nt\ " 

H(l:her Qu11Jity {!t" Scrtlias Pnwldcd to Custmncrs: A b.mk with ,1nwrc di\-,'nitlcd. ·'''t (\fi-\n.mcul 

'>Crviccs 1g h11~1Jle'i~ model \vill end up gathcri11g more mfi.)nlHtion about nvrket comhtiom tlun a bank 

that does not pnwHk ,l~ divcr~ificd .l ~ct nf ~lTVin:~. Thl~ \Vd~ di>CU<;<-cd ,l. hendit or cnw .. -\,"ctWn,d 

ml(>rnution rem,lbllity. \'>hKh incrC.l\t'~ \\llue of the the bJnk provide> to 1t\ Cll\hilHt'r~.The 

\~;kh:r Rule on illlpl'de thi\. 

the bJnk \ ovcnll slliifQ!}'- (~ruwth 

oppnrtumties ill one <;ector Cl!l W'llerJ.tc potenti-11 opporttmitic'i m another sector Lrrgcly hcnn>C of 

cmnplcmentaritie~ or \rope enmomic\ m operating in both 'cctor'i. Pnr exAmple, growth in n:btiomhip 

kndl!lg to ~nu!l or mid-~1znl pri"v'.ltC' tlnm permit the h,mk to lc.1rn mort, ,1hout the need\ ofthe~e 

finn~ ,md t'V<.'Il(U,J.Jly figure out dw npt111L<I t11ning f;w okmg thc~c finn~ puhhc by umknvntmg then 

inirul pub he offCring~. '·' Th1s em t~1nhute the hank ·s ~rcnntir' undcnnitmg bmttk~"- and a bank 

th:1t \Jb~t:rVl'\ " growth in n::htwn~htp knding in it~ comml'rci,ll h,mking (11\-ioion nuy chome to {;xnml.Jte 

a growth or' e"p:ms1on in und\'1\\Titmg, ~~erh.1ps through ,\lquiqtion.To put it in :1 nut\hdl. a 

hmk's bu~mhs model :dl.(·n\ it-; growth \tClh'f..')',:md rq:;uLnnr)-' hkc thcVokktT 

Ruk rbat ,l!Tecr th!.:' bmtm·~~ 111ndel wlll ,1ho 1nrlnnKe tlw bank\ gnmth '>1T,Jtq;y 

dmwn~JO!l to thi~ li·nm the ~t.mdpoint of the lunk\ bmmt'S~ model. When the Junk\ xtlvJues ,u-c 

,lrtJficially curLnkd by rq;utnnry pro~cnpunn~, the h.mk ~~ 11ot only fprced to rctTCIKh tl-nm ,l pntenti,dly 

pn~fiubk actw1ty, hut ,J,o nuy be CPmpclkd tn ,t]tcr lh hminc~s JJ\O(kl.-!'hc rc.t,<Hl i~ dut rctrcnclung 

fro1n one .lt:rJ\'Jty 

inw,uJcn, '>Ullll' ofthl''l' M'tl\'ltic" 111,\} no ln11gcr he ,I, pr~)lit,lhk ,\\they 

lxml to call1ts cntne btJ"lnC>S model mto qu<='~non 

m ,JctdenliL rese;m·h hA\ been dut conmJerci;tl h.mks compete \Yith the npit.1l 

m,ulct f(>r bu\int"';s.A hAnk loJn ;md (·ommerci,d p;i[Wr .trc often dm<' \ubstitutc~ f(Jr high-n\'dit-qu,lhty 

h(llTO\Yt'f'i. Mutodl fimd;, ,Jrc d'N' '>Uh'iitutt'' t(w hJnk dcpo~its, and grew in prommcnce wlwn Rq.;uLmon Q 

n:ilmh:s on depn\tt mten_·sts h'Lllll<' hindu1g dunng the high ·intt'l'ht--nte pt'nm1 (If the l'IN(k. 

In,\ nxcnt p.lfWr, Song :md Tfukor (201 0) ~how, hmYcvcr. that lwside-, comp~'ting. h:mb and 

42 rhi' i-; nnport.llll Ill p.1rt bee .lll'<!C then: 

ft'qUJJTnlC!lt\ ,md AJoO bl'C\\!'>l" fqnk<, Cln 

a' bc'mg t('0 onerous. tlwrdw 

JJJdtJ~tn 

:we Ih~ot ,md r!uKPr (:)0(1{)) 
126 


27369.085

,1blc to fl1utk-e ilwmsehT5 with l'guny capt,tl a[ lnw,T nv;t, which cn,tbks them to cxpJtld their ~cop(' of 

by to mkier borrower'>. Tlm fJnhLne.s th<' devdnpment of b;mking. Sin11larly. 

\Y(wn 1Mnks hecmnc Jth)f(' <.:lf\'Ctl\'1.' 11\ 'iO:n'Olillg horn)\\'n~. tlwy Jrl' -1hk to cnsun: t!ut only horro\Yi:'rS. 

.:~bow a qtulity thre~hold able to go public :md their 'enmty tsstnnce~ undcnwlHcn. This 

benefit~ the c1p1t~l market. The Song ;md Tlukor (2U10) 

hro,1dcr Llngt" of ;h.:tiYllw~~pnv-:<te t'q11ity, hedgl~ fund~. m,u ket making .. md the lih.t'· -·th.m were' pcnnitted 

befOre CLt'i'>-Ste;gall dJ'imantlecL tht' coevolut10n of b,mb and is (Kilitatcd. Th.H is, the imp<li'l 

ofpv;itn·c tkwlopmenb in the optalmarh·t on the dt.'Vl'k)pmcnt ofb,wb :md the imract ofpo<.inve 

de-velopments b,mking on the devdopmt.'tlt oftlw capital nurkct both clcv.tteLLTlm the 

dJ~turbing po~~ibJJity th,lt denymf:'; banks oppnrtunny tn hedge Ji.md.\, pri\.~,ltC equity', .lnd the 

l1ke \\Ill ,\rtlflci.l1ly comtr,lin cocvnlL:n<.m of!\olh h,mb ,md m,lrkct~ 

\\'W\'>'.(_:cntcrf()r(:af~lta!J'vhrkets.ct1m ! 
127 


27369.086

THE VOLCKER RULE AS ONE PART OF OVERALL 

REGULATION AND ALTERNATIVES TO THE RULE 

Thi<> section di'icm~es t\vo i'<:Ue'i: the LKt thar the Volcker Rule is but one piece of.m emerging 

C(lmpkx mnsJJC oCrcgulatwn and lt\ potcntlJ! etll:n mmt lw n·aluall'd w11h dut mmd, ,md th:H the gcnl~ 

oftheVokhT Rule conld be met by other me am tiut 111ay bt \'Conomic·,Jlly mon: \Cll'lhl<.:'. 

v.Kuum; it J'i only one of many other regulations th:Jt 

,lfl' ,thout to lnt fin.mci.tl .md nnnfi.nMKul finn~ in the 1w.u 

the impa~.~t of the Vnkkcr Rule in i>obtJOt1, hut ill (N!/uWlltJ!i with uthcr rcguLttinm. some uf \VhKh m.ry 

its ctil'{"t'< In p.lrtitnLlr. we llCl'd to rhmk about lww th,' ctkcb ofth,· Vokkcr Rule nus;ht imcmo 

with dw dli.Yr~ of <Ahcr n'gulJtlOH\, with potCl1tnl ,unplitlntion ,·nnscqucnccs for thl' "\\lriom dfcct\. Sunw 

of the~e derivJti\'e\ regtlldtion, money ·Jlutkct fimd~ regubtion. Jnd lb~elll! Uj'1Lll 

reqnirements fbr banb.' 1Thc\(' n'gnLltlOll\ .nT bndiy dhcnw:d here 

DcrithHh•es: Rt'~uhtion oLknv,\tl\'(~S l\ tht' H''>POJNbiliry of tlw CFT(: .md SEC Title vn o( the 

Dockl-FLmk Act pnw1de' .1 fram~·\mrk t(lJ regulatxm of the OfC ~wap~ m.1rket.Tlw CTTt ~ ,md the SEC 

n::qmrcd to define 

reqwronents" 

J4ouey Jidrker Funds: The U.S. money m.nkct nnmullimd indmtry JS a tnlhon bmine\s.'1'hc 

mdmtry now ClCt''- ,\11 owrv1ew by the Fnunci.1l St1h1hty Ovet\ight Councd, ,md OJH' of the go,<l' of the 

propo~ed new rcguLmono i\ to prcv~·nt rum on mom·y nnrkd motn,tl fim,k The~l' fimd~ an.: among '>t'\Tral 

tinJl)( ul mtcnJKdurK'> th.Jt coilcctivdy to ,h the '\h,Hbw h.mkm; 'Y\tnn.'' In W\)'()11\~' in 

f{lrcm~ !im(h to ohortcn ilK m.Hunty ol thur bnklm~">. kcer .)0 pcrccn1 o(dKir ,,,~n' m wcurnic~ 

com·crtJbk mro Cl'ih wnhin \CWn dJy~. ,md di-;do~c holdm1:-"' monthly. J~urth·r rq . .,'11bt1ons .m' expected 

(il)( luding ,, propo~.1l tlut fimd.; Jh,<mlon the1r \t,;hle \h,ln' policy) Hl rc~pome to optiom t~w ,lddttion.tl 

rq:ubuon pmpn>ed hy the Pn.::qJent\ \Vorking (;roup on Fin,uKi,,] fvLlr/;eK 

Basel III Capiral RL'gulation: H:m·lll! ~~ J gloh.1l 

\In"'~' tt.'$ting and market liquidity n\k .1gret'd npon hy the mt•mhcro; o( the H,<Scl Comnntwe on ltmking 

Supervbion, lt will rcqmre b:m.ks to hold pnccnt of common t'quity (up fi--om 2 pncem in l:Lt~d ll), 

6 pern·ntTwr~( )n~· Clpltll (up tfom ~ pctn.·ntm Rt.'>cl If) ofmk-wciglw:d mand,Jtory cJptul 

regulcttof\ to require up to ,m .1ddmon.tl 2.5 percent!.\( ~·,1p1t.Jl during pcnocb ufhigh cn'dit growth. Furtlwr, 

there 1c. :1 mmJmtHn _1 pcnxnt Lll1o, ,l bquidny cowr;tge Clt!O tlut n:qmrcs a h,lllk to hold ~utfinent 

high,qu,lhty liqmd ,l'i'iet'> to co\'er lt'i net :-table fimdmg ratio.Th1" w1!l reqmre hanb to hold an Mnount nt 

5tabk ii.111dmp.: tlur t"i:C\'\'(ls tlw amount of '>f,lblc funding ncc~·~~.lry owr ,1 one· yc,lr penod of 'trc'>-;. 

no nwsns an cslMU,l!H' h't 

~nd Exch,m~l' Cmnni-;\ion (2011). 

Page>:; l'Hl.l:U.):-.J()MH: C(lt\\l'Q\Jl:Net:;; l)F H!f\1()1 ("KCR RUt L 
128 


27369.087

The combination of thc'>c regulations will rt"mlt in sub,Lmtlally gre.1rer n·~triction~ on b.mk~ 

other lll'tltutton~- and ·will alkct the ( <ht'i ofclplul for the ( thlnmcTs oftlK~c lin,mcul tnstltutlnm. \Vuh J. 

lnghly interconnected ecorwmiL -;y~tem, 1t would be dmgerou~ to \"it.'\\- any ofthc~e rq._,'11la1wm m isot\tlon 

m tnm~ of it~ J-~Ott'ntul impact. 

Tlh' ma.in ol-:iectin• Gf the Vokker Rule IS to reduce sy'-tt·mil' ri'>k aJld banking ff-,<plity. <;-o dut \Yt' 

,lo !l<lt luvc .mother deb1litanng fl;unn:tl crJ,j,_Thi' J'i ,\ LmdJhk go,d, Jnd one thar fi:w wuuld dio.,put<.:.Thc 

thcn'Jn' hettn to meet thi~ objective. 

lt j, uo.,efiJ] to begin tlw; discu:;\ion by reiteratmg dut the demi'i~:' of the Chs~ Stt~.rg-,dl t\<:t w:t~ 

brought about by marf..•ct_j(H{CS and tbc d1angmg cconomJC' offin,mt·t.t1 '>Cl'VHC\.Thc ~,Hue Cor(c'i chcute the 

of provld.ing .< divcnlf!cd ,l't offin.1tloal <.cn'H c~ 1mla;,; .1t ka~t dw L\'-C o(Lnp;t' b,mb \\'hmc 

<:ort' cmnpetetKte~ .trc aligned wllh -;Hch ,\ ~tr.ltq . .,')·. Tb ''turn b,H:k the ,·J,Kk" and rnurn to the fi.mnional 

'>l'par.<tion !l1J.I\d,ttl'd by c;L,,~ St~·ag,dl. \\ hik .lppealing to a populiq theme f(lf holding bank\ '\l<.:COn!ltJblc," 

i~ <-nnrly not sound economK~. Nonethc·Je,,, the 1';\lll' ofhm\ to contain tht' ri.>k nfkwh 15> gernunc .md 

to!w t;~ekkd .. 

One .tppmpri,lte to ,lt'bwvc thi'i go.tlls through -:;onnd capit.:!l n::gubtion.AclHrya, i\:1chran, 

Schuernunn, :md Thakor (~01.!) dl\cthS ,m ,lppro.Kh f()r a capit,ll rcqmrcment on b:mb. "ll>i-> 

.tpproxh c.lll-> for l~oth h1ghcr npiul n'qum'nl<_'m<. ,md op1t,tl rcqmn'HICiltS of-t tliffl-rcm l(mn. Sp,·6tic.llly, 

lunh would be ~ubj~,,-red to ,1 Tll't~One npital rcqmn·nwnt they llO\\~ J.lthout;h <-trc~~ tc't~ ,md 

may be ntcdcd detnminc the lew! ,1ppropnnc filr dficienr microprudcnti,d 

n:guLnion. In additton. t!wn: would he a ··,pect.ll c,1pit.1l ,w\-Ollnt" th,n b.mb would need lp budd up 

tlimu~h earntn~' retention~. The kw! ofetp!Ltl tlu~ ,tccount be nude roHntary<fir,d, 'o that bank> 

tn lcep more caplt,d wlwn they (,md the economy) ,uc domg wdl, and k\\ ,-,lpit,<l dmmg dmYnturn~. 

\Vh.n\e\·cr the rcp,ul,trT!eJ~()nc c1p1,d ,JCcouot Lll-.es .< lnt, c,lfl!Ll]!.., tr,w,f<:rn:d <..lut oftlw '<pen,d <..tp1t.<l 

acrount 1nto the rcguL<r ,1ccmmt to bring the lunk b,1ck m e<JmpliJ!l( e. Dl\'idcn.~ . .b .llT then rcstn .. -tcd to 

.11low the bnk to gndtLllly budd '-pecial capital ac~·mmt back up to it~ ongHul (pre~tran-;ft'r) kn·l 

The "JX'n,d op!t,11 an:oum em al<;(l do "doubk duty" by ~,ttl<.t)·m~ a hqmdiry Jt:qutrement. .!.hi<> on 

lw achie\·-1..'d requirinf): t!Pt sorne pnrtmn or :1ll of the ~pe,-i«l c~ccoum 1~ mw-;tcd 1n wry hquid 

't'1'tuitit:\ hkeTrea~uric\.Thls propqqj h,h li:'Jtlll~~ th:lt snmtn to ~ome otthc fi:,tltln•'- m the Ha'd !J! 

C.ipiul n:gubtion di\Oh\ed c.uher 

Phcmg more in l-)Jnking, c~pecJJ.lly A conntncyclic;:~lman!ler, C<)nlhlh'd with other 

nwch::umm~ hkc rcgubwry monitorin~, \Jil .1 long 

fimncul '>)'\tern. TlMt 1~ ,t [und.tml'!lt.tl!y better \'ConomJC ,1pproxh th,m trying to "put the tuck m 

tlw bottle'' by revivmg a part ot.the (;]J~<:.-Ste.Jgall Note, ho\\THT, that there 1-s ,\ <:.trong wmd of caution 

here. Although it make'i 'it'JN' to emph.l\i:te tlw role uL1ddit10H.ll (:;lpitllm miCl\lprwlenti,ll bank 

rq.:;uLHion, thi-; empln;i~ aNmlt:~ th.lt rlh>re arc not other rq~ubtwm hke the Vokkcr Rule lhat arc ,1!so 

,tdl)pted. ALldmp: tlw Vokker R nlc nn top of higher c1p1tal reqmrcment> m.1y he cconomio!ly d,lmagmp:, 
129 


27369.088

CONCLUSION 

This lHpcr ]J,,, e;.;-Jmint•d the porcnti,d economic cm1iilcltiom o(thc\'okkcr Rule. The 

nurkn nuktnf!, ,u1d liqmdiry pnwi~wn gcncr.tL tlw dl(·ns on d\1.' ClhtomtT~ nflHnk,, and rhc pm,1hk 

on h:mks lun' ben1 di,cm'><-'(L 

\Ve luw witne-,~cd time and the dimullthng of regubtory n.·~triction~ hec.m$c of the evolution 

of nurkn t\:m.·c~ tlut nwk thnt' r<-'>lTldiPm ecm;nmJca!ly 1>hsolnc cn·n hcf(wc nHie~,ll!y n:n1ovnl 

One example i'\ RcguLlt!Uil Q lTiling> on inten:'>t r,1t1'~ \)ll hmk dcp\hlts.Tik' high-1nfLltion pcrind nfthc 

19Hlh th,tt drove np market mterest rate> and Jed to the enwrgt·nn' of moncy-nurket mutn,>l fimd, nTnttully 

led to the demise ofR.:gubtion (~.Anutlwr exw1pk 1s Jnter~talt' branching rc>rnniom.The econo1mc'i of 

b:mkmr; mdiuttd sen om mdllctencK\ ;l\\ocutcd \Vith thc~e n'>tncriom aud <'Vcntu,llly ctmnl them tn lv .. · 

n:m1lW'd in 199.t. !n none oft!w,e C.l'C~ zhd we try to t11rn the dnck hxk md n•nvc a mod1tied ver~10n of 

outdated re'\tnctiom. So it 1'- \Yith Cb\s~Stc'J)..;all ,\ud theVokkcr Ruk 

The Rule Market Afaking and Liquidity Provision: 

Din1inished lVIarket !\'laking Services: One dfcct oft!w Vokkcr Ruk 1s likdy rn he dimini<:lKd 

nurkct m,1king >ervicc~ prov1ded by b,mb, ,md comcqucntly lower hqmd1ty in rn,\rkds wlwn: 1unb are 

m,trb:t m,tker,_Tiw reduction in m.trk<.:t making by h,mh \Yill also cm'e h,mb to retrench from 

nurket nuking in \nullcr .. md n\k.Jcr '>ecurincs \Vherc L1rge ,md tmcxpcctcd \upply--dnn.md 'hocks ,lrt' 

mun· hkdy.Tilh wll! reduce market mJ.kmg in pn·n>ely those '>CCnritw'> where lt i~ mo->t v,1lnabk. 

Market mAl~·r~ opna.t(' in ;t rwtwork. tnd 

tln~ network pnmtts nurkc1 nukns to bcndit tl:-nm the Jll\'('!\t(_ory h,d;met":i of othn marh·t nLlkU\ ,\, \vdl 

then knowkdge of m,1rh·t ~·ondition~. A reduction in the tdlo\nng the n.'trcnchment ofb:mk\ 

induced by the Volt \..:er Ruk ts hb•ly to dnnnmh the v,tlw: of the networl.a.nd hence the \qlue of market 

m,tl-,_mg ~tTVJCt'" to the b.mk \ cu,tomer~. 

Businesses: 

I )ue to retrenchment tfom market making by bank<. i'>~UeE of ~ecnritie~ 

w1th a les~ liquid m,H"ket. Jnd lllt' lower l1quid1ty wtll be numtt·,t,·d m both ,< 

htgher pnn· Ullp.td oftr.lde' and ,J higher bJd·,hk '-PH' Ad. l"hi\ ha' both cO'>t~d:..c.lpit,ll ,md IHJrh•t ·,lCct''>~ 

con,eqm'JHT~ l(n (inn> th.H go 10 tile opl\,lltl1,ll"kd to l~\tW \l'CUntit·~ and ctplt,d 

J\1ark-to-l'vlarket Losses: An mnn;;di,ne imp.Kt of the Vokkt'r Rnk will btc the anticipation of!ower 

t"imnc hqmdity tfut \l.'ill cm~c expected n::turm on sccmitie~ to ri~e. ,\, both the liquidity prcmmm and the 

!"C)-!,\lLnory mKt'rt.1inty premmm go up. Com~_'quently, prices of ~eruritK'<; ltkely to 611. oming !11\'l'\l\\f~ 

to hook rn,lrk ·-to nurket lm~e~. 

Distorted Security Prices: The retrenchment of hanb fi-om nurket making dtw to the Volckcr 

1--t.ulc is likely to c.n1~C <;t:curity price di\lortton\ bn-.um' nf,upp!y ~hocb th:Jt an· larger in m,;gr>Jtudc ;md 

front the t1Jnd,tllletll,th 

Page i THI: H'<)f'.:\"ll\1](' ('( )N\L\~UrNt:L\ or T!H:\\l! \"l<Ut fU 'IX 
130 


27369.089

Higher Cost of Capital: Firm~ will tX}Wriew.-e hight'r rost-; of debt and equity opital heou~e of 

!O"-\'cr liquidity ,tnd gn·,ncr n•p:ubtor-:;: nnn·rrainty Jbout the future.The 

h<.: sJgnificmt, bm \t'> nMgnitude 1:- h,1rd to c~tinutc ff(llll dw d.ttL 

Ullccruinty effCct nuy 

PotentiaHy Lower, Riskier and ?v1ore Short-Tcnn-Orientcd Investnu·nts~ and 

Lo,ver En1ploynu•nt: As.~ rC\tllt of,\ higher cmt ofctp1ui, finm may t"Cduc~' the .unoum of 

im-c\tnwnt and aho pm~ihly ~witch to ri\kier inn-~tmcnts. as \YCJl J~ tlw~\' with \hortcr payback pt'rimk 

Volcker Rule Financial Institutions; 

hnpact on Risk Managen1cut in Financial Institutions: 

A rigid impkmcnurion ofdwVul\·hcr Rule nuy iml'lfcrc with efficient rbk nurugi.'mtnt in b;mks. 

Loan Quality Signaling in Securitization: Banks th:lt \cnnitin· th~· hms they orig-inate can \ignal 

the qu,dity of the hm~ tlwy ~l'Curilizt' by hmY much nfthe \CC!Jritized trawhes they hold on their bLuKc 

~hecK If the Volcker Rule imv·dcs their ,<bJJity to do thi<;, it will intcrftTt' \Vith the )i!::,'1laling th,n b;mb em 

engagt' in, pote-ntially c1ming ,\ dcdinc in tht' price> at which the ~ecuritit.,ltion tnndws c.m be sold. 

Reduction in the Value of Financial St~rvkes Sold. by Banks: A dnnini~hed rok fix 

mJrket m:1kcr~ wll! Jmoum of inf{)rn\Jtion J.bNlt mArket conditions th,lt bank\ gatlwr_ 

and hcnCl' dHmni~h the value nf ad\·i\ory ,md other set vice~ tlnt h.mk.~ pnwhk tn t!wir CtlstonH.Ts. 

hnpact on the Structure of Financial Institutions: ( :urrently, hanb have a bmme~" 

nHllL·l nlprn\"ldint; din·r~itled fllt.nh't.ll ~crviccs. and t1H5 IHl><kl ~~ driwn by scopt: economic~ and 

on 

i\dv;wces m 

cmTolution 

Rntrinwm on proprivtJry tr,u:im[': <>f t!K 

m,nlet\ t"Ot'\'olw" 

R uk may impedt' thi" 

Tht' 1min goal ofthcVokkn Rule is to hnut (~ystenuc) ri\k in b,mking,This is ,1 good go.1l. bnt 

HJ<,tc,!d of u'>ing the Vnl< kcr R ulc. 1t LH1 he .H h1cved mun.' diincnt!y by <l'kmg h,mb W rhc 

.tppropn,*' amount of (equity) Clpiol ,md on"·b,tlaon·-·,hc~:t liquidity to cope wllh !he rid.::~ they 
131 


27369.090

REFERENCES 

AdriMl.T_.md H. S. Shin, "Liquidity :md l t'verag~': \Yorking p;tpcr, Feder.tl Rt'~t'P..'C B.mk ofNc\YYork 

St.<ifRcp~)rt J2B,Junc 

i\kerlof. (; __ "The MArket fl1r 'Lemons': Q1uhtariw Uncertainty ,md the ,IVbrket Mecluni\m." C)uarra!y 

]i>!inMl~:f 1 ;·rNwmic< 84, nn. 3 (Augtl\t 1 970). I'P· ·1-BB-·:10ll. 

J\clurya,V, l·L Mchran.·r Schuermann, and A.V"l"h,lkor. "Rnbu'-1 C.1pit1l Reg:ubtion." wniking p<~rcr, 

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An:llJ.rya.V, P Schmhl and(;, Smru."St-curitiz,l\ion Without Rd.,_ Tr:m~fcr." 20!0,_Totlfl!<~icfFinml(t,d 

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(?1109), l't'· ?.)3ll·-J8 

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Uudbounw t"'- b.rkt'. LLP. "Client i\lerc''July :::9, .-:'OW. 

Con1erttm, hmk C~., T Hcnder\hott, c:.Joll(::~, E ( :. iv1onltml, and tv1. S. Sc,1shok~. ''TimeV1ri,1tion 

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!.,T N.HJ:m!J. ,wd R, M. Stulz, "\'l:ihy Did U.S. B.mks lll\'l'\t m l Iigh1y--R,lted Sccuntization 

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State \JniveNty.July :::011. 

G1khri~t, .S .. C. P Htmm\'llwrp;, and c;. llubcrnun, "l)o Stock Bubbk~ InfltKnn' Corpont;.' 

P,tgc rilE f:t'(IN(\11.-1l<'Cl1KSI·.QUCMT\OrTflLVOL(:K[R R\Jll 
132 


27369.091

Invcstment?"}rlllfiWf c:f,\!Nirlllr)' r:.rolhll11ic<: 

c;Jlchn5t, S., and ''lnve'>tment ;md the c:mt of< :.lpitctl: Nt·w 

Bond Markd." NBER Wmking P:1p,T 13171-I.June 

and Fill!IWC 1 (Seprembn 1987), pp. _-p(J--101 

(;n'Cllb:mll\. S. I .. ::111d A.VTlukor. Cour<'mporary }·"i!;{mti,J! Intcrmrdi,lri\>n, El~e\·i,•r, ?,(Hl7. 

K.l'>hy.lp. A .. R. R~j.m .. ond J Stem. "B,mh :l\ ProvJtltrs of Liqmzhty: An Expl.marioll t(n th~· ( :n-E:\i<;tt•nct' 

of Lendmg and I>epo\it ·rJ.king:')ollln.t/ c:( Fimmrc 57, no. 1 (F\·brn.wy :?.002), pp. 33--73. 

Knm:ncc R ... md R. RJ_jJ.n. · Org.miz.1tion Structurt' .md Credibility: Fxidt•nce fi·om Commt•n_·ial [\:ink 

Secuntic" t\ct1v1tie' Bd()rt' (;Lh'>-Stc.>gJil An," _lou mal 11{_\iNitrrlry /:nlll(•wit.; YJ, no.;\ (Au~ust JZl9/), pp. 

Mttchdl, M., and T Pnlnrw. 'ArbltLlf!,C C:r,t'-ln'o ,ln\1 tlw Spl'('d of (:.lpit,ll." \\or king pJp,·r. "·1QR (.'ap~'t<il 

_\1(//l<~l!<'lll('nf,2009, 

Nc\YJHJn.Y S., :md M.A. Ricrv1n, ''H!iquidity Spi!lovers:Theocy and Evidence fi·ont EuropeJn Td,·com 

Bond kstunc~' ... working paper. CndlLlt<' School of BH:.i1w:.\. Stant(ml Uni\·ef\ity. 2UO.l 

( )!Jwr \Vynun. '·The Vokker Rnlc Re\trJCtJOm on ProprH.'Llry TL<chng: lmphotiom f(w the US Corpor;w." 

B1)1ld M:~rht," monograph.lkn·m!wr 201 1. 

Orur:m. '{.,·'!\tuck on Vokkn Rule Seen Exa~~;er,1tmg Co"r nf I )Nnprion to Bond tVLlrket," http:; hv\\'w. 

hluolllhcrg.cum/m·ws,Jlmw·y lH. 2(11 :!. 

Pol+y.A., "Re\tnctiom on Prnpnt:t~1ry TL1dmg Jnd Certain lntere~ts m. and RdJti<.)whip\ \Yith, l kdp' 

hmds J.nd Pri\·ate Eqmty hmd<,," letter to the OTC. Bo.ud of Covcnwr'- nf the FedeLll 

FDJC ,md SEC. ,\111ninpal SlYtJrili<"O Rulon.Jkiu.-.; H.l.:Jrd.J.1nuary 

Pun, IVL, "Comntcrn,tl B,mk~ m lnvcmn<.'llt B,!!lkmg: CotdlJcr oflnternt or Cntitic,Jtiou Rok? '_!oum,lf 11f 

h·na111ial h,11/MIIits ·10.uo. j (199h), pp. 373--·101. 

s~)ng, E, and A.VTh,1km. "hn.mn.ll Sy~tem Architecture ,md the (:o~Evolntion uf ltmks md Mat let~." '17w 

EronomicJouma/1 02. no. 5-t7 (September 2010). pp. 1!111- !2 

Spem·,·. M.A., '·Compl'tlltve and Opll!H,d Rt''-{ll\1\\l'~ to \ign.1h: /\n,tly~i~ ofEffi,·iency .md l>i~tTthuunn," 

_l<Himaf 1!F htNWimr D1cory 7, lhl. ,1 (,''v1Arch 1 \)74), pp. _2W,-<UL 

l·h,1kor, A. V, "Sources nf(:,lptt:ll and Economic Growth: lnren·\mncctcd and !)1\·er\c J\1Jrkets Dri\·ing 

L:.S. Compctitivene~<-." mnnogr:tph. Cmtcr)~w ( ,·iipir<J{ ,\ !arkcrs ( :ompcririn'IICS".U.S. ( :l1Jmber c,f Commerce, 

Srnng ~01 L 

us Secuntie<; Jthi Exdung(' c:ommi,~ion. })ecnnber ,1(), 2011' http://\\"W\V.S-l'Cf;OV/<,podight/dnddff.lnk/(kriv,ltiw-,.~hunl 

\V!nreh\'JcL (. K. "'rlw 'Vokkn Rule :111d Evoh1ng PlRmci,tl J\:tu-ket\," 1 [wPard Businc.:;s Lm· Rcuicu', 2tll1, 

pp. "10-·72 
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CENTER FOR CAPITAL MARKETS 

OMPETITIVENESS. 

U.S. Chamber of Commerce 

Center for Markets Competitivenes." 

1615 H Street, Washington, DC 20062 

Phone: 202-463-3162 

\\'\\W.centerforcapitalmarkcts.com 
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Finance and Economics Discussion 

Divisions of Research & Statistics and 

Series 

Affairs 

Federal Reserve 

The Volcker Rule and in Times of Stress 

Jack l\~aureen and Alex Zhou 

2016-102 

ami Alex Zhou (20Hi). 

papers 

matPrials circnlah-:d to stimulate discussion <:l.!Hl critical commf'Ht. The nnal.vsis and 

are tho:c>e of t.he author:-; and do not indicate concurrence by ot,her members of the- n:scarch stalf or the 

Board of Gon:ruors. References in publications to t ht' Finauce nml Economics Discussion ScriPs ( ot.ltcr l ban 

.nckWJ\Yledgcmcut) should lw c1<'arnl with tllf' anl.hor(s) to pro1cct Uw Lt.'ntntlv(' dwrncl.(T of tlw:w pap<'rs. 
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The Volcker Rule and Market-Making in Times ofStress 1 

Jack Bao 

Federal Reserve Board 

Maureen O'Hara 

Johnson Graduate School of Management 

Cornell University 

Xing (Alex) Zhou 

Federal Reserve Board 

September 20 16 

Abstract 

Focusing on downgrades as stress events that drive the selling of corporate bonds, we document 

that the illiquidity of stressed bonds has increased after the Volcker Rule. Dealers regulated by 

the Rule have decreased their market-making activities while non-Volcker-affected dealers have 

stepped in to provide some additional liquidity. Furthermore, even Volcker-affected dealers that 

are not constrained by Basel Ill and CCAR regulations change their behavior, inconsistent with 

the effects being driven by these other regulations. Since Volcker-affccted dealers have been the 

main liquidity providers, the net effect is that bonds arc less liquid during times of stress due to 

the Volcker Rule. 

JEL classification: G 14, G21, G23, G24, G28 

Keyword~: Volcker Rule, Corporate Bond llliguidity, Regulation, Capital Commitment, Dealer 

Inventory, Market-Making, Financial Crisis 

1 We thank Manuel Adeline, Sergey Chernenko, Dan Covitz, Alie Diagne, Darrell Duffie, Josh Gallin, Adam 

Kolasinski, Jongsub Lee, Nellie Liang. Kleopatra 1\ikolaou, and seminar participants at the Federal Reserve Board for 

helpful comments and discussions. The views expressed herein are those of the authors and not necessarily of the 

Federal Reserve Board of Governors or its staff. All errors are our own. 
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I. Introduction 

Among the many regulatory changes following the financial crisis, few are more 

controversial than the Volcker Rule. Enacted as part of the Dodd-Frank Act, the Volcker Rule 

was intended to limit bank risk-taking by restricting or prohibiting certain speculative activities. 

Critics (for example, Duffie [2012]) contended that an unintended consequence of the Rule could 

be diminished bond market liquidity, resulting from a reduction in banks' market making activities. 

Advocates of the Rule disagreed, arguing that non-Volcker affected dealers could compensate for 

any market making reductions, leaving liquidity essentially unchanged. Recent empirical studies 

of post-crisis market behavior (e.g., Trebbi and Xiao (2015), Bessembinder, Jacobsen, Maxwell, 

and Venkataraman (20 16), and Dick-Nielsen and Rossi (20 16)), however, find conflicting 

evidence of the effect of regulations on bond market liquidity. In this paper, we focus specifically 

on the implementation of the Volcker Rule and its impact on bond market liquidity, particularly in 

times of market stress. 

We argue that fully understanding the impact of the Volcker Rule on market liquidity 

requires understanding how liquidity behaves in the face of severe conditions, or exactly when 

liquidity is needed most. As shown by recent research, liquidity deterioration was particularly 

pronounced during the height of the Financial Crisis2 Practitioners and policymakers alike have 

noted that illiquidity in times of market stress may be the more relevant metric for gauging market 

stability and perfonnancc. 1 The main motivation and first major contribution of our paper is to 

study whether illiquidity is relatively worse in periods of stress after the Volcker Rule was 

'Sec Bao, Pan, and Wang (2011), Dick-Nielsen, Feldhuttcr, and Lando (2012), and Friewald, Jankowitsch, and 

Subrahmanyam (2012). 3 See recent comments by Deutsche Bane Research (2016) and testimony by Powell (2016) that even if liquidity is 

high in nonnal conditions, it may become more troublesome in periods of stress. 

2 
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implemented. Motivated by Ellul, .Jotikasthira, and Lundblad (2011) who find evidence offorced 

selling of downgraded bonds induced by regulatory constraints imposed on insurance companies, 

we use downgrades of corporate bonds to junk as stress events where liquidity is demanded by 

clients. Focusing on regulation-induced sales has the added advantage of plausibly preventing 

investors from optimally timing their trades, thereby providing a more reliable estimate of the 

liquidity conditions that investors face. 

Our focus is on a difference-in-differences test comparing the illiquidity of downgraded 

corporate bonds to a baseline control group both before-and-after the Volckcr Rule was 

implemented. Tn particular, the first difference is the difference in price impact between a set of 

bonds recently downgraded to speculative-grade from investment-grade and a set of BB bonds 

used to control for the general level of illiquidity4 The second difference is between the postV olcker difference and the pre-Volcker difference. Our results show that bond liquidity 

deterioration around rating downgrades has worsened following the implementation of the Volcker 

Rule. We find such adverse effects whether we benchmark to the pre-crisis period or to the period 

just before the V olcker Rule was enacted, and we find that the relative deterioration in I iquidity 

around these stress events is as high during the post-Volckcr period as during the Financial Crisis. 

Given how badly liquidity deteriorated during the financial crisis, this finding suggests that the 

V olckcr Rule may have serious consequences for corporate bond market functioning in stress 

times. 

The second motivation and contribution of our study is to understand how the V olcker Rule 

induced changes in dealer behavior, and particularly to identify any differential effects on Volckeraffected vs. non-Volcker-affectcd dealers. Because the Volckcr Rule applied only to banks with 

·• Results are similar if we instead use bid-ask spreads. 

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access to government backstops (such as deposit insurance or Federal Reserve borrowing), other 

dealers without such access can continue to trade and could, in principle, step in to provide 

additional liquidity in cases where the lines between permissible market-making and prohibited 

proprietary trading are blmTed. 

Using a unique data set with dealer identities, we present evidence that non-Volckeraffected dealers have been providing more liquidity during post-Volcker stress times. In the postVolcker period, the relative share of dealer-customer trades taken by non-V olcker dealers has 

increased. Dealers affected by the Volcker Rule sec a statistically significant increase in agency 

trades, or trades in which the dealer has pre-arranged an of(~etting trade so as not to have inventory 

risk. For non-Volcker dealers, we see no such effects on agency trades in the post-Volcker period. 

We also find that Volckcr-affected dealers significantly reduce their capital commitment, while 

non-Volcker dealers commit more capital in market-making. Combined with our results on the 

increased illiquidity during the post-Volcker period, these results suggest that while non-Volcker 

dealers have stepped in (as proponents of the Volcker Rule suggested would happen), opponents 

oftbc Volcker Rule were correct in arguing that the change would not be immediate. 5 At least 

during stress times, this new participation is not yet enough to offset the decreased liquidity in 

bond market trading. 

Finally, a third goal of our research is to disentangle the effects of the Volcker Rule from 

those of other important regulations on dealer bond market behavior. We do so by focusing 

particularly on the implementation period as compared to the period just before implementation 

and also by splitting dealers by their exposure to Basel Ill. Though most banks' capital ratios are 

significantly ahove Basel !IT minimums, increased Basel Ill capital requirements along with 

5 See the Federal Register (2014) publication on the Volcker Rule for details of comment letters. Liquidity 

deteriomtion was particularly severe during the height of the Financial Crisis. 

4 
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Comprehensive Capital Analysis and Review (CCAR) requirements may potentially mean that 

some banks will reduce their market-making activities because of CCAR constraints. These 

constraints arise from the fact that dealers are required to meet minimum capital requirements in 

stress scenarios. Thus, to ensure that our results arc not driven by banks constrained by the start 

of Basel Ill implementation (along with existing CCAR requirements), we split Volcker-affected 

dealers into those that arc CCAR-constrained and those that are not. We find that capital 

commitment has decreased significantly for dealers that have neither failed CCAR tests nor been 

given a conditional pass. Thus, our results are unlikely to be driven by banks adjusting their 

business to remedy failed CCAR tests. 

Our paper is most closely related to three recent studies on regulation and liquidity, all of 

which focus on the general regulatory environment following the global financial crisis. Studying 

general trends in corporate bond market liquidity, Trebbi and Xiao (20 IS) argue that liquidity has 

not deteriorated following post-crisis regulations. Bessembinder, et al. (20 16) provide a similar 

finding, but also add an examination of dealer behavior. They find that while there is little 

evidence of increases in transactions costs, there is evidence that dealers behave differently as new 

regulations have been implemented. Dick-Nielsen and Rossi (2016) study liquidity provision 

around index exclusion events, finding that liquidity has deteriorated post-crisis. All three papers 

provide evidence of how liquidity and market-making has changed in post-crisis years following 

the passage of reform rules, but in contrast to these studies, our focus is on isolating the specific 

effects arising from implementation of the Volcker Rule. Our main results relate to comparing the 

post-Volcker implementation period to the period just before Volcker implementation, whereas 

both Besscmbindcr eta!. (20 16) and Dick-Nielsen and Rossi (20 16) focus on the years prior to 

5 
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Volcker Rule implementation6 Trebbi and Xiao's (2015) sample extends to the end of2014, but 

they also do not focus on the Volcker Rule implementation period. Furthennore, our usc of the 

regulatory version of TRACE, with dealer identities, allows us not only to split dealers by those 

that are directly affected by the Volcker Rule and those that are not, but also to identify which 

dealers were potentially affected by other regulations such as Basel Ill and CCAR. 

The evidence in our study suggests that there are significant costs to the proprietary trading 

ban in the Volcker Rule, but it is important to note that we do not do any welfare analysis to assess 

whether the Volcker Rule is overall net positive or net negative tor financial markets and the 

economy. 7 One obvious potential benefit of the Volcker Rule is the ban of risky trades by 

institutions that could eventually seek government support if their risky trades led to significant 

losses. Such analysis requires modeling the trade-otT between the social cost to the loss of liquidity 

in corporate bond markets and the societal benefit of safer banks and is beyond the scope of our 

study. 

The rest of the paper is organized as follows. In Section 2, we discuss the Volcker Rule 

and its potential impact on market-making in the corporate bond market. In Section 3, we describe 

our data sources and variable construction. In Section 4, we examine changes in liquidity around 

times of stress. In Section 5, we examine how the behavior of Volcker-affected and non-Volckeraffected dealers changes with the implementation of the Volcker Rule. We also discuss Basel !II 

and CCAR regulations. Section 6 concludes. 

6 In fact, both papers discuss their results as being related to an anticipation of new regulations. Our results, in contrast, 

look at the implementation of the Volcker Rule. 7 There are, of course, costs to not having regulation. For example, Chemobai, Ozdagli, and Wang (20 16) show that 

operational risk events increased during the gradual deregulation of bank holding companies from 1996 to 1999. We 

are. however. unaware of any studies quantitatively measuring the costs of allowing banks to participate in proprietary 

trading, 

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2. Potential Impact of the Volcker Rule on the Corporate Bond Ma•·ket 

As part of the Dodd-Frank Act, passed July 21, 20!0. section 13 (the ·'Volcker Rule") was 

added to the Bank Holding Company Act of 1956. Section 13 generally prohibits banking entities 

from engaging in proprietary trading or having ownership or relationships with hedge funds and 

private equity funds. Implementation of section 13, however, was not immediate and followed a 

laborious process. On January 18, 2011, the Financial Stability Oversight Council (20 II) released 

a study of its recommendations for implementing section 13. The Treasury, Board of Governors. 

FDIC. and SEC worked with the CFTC in formulating a proposal before releasing a version for 

comments in the Federal Register (20 11) in November 2011. In December 2013, final regulations 

were issued, and final regulations with details of market participants· comments were released in 

the Federal Register (2014) on January 31,2014. On April 1, 2014, the Volcker Rule became 

effective with banks of at least $50 billion in trading assets required to report some quantitative 

metrics starting July 2014. By July 21, 2015, large banks were required to be fully compliant with 

the Volcker Rule. During the conformance period, banks were required to make good faith efforts 

to conform to the new rules8 Hence, we expect to already see some effects of the Volcker Rule 

starting in April 2014. 

Other research (e.g .. Bessembinder eta!. (2016) and Dick-Nielsen and Rossi (2016) has 

argued that anticipation of new regulation implementation could lead to earlier changes in dealer 

behavior. Though we expect the impact to be the greatest once the implementation period requires 

dealers to begin reporting metrics on market-making activity, our tests do not preclude the 

possibility of some changes in dealer behavior prior to rule implementation. In particular, our tests 

'See Federal Reserve Board (2016). 

7 
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are designed to gauge the additional impact of Volcker Rule implementation, mainly 

benchmarking to the period just before implementation. 

The intent of the Volcker Rule is to prohibit banking entities with access to the discount 

window at the Federal Reserve or to FDIC insurance from engaging in risky proprietary trading. 

It is important to keep in mind that not all financial fin11S are covered. For example, an Oliver 

Wyman and SIFMA (20 II) study lists Cantor Fitzgerald & Co., Daiwa Capital Markets. Jefferies 

& Co .• and Nomura as explicitly not covered. It is also the case that not all trading activities are 

precluded. Recognizing that some activities are necessary for the market to function normally. the 

Volcker Rule includes an explicit set of permitted activities. The most relevant one for this paper, 

and arguably the most controversial, is a provision that permits market-making. Essentially. 

affected dealers can trade securities in a way to facilitate client-driven transactions. but cannot 

transact in a way intended to make profits based on the price appreciation of securities. 

A major difficulty in implementing the market-making exception is distinguishing allowed 

market-making from prohibited proprietary trading. The Financial Stability Oversight Council 

(20 1 1) proposed a number of principles to distinguish between the two. Among these are that 

market-making should have rapid inventory turnover with the vast majority of profits from bidask spreads rather than profits ti·om inventory appreciation. Proprietary trading is likely to have 

more modest turnover with significant profits from inventory appreciation. The FSOC also 

proposed a number of metrics including measures of inventory aging, customer-initiated trade 

ratios, and revenue from customer-initiated tlows. The tina! law requires establishment of an 

intemal compliance program and the reporting of seven sets of mctrics: (I) Risk and Position 

Limits and Usage. (2) Risk Factor Sensitivities, (3) Value-at-Risk and Stress VaR, (4) 

8 
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Comprehensive Profit and Loss, (5) Inventory Turnover, ( 6) Inventory Aging, and (7) Customer 

Facing Trade Ratio. 

Critics of the Volcker Rule noted many gray areas in the rule and further argued that 

ambiguity in how the rule would be enforced was likely to be detrimental to market liquidity. 

Furthermore, though the intent of market-making and proprietary trading may be different, 

observationally, they are difticult to distinguish. In fact, some argued that proprietary trading 

could be deemed ··risky market-making." Duffie (2012) writes, ·' ... an attempt to separate 

'legitimate and acceptable' market-making from 'speculative and risky' market-making is not 

productive, in my opinion." Duffie and other commenters suggested that the Volcker Rule could 

be particularly problematic in illiquid markets such as corporate bond markets. Duffie notes that 

whereas the average half-life of order imbalance in equities is three days, for investment grade 

corporate bonds it is roughly two weeks. Thus, mctrics based on measures such as inventory aging 

and inventory turnover could be particularly problematic for market-making in corporate bonds. 

Furthermore, dealers who fear violating the Volcker Rule could be unable to properly manage 

inventory. One of the guidelines for the Volcker Rule is meeting "near-term customer demand." 

But absent perfect predictions about future customer demand, market makers may be hesitant to 

acquire bonds in advance of a predicted spike in customer demand. 

The final rule also presents complications for fultilling customer demand because of the 

required internal compliance metrics. The Federal Register (2014) notes that trades exceeding 

internal limits ''should not be permitted simply because it responds to customer demand." Instead, 

a banking entity is required to have escalation procedures that include "demonstrable analysis and 

approval." Such regulations mean that market makers will find it particularly difficult to respond 

to large sells in the market. 

9 
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One initial proposal that was dropped in the final rule was a requirement for detailed 

revenue attribution. This included identifying revenue attributable to the bid-ask spread as 

opposed to price appreciation. While the final rule no longer has such a requirement. it does have 

a profit and loss attribution requirement that focuses on revenue generation patterns. Abnormal 

patterns could raise a red flag and lead to further review. Given the illiquid nature and infrequent 

trading patterns in corporate bonds, this could potentially cause issues for market makers. 

particularly when a significant subset of its bonds has a severe order imbalance. 

In summary, Volcker Rule requirements have the potential to impact the behavior of 

dealers covered by the rule and lead to less liquid markets. Ambiguity as to what is legal marketmaking and what is prohibited proprietary trading may exacerbate the problem by pushing dealers 

toward more conservative trading strategies. New rules favoring customer-facing trades may 

discourage dealers from using the interdealer market, while inventory-based metrics may lead 

dealers to reduce their inventory exposure. Perhaps most pertinent to our study, the requirement 

that dealers set internal limits may result in dealers being unable to respond to increased customer 

demands during times of stress. With all of these theoretical reasons why the Volcker Rule may 

damage corporate bond liquidity, pa1ticularly in times of stress, we turn to assessing whether the 

empirical evidence is consistent with these concerns. 

3. Data and Sample Description 

To examine how the Volcker Rule has affected corporate bond liquidity in stress periods, 

we focus on bond trading around times when a bond was downgraded from investment-grade to 

speculative-grade. Insurance companies, the dominant investors in the corporate bond market, face 

regulatory restrictions when investing in the corporate bond markets. The National Association of 

Insurance Commissioners (NAIC) classifies corporate bonds into six risk categories (NAICl to 

10 
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27369.104

NAIC6) based on their credit ratings. and requires insurance companies to maintain a higher level 

of capital when investing in bonds in a higher risk category.9 In addition, insurance companies are 

usually required to invest no more than 20% of their assets in bonds below NAIC2, i.e .. 

specnlative-grade bonds. Ellul, Jotikasthira, and Lundblad (20 II) lind that rating downgrades to 

speculative-grade can trigger fire sales in the bond market since greater capital requirements and 

other regulatory constraints prompt widespread divestment by insurance companies. Such 

regulation-induced fire sales generate high demand for liquidity, and can cause substantial price 

pressure in the absence of adequate liquidity provision. 

We obtain the rating history file fi·om Mergenfs Fixed Income Securities Database (FISD) 

for the period from January 2006 to March 2016. This data file provides the announcement date 

of rating actions by the three largest rating agencies: Standard & Poor's (S&P), Moody's, and 

Fitch. We focus on fixed coupon corporate bonds with semi-annual coupon payments. $1000 par 

amount, and fixed maturity. These bonds are issued in U.S. Dollars by U.S. firms in the following 

three broad FISD industry groups: Industrial, Finance. and Utility. We exclude from our sample 

the following bonds: convertible or putable bonds, private placements, asset-backed issues. and 

issues which are part of a unit deal. Since rating agencies ditTer with respect to the timing of rating 

actions. we follow Ellul, Jotikasthira. and Lundblad (2011) and define the rating change event as 

the date of downgrade from investment-grade to speculative-grade announced by the first acting 

rating agency. 

We then extract data from FINRA's TRACE database on corporate bond transactions 

during the one month following each rating downgrade. These data provide detailed information 

9 Bonds rated AAA, AA, A are in NAIC risk category 1 (NAICI). NAIC2-NA!C5 correspond to BBB. BB, Band 

CCC rated bonds respectively. Bonds rated CC or lower belong to NAIC 6. The capital charge for C:A!CI to NAIC6 

is 0.4%,~ 1.3%, 4.6%, 1 O~b, 23% and 30~/o, respectively. 

11 
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27369.105

on all secondary market transactions in the downgraded bond, including bond CUSIP, trade 

execution date and time, trade price and quantity, a buy or sell indicator, an indicator for agency 

or principal trade, and an indicator for inter-dealer trade. In addition, the data also contain 

information on dealers for each trade and, in the case of inter-dealer trades, both sides of the trade. 

Our version of TRACE is the regulatory version of TRACE, which has dealer identities. The 

standard version of TRACE, while including flags for dealer-customer and interdealer trades, does 

not identify the dealer(s) involved in a trade. Knowing dealer identities allows us to separately 

analyze liquidity provision by Volcker-affccted and non-Volcker-affccted dealers. Lastly, for each 

of the rating downgrades in our sample, we obtain characteristics information, including total par 

amount outstanding, issuance date and maturity date, from Mcrgent FISD. 

To examine bond liquidity during stress times, we estimate the average price impact during 

the one-month post-downgrade period in the spirit of Amihud (2002): 

Pricelmpact; _l_LN~ (Pu-Pu- 1 )' 

(N;-1) t-2 Q;,, 

where P;,t and Qi,t represent the price (per $1 000 of par value) and par amount (in thousands) of 

the 1-th trade in bond i, and N; represents the total number of trades during the one month following 

the downgrade of bond i. 10 In calculating the price impact measure, we exclude the following 

transactions: when-issued, cancelled, suhsequcntly corrected, reversed trades, and exclude interdealer trades. Following Bessembinder. Kahle, Maxwell, and Xu (2009) and Ronen and Zhou 

(20 13), we remove trades with $100,000 or less in par amount to avoid the substantial noise that 

these small trades introduce into prices. 

10 Because we have transaction-level data with trade direction, we modify our calculation of the Amihud (2002) 

measure to use transaction-level data (as in Dick-Nielsen, Feldhutter, and Lando (2012)) and also use signed trades 

rather than using absolute changes in prices. As in Amihud (2002), which is based on the theoretical model of Kyle 

( 1985), we aim to capture liquidity by using the response of price to order Jlow. 

12 
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27369.106

Table l presents our final sample of rating downgrades after matching FISD's rating 

history file with FINRA's TRACE data. A total of687 bonds by 218 firms were downgraded from 

investment grade to speculative-grade during the period from January 2006 to March 2016. 

Moody's acted first in 375 bonds, followed by S&P, which downgraded 247 bonds, and then Fitch 

who acted first for the remaining 89 bonds. Out of the 687 bonds, 356 were downgraded by one 

notch, and 157 were downgraded by two notches. ·rhe remaining I 74 bonds were downgraded by 

three or more notches. 

We divide our sample period into live sub-periods: Pre-crisis Period (January 1, 2006-

June 30, 2007), Crisis Period (July I, 2007- April 30, 2009), Post-crisis Period (May 1, 2009-

July 20, 2010), Post-Dodd Frank Period (July 21, 2010- March 31, 2014), and Post-Volckcr 

Period (April I. 2014- March 31, 2016). We focus on comparing bond liquidity during the PostVolcker Period with that during the other four sub-periods prior to the effective date of the V olcker 

Rule I 1 The designations of the four pre-Volcker sub-periods are generally consistent with existing 

studies (e.g., Dick-Nielsen, Feldhutter, and Lando (2012), and Besscmbinder et. aL (2016))_12 

As pointed out by Trebbi and Xiao (2015), using exact dates of regulatory policies to study 

the impact of regulation on market liquidity is potentially complicated by anticipatory or delayed 

responses by market participants. For example, bank dealers might have become more 

conservative in market-making in anticipation of the rule prohibiting proprietary trading. In 

addition, regulators gave market patticipants over one year to fully comply with the Volcker Rule. 

Thus, using the effective date of the Vo!ckcr rule allows us to capture only partial efl'ects of the 

Volckcr Rule on bond liquidity and biases against finding results. The complete effects (including 

J 1 Since our focus is on examining bond liquidity during the one-month following each downgrade, we exclude those 

downgrade events that happened during the last month in each of the five sub-periods. 

The regulatory period that other papers study largely coincides with the period we classify as the Post-Dodd Frank 

Period. 

13 
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27369.107

both implementation and anticipation-related actions) could be larger than our empirical 

methodology captures. 

Table I shows how the distribution of sample of rating downgrades across the five subperiods. A total of 182 bonds were downgraded during the post-Volcker Period. The number of 

downgraded bonds increases from 1!4 for the Pre-Crisis Period to 210 for the Crisis Period, and 

then declines to 68 and 1!3 for the Post-Crisis Period and Post-Dodd Frank Period, respectively. 

4. Liquidity around Stress Events 

Studying the effect of Volcker Rule on corporate bond liquidity during stress times is 

challenging since liquidity of the bond market might have changed over time for reasons unrelated 

to the post-crisis regulations. To account for the potential influence of such time trends. we use a 

difference-in-differences methodology by first comparing the price impact in the BB bonds newly 

dov.'llgraded from BBB with that in the existing BB bonds, and then examine how their differences 

have change from the Pre-Volcker periods to the Post-Volcker Period. Specifically, for each 

downgrade event, we calculate the average Pricelmpact in bonds which were rated BB by the 

acting rating agency during the same one-month period, labeled as PricelmpactControl,. 

Price!mpactDiff, is the first difference and is defined as the difference in Pricelmpact between the 

downgraded bond i and other BB bonds during the same one-month period 

PricelmpactDif{; Pricelmpacti- PricelmpactControli· 

We then compare Price!mpactDiflover different periods. 

4.1. Univariate Analysis of Price Impact Measures 

Table 2 shows that the average PricelmpactDiffi is 0.016 during the Post-Volcker 

Period. This is substantially higher than the mere 0.003 during the Pre-Crisis period. It is also 

higher than the 0.007 and 0.0 II for the Post-Dodd Frank Period and the Post-Crisis Period, and 

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only slightly smaller than the 0.018 for the Crisis Period. To benchmark these numbers, consider 

two trades at $1000 and $1016 (per $1000 in face value). respectively. Suppose that the second 

trade is for $1,000,000 in face value. This gives a price impact measure of ( 1016- 1 000)/1 000 ~ 

0.016. 

The changes in PricelmpactDif fi across sub-periods mainly reflect changes in 

Pricelmpacti of the downgraded bonds. rather than those of the BB bonds in the control sample. 

For our sample of downgraded bonds, Pricelmpacti was 0.007 during the Pre-Crisis Period. It 

jumped to 0.03 during the Crisis-Pe.riod, but has since declined to 0.021 in the Post-Crisis Period, 

and further to 0.015 in the Post-Dodd Frank Period. However, following the implementation of 

the Volcker Rule. the trend of declining price impact reversed: Pricelmpacti increased to 0.024. 

higher than any of the Pre-Volcker sub-periods except for the Crisis Period. This finding is 

intriguing given that PricelmpactControli did not change from the Post-Dodd Frank Period to 

the Post-Volcker Period. In fact, the changes in PricelmpactControli over time for the control 

sample of BB bonds not in stress are consistent with that documented in Besscmbinder ct al. 

(2016). In sum, bond liquidity around stress events have deteriorated since the Volcker Rule took 

effect. 

4.2. Reg•·ession Analyses 

To check the statistical significance of the changes in PriceJmpactDif {; from the prcVolcker sub-periods to Post-V olcker Period, and also to control for the intluences of other factors 

on bond liquidity during stress times, we conduct regression analyses in this section to further 

study the Volckcr Rule effect on corporate bond liquidity. 

We create four dummy variables for the tour sub-periods after the Pre-Crisis Period: Crisis, 

Post-Crisis, Post-Dodd Frank, and Post-Volcker. Crisis takes the value of one if a rating 

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downgrade occurred during the Crisis Period, and it takes the value of zero otherwise. The other 

three sub-period dummies are created in a similar way. We then regress PricelmpactDif[; on the 

four sub-period dummies, and a host of control variables. 

First, although all our sample bonds were downgraded from investment grade to 

speculative-grade, they differ from each other in terms of both pre-downgrade rating and the 

number of notches downgraded. Since such differences can affect bond trading following the 

downgrade announcement, and hence the PricelmpactDiffi measure, we include as control 

variables Previous Rating and 11Rating, which refer to the rating of the bond prior to the downgrade 

and the number of notches by which it was downgraded, respectively. Second, we control for bond 

characteristics, including (the log of) number of years since issuance (Log Age), number of years 

until maturity (Log Time to Maturity), and total par amount outstanding (Log Amount 

Outstanding). Lastly, we include into the regressions several variables that capture general market 

conditions during the same one-month period following each downgrade. These variable include 

aggregate market index returns, such as the return to the S&P 500 Index (SP500 Index Return), 

the return to the Barclays Capital U.S. Investment-Grade Corporate Bond Index (IV Bond Index 

Return) and the Bare lays Capital U.S. High-Yield Corporate Bond Index (HY Bond Index Return). 

We also include changes in market volatilities, such as the change in CBOE stock market volatility 

index (11 VD{), the change in the volatility of the Bare lays Capital U.S. Investment-Grade Corporate 

Bond Index (11/V Bond Volatility) and the Bare lays Capital U.S. High-Yield Corporate Bond Index 

(11HY Bond Volatili(y), and the change in 3 month LIBOR rate (113M LIB OR). Changes in market 

volatilities and interest rates are calculated by comparing the one-month following a downgrade 

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to the one-month prior to the downgradcu Since bonds issued by the same firm are usually 

downgraded at the same time, we cluster the standard errors at the firm level. 

Column I of Table 4 presents the result from this regression analysis. We find that bond 

characteristics affect the PricefmpactDif!; measure, with older bonds and bonds with longer timeto-maturity experiencing lower liquidity following their downgrade. while larger issues enjoy 

higher liquidity. Previous Rating and Rating Change do not have a significant impact on the 

PricefmpactDifj;, and neither do the macro-economic variables. 

More importantly, the coefficient for all four sub-period dummies are positive and 

significant at the 5% level, suggesting that bond liquidity around stress events has significantly 

deteriorated since the beginning of financial crisis. Consistent with the summary information 

presented in Table 2. the magnitude of the coefficient for sub-period dummies first declines 

monotonically from Crisis to Post-Dodd Frank, but then increases from Post-Dodd Frank to PostVolcker. Tests on the differences in the coefficients on sub-period dummies show that the 

coefficient for Post-Volckcr is significantly higher than that for Post-Dodd Frank, and it is not 

statistically significantly different from that for Crisis and Post-Crisis. These results suggests that 

bond liquidity around stress events has worsened following the implementation of the Volcker 

Rule. and it has deteriorated to a level similar to that during the financial crisis. 

To confirm that the increase in PricefmpactDif!i for Post-Volcker is mainly driven by 

higher price impact for the downgrade bonds, rather than lower price impact for BB bonds, we run 

the regression by using either Pricefmpact; or PricelmpactControl, as the dependent variables. 

These results are presented in Columns ll and liT, respectively. For the sample of downgraded 

bonds. Post-Volcker has a significantly higher coefficient than Post-Dodd Frank. The coefficient 

1' For ease of reference. we also provide a definition of all of these independent variables in Table 3. 

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for Post-Volcker is not statistically different from Crisis and Post-Crisis. These results minor those 

from using PricelmpactDiffi as the dependent variable. Meanwhile, for the sample of BB bonds 

not experiencing any rating changes, there is no significant difference in the coefficients for PostVolcker and Post-Dodd Frank, both statistically and economically. Taken together. these results 

are consistent with Volcker Rule degrading liquidity in the bond market around times of stress. 

4.3. Robustness Checks 

We conduct three tests to examine the robustness of our results on post-Volcker bond 

liquidity changes. First, we investigate the sensitivity of our results to an alternative measure of 

liquidity, Realized Sj)read. Second, we study whether using the compliance date instead of the 

effective date of the Volcker Rule affects our results. And finally, we use a matched sample 

approach to conduct the difference-in-differences test. 

4.3.1 Alternative Liquidity Measure 

Measuring liquidity in financial markets is challenging. The fact that most bonds do not 

trade often makes it even hard to measure liquidity in the bond market as almost all the existing 

bond liquidity measures rely on transaction data14 The reliability of these liquidity measures 

varies with the amount of trades used in estimation. In this section, we estimate a measure of 

Realized Spread which has relatively low requirements on trade frequency. Specifically. for each 

downgraded bond. we first calculate the daily Realized Spread by taking the difference between 

volume weighted average customer buy prices (Ask) and volume weighted average customer sell 

prices (Bid) during the one-month following the downgrade. To avoid the noise embedded in 

small trades. we exclude trades with $100,000 or less in par amount. We then average the daily 

spread across days within the one-month period to get an event level estimate: RealizedSpread;. 

14 One notable exception is Mahanti ct a!. (2008) who propose a latent liquidity measure for corporate bond by using 

the holding-weighted average tumover rate of bond portfolio of each fund that holds the bond. 

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For each downgrade event, we also calculate the average RealizedSpread in bonds which were 

rated BB by the acting rating agency during the same one-month period. We tben subtract the 

average BB bond RealizedSpread from that of the downgraded bond to get a SpreadDifji measure. 

We regress SpreadDifj; on the four sub-period dummies and all the control variables and 

the results arc presented in Column I of Table 5. The coefficients for sub-period dummies declines 

from 0. I 66 for Crisis to 0.066 for Post-Crisis, and further to 0.051 for Post-Dodd Frank. However. 

the downward trend of RealizedSpreadreverses following the implementation of the Volcker Rule. 

The coefficient of Post-Volcker is 0.09, which is higher than that for the Post-Dodd Frank at the 

I 0% level. Therefore, liquidity as captured by RealizedSpread also seems to have deteriorated 

post-Yo lcker. 

4.3.2 Alternative Oefinition ofPost-Volcker Period 

The final Volcker Rule became effective April I, 2014, but the compliance date for banks 

to fully conform their proprietary trading activities to the Volcker Rule was July 21, 2015. To 

examine how any Jagged reaction of market participants to regulation during the gap between the 

effective date and compliance date affects our results, we use the compliance date of the Volcker 

Rule to redefine Post-Volcker period. Specifically, Post-Dodd Frank period now is from July 21, 

2010 to July 20,2015 and Post-Volcker period is from July 2L 2015 to March 31.2016. The other 

sub-periods arc defined as earlier. 

Column II of Table 5 again provides evidence of deteriorating liquidity following Volckcr 

Rule. The coetlicicnt ofPost-Volcker is 0.026, more than double that of Post-Dodd Frank (0.0 II) 

and the different is statistically significant at the I 0% level. Also similar to the results from using 

the Final Rule Effective date to define Post-Volcker, the coefficient of Post-Volcker is not 

significantly different from that of Crisis and Post-Crisis. 

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4.3.3 Alternative Approach for the Difference-in-Differences Test 

In examining how liquidity in downgraded bonds has changed over time. we compare each 

downgraded BB bond with a sample of BB bonds not experiencing any recent rating changes. 

Although both downgraded bonds and bonds in the control group have the same rating, they can 

differ in other key attributes, which could affect their liquidity. To account for this possibility. we 

use a matched sample approach by comparing each downgraded BB bond with a sub-sample of 

the BB bonds that are similar to the downgraded BB bond in terms of time-to-maturity. total par 

amount outstanding. and age. 

Specifically, we first segment BB bonds in the control group into three time to maturity 

categories: short-term (maturing within one year). medium-term (with time to maturity greater 

than one year by no more than seven years), and long-lenn (maturing over seven years). Within 

each maturity category, we further segment bonds into three size categories: small issue, medium 

issue, and large issue, using $0.5 Billion and $l.5 Billion in total par amount outstanding as the 

cutoffs. Finally. we divide bonds within each size category into new issues and seasoned issues, 

depending on whether its time since issuance is greater than one year. Therefore, we form a total 

of eighteen bond groups in the control sample based on time to maturity, amount outstanding. and 

age. We then calculate PricebnpactDifl for each downgraded bond by taking the difference 

between the Price Impact of the downgraded bond and the average Price Impact ofBB bonds from 

the matching group during the same one-month period. 

Column lll of Table 5 shows that using the matched sample approach has little impact on 

our results. We continue to observe that following Volcker Rule, the marginal deterioration in 

bond liquidity during stress times is as severe as during the financial crisis period. 

5. Dealer Behavior Around Stress Events 

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In this section, we study how the behavior of dealers has changed around Volcker Rule 

implementation and, importantly, compare the behavior of Volcker-atTected dealers and nonVolcker-atTected dealers. In Subsection 5.1, we discuss how we identify whether a dealer is 

Volcker-affected and in Subsections 5.2 and 5.3, we document the change in behavior across the 

two groups over time. Finally, we discuss other regulations in Subsection 5.4. 

5.1 Identifying Volckcr-Affcctcd Dealers 

A key issue is identifying which broker-dealers are subject to the Volcker Rule. This is a 

non-trivial task as full lists of Volcker-affected institutions are not published. In a study of the 

Volcker Rule, Oliver Wyman and SIFMA (2011) provide a list of21 liquidity providers and 

whether they categorize as affected by the Volcker Rule. 15 Of these 21 banks, they identify four 

(Cantor Fitzgerald & Co., Daiwa Capital Markets, Jefferies & Co., and Nomura) that are not 

affected by the Volcker Rule. Among those affected are major bank holding companies such as 

Goldman Sachs and Morgan Stanley. However, this list is far from complete as TRACE data 

identifies hundreds of dealers transacting in the bond market. 

To determine whether other broker-dealers are covered hy the Volcker Rule, we follow the 

principle that the Volckcr Rule was designed to prevent institutions with access to government 

backstops from participating in proprietary trading. The two most prominent backstops mentioned 

in the Federal Register (2014) discussion of the Volcker Rule are FDIC insurance and access to 

the Fed's discount window. We start with the broker-dealers on the Oliver Wyman and SIFMA 

(20 ll) list and add to it the top 300 broker-dealers in terms of trading volume; together. these 

broker-dealers account for 97% of total bond market trade volume. W c then search both the 

FDIC's database of FD!C-insured banking institutions and the National Information Center's 

15 We reproduce this list in Table 6. 

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institution database to see which of the 300 broker-dealers were subject to the Volcker Rule. The 

former is relatively straightforward. If a broker-dealer, or more likely an affiliate (i.e., a 

commercial bank with the same parent holding company) is listed as having FDIC insurance, we 

code it as Yolckcr-affected. The latter is more complicated astheNIC database contains "'banks 

and other institutions for which the Federal Reserve has a supervisory, regulatory, or research 

interest..." Thus, not all institutions in the database are necessarily Yolcker-affected. We look 

for institutions coded as National Banks, State Member Banks, Bank Holding Companies, and 

Financial Holding Companies and treat these as Volcker-affected. Among the main types of 

institutions in the NJC database that we do not treat as Volcker-affected are Securities 

Broker/Dealers and Domestic Entity Other. As a third source, we search the Federal Reserve 

Board's Resolution Plans website (h!1tlSiLv~·~,y.fcdsn!h:cservc.!.!O\'ibankinforcg/rcsolutionplans,htm) to identify large bank holding companies under Fed supervision that must submit a 

living will. 16 Combining results from our manual search with the list in Oliver Wyman and SIFMA 

(2011) results in approximately 45% of the top dealers being determined to be Volcker-affected. 

5.2 Dealer Trading Activities 

We start by documenting basic dealer trading patterns around downgrade-to-speculative 

("stress") events in Table 7. In the month following a downgrade, the average turnover of 

downgraded bonds is close to 40% in the Post-Volcker period, higher than any of the other four 

periods in our sample. It is also much higher than the 9% monthly turnover of BB bonds during 

the Post-Yolcker period, consistent with significant selling by insurance companies in the period 

just after downgrades to speculative-grade. However. the proportion of total trading volume that 

16 Living wills are mandated by Dodd-Frank to prevent taxpayer bailouts in the future. Thus, the fact that regulators 

require a living will suggests that these are institutions with government backstops. 

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is dealer-customer (as opposed to interdealer), 62%, is roughly in line with the other periods of our 

sample, 

Of perhaps more interest, we compare Volcker-affected and non-Voleker-affected dealers 

in the other panels of Table 7, Our focus is on the proportion of dealer-customer trading handled 

by Volcker vs. non-Volcker dealers and also the dealers' use of agency trading. The underlying 

evidence in Ellul, Jotikasthira, and Lundblad (20 II) is that around stress events, some institutional 

investors (e.g., insurance companies) sell bonds due to regulatory constraints. Dealers then 

intermediate these trades, and potentially hold inventory in bonds when selling demand exceeds 

buying demand. Both the prop01iion of customer-dealer trades and the percentage of agency trades 

address how dealers react to customer demands. 

Volcker-afTected dealers tend to be larger than non-Volcker dealers and handled 93% of 

dealer-customer volume around stress events in the pre-crisis period. Over our sample period, we 

see a gradual decline in the share of dealer-customer volume handled by Volcker-affected dealers. 

By the Post-Volcker period, non-Volcker dealers were handling almost one qumter of the dealercustomer volume. Though the increasing volume handled by non-Volcker dealers is consistent 

with Volcker-affected dealers scaling back their market-making due to the Volcker Rule, we 

cannot rule out the explanation that there has been a gradual time series change in the dealer 

business that has led the smaller, non-Volcker dealers to take a greater share of dealer-customer 

volume. 

Next, we turn to how agency trading has changed over time for Volcker and non-Volckcr 

dealers. Agency trading occurs when a dealer has lined-up a counterparty to immediately offset a 

trade with a customer. For example, if an insurance company decides to sell a downgraded bond, 

a dealer in an agency trade would line-up another customer (or dealer) to purchase the bond. In 

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such a case, dealers do not commit capital or take on any inventory risk. A principal trade, in 

contrast, involves dealers taking on one side of a trade without pre-existing knowledge that they 

will be able to unwind the trade quickly. We follow Harris (20 15) and Bessembindcr et al. (20 16) 

and define a trade as an agency trade if it is offset by another trade in the opposite direction within 

one minute. 

Our empirical results indicate that Vokker-affected dealers have increased the proportion 

of their total volume that is done on an agency basis. Pre-crisis. only 12% of the volume traded 

by Volcker-affected dealers was in agency trades. This number jumped to a little over 15% with 

the onset of the Financial Crisis and stayed fairly flat until jumping again to almost 23% with 

enforcement of the Volcker Rule. The sudden jump in the proportion of volume done as agency 

trades is suggestive of a causal effect of the Volckcr Rule on Volcker-affectcd dealers' willingness 

to hold bonds on their balance sheet without pre-arranging an of(~etting trade. Non-Volcker 

dealers, in contrast, have seen a decline in the proportion of trades that they do on an agency basis. 

During the Pre-Crisis Period, almost half of the trades done by non-Volcker dealers around stress 

events were done as agency trades. By the Post-Volcker Period, this percentage had dropped to 

29%. 

To more formally study the changes in agency trades across time for Volckcr and nonVolckcr-affcctcd dealers, we run a regression of proportion of trades that are agency trades on 

period dummies and controls. Our base regression is, 

Proportion of agency volumei 

= {30 + /31 Crisis+ f32Post- Crisis+ f33Post- Dodd Frank 

+ f34Post- Volcker + yX + E, 

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where the unit of observation is a stress event. the dependent variable is the proportion of volume 

done by either Volcker or non-Volcker dealers done on an agency basis, and the omitted period 

dummy is the Pre-Crisis Period. X represents a vector of control variables that are the same as 

defined in Table 3 and used in Table 4. Our variable of interest is p4, which directly measures the 

difference in the proportion of volume done on an agency basis between the Post-Volcker Period 

and the Pre-Crisis Period. Also of interest is the difference between P4 and the coefficients on the 

other sub-period dummies. 

The regression results are presented in Table 8. In the tirst column, the dependent variable 

is the proportion of agency trading done by Volcker Rule affected dealers after stress events. The 

coefficient on the Post-Volcker dummy is 0.133, indicating a 13 percentage point increase in 

volume done on an agency basis relative to the pre-crisis period. This change is slightly larger 

than the II percentage point increase without controls in Table 7. Importantly, we also see that 

the coefficient on the Post-Volcker dummy is also significantly larger than for the other periods in 

our sample. The Post-Dodd Frank period has a statistically significant coefficient of 0.046, 

indicating a 4.6 percentage point increase in agency trades compared to the Pre-Crisis Period, but 

also much smaller than the Post-Volcker Period. The nine percentage point increase in agency 

trading from the Post-Dodd Frank Period to the Post-Volcker Period is both statistically and 

economically significant. 

In the second column of Table 8, we re-run our agency trade regression, but instead 

consider the proportion of trades done on an agency basis by non-Volcker-affccted dealers. While 

the coefficients on all of the sub-period dummies are negative and the amount of agency trading 

done by non-Volcker dealers is smaller (in magnitude) during the Post-Volckcr Period as 

compared to any other period, we do not find any statistical significance. In particular, unlike 

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Volcker-affected dealers, we do not find a sharp jump in the proportion of agency trading for nonVolckcr dealers upon implementation of the Volcker Rule. If anything, we find the opposite, at 

least in tem1s of point estimates. Our results are consistent with the Volcker Rule inducing 

Volcker-affected dealers to shift from principal to agency trading as a way to avoid inventory 

imbalance. 

5.3 Dealer Capital Commitment 

A more direct measure of dealers' willingness to hold inventory imbalances is the timeweighted capital commitment. In the one month following a stress event, we calculate for each 

dealer the absolute deviation from starting inventory. The intuition is that if a dealer starts with a 

particular desired inventory level, the first purchase moves the dealer above this desired inventory 

level, but a following sell will again move the dealer back towards the desired inventory level. 

The actual desired inventory level is unobservable, so our implicit assumption is that the starting 

level of inventory is optimal. To calculate how far a dealer is from the starting inventory level. we 

simply take the accumulated buys and subtract the accumulated sells from the stm1ing point. To 

calculate the time-weighted capital commitment, we then average the absolute distance from the 

starting inventory, weighting by the amount of time the inventory level is held. 

While our measure is similar to the dealer capital commitment measure in Bessembinder et 

al. (20 16). it is important to note that we measure capital commitment over the course of a month 

while they construct a daily measure. Their measure implicitly assumes that the starting point at 

each day is the optimal inventory. whereas our monthly measure allows for inventory to continue 

to move away from optimal inventory over the course of a few days. In particular, if a dealer has 

purchased a large volume of a bond in a day and has not sold this volume to another customer or 

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dealer, the dealer still has significant capital commitment the next day. Once we calculate bonddealer level capital commitment, we sum across dealers for a given stress event 

In Table 9, we report regressions of time-weighted dealer capital commitment on subperiod dummies and controls separately f()f Volcker-aiTected and non-Volcker-affected dealers, 

similar to our proportion of agency volume regressions. The units for time-weighted dealer capital 

commitment are the number of bonds, with each bond being $1000 in face value. In the first 

column, we find that dealer capital commitment by Volcker-affected dealers has declined in all 

periods relative to the pre-crisis period. Dealer capital commitment is roughly $10 million in face 

value lower on average for a downgraded bond during the Crisis, Post-Crisis, and Post-Dodd Frank 

periods as compared to the Pre-Crisis periodn For the Post-Volcker Period, this decline is $20 

million in face value relative to the Pre-Crisis Period. The lower capital commitment for the PostVolcker Period is also statistically larger for the Volcker Period than it is for the Crisis, Post-Crisis, 

and Post-Dodd Frank periods. Thus, while there is a large and sudden drop in capital commitment 

from the Pre-Crisis to the Crisis Period, there is also a large and sudden drop from the Post-Dodd 

Frank Period to the Post-Volcker Period, suggesting that there was a significant shift in Volckcraffected dealers around the implementation of the Volcker Rule. Column I! of Table 9 considers 

whether capital commitment has changed for non-Volcker dealers. Our results indicate that capital 

commitment has actually increased for non-Volckcr dealers during the Post-Volcker period, in 

contrast to Volcker-affected dealers. 

SA Capital Commitment and Basel III 

17 As a benchmark, the average capital commitment ofVolcker-affected dealers in BB-rated bonds during non-stress 

periods is $6 million. For non,Volcker dealers, it is $1.6 million. 

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A potential concern in trying to isolate a Volcker Rule implementation effect is that, in the 

post-crisis period, a number ofrcforn1s were passed to regulate the finance industty. In particular, 

the Comprehensive Capital Analysis and Review (CCAR) process began in 2011, requiring bank 

holding companies (BHCs) to submit capital plans to the Federal Reserve. The capital plan requires 

that the BHC is able to maintain minimum capital requirements even under stress scenarios, 

providing a stiff test of a BHC's regulatory capital. The punishment for not passing a CCAR test 

is that the BllC is not allowed to make capital distributions unless the Federal Reserve indicates 

in writing that it allows the distribution. 18 Each year, the Federal Reserve publishes a list ofBHCs 

that have either failed their CCAR tests or received only a conditional pass. 

In January 2014. the start of Basel III implementation went into effect, adding additional 

capital requirements above what was required in Basel!!. In conjunction with CCAR regulations, 

this potentially made banks more capital constrained and may have caused BHCs to change their 

market-making businesses. 19 To test the hypothesis that it was the combination of Basel Ill and 

CCAR that is driving our results on dealers, we split dealers into those that were CCARconstrained and those that were not. We classify any bank that failed a CCAR test or was given a 

conditional pass in 2014 or 2015 as CCAR-constrained. 20 lfBHCs change their market-making 

behavior in response to changing capital requirements, then we would expect CCAR-constraincd 

banks to lower their capital commitment more than BHCs that were able to pass their CCAR tests. 

In Table 10, we find that both dealers that passed the CCAR tests and dealers that failed or 

conditionally passed the CCAR test had lower capital commitment in the Volcker Rule 

18 Historically, the federal Reserve has continued to allow failed BHCs to continue capital distributions at the same 

rate as in the pasL Effectively. the main constraint is that these BHCs cannot increase their capital distributions. 19 We thank Darrell Duffie for suggesting the CCAR linkage to us. 20 BHCs receiving a conditional pass are required to rcmcdiatc deficiencies and resubmit a new capital plan later in 

the year. Thus, such BHCs would have similar incentives to BHCs that fail CCAR tests. 

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implementation period as compared to the Post-Dodd Frank Period. However. the decline in 

capital commitment is higher for the dealers that passed CCAR tests (roughly $4.5 million) than 

for dealers that failed or conditionally passed CCAR tests (roughly $2.6 million), a result at 

variance with the prediction above. 21 Hoarding capital to pass the CCAR test is thus not supported 

as an explanation for decreased dealer capital commitment in bond trading. 

6. Conclusion 

In this paper. we study the impact of Volcker Rule implementation on corporate bond 

illiquidity and dealer behavior. Our main finding is that the Volcker Rule has a deleterious effect 

on corporate bond liquidity and dealers subject to the Rule become less willing to provide liquidity 

during stress times. While dealers not affected by the Volcker Rule have stepped in to provide 

liquidity, we find that the net effect is a less liquid corporate bond market. We also rule out that 

the effects are due to the implementation of Basel III in conjunction with CCAR requirements. 

Our study focuses on events where investment-grade bonds are downgraded to speculativegrade to capture plausible events of forced selling. Using these stress events, we find that 

downgraded bonds exhibit a larger price impact of trading than a control group ofBB bonds. More 

importantly, the relative level of the excess price impact is larger after the Volcker Rule is 

implemented than the period just before the Volcker Rule is implemented. Indeed, we find the 

disturbing result that illiquidity in stress periods is now approaching levels see during the financial 

CriSIS. 

21 It is possible that the BHCs that passed their CCAR tests chose to change their capital commitment in anticipation 

of Basel Ill, prior to the actual implementation, whereas the BHCs that failed did not. Nevertheless, this also predicts 

that ifBHCs commit less capital to try to pass CCAR tests, we should still see stronger declines in capital commitment 

during the Volcker implementation period for those BHCs that failed CCAR tests, relative to those BHCs that passed 

CCAR tests. 

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Examining individual dealer behavior allowed us to rule out the possibility that our results 

are driven simply by time series changes in dealer behavior. We find that following Volcker Rule 

implementation Volcker-affccted dealers are less involved in dealer-customer trades, usc a greater 

proportion of agency trades, and are less willing to commit capital. Non-Volckcr dealers pick-up 

a greater proportion of dealer-customer trades and do not have statistically significant changes in 

their use of agency trades or willingness to commit capital. Splitting Volcker-affectcd dealers into 

those who have failed CCAR tests in 2014 and 2015 and those who have not, we find that capital 

commitment among downgraded bonds has decreased more for dealers that passed CCAR tests. a 

result inconsistent with a Basel III explanation for decreased bond market liquidity. Overall, our 

results show that the Volcker Rule has had a real effect on dealer behavior, with significant effects 

only on those dealers affected by the Volcker Rule and not all bond dealers. 

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Table l: Sample Description 

This table provides a description of the corporate bonds downgraded from investment grade to speculative-grade by one of three 

credit rating agencies (S&P, Moody's, and Fitch) over the period from January I, 2006 to March 31, 2016. Data on historical 

changes by the three major rating agencies are obtained from Mergent's Fixed income Securities Database (FISD). We use the d

announcement by the rating agency who acted first to define the downgrade event. We divide the full sample period into fiv

periods: Pre-crisis Period (January I, 2006 June 30, 2007), Crisis Period (July 1, 2007- April 30, 2009). Post-crisis Period (M

2009 July 20, 201 0), Post-Dodd Frank Period (July 21, 2010- March 31, 20 14). and Post-Volcker Period (April 1, 2014- Mar

20 16). For the full sample period and each of the sub-periods, we present the number of bonds downgraded and number of firms 

bonds were downgraded. We report the number of bonds in which S&P, Moody's, or Fitch was the first to take action. Note that m

rating agencies can downgrade a bond on the same day. We also report the number of bonds that were downgrade by one notch, 

notches, and by three or more notches (which are in the "'other" column) respectively. 

# of # of by by by by One by Two 

Bonds Firms S&P Moody's Fitch Notch Notches 

full sample period 

January I, 2006 March 31,2016 687 218 247 375 89 356 !57 

by sub-periods 

Pre-crisis Period (January !, 2006 June 30, 2007) 114 45 36 50 37 54 17 

Crisis Period (July 1, 2007- April 30, 2009) 210 57 105 100 8 97 80 

Post-crisis Period (May I. 2009- July 20, 201 0) 68 16 3 61 4 46 3 

Post-Dodd Frank Period (July 21,2010- March 31, 2014) 113 45 51 41 33 64 28 Post-Volcker Period (April I, 2014- March 31, 20 16) 182 55 52 123 7 95 29 

31 

27369.125

Table 2: Lnivariatc Analysis of Corporate Bond Liqnidi(l' Following Downgrades 

This table analyzes the liquidity of a bond during the one-month following its downgrade from investment-grade to speculativ

over the period from January I, 2006 to March 31,2016, We measure bond liquidity by using a price impact measure, Pricelm

(P,- Pt-I)IQ,, where Pt and Qt refers to the price (per $1000 of par value) and par amount (in thousands) of the trade at timet respe

Retail-sized trades. i.e,, those with par amount less than $100,000 are excluded from calculation in order to avoid the noise they 

carry as suggested by Bessembinder et al. (2009), We first calculate the Pricelmpact measure for each trade, and then average i

the trades within the one-month following each downgrade to get an event level estimate, For each downgrade event, we also c

the average Price Impact in bonds which were rated BB by the acting rating agency during the same one-month period, and is 

as PricelmpactControl. PricelmpactDiffis the difference in Price Impact between the downgraded bond and other BB bonds. We 

the full sample period into five sub-periods: Pre-crisis Period (January I, 2006- June 30, 2007), Crisis Period (July I, 2007 A

2009), Post-crisis Period (May I, 2009- July 20, 20 I 0), Post-Dodd Frank Period (July 2 J, 2010 March 31. 20 14), and Post-V

Period (April 1, 2014- March 31, 2016). Since our focus is on examining bond liquidity during the one-month followin

downgrade, we exclude those downgrade events that happened during the last month in each of the sub-periods. We test w

PricelmpactDif f for each sub-period is statistically different from zero and report the p-value. We also conduct tests on the diff

in the Price Impact liquidity measures between two sub-periods and report the p-value. Since bonds issued by the same firm arc 

downgraded at the same time, we cluster the standard errors at the firm level. 

Pre-crisis Period 

Crisis Period 

Post-crisis Period 

Post-Dodd Frank Period 

Post-Volcker Period 

Pricelmpact Pricelmpact 

Control 

0.007 

0.030 

0.021 

0.015 

0.024 

32 

0.004 

0.012 

0.011 

0.008 

0.008 

Pricelmpact 

Diff 

0.003 

0.018 

0.01! 

0.007 

0.016 

p-value 

0.062 

0.000 

0.129 

0.000 

0.007 

Number N

of Bonds o

14 

210 

68 

113 

182 
167 


27369.126

Table 3: Independent Variable Definitions 

This table provides detailed definitions of independent variables used in the tables below. 

Dependent variables are defined in the respective tables that they are used in. 

Variable Definition 

Crisis Dummy variable equal to I for July 1 2007 to April 30. 2009 and 

0 otherwise. 

Post-crisis Dummy variable equal to I for May 1, 2009 to July 20, 2010 and 0 

otherwise. 

Post-Dodd Frank Dummy variable equal to l for July 21, 201 0 to March 31, 2014 

and 0 otherwise. --··----·-- --·--·-· ··--

Post-Volcker Dummy variable equal to I for April l, 2014 to March 31, 2016 

and 0 otherwise. 

Previous Rating The rating of a downgraded bond before the downgrade from 

investment-grade to speculative-grade. A numeric value is 

assigned to each notch of credit rating, with l, 2, 3, 4 ... denoting 

AAA, AA+, AAA, AA- ... resl_lectivel):'. 

/\Rating The number of notches that a bond was downgraded. 

Age The log of the number of years since issuance for a bond. 

Time-to-Maturity The log of the number of years to maturit):' for a bond. 

Amount Outstandinu The log of the total amount outstan~jrlg in $thousands. 

S&P 500 Index Return The return of the S&P 500 over the one-month post-downgrade 

period. It is expressed in decimal form. -- IV Bond Index Return The return to the Barclays Capital U.S. Investment-Grade 

Corporate Bond Index over the one-month post-downgrade period. 

It is expressed in decimal form. 

HY Bond Index Return The return to the Barclays Capital U.S. High-Yield Corporate 

Bond Index over the one-month post-downgrade period. It is 

-------------·-··· expres_:;_~~J~<:I_~~jmal form. 

i\VIX The change in CBOE stock market volatility index from the onemonth pre-downgrade period to the one-month post-downgrade 

period. 

L\IV Bond Volatility The change in the standard deviation of the Bm·clays Capital U.S. 

Investment-Grade Corporate Bond Index Return ti·om the onemonth pre-downgrade period to the one-month post-downgrade 

period. It is expressed in decimal form. ---

L\BY Bond Uldtifity The change in the standard deviation of the Barclays Capital U.S. 

High-Yield Corporate Bond Index Return from the one-month predowngrade period to the one-month post-downgrade period. It is 

expressed in decimal form. 

L\3M LIBOR Change The change in the 3 month L!BOR rate (in percentage) from the 

one-month pre-downgrade period to the one-month postdowngrade period. 

33 
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27369.127

Tab!~ 4: CorporMc Bond Liquidity Following Oo>Hlgradcs 

This table analyzes how corporate bond liquidity evolves during the period from January I, :woo to March 31, 2016, especially following the eiiectivc date ofVolcker rule. The dependent variables 

for Columns [ - Ill are !'rice!mpactDifj; Pricelmpact, and Price!mpactCon/rol, respectively. 

l'ricelmpacl is price impact of trading in a downgraded bond in the month after the downgrade. 

PricelmpactControl is the average price impact lor BB-rated corporate bonds in same horizon as 

Price Impact. Price!mpactDiff is the difference between Price Impact and PricelmpactControl. 

The primary independent variables of interest are dummy variables for Crisis, Post-crisis, PostDodd Frank, and Post-Volcker. Detailed definitions of all of the independent variables are 

provided in Table 3. Since bonds issued by the same firm are usually downgraded at the same 

we cluster the standard errors at the firm leveL 

I. Pricelm(!actDiff II. Priceimpact Pricelm (lactControl 

Estimate [!-value Estimate (l-Value Estimate (l-value 

Intercept -0.024 0.339 -0.001 0.491 0.022 0.000 

Crisis 0.017 0.003 0.022 0.000 0.006 0.000 

Post-crisis 0.016 0.024 0.024 0.002 0.007 0.000 

Post-Dodd Frank 0.010 0.010 0.013 0.001 0.004 0.000 

Post-Volcker 0.021 0.002 0.025 0.000 0.004 0.000 

Previous Rating -0.002 0.361 -0.004 0.252 -0.002 0.000 

~'.Rating 0.001 0.348 0.000 0.405 0.000 0.176 

Log Age 0.005 O.ot5 0.005 0.014 0.000 0.213 

Log Time to Maturity 0.008 0.010 0.008 0.014 0.000 0.142 

Log Amount Outstanding -0.016 0.000 -0.016 0.000 -0.001 0.018 

SP500 Index Return 0.006 0.477 -0.002 0.493 -0.008 0.227 

IV Bond Index Return -0.021 0.460 -0.031 0.443 -0.010 0.347 

IIY Bond Index Return -0.152 0.299 -0.182 0.267 -0.030 0.015 

I'.VIX -0.001 0.242 -0.001 0.201 0.000 0.142 

AIV Bond Volatility 0.313 0.457 1.!63 0.345 0.850 0.009 

AHY Bond Volatility 0.146 0.476 -0.500 0.418 -0.645 0.004 

63M L!BOR -0.015 0.251 -0.012 0.300 0.003 0.024 

Number of Observations 687 687 687 

R2 0.079 0.079 0.079 

Post-Volcker vs Crisis 0.296 0.384 0.062 

Post-Volcker vs Post-crisis 0.315 0.454 0.000 

34 
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27369.128

Table 5: Robustness Checks on Liquidity Following Downgrades 

This table presents results from robustness checks of the analyses on bond liquidity changes 

following the implementation of the Volcker Rule. ln Column I, we use an alternative measure, 

Spread, to capture bond liquidity. For each downgraded bond, we first calculate daily Spread by 

taking the difference between volume weighted average customer buy prices (Ask) and volume 

weighted average customer sell prices (Bid) during the one-month following the downgrade. We 

then average the daily spread across days within the month to get an event level estimate. For each 

downgrade event, we also calculate the average Spread in bonds which were rated BB by the acting 

rating agency during the same one-month period. We then subtract the average BB bond Spread 

from that of the downgraded bond to get a SpreadDiff measure. This is the dependent variable for 

the regression in Column I. In Column II. we used the compliance date for banks to conform their 

proprietary trading activities and investments in and relationships with non-legacy covered funds 

under the Volcker Rule, which is July 21, 2015, to define Post-Volcker period. Specifically, PostDodd Frank period is from July 21, 2010 to July 20, 2015 and Post-Volcker period is from July 

21,2015 to March 31.2016. The other sub-periods during our sample are defined as earlier. In 

Column TIT, we compare each downgraded bond to the average of other BB rated bonds with 

similar time to maturity, amount outstanding, and age when calculating the l'ricelmpactDiff 

measure. We first segment bonds into three time to maturity categories: short-term (maturing 

within one year), medium-term (with time to maturity greater than one year by no more than seven 

years), and long-term (maturating over seven years). Within each maturity category. we further 

segment bonds into three size categories: small issue. medium issue. and large issue, using $0.5 

Billion and $1.5 Billion in total par amount outstanding as the cutoffs. Finally, we divide bonds 

within each size category into new issues and seasoned issues, depending on whether its time since 

issuance is greater than one year. Therefore, we form a total of eighteen bond groups based on 

time to maturity, amount outstanding, and age. We then calculate PricelmpactDiff for each 

downgraded bond by taking the difference between the l'ricelmpact of the downgraded bond and 

the average Pricelmpact of BB bonds from the matching group during the same one-month 

period. Downgrade events that happened during the last month in each of the newly defined subperiods are excluded since the one-month following those downgrades overlapped with the next 

sub-period. The dependent variable in Column 1l is PricelmpactDiffas in Table 4. The primary 

independent variables of interest arc dummy variables for Crisis, Post-crisis, Post-Dodd Frank, 

and Post-Volcker. Detailed definitions of all of the independent variables arc provided in Table 3 

Since bonds issued by the same firm are usually downgraded at the same time, we cluster the 

standard errors at the firm level. 

35 
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27369.129

I. Measuring II. Use Compliance III. Use Matched 

Liquidity Date to Define Bonds to Calculate 

by Spread Post-Volcker __ l'!il:_elmpactDiff -------~-·-----------

Estimate !'-value Estimate !'-value Estimate !'-value 

Intercept -0.229 0.165 -0.033 0.285 -0.035 0.266 

Crisis 0.166 0.002 0.016 0.003 0.013 0.013 

Post-crisis 0.066 0.152 0.017 o.o:w 0.013 0.061 

Post-Dodd Frank 0.051 0.156 0.011 0.007 0.008 0.028 

Post-Volcker 0.090 0.056 0.026 0.007 0.019 0.004 

Previous Rating 0.008 0.349 -0.001 0.418 -0.001 0.450 

£>Rating -0.022 0.004 0.001 0.353 0.000 0.462 

Log Age -0.009 0.292 0.005 0.013 0.005 0.023 

Log Time to Maturity 0.076 0.002 0.008 0.008 0.008 0.006 

Log Amount Outstanding -0.004 0.433 -0.017 0.000 -0.015 0.000 

SP500 Index Return -0.328 0.186 0.016 0.436 0.013 0.443 

IV Bond Index Return -0.440 0.375 -0.071 0.368 -0.006 0.489 

IIY Bond Index Return 0.932 0.152 -0.176 0.269 -0.158 0.286 

L'>VIX 0.007 0.145 -0.001 0.198 -0.001 0.221 

t>IV Bond Volatility 10.592 0.221 -0.009 0.499 -0.096 0.487 

t>IIY Bond Volatility -21.171 0.025 0.336 0.445 0.705 0.382 

i\3M UBOR 0.105 0.101 -0.018 0.223 -0.020 0.184 

Number of Observations 647 687 687 

R' 0.058 0.079 0.074 

Post-Volcker vs Crisis 0.050 0.196 0.212 

Post-Volcker vs Post-crisis 0.283 0.217 0.255 

Post-Volckcr vs Post-Dodd Frank 0.075 0.070 0.034 

36 
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27369.130

Table 6: Major Li<1uidity Providers in the Coq1oratc Bond Market and Vold;cr Rule 

This table provides a list of2l major securities dealers and whether they are subject to the Volcker 

Rule. Dealers affected by the Volcker Rule are prohibited from participating in proprietary trading. 

but have a market-making exception. Non-affected dealers are not subject to bans on proprietary 

trading or market-making. 

Source: "The Volcker Rule restrictions on proprietary trading: Implications for the US corporate 

bond market" presentation by Oliver Wyman and SIFMA. 

Dealers Affected by Volcker Rule 

Bank of Nova Scotia 

Bare lays Capital 

BMO Capital Markets 

BNP Paribas Securities 

Citigroup Global Capital Markets 

Credit Suisse Securities (USA) 

Deutsche Bank Securities 

Goldman, Sachs & Co. 

HSBC Securities (USA) 

J.P. Morgan Securities 

Merrill Lynch, Pierce, Fenner & Smith 

Mizuho Securities USA 

Morgan Stanley & Co. 

RBC Capital Markets 

RBS Securities 

SG Americas Securities 

UBS Securities 

Dealers Not Affected by Volcker Rule 

37 

Cantor Fitzgerald & Co. 

Daiwa Capital Markets Americas 

Jefferies & Company 

Nomura Securities International 

27369.131

Table 7: Trading ActiYity by Dealers Affected by Volckcr Hule and those not affected by Vo!cker Rule 

This table presents summary information on trading activities by dealers affected by Volcker rule and those not affected by Volcker ru

during each of the five sub-periods between January I, 2006 to March 31,2016: Pre-crisis Period (January!, 2006- June 30, 2007

Crisis Period (July l, 2007 April 30, 2009), Post-crisis Period (May l, 2009 July 20, 20 l 0), Post-Dodd Frank Period (July 21, 20 I 

March 31, 2014), and Post-Volcker Period (April I, 2014- March 31, 2016). All Trade refers to the aggregate trade volume by a

dealers, including both inter-dealer trade and dealer-customer trade, during the one-month following each rating downgrade. To contr

for the effect of issue size on trade volume, we first divide the aggregate one-month trade volume for each downgrade event by the tot

par amount outstanding of the downgraded bond, and then average it across bonds within each sub-period. We report the percent o

Dealer-Customer trade volume out ofthe total trade volume for all dealers (D-C Trade), as wells as for dealers affected by Volcker ru

and those not affected by Volcker rule separately. In addition, for the two groups of dealers, we also report their respective share of th

total dealer-customer trade volume (Share of Total D-C Trade), and the percentage of their dealer-customer trade that is effective

agent trade (Dealer Agency Trade). We classify a trade as being effectively agent if it offset by another trade that occurred within on

minute with the same trade size by the same dealer but with opposite trade direction. This one-minute algorithm is similar to that use

in Harris (20 15) and Bessembinder et a!. (20 I 6). 

Pre-crisis Period 

Crisis Period 

Post-crisis Period 

Post-Dodd Frank Period 

Post-Voleker Period 

Full Sample Dealers Affected by Volcker Dealers Not Affected by Vo

Rule 

All 

Trade 

0.300 

0.277 

0.219 

0.306 

0.383 

D-C 

Trade 

D-C Share of Total 

Trade D-C Trade 

Dealer 

Agency 

Trade 

D-C Share of Total 

Trade D-C Trade 

A

(%) (%) (%) (%) (%) (%) 

65.601 77.428 93.371 12.104 22.119 6.629 

70.037 83.295 89.117 15.413 37.803 I 0.883 

62.324 75.958 84.569 15.543 29.192 15.431 

53.913 67.224 79.728 15.965 33.063 20.272 

62.032 75.608 76.297 22.709 48.722 23.703 

38 
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27369.132

Table 8: Volckct· Rule and Agency Trades 

This table analyzes how dealers' willingness to arrange trades on a principal basis change 

following Volcker Rule. We first estimate for each dealer the proportion of dealer-customer trade 

volume completed on effectively agent basis (expressed in decimals) during the one-month 

following each downgrade. for each downgrade, we divide the active dealers into two groups: 

those affected by Volcker rule and those that were not. We then average the percent of agency 

trade across dealers within each dealer group, and use them as the dependent variables in Columns 

rand II. The primary independent variables of interest arc dummy variables for Crisis, Post-crisis. 

Post-Dodd Frank, and Post-Volcker. Detailed definitions of all of the independent variables arc 

provided in Table 3 Since bonds issued by the same firm are usually downgraded at the same time, 

we cluster the standard errors at the firm leveL 

I. Dealers Affected II. Dealers Not Affected 

b_y Volcker Rule by Volcker Rule 

Estimate [!-value Estimate [!-value 

Intercept 0.219 0.163 -0.041 0.454 

Crisis Period 0.030 0.176 -0.026 0.361 

Post-crisis Period 0.037 0.199 -0.062 0.175 

Post-Dodd Frank Period 0.046 0.049 -0.048 0.232 

Post-Volcker Period 0.133 0.000 -0.077 0.! 14 

Previous Rating -0.016 0.223 O.D35 0.147 

/\.Rating -0.011 0.086 0.017 0.087 

Log Age 0.016 0.083 0.026 O.o78 

Log Time to Maturity 0.006 0.384 -0.008 0.391 

Log Amount Outstanding -0.035 0.006 -0.020 0.209 

SP500 Index Return -0.164 0.280 -0.627 0.110 

IV Bond Index Return -0.520 0.292 1.421 0.226 

HY Bond Index Return 0.688 0.117 -0.821 0.232 

1\..VIX -0.002 0.232 -0.008 0.1 !4 

1\.IV Bond Volatility 4.730 0.386 -2.517 0.451 

L\HY Bond Volatility 20.346 0.004 3.674 0.409 

/\3M LIBOR -0.082 0.105 0.016 0.431 

Number of Observations 687 687 

R2 0.073 0.031 

Post-Volcker vs Crisis 0.003 0.212 

Post-Volcker vs Post-crisis 0.019 0.375 

Post-Volcker vs Post-Dodd Frank 0.003 0.266 

39 
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27369.133

Table 9: Bealer Capital Commitment around Vulckcr Hulc Implementation 

This table analyzes how dealers' willingness to commit their own capital to bond trading changes 

following Volcker rule. During the one-month following a bond's downgrade, we first calculate 

for each dealer, the absolute value of a dealer's accumulated principal buy volume and 

accumulated principal sell volume at the time of each of the dealer's trades in the downgraded 

bond (in thousands of dollars of face value). We then average the absolute difference between 

accumulated buys and accumulated sells across trades within the one-month for each dealer, 

weighting each observation by the time for which the capital is committed. Trades that were not 

offset prior to day end hence received larger weight in the capital commitment calculation. For 

each downgrade, we divide the active dealers into two groups: those affected by Volcker rule and 

those that were not. We then aggregate each dealer's capital commitment measure within each 

dealer group, and use them as the dependent variables in Columns 1 and TL The primary 

independent variables of interest are dummy variables for Crisis, Post-crisis, Post-Dodd Frank, 

and Post-Volcker. Detailed definitions of all of the independent variables are provided in Table 3. 

Since bonds issued by the same finn are usually downgraded at the same time, we cluster the 

standard errors at the firm level. 

40 
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27369.134

I. Dealers Affected II. Dealers Not Affected 

b:y Volcker Rule by Volcker Rule 

Estimate p-value Estimate _p-value ------·-

Intercept 45675.140 0.030 6371.760 0.003 

Crisis Period -9025.310 0.003 -617.660 0.012 

Post-crisis Period -11231.500 0.000 609.720 0.023 

Post-Dodd Frank Period -12891.800 0.000 1879.880 0.000 

Post-Volcker Period -20127.890 0.000 2131.810 0.000 

Previous Rating -894.800 0.337 -391.460 0.029 

11Rating 1371.910 0.025 -117.810 0.099 

Log Age -5690.310 0.000 -321.400 0.034 

Log Time to Maturity 4250.750 0.002 50.050 0.387 

Log Amount Outstanding 16734.870 0.000 966.710 0.000 

SP500 Index Return 55463.810 0.004 3324.580 0.072 

IV Bond Index Return 38394.350 0.301 -13601.550 0.162 

HY Bond Index Return -149809.210 0.000 -8738.820 0.085 

11VIX -589.090 0.033 -42.560 0.110 

!\IV Bond Volatility -528626.130 0.269 -94993.340 0.214 

M!Y Bond Volatility 633910.390 0.166 33231.020 0.348 

113M LIBOR 2868.600 0.232 -721.820 0.161 

Number of Observations 687 687 

R2 0.472 0.031 

Post-Volcker vs Crisis 0.000 0.000 

Post-Volckcr vs Post-crisis 0.000 0.068 

Post-Volcker vs Post-Dodd Frank 0.000 0.086 

41 
176 


27369.135

Table tO: Capital Commitment by Volckcr Affected Dealers: The Effect nf CCAR Testing 

This table analyzes how CCAR regulations affect capital commitment among Volcker affect 

dealers. During the one-month following a bond's downgrade, we first calculate for each dealer. 

the absolute value of a dealer's accumulated principal buy volume and accumulated principal sell 

volume at the time of each of the dealer's trades in the downgraded bond (in thousands of dollars 

of face value). We then average the absolute difference between accumulated buys and 

accumulated sells across trades within the one-month for each dealer, weighting each observation 

by the time for which the capital is committed. Trades that were not offset prior to day end hence 

received larger weight in the capital commitment calculation. For each downgrade, we divide the 

Volcker affected dealers into two groups: those who passed the CCAR testing in both 2014 and 

2015, and those either failed or conditionally passed the CCAR test in at least one year. We then 

aggregate each dealer's capital commitment measure within each dealer group, and use them as 

the dependent variables in Columns I and II. The primary independent variables of interest are 

dummy variables for Crisis, Post-crisis, Post-Dodd Frank, and Post-Volcker. Detailed definitions 

of all of the independent variables are provided in Table 3. Since bonds issued by the same tirm 

are usually downgraded at the same time, we cluster the standard errors at the finn level. 

42 
177 


27369.136

I. Volcker Affected II. Volcker Affected 

Dealers who Dealers who 

Passed the Failed/Conditionally 

CCAR Test Passed the CCAR Test 

Estimate ('-value Estimate ('-value 

Intercept 21561.340 0.065 23872.770 0.027 

Crisis Period -4255.380 0.022 -5114.490 0.001 

Post-crisis Period -7449.130 0.000 -4186.190 0.008 

Post-Dodd Frank Period -6207.900 0.002 -7171.690 0.000 

Post-Volcker Period -10732.840 0.000 -9816.140 0.000 

Previous Rating 368.070 0.382 -1240.680 0.138 

6Rating 808.620 0.035 588.190 0.039 

Log Age -3098.010 0.001 -2670.770 0.000 

Log Time to Maturity 2146.430 0.014 2300.440 0.000 

Log Amount Outstanding 12345.580 0.000 4428.690 0.000 

SPSOO Index Return 45166.660 0.000 10757.080 0.153 

IV Bond Index Return 11309.940 0.415 33251.730 0.185 

HY Bond Index Return -104937.140 0.000 -46102.670 0.019 

6VIX -481.870 0.004 -101.680 0.277 

61V Bond Volatility 153290.210 0.393 -636766.770 0.071 

6HY Bond Volatility 279028.120 0.239 377606.390 0.118 

63M LIBOR 3094.440 0.107 -336.950 0.433 

Number of Observations 683 683 

Rz 0.420 0.369 

Post-Volcker vs Crisis 0.002 0.000 

Post-Volcker vs Post-crisis 0.020 0.000 

Post-Volcker vs Post0.003 0.007 -··-·-····- -· .. ·---·-----·--·· .. 

43 
178 


27369.137

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Corporate Bond Markets. Working Paper, USC. 

Kyle, A.S. (1985). Continuous Auctions and Insider Trading. Econometrica 53, 1315-1335. 

Mahanti, S., A. Nahikkar, M. Subrahmanyam, G. Chacko, and G. Mallik (2008). Latent liquidity: 

A new measure of liquidity, with an application to corporate bonds. Journal of Financial 

&onomics 88, 272- 298. 

Oliver Wyman and SIFMA (20 1 J ). The Volcker Rule restrictions on proprietary trading: 

Implications for the US corporate bond market, December 20 !I. 

Powell, J. H. (2016). Trends in Fixed-Income Markets. Testimony before the Subcommittee on 

Securities, Insurance, and Investment, and Subcommittee on Economic Policy, Committee 

on Banking, Housing and Urban Affairs, U.S. Senate, Washington, D.C., April 14,2016. 

Ronen, T., and X. Zhou (2013). Trade and information in the corporate bond market. Journal ol 

Financial Markets 16.61-103. 

Trebbi, F. and K. Xiao (2015). Regulation and Market Liquidity. Working Paper, University of 

British Columbia. 

45 

27369.139

CENTliH FOH CAPITAL 

0 l 

'"•M1che·rw'" 

Illustrative Funding Cost Analysis: Annual Term Debt Issuance of Select Large U.S. Borrowers111 

Fmance Company 7.5 Years 3.180% 6.5 Years $30Abn +$498.7mm +$99

Automotive Finance 5.3 Years 2.267°/o 4.8 Years $10.1bn +$122.1mm +$24

Captive Finance 5.0 Years 2.055%) 4.7 Years $5.8bn +$68.0mm +$13

Captive Finance 3.5 Years 1.607% 3A Years $5.2bn +$43.3mm +$86

Aircraft Finance 5.8 Years 2.383% 5.3 Years $0.8bn +$9.9mm +$19

Total .. .. .. $52.3bn +$742.0mm +$1 ,4

Illustrative Funding Cost Analysis: Annual Term Debt Issuance of Three Hypothetical Small U.S. Borrowers 

5.0 Years 3.750% 4.4 Years +$5.6mm +$1

Company A $250mm 

10.0 Years 4.750(Yo 7.7 Years +$9.7mm +$1

5.0 Years 3.875°/o 4.4 Years +$11.1mm +$22

Company B $500mm 

10.0 Years 4.875% 7.7 Years +$19.2mm +$38

5.0 Years 4.000'% 4.4 Years +$22.1mm +$4

Company C I $1,000mm 10.0 Years 5.000% 7.7 Years +38.3mm +$76

Total I .. .. .. ·- +$106.0mm +$21
181 


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182 


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#Financing Growth 

Table Contents 

Executive Summary .. ...................................................................................................................... 3 

State of Corporate Finance ... . ................................................................................................................ 3 

The Future: What Are Companies Facing .. . ...... 4 

Introduction .. . ............................. 6 

Methodology .. . .......................................................................................................................................... 7 

State of Corporate Finance .. ..8 

The Future: What Are Companies Facing .. . ...... 11 

Cash Crunch., .. . ................................................................................................................................................... 11 

Impact of Financial Regulations on Main Street Companies .. . .................... 14 

Appendix .... . .................................................................................................. 16 

Learn More from Main Street 
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More than three--quarters of American companies of all sizes report that the cumulative effect of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act and other financial regulatory rules adopted over the past six years is 

making it harder for them to access the financial services they need. This !s true among small, midsized, and even large 

companies and is felt most acutely in a lack of access to services helping them manage day-to-day liquidity. 

This matters because the financial needs of businesses are as diverse as the American economy. Companies work to 

ensure that they have affordable access to a variety of suppliers for the financial products they need. One of the 

unintended consequences of the regulatory efforts to reduce risk in the financial system is that many service providers 

have decided to walk away from providing some products and markets. 

Without a robust financial services supply chain, our nation cannot finance adequate economic growth. Regulatory 

efforts to ensure financial stability must be accompanied by equally vigorous, data ·driven analysis to make ce11ain that 

Main Street companies continue to have access to the financial servlces they need. 

The U.S. Chamber of Commerce surveyed more than 300 corporate finance professionals about their core financial 

services needs and the indirect regulatory impact of a!! the newly adopted financial regulations. We asked them about 

the products they use and the types of financial services they rely on. We also asked them lf and how they are seeing the 

impact from financial regulation on businesses and their customers. 

Main Street Companies Have Different Financing Needs 

Companies access and use a variety of different financial products and services on a routine basis, such as1

: 

'* Cash management tools 

'» Commercial paper 

¥- Debt financing 

+ Derivatives 

·* Equity financing 

Long~term loans 

1 See Appendix for a glossary of key terms used throughout this r-eport. 
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Short-term loans 

Trade financing 

Each of these products and services addresses a specific need 

faced by Main Street companies. To meet those needs, 

companies place a high value on the accessibility of products and 

services to manage their finances. 

More than half of companies surveyed utilize all eight 

products and services listed on a routine basis and 85% 

used 4 or more. 

86% said that it is important for financial services 

providers to offer a wide spectrum of services. 

65% want providers to specialize in specific products. 

Companies Rely on Financial Institutions of All Sizes 

The survey found that businesses use a combination of financial 

institutions for critical financing activities, and the mix of financial 

services and products used is closely tied to the availability and 

diversity of financing sources. 

+ 20% of all small and midsize companies said that they use 

four or more financial institutions to issue commercial 

paper, raise corporate debt, or access trade financing. 

0 large businesses use four or more financial institutions in 

a variety of contexts, particularly when obtaining longterm loans, purchasing derivatives, and issuing corporate 

debt" 

~'' 68% (up from 50% in 2013) indicated that it is important 

for their financial services provider to have a global 

footprint. 

Knowing that Main Street companies depend on a vibrant and 

diverse financial services industry, we wanted to understand how 

nFinancingGrowlh 

Takeaways 

State of Corporate Finance 

• BuslnesSes are simultaneously relying on 

multiple financial services providers for a 

diverse range of critical services. 

financing needs. 

Cash Crunch: ,Access to Capital Is the Top Financial 

ConCern for U.S. B1,.1sinesses 

• Managing cash flow and liquidity is the biggest 

firiancial concern for companies, and c:ompanies 

beJ!eve current and pending regulations will 

make those operatio~s more challenging. 

• One ln three companies ls td~lng tmantklpated 

~teps in responSe to regulations aOd economic 

changes. 

• Companies are con-cerned about accessing 

credit, managing day-tp-day currency risk, and 

raising short term capital. All are necessary' 

functions to manage cash flow, !iquldity, and' 

fund future expansion and growth. 

Regulatory Impact 

• Nearly four in everY five businesses say that 

financial industry regulation has directly 

affected their financing activities. 

• This is no longer just a corporate issue, as 

businesses are lncreaslng!y being forced to pass 

the impact of finarlda1 regulations on to 

customers and employees. 

• Increased bank capital charges are viewed as 

the primary source- of increased costs. 

• One-third of companies expect the regulatory 

effect to worsen in the next three years, 

4 
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the implementation of financial services regulation is impacting how companies operate and serve their customers. 

What we heard was a particularly strong and growing concern for the ability of businesses to access credit and to 

manage cash flow and liquidity due to existing and pending regulations. Moreover, many businesses are taking 

unanticipated steps to address increased costs or a lack of access to financial services at the expense of customers or 

expansion. 

41 43% of the companies surveyed said that maintaining cash flow and liquidity are their chief concern. 

·>& 50% said that increased bank capital charges have increased their costs and challenges. 

'f> 79% have seen their business affected by changes in the financial services markets. 

-G· 29% have increased prices for customers and consumers as a result of changes to the financial services market 

(double the level seen in 2013). 

*' 76% believe that the regulations on the financial services sector will not help their company's outlook over the 

next two to three years. 

As a result, in an era where economic growth has been stagnant, we find that existing and additional regulation of the 

financial services industry must strike a better balance between its impact on business and economic growth. 
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#FinancinyGrowth 

America is stuck In the worst economic recovery since the Great Depression, with little forward momentum, To mount a 

turnaround, the country will depend on businesses~ large and small-to create jobs and drive new economic growth. 

Companies across the country understand and appreciate this responsibility and believe that they could be doing better. 

But the facts are hard to ignore: Profits are down; there are fewer entrepreneurs starting small businesses; raising 

capital and accessing credit is more expensive; and capita! expenditures are hitting a!!~time lows. For companies to 

overcome these hurdles and get the economy back on track, they need a diverse and robust financial system. They need 

access to reasonably priced capita!, cash management solutions, and tools to manage day-to-day business risk 

For example: 

+ Agricultural companies need access to competitively priced derivatives to hedge swings in commodity prices< 

:1t Multinational corporations use derivatives to hedge fluctuations in 

currencies and interest rates. 

0 Company expansions necessary to support growth are financed by 

short- and long-term debt serviced by banks. 

Emerging companies re!y on investment banks with a global footprint 

to underwrite public offerings and provide counsel on the timing and 

type of capital to issue. 

Companies that experience cash fluctuations due to inventory production or 

lag time between production and sales depend on cash management tools to 

ensure that they have the liquidity to pay suppliers and employees. 

We talked directly to corporate treasurers, CFOs, founders, and CEOs, 

Co!!ective!y, these are the corporate employees who are accountable for 

Sams Carpet Cleaning and Repairs 

making sure that their companies have the resources and funds necessary to manage and safeguard corporate 

finances~ the fuel to sustain and grow any company, 

The overall message we heard is that companies have many different financing needs and rely on financial institutions of 

all sizes, Further, the financial regulatory environment is getting worse and hampering their ability to acquire the 

financial resources they need. 

6 
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While this report provides insight into how businesses of all sizes use the financial system and how financial services 

regulation impacts that system, many questions remain. Specifically: 

Can our financial system succeed in meeting the demands of Main Street companies? 

? Will changes in the regulation of financial institutions continue to limit credit availability or put a strain on 

market liquidity? 

!tis already dear, however, that current financial regulations are making it hard far companies to lift the American 

economy. ln fact, 76% of survey respondents believe that the regulations on the financial services sector will not help 

their companies' outlook over the next three years. 

The Chamber is committed to advancing an agenda 

that promotes well-functioning and strong capital 

markets so that American businesses have the tools 

and resources necessary to drive economic growth. 

The U.S. Chamber's Center for Capital Markets 

Competitiveness (CCMC}, working with Brunswick 

Insight, surveyed more than 300 corporate 

treasurers, controllers, CFOs, and CEOs from a wide 

range of companies with gross revenues from under 

FACES DaySpa 

$100,000 to more than $100 million. The online survey, which built upon CCMC's survey work in 2013, was conducted 

from April 21, 2016, to May 8, 2016. Questions covered topics such as economic outlook, regulatory challenges, cash 

operations, relationships with financial institutions, and what types of institutions companies use for different financial 

functions, among other topics. 
188 


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#FinancingGrowlh 

Companies Have Different Financing Needs and Rely on Financial Institutions of All Sizes 

From the large multinational manufacturer that uses over-the-counter derivatives to hedge gas prices to the small town 

florist that uses a short-term loan from the local bank, companies 

of all sizes rely on the financial services industry to drive growth. 

Businesses access and use various financial products and services 

and rely on multiple banks and other financial institutions to 

mitigate day-to-day business risk, raise capital, issue debt, and 

manage liquidity. 

Since 2013, companies are using more and more varied financial 

services to provide the tools and services necessary to operate and 

grow their businesses in an increasingly competitive global market. 

Unfortunately, the cost and complexity of obtaining these services 

in the United States has risen due to the regulatory environment. 

0 More than half of companies surveyed utilize all eight 

products and services listed on a routine basis and 85% 

used 4 or more. 

0> 20% of small and midsize companies said that they use 

four or more financial institutions to issue commercial 

paper, raise corporate debt, or access trade financing. 

-& Large businesses also used four or more financial 

institutions in a variety of contexts, particularly when obtaining long-term loans, purchasing derivatives, and 

issuing corporate debt. 

4 86% indicated that it is important for financial services providers to offer a wide spectrum of services. 

*· 68% (up from 50% in 2013) indicated that it is important for their financial services provider to have a global 

footprint. 

65% want providers to specialize in specific products. 
189 


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rurcllaslngderivanws 

Equity tssuant~s 

!ssulngmmmerfi<>lpanN, 

Use 4+ services 

Useofb:ankservkes 

Use 6+ services 

How important is il for your mmpany to have a b.mk !hat 

Use all services 

9 
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Pmentage of respondents that use 4 or more financial institutions for each at!ivity 

Obtaining long-term loans 

Purchasing derivatives 

Issuing debt 

Issuing tommerdal paper 

Trade financing 

Payments 

Cash management 

Equity Issuances 

#Financing Growth 

&Smaii/Mi-d·Size(nmpani-es 

targeCompanres 

10 
191 


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With a reliance on constrained financial services partners, cash flow and credit access pose the greatest finance 

challenge to US. businesses 

Companies often fail or face turmoil because of cash management 

problems. For example, supplier invoices can come due before revenues or 

growth in sales needs to be supported by added investment. Managing 

cash and liquidity are top concerns of Main Street businesses and, in the 

last five years, regulations and economic changes have forced one in three 

companies to take new or unexpected steps to manage their cash. This 

challenge is especially acute for America's smallest businesses. 

43% of respondents said that maintaining cash flow and liquidity 

are their chief concerns. 

+ Companies are most concerned about accessing credit, managing 

day-to-day currency risk, and raising short term capitaL Ail are 

necessary functions to manage cash flow and liquidity. 

Regulations and economic changes have forced one in every three 

companies to take new or unexpected steps to manage their cash. 

-0 50% said that increased bank capita! charges have increased their 

costs .and challenges. 

11 
192 


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#FinancingGrowlh 

Over the next 12 months, which of the following issues do you foresee as the biggest fin"ncial concerns for your business? 

IIIII Maintaining mh ftow and liquidity 

Concern (rank) 

12 
193 


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!n toKen! year>. many new flnandal rult>s aM regu1a!!om ha~ !l~n implemented. Would you say !hat the- foi!owing 

regu!aUonsha-vehadaposltiveor!lega!iveimpadonyourwmpany? 

Netlmpattofregu!ation~on ... 

The numbers reflect the net of the percentage of businesses who .'iaid each regulation had a positive impact minus 

the percentage of businl'sses who SOld the impact of each regulation was a negative on their business. Tor pxomple, 

the negative numbers mdtcate that mort' businesses fe!! the 1mpoct was negattvc for the company 

#FinancingGrowth 

13 
194 


27369.153

The trickle-down impact of regulatory overreach on customers 

Businesses depend on a healthy, well-regulated financial system to spur economic growth. However, the past decade 

has been turbulent-from the financial crisis to its legislative response. While many of these reforms have improved the 

resilience of our financial system, a number of policy responses have gone too far and are negatively influencing Main 

Street companies and their customers. 

79% of the businesses respondents are affected by changes in the financial services market. 

29% have increased prices for customers and consumers as a result of changes to the financial services market 

(double the level seen in 2013). 

0 39% have absorbed the higher costs. 

19% have delayed or cancelled planned investments. 

4' 76% believe that the regulations on the financial services sector will not help their companies' outlook over the 

next two to three years. 

% of U.S. businesses affected by changes in financial services market 

2013 2016 

14 
195 


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Do you expect the regulations [for the financial services sector] to improve or 

worsen the outlook for your own company over the next H years? 

a Signlfkanlly improveSomewhat improve 

TII'Ne!ther/Unrure 

Somewhatwomn 

Signlflcant!ywors.en 

Regulatorylmpactin2~3Vears 

#FinancingGmwth 

15 
196 


27369.155

Glossary of Key Terms 

Bank regulatory capital: The amount of capital that a bank must hold 

as required by its financial regulators. This is usually expressed as a 

ratio of required equity versus the assets held by a bank, adjusted for 

the assets' potential risk. Bank regulatory capital levels are 

established by international and domestic standard-setters and 

regulators, such as the Basel Committee on Banking Supervision and 

the Federal Reserve, respectively. 

Bond: A debt security that represents a fixed-income claim on the 

cash flows and assets of a company. 

Cash flow: The amount of cash and cash-equivalents moving in and 

out of a business. Businesses need positive cash flow in order to pay 

short-term obligations, such as everyday expenses, as well as maintain 

a cash buffer for unanticipated pnyments. 

Cash management tools: These tools assist a company with their short-term financial management needs and include a 

wide variety of products and services, including money market funds and certificates of deposit. 

Commercial bank: A chartered financial institution that provides a variety of services to businesses, including accepting 

deposits, making loans, and other payment-related services. 

Commercial paper: An unsecured short~term debt instrument issued by a company to raise short~term capital and 

manage near-term liabilities. 

Debt financing: A form of raising capita! that in dudes issuing bonds and other forms of indebtedness through the public 

and private markets or borrowing rnoney directly from a lendec Debt financing requires paying interest and principal at 

specified dates. 

Derivatives: Financial contracts whose value is driven by the value of another asset or security (known as an 

"underlying"). Commonly used derivatives include forwards, futures, and swap contracts. For example, swap contracts 

are used by businesses to manage risk, such as locking in a fixed rate of interest for an overseas payment. 

16 
197 


27369.156

FINANCING::: #FinancingGmwl:h 

Equity financing: A form of raising capital that allows cash to be contributed to a business in exchange for an ownership 

interest. Investors participating in equity financing typically have voting rights and share in the percentage of the firm's 

profits or potential losses. 

Investment banks: Financial institutions that provide advisory services and help to raise capital for businesses in the 

public markets, including through underwriting, asset management, sales and trading, and research. 

liquidity: This refers to the volume of activity in a market, as well as a general measure of the ease of selling securities, 

such as bonds and stocks, or converting assets to cash. Market makers, like investment banks, help facilitate the flow of 

trading and ensure efficient, liquid capital markets. 

longMterm loans: A loan or other long-term debt obligation that generally lasts more than one year. 

Payment systems: These financial tools permit settlement of financial transactions by transferring monetary value 

such as by wiring payment. 

Risk management tools: These too!.s, such as derivatives, assist a company in managing their exposure to a variety of 

different risks, such as changes in interest rates, commodity prices, or foreign currencies. 

Short-term loans: A loan or other short-term debt obligation that generally lasts less than one year. 

Trade financing: A form of domestic or international financing that allows a firm to extend credit to its customer by 

selling its goods and services and permitting the customer to pay some date after the receipt of goods and services. 

U.S. Chamber of Commerce 

Center for Capital Market Competitiveness 

1615 H Street, NW 

Washington, DC 20062 

17 
198 


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TESTIMONY BEFORE 

THE UNITED STATES HOUSE OF REPRESENTATIVES 

COMMITTEE ON FINANCIAL SERVICES 

SUBCOMITTEE ON 

CAPITAL MARKETS, SECURITIES, AND INVESTMENTS 

Hearing on 

"Examining the Impact of the Volcker Rule on 

Markets, Businesses, Investors, and Job Creation" 

Testimony of 

Charles K. Whitehead 

Myron C. Taylor Alumni Professor of Business Law 

Cornell Law School 

Professor of Law and 

Director of the Law, Technology, and Entrepreneurship Program 

Cornell Tech 

March 29,2017 
199 


27369.158

Chairman and Members of the Committee, thank you for inviting me to testify 

today regarding the impact of the Volcker Rule 1 on the financial markets and the 

general economy. My name is Charles Whitehead, and I am a Professor of Law at 

Cornell University specializing in capital markets, financial institutions and transactions, business organizations, and mergers and acquisitions. Before becoming an 

academic, I spent 17 years in the private sector and held senior legal and business 

positions in the financial services industry in New York and Tokyo. 

I testify today in favor of repealing the Volcker Rule. A principal goal of the 

Volcker Rule is minimizing risky trading activities by banks and their affiliates and, 

consequently, enabling banks to pursue a "traditional" banking business in providing 

capital to businesses and consumers. What the Rule fails to reflect is change in how 

credit is provided today, moving from traditional banking to increasing participation 

by banks in the capital markets. This necessarily involves the banks' use of their 

own balance sheets to buy and sell securities as part of a market-making function. 

Artificially constraining their ability to do so affects the smooth operation of the 

capital markets. 

There is certainly an argument for regulating risky trading activities. But the 

Volcker Rule addresses the wrong problem in the wrong way. The Volcker Rule 

was sold to Congress as a response to the 2008 financial crisis, an attempt to reduce 

risk in banks principally by banning short-term proprietary trading directly by banks 

and their affiliates and indirectly through investments in hedge funds and private 

equity funds. But why was restricting short-term proprietary trading a solution to 

the crisis? The answer is far from apparent and is unsupported by the facts that 

Congress had at the time. As Treasury Secretary Geithner testified, "most of the 

losses that were material . . . did not come from [proprietary trading] activities."2 

1 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 619, 124 Stat. 

1376, 1620 (2010) (codified at 12 U.S.C. § 1851 (2014)) (the '·Dodd-Frank Act"). The Volcker Rule 

technically is not a ''rule," but part of the statutory text in the Dodd-Frank Act, implemented in 2013 through 

final regulations (the "Final Rule") adopted by The Office of the Comptroller of the Currency, the Federal 

Reserve, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the 

Commodity Futures Trading Commission. See OCC, Federal Reserve, FDIC, and SEC Prohibitions and 

Restrictions on Proprietary Trading and Certain Interests in, and Relationships with. Hedge Funds and 

Private Equity Funds, 79 Fed. Reg. 5536 (Dec. I 0, 20 I 3); CFTC, Prohibitions and Restrictions on 

Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity 

Funds, 79 Fed. Reg. 5808 (Jan. 31, 2014). The Final Rule became effective as of April I, 2014. The 

Federal Reserve granted banks and their affiliates an extended conformance period until July 21, 2015. 

Unless the context otherwise requires, when l refer to the Volcker Rule in this testimony, I mean to refer to 

the statutory text and its implementing regulations. 2 Hearing Before the Congressional Oversight Panel, lll'h Cong. (2009) (testimony of Sec. of Treasury 

Timothy Gcithncr) (testifying about the causes of the 2008 financial crisis). 
200 


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Rather, many of the most significant bank losses arose from traditional extensions 

of credit, especially loans related to real estate. 3 

I believe it is fair to say that the Rule's proponents were less interested in 

curing a particular cause of the financial crisis4 and more interested in championing 

the view that commercial banking should be separated from investment banking, 

particularly proprietary trading and principal investing. 5 By barring proprietary 

trading by banks and their affiliates, the Rule's sponsors hoped that utility services, 

such as taking deposits and making loans, would once again dominate the banking 

business.6 But that view reflected hope over experience. In light of the fluid and 

evolving nature of the financial markets, it was unlikely that regulation could force 

a return to the financial sector model of an earlier era when banks and bank lending 

were kept separate from the capital markets. 

What has been the result? The Volcker Rule imposes a static divide - a 

financial Maginot Line - between short-terrn proprietary trading and banking, but 

does so within a world where capital markets and bank loans compete for corporate 

lending, and fluid financial markets continue to evolve and can sweep around a fixed 

position.7 Changes in the financial markets spurred by the Volcker Rule still expose 

banks to the kinds of risks the Volcker Rule was intended to minimize or eliminate. 

Hedge funds and other, Jess-regulated entities whose activities can affect banks and 

bank risk taking picked up the proprietary trading that exited banks and their 

·'!d. Chairman Volcker himself acknowledged that the restrictions in the Volcker Rule would not have 

prevented the financial crisis: .. It certainly would not have solved the problem at AIG or solved the problem 

with Lehman Brothers, alone. It was not designed to solve those particular problems." Hearing Before the 

S. Comm. On Banking. Hous. & Urban Affairs, Ill'" Cong. (2010) (statement of Paul A. Volcker, 

Chairman, President's Econ. Recovery Adv. Bd.). To the extent trading contributed to bank losses. shortterm proprietary activity may have been less of a concem than the losses surtered from longer-term holdings 

of risky asset-based (primarily mm1gage-backed) securities not covered by the Volcker Rule. See Matthew 

Richardson et al., Large Banks and the Volcker Rule, in REGULATING WALL STREET: THE DODD-FRANK 

ACT AND THE NEW ARCIJITECTURE OF GLOBAL FINANCE 181, 203-04 (linking hank losses in the 2008 

financial crisis to the banks' strategy of holding mortgage-backed securities as long-term investments). 4 See Kim Dixon & Karey Wutkowski, Volcker: Proprietill)' Trading Not Centra/to Crisis, REUTERS, Mar. 

30, 2010 (reporting that Chairman Volcker, although still supporting the ban on proprietary trading. 

conceded it was not central to the financial crisis). 5 See DAVID SKEEL, THE NEW FINANCIAL DEAL 86-87 (2011) (noting that. due to changes in market 

practices and technology, proprietary trading has become crucial to investment banking). 6 See !56 CONG. REC. S5894 (daily ed. Jul. 15, 2010) (statement of Sen. Jeff Merkley) (describing the 

rationale for the Dodd-Frank Act). 7 See Charles K. Whitehead. Reframing Financial Regulation, 90 B.U. L. REV. I. 2-5. 36-40 (2010) 

(describing changes in the financial markets relating to market participants and tinancial instruments). 

-2-
201 


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affiliates.8 Moreover, in order to make up for losses in revenues, banking entities9 

shifted their risk-taking activities to other businesses increasing their risk taking, 10 

potentially through activities with which they were less familiar than the proprietary 

trading they were compelled to abandon. 11 

The problems around the Volcker Rule are exacerbated by practical difficulty 

in implementing the Rule itself. What is proprietary trading, and how is it 

distinguished from market-making? When implementing the Rule, the regulators 

noted that it was difficult to define certain permitted activities because it ''often 

involves subtle distinctions that are difficult both to describe comprehensively 

within regulation and to evaluate in practice." 12 Specifically, in the Final Rule's 

proposing release, the regulators found that "f a]lthough the purpose and function of 

[market making activities and proprietary trading] are markedly different ... clearly 

distinguishing these activities may be difficult in practice." 13 Likewise, industry 

participants have complained that the Jack of definitional bright lines makes it 

difficult for banks to comply with the Rule. 14 As a result, banking entities have had 

to incur substantial costs in order to implement cumbersome supervisory and 

compliance regimes; 15 and in order to avoid stepping over the line, many have pulled 

back from permissible market-making activities. 16 The resulting increase in 

8 See Charles K. Whitehead, The Volcker Rule and Evolving Financial Markets, I HARV. Bus. L. REV. 39. 

46 (2011) (noting that banks will continue to be exposed to proprietary trading through their reliance on 

less-regulated hedge funds as one means to hedge credit risk). 9 The term '"banking entity" is defined inji·a at note 20. 10 See .Jussi Keppo & JosepfKorte, Risk Targeting and Policy Illusions- Evidencefi·om the Announcement 

of the Volcker Rule, MGMT. SCJENCE 2-3 (Articles in Advance, 2016) (concluding that overall bank risk 

levels did not decline after announcement of the Volcker Rule); Sohhyun Chung et al., The Impact of 

Volcker Rule on Bank Profits and Default Probabilities 2-3 (Working Paper. June 19, 2016) (finding that 

the Volcker Rule raised the default probabilities of34 U.S. banks by decreasing the size of the liquid trading 

book and increasing the illiquid hanking book). 11 See iJ?fra notes 52-56 and accompanying text. 12 See Prohibition and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, 

!ledge Funds and Private Equity Funds, 68 Fed. Reg. 68.849 (Nov. 7, 2011). 

"68 Fed. Reg. 68,869. 14 See, e.;; .. Dcloitte, The Volcker Rule's Impact on Infrastructure 2-3 (Jul. 2011) (noting that ·'[c]onstructing tests that definitively delineate between [proprietary trading and pem1itted activities] may be quite 

difficult" and that banking entities "will require robust infrastructure and processes to monitor and 

comply."'). 

15 See Robin Greenwood eta!., The Financial Regulatory Reform Agenda in 2017 11-12 (2017)(Harv. Bus. 

Sch. Project on Behav. Fin. and Fin. Stability, Working Paper 2017-9). 16 :i'ee Jack Bao eta!., The Volcker Rule and Market-Making in Times of Stress 10 (Fed. Res. Fin. and 

Econ. Disc. Series 2016-102) (finding that the illiquidity of stressed bonds has increased after adoption of 

the Volcker Rule); see also Darrell Duffie, Market Making Under the Proposed Volcker Rule 4-6 (Stan. 

Univ. Working Paper. Jan. 16, 2012) (stating that the Volcker Rule will reduce the overall quality and 

capacity of market-making services provided to U.S. investors). 

-3-
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investors' execution costs and the decline in market liquidity means that investors 

will demand higher yields on new bond issuances. The challenge is not how much 

capital is raised, but the incremental cost to issuers of raising it a cost that affects 

Main Street as much as it affects Wall Street. 17 

The result is costly regulation with limited upside and the potential for greater 

downside. 18 There are legitimate reasons to be concerned over the risks associated 

with a bank's trading operations. But those risks can be more effectively addressed 

through other means, such as imposing capital charges on a bank's trading books 

and the traditional bank regulators' focus on risk management and assessing a bank's 

safety and soundness. 19 For those reasons, the Volcker Rule should be repealed. 

Background 

The Volcker Rule is intended to reduce risk taking by U.S. "banking entities" 

essentially deposit-taking commercial banks, companies that control those banks, 

and any affiliate of any of the foregoing. 20 It does so by prohibiting a banking entity 

from "engag[ing] in proprietary trading" of securities, derivatives, commodity 

futures, and options on those instruments for their own account or "acquir[ing] or 

retain[ing] any equity, partnership, or other ownership interest in or sponsor[ing] a 

hedge fund or private equity fund." 21 

17 See infra notes 71-72 and accompanying text. 

" Professor John Coates has argued that the Volcker Rule is a structural law that is designed to change the 

organizational culture of banks by, among other things, reducing bankers' incentives to take risk and 

reducing the authority of traders. See John C. Coates IV, 711e Volcker Rule as Structural Law: Implications 

for Cost-Benefit Analysis and Administrative Law, 10 CAP. MARKETS L.J. 447, 454 (2015). In light of its 

non-quantifiable goals, and the difficulty of anticipating private market response to the new regulatory 

structure, Professor Coates argues that the Volcker Rule should not be subject to a cost-benefit analysis. 

!d. at 468. Dif1iculty in assessing private market responses to changes in financial regulation is not 

uncommon, and the Volcker Rule is no exception. See Charles K. Whitehead, The Goldilocks Approach: 

Financial Risk and Staged Regulation, 97 CORNELL L. REV. 1267, 1272-73, 1299-1302 (2012). 

Nevertheless, without addressing Professor Coates' specific contention- namely, that structural law should 

never be subject to a formal cost-benefit analysis- when new regulation like the Volckcr Rule imposes 

substantial costs on market participants, and the benefits are vague or open to interpretation, serious 

consideration should be given to whether those costs arc justified by the likely merits. See infra note 72 

and accompanying text. 

"See Greenwood et al., supra note 15. at 12. 20 The definition of"banking entity" appears at 12 U.S.C. § l85l(h)(1). The Volcker Rule also limits 

similar activities by certain systemically important financial institutions supervised by the Federal Reserve 

Board. 12 U.S.C. § 185l(a)(2). 

"12 U.S.C. § 185l(a)(l). 

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Proprietary Trading: What's in a Name? 

Traditionally, proprietary trading referred to activities by trading desks that 

were allocated capital to invest for the firm's own account as opposed to other functions, such as assisting the firm in its asset-liability managementP The Volcker 

Rule's definition is both broader and narrower. The Rule is broader, because as 

implemented, it prohibits a banking entity from engaging as principal in any 

purchase or sale of the designated financial instruments, unless the activity is 

excluded from the definition of "proprietary trading'' or an exemption is available. 

It is narrower, because "proprietary trading" principally covers the buying and selling of financial instruments for near-term gain; it does not extend to longer-term 

proprietary holdings. 23 

The problem, of course, is distinguishing proprietary trading activity from 

other trading that uses a banking entity's balance sheet, and distinguishing near-term 

from long-term trading activities. Generally speaking, trading activity is classified 

as proprietary if it satisfies one of three tests set out in the Final Rule (relating to the 

trade's purpose (the Purpose Test), its treatment under the market risk capital rules 

(the Market Risk Capital Rule Test), and whether the trade relates lo the banking 

entity's status as a dealer, swap dealer, or security-based swap dealer (the Status 

Test)) and is not otherwise excluded from the proprietary trading definition.24 

Of the three, the Purpose Test is the most ambiguous - principally due to its 

reliance on the "purpose" of the trade in classifying whether it is proprietary or not. 

The purchase or sale of a financial instrument will be considered near-term and 

proprietary (and, therefore, subject to the Volcker Rule, absent an exemption) if it is 

principally for the purpose of short-term resale, benefiting from actual or expected 

short-term price movements, realizing short-term arbitrage profits, or hedging one 

or more positions resulting from purchases or sales of financial instruments in one 

of the foregoing transactions. 25 

The Final Rule includes a rebuttable presumption that any financial instrument held for fewer than 60 days (or whose financial risk is substantially transferred 

See Camille L. Onnc & Whitney A. Chatterjee. The Volcker Rule, in REGULATION OF FOREIGN BANKS 

& AFFILIATES IN THE UNITED STATES (9th ed. 2016, Randall D. Guynn, ed.). 23 Specifically, the activity must be tor the "trading account'' of the banking entity. A "trading account" is 

a set of transactions '·used tor acquiring or taking positions in the [covered financial instruments] principally 

for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from shortterm price movements)" or as otherwise determined by applicable regulation. 12 U.S.C. § 185l(h)(6). 24 A description of the three tests can be found in Onne & Chatterjee, supra note 22, at !317-19. 25 Final Rule §_.3(b )(I )(i). 

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within 60 days) meets the Purpose Test and, therefore, is proprietary. The presumption can be rebutted if, based on the facts and circumstances, the banking entity can 

demonstrate that the instrument was not purchased or sold for any of the purposes 

covered by the Purpose Test.26 That means that two identical trades may be treated 

differently based on whether or not the banking entity is able to rebut the presumption that they are proprietary. Doing so requires some evidence of the trade's 

purpose and the trader's intentions- difficult to establish, particularly in light of the 

limited regulatory guidance on how the presumption can be rebutted in practiceY 

Market-Making: What's in a Name? Part 11 

Among the proprietary trading exceptions, market-making is perhaps the most 

important. 28 It mirrors a classic bank function- providing liquidity to lenders without affecting the borrower's access to a stable source of capital - relying on the 

capital markets rather than traditional banking channels to do so. The exception was 

included in light of the importance of market-making to well-functioning capital 

markets and, in turn, the general economy. 29 

Market-making supports secondary trading liquidity, comprised of market 

liquidity and funding liquidity. Market liquidity refers to the ease by which an 

investor can sell a portfolio asset, like a stock or a bond. An asset's market liquidity 

is low when it becomes relatively difficult to raise money by selling the asset -

where, in effect, there are sellers but relatively few buyers, causing a drop in the sale 

price. Anticipating that risk, investors are more likely to demand a higher return on 

their investment; the greater the risk, the greater the overall cost of raising capital. 

Funding liquidity refers to the ability of investors and other market participants to finance their investment portfolios. Many investors use the assets they buy 

as collateral against short-term borrowings, often structured as sales at a discount (or 

26 See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with. 

Hedge Funds and Private Equity Funds, 79 Fed. Reg. 5535, 5550 (Jan. 31, 2014). 

See Orme & Chatterjee, supra note 22, at 1318 n.78. 28 12 U.S.C. § l85l(d)(l)(B). Other exceptions include trading in U.S. Treasuries and other government 

instmments, 12 U.S.C. § 185l(d)(l )(A), risk-mitigating hedging, id. § 185l(d)(I)(C), trading on behalf of 

customers, id. § l851(d)(l)(D), and proprietary trading by non-U.S. banking entities occnrring solely 

outside the United States, id. § 1851 (d)( I )(H). Even then, the statutory exceptions to the Volcker Rule are 

subject to broad prudential backstop provisions that prevent banking entities from engaging in activity that 

would "involve or result in a material conflict of interest," ''result, directly or indirectly, in a material 

exposure by the banking entity to high-risk assets or high-risk trading strategies;· "pose a threat to the safety 

and soundness of such banking entity," or "pose a threat to the financial stability of the United States." 12 

U.S.C. § 1851 ( d)(2)(A). See also Orme & Chatterjee, supra note 22. at 1380-83. 29 79 Fed. Reg. 5576, 5581. 

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a "haircut") and repurchases in the "repo" market. The size of the haircut is a reflection of the lender's ability to sell the collateral if the borrower defaults. Thus, a 

decline in market liquidity is likely to increase the haircut. It also limits how much 

the investor can borrow and, therefore, its business and operations - most likely 

prompting investors to demand an even greater return on the assets they buy. 30 

Stated differently, market and funding liquidity are two sides of the same coin. 

If market liquidity drops, the resulting rise in haircuts will lower the amounts 

available to buy new assets, in turn, prompting a further drop in market liquidity. 

This feedback loop is precisely what occurred during the 2008 financial crisis, 

resulting in a rapid decline in bond market liquidity. 31 

Even outside of a crisis, the relationship between market and funding liquidity 

can limit the amount of new capital that is available to end-users -those who rely 

on the capital markets to raise funds- or increase the overall cost of funding. More 

to the point, investors purchase securities on the basis of there being an adequate 

secondary market for resale, which largely depends on market-making activities. 

Unless an alternative source of liquidity appears, a decline in market-making is 

likely to increase portfolio risk and either reduce returns to investors or increase the 

issuer's cost of capital, or both.32 

In order to qualify as market-making, the Volcker Rule requires that the 

trading desk that manages the exposure "routinely" be ready to purchase and sell the 

financial instruments for which it is making a market and be able to quote, purchase 

and sell, or otherwise enter into long and short positions in, those types of financial 

instruments for its own account, in commercially reasonable amounts, and throughout market cycles on a basis appropriate for the liquidity, maturity, and depth of the 

market for the relevant financial instruments. 33 In addition, the amounts, types, and 

risks of the financial instruments in the trader's market-making inventory must be 

designed not to exceed, on an ongoing basis, the reasonably expected ncar-term 

demands of clients, customers, or counterpartics, based on the liquidity, maturity, 

and depth of the market for the relevant financial instruments, and a demonstrable 

30 See Markus K. Brunncrmeier & Lasse Heje Pedersen, Market Liquidity and Funding Liquidity. 22 REV. 

FIN. STUD. 220 I, 2201-07 (2009); 31 See id. at 2203-05. 

See infi·a notes 69-72 and accompanying text; see also Duffie, supra note 16, at 18-19. 33 Final Rule § _.4(b). 

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analysis of historical customer demand,34 the current inventory of financial instruments, and market and other factors regarding the amount, types, and risks of the 

financial instruments. 

Compliance Complexity 

Each banking entity is required to institute a compliance program that is 

"reasonably designed to ensure and monitor compliance'' with the Volcker Rule. 35 

The scope of each compliance program will vary based on "the types, size, scope 

and complexity of activities and business structure of the banking entity."36 The 

program requirements are organized into five tiers, based on the banking entity's 

asset size and the volume of its trading activities. In general, however, for banking 

entities that conduct proprietary trading, each compliance program requires the 

banking entity to implement a wide array of policies and procedures, training, 

internal controls, and testing that may be enterprise-wide (to the extent applicable to 

one or more trading desks) or implemented for a particular business unit. 

A banking entity must also report certain quantitative measures of its trading 

activities to the regulators if its trading assets and liabilities meet certain thresholds. 37 

Those trading metrics must be calculated each trading day at the trading desk level 

tor each desk that relies on, among others, the exemption for market-making. 38 The 

Final Rule includes detailed directions on how to calculate the metrics, including 

risk and position limits and usage, risk factor sensitivities, Value-at-Risk and Stress 

VaR, comprehensive profit and loss attribution, inventory turnover, inventory aging, 

and the ratio of customer-facing trades to trades with non-customers. 39 Those 

metrics are not intended as a means to assess compliance with the Volcker Rule, but 

rather are used to monitor trends and identify activities tor further review. 40 

Additional metrics may be needed in order to implement an effective compliance 

program.41 

14 The types of information that could he used in this analysis include: "(i) [r]ecent trading volumes and 

customer trends; (ii) trading patterns of specific customers or other observable customer demand patterns; 

(iii) analysis of the banking entity's business plan and ability to win new customer business; (iv) evaluation 

of expected demand under current market conditions compared to prior similar periods: (v) schedule of 

maturities in customers' existing portfolios; and (vi) expected market events, such as an index rebalancing, 

and announcements." 79 Fed. Reg. 5610 to 5611. 35 Final Rule§ _.20(a). 

36 !d. 

" !d. § .20( d). 38 !d. Appendix A §§ I, II. 39 See also Onne & Chatterjee, supra note 22, at 1386-87 (summarizing the required metrics). 40 79 Fed. Reg. 5765. 

"Final Rule Appendix A § 1; 79 Fed. Reg. 5761. 

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Out of the Frying Pan Into the Frying Pan 

Not surprisingly, much of the proprietary trading activity often, internal 

hedge funds and walled-off speculative trading desks was sold or pushed out of 

banking entities in anticipation of the Volcker Rule being implementedY In many 

cases, the trading activity moved to less-regulated hedge funds. 43 

A key question is whether moving those risk-taking activities to hedge funds 

insulated banking entities from the problems the Volcker Rule waq intended to 

address. There are a number of reasons to believe it does not. 

Seven (or Fewer) Degrees of Separation 

It is difficult today to wall-off one sector of the financial markets from 

another. Before the 2008 financial crisis, standard risk measurement methods underestimated how closely commercial banks, investment banks, hedge funds, and insurance companies are linked. As a result of that linkage, when financial conditions 

worsen for one type of institution, the effects can spread quickly to others. Spi II overs 

among financial institutions may be small in times of financial stability, but quickly 

escalate when the system is under stress, particularly among certain types of entities. 

Key among them arc hedge funds. One recent study found that "hedge funds may 

42 See MJCHML S. BARR, HOWELL E. JACKSON & MARGARI·:T E. TA!IYAR, FINANCIAL REOULATION: LAW 

AND POLICY 684 (2016). 4 ' See Sam Jones, More Goldman Traders to E\-itj(Jr Funds, FIN. TIMES, Jan. 9, 201! (reporting that senior 

members of Goldman Sachs' last big proprietary trading desk left to launch a private hedge fund); Aaron 

Lucchetti, !\.forgan Stanley Team ro Exir in Fallout ji·om Volcker Rule, WALL ST. J., Jan. 11, 2011. at Cl 

(repotiing that Morgan Stanley's proprietary trading unit will leave to form an independent trading tirm); 

see also Privare Equity Groups Diversify. FIN. TIMES, Dec. 20, 20 I 0 (reporting that private equity firms 

arc capitalizing on the forced divestiture of proprietary trading units by purchasing stakes in newly-created 

funds launched by those units). To be sure, the Dodd-Frank Act expanded hedge fund regulation by, among 

other things. eliminating the private advisor exemption from the Investment Advisers Act of 1940 and, with 

certain exceptions, requiring private fund advisers to register with the Securities and Exchange Commission. Dodd-frank Act§ 403. As a practical matter, however, the new requirements did little to affect the 

hedge fund industry. since many of the largest advisers were already registered. About 70% of hedge fund 

assets were managed by advisers that had voluntarily registered. See After Dodging Many Bullets, Hedge 

Funds Are Back in Regulators' Sights. KNOW!.FDGE@WH!ITRON (Mar. 18, 2009) (noting that many hedge 

funds were willing to voluntarily register in order to attract institutional investor funds). Moreover, hedge 

funds typically are not subject to the prudential financial regulation that helps police the amount of risk that 

a bank can incur. See Whitehead, supra note 7. at 15-16, Appendix B. 

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be the most important transmitters of shocks during crises, more important than commercial banks or investment banks."44 The reason relates to the trading strategies of 

hedge funds and their interconnectedness with other entities, including banks. 

Hedge funds are often highly leveraged and, in times of crisis, are likely to be forced 

to liquidate assets at fire-sale prices, causing hedge funds as a group to sustain heavy 

losses. Consequently, under some circumstances, hedge funds may perform in the 

same way, irrespective of management style, causing an overall decline in hedge 

fund stability at the same time. 45 This can lead to defaults that threaten banks directly 

as counterparties or creditors, and indirectly through the effect of the hedge funds' 

tire sales on the credit market."16 Moreover, to the extent hedge funds provide a 

means for banks to outsource credit risk (through, for example, credit default swaps 

that transfer bank credit risk, often to hedge fund counterparties), a problem in the 

hedge fund industry can directly affect how banks manage risk precisely at the time 

they most need it, during a financial crisis.47 

The Volcker Rule is also intended to suppress a bank's risk-taking "culture".48 

Its approach, however, presupposes a financial industry that no longer exists. 

Whether or not a bank has a risk-taking culture increasingly depends less on the CEO 

or the entity itself, and more on the opportunities for employment that exist elsewhere within the financial markets, including in hedge funds. 49 The focus on entities 

misses the effect on compensation (and risk-taking) of the competition among financial firms to hire good employees. That effect is significant. In a competitive 

market, firms are expected to adjust compensation in line with market demand, 

assessing and paying employees based on their relative ability to generate returns. 

In principle, that competition should align employee and employer incentives, allo-

"Reint Gropp. How Important Are Hedge Funds in a Crisis" 1·2 (FRBSF Economic Letter 2014-11, Apr. 

14.20H). 

45 See Nicole M. Boyson et aL, Hedge Fund Contagion and Uquidity Shocks, 65 J. Fll\. 1789, 1814-15 

(2010) (linking contagion in the hedge fund industry to liquidity shocks). 46 See Gropp, supra note 44, at 2-3. 47 See Whitehead, supra note 8, at 66. 

"Chairman Volcker commented that one of the policy purposes of the Volcker Rule was to address a 

banking "culture" that was ''manifested in the huge incentives to take risk inherent in the compensation 

practices for the traders. Can one group of employees be so richly rewarded, the traders, for essentially 

speculative, impersonal, short-term trading activities while professional commercial bankers providing 

essential commercial banking services to customers. and properly imbued with fiduciary values. be 

confined to a much more modest structure of compensation?'· Paul A. Volcker, Commentary on the 

Restrictions on Proprietary Trading by Insured Depository Institutions 2 (Feb. 13. 20 12). 49 See Simone M. Sepe & Charles K. Whitehead, Paying ji;r Risk: Bankers, Compensation, and 

Competition, 100 CORNELL L. REV. 655,658-60 (2015) (finding that greater risk taking can increase shortterm bank pro tits and, in tum, employee compensation, potentially at the expense of long-term bank value, 

so long as the employee can depart before any losses materialize). 

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eating the best employees to the most profitable firms. In the case of banks, however, combining performance-based pay with competition where employees can 

move from one employer to the next- has had perverse results. Greater risk taking 

can increase short-term bank profits and the amount an employee is paid, potentially 

at the expense oflonger-term bank value. 5° Employees, therefore, have an incentive 

to incur risk so long as they can depati for a new employer before any longer-term 

losses (and corresponding drop in pay) materialize. Competition results in an 

upward spiral in pay and limits the bank's ability to efficiently adjust compensation 

to reflect risk taking and long-term outcomes. 5 1 Stated differently, even if proprietary traders move to a different entity, a bank's executives are still trapped into 

providing risk-prone incentives to employees due to the pressures that arise from the 

market-wide competition for talent. 

Unintended Consequences 

A recent study focused on the Volcker Rule's effect on the investment, dividend, and recapitalization decisions, and also the profits and default probabilities, of 

34 banks. It found that the Volcker Rule raised bank default probabilities. It did so 

by decreasing the bank's trading portfolio and increasing its illiquid banking portfolio, which is more difficult to manage. 52 Another recent study found that 

announcement of the Volcker Rule caused banks to reduce the size oftheir trading 

portfolios, but did not reduce their overall risk taking. To keep their risk targets, 

banks simply raised the trading risk of their remaining portfolios. 5

3 

This shift in bank risk taking should not be a surprise. It has happened before. 

When first introduced, risk-based capital requirements (and later increases in those 

requirements) had disparate effects on banks, decreasing a bank's risk taking in some 

cases but increasing it in others. Managers who were risk-averse chose to trade off 

50 Although banking has evolved, a portion of a bank's losses may not be realized until the long term due 

to its investment in illiquid assets with maturities that are longer than a bank's demand deposits. See 

Jonathan R. Macy & Geotlrey P. Miller, Deposit Insurance. the Implicit Regulatmy Contract. and the 

Mismatch in the Term Structure of Banks' Assets and Liahilities, 12 YALE J. 0!\ REG. I, 7 (1995). The 

Treasury, the Federal Reserve, and the Federal Deposit Insurance Corporation also noted the effect of 

compensation on bank risk prior to the financial crisis: "Flawed incentive compensation practices in the 

financial industry were one of many factors contributing to the financial crisis that began in 2007. Banking 

organizations too often rewarded employees for increasing the organization's revenue or short-term profit 

without adequate recognition of the risks the employees' activities posed to the organization.'' Guidance 

on Sound Incentive Compensation Policies, 75 Fed. Reg. 36,395,36,396 (June 25, 2010). 51 See Sepe & Whitehead, supra note 49, at 659. 

"See Chung et al., supra note 10, at 3 (concluding that "in the default probability sense, the Volcker Rule 

is not effective"). 53 See Keppo & Korte, supra note 10, at 2-3. 

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profits for decreased risk. Managers who chose to maximize a bank's expected 

profits shifted investments into higher-risk portfolios. A 1998 study found that 

banks reacted differently depending on their capital positions and the particular 

regulatory requirements. Specifically, using a cross-section of bank data from 1984 

to 1993, the study found aU-shaped relationship tied to changes in capital position 

and risk taking. 5

4 Severely undercapitalized banks were likely to take on significant 

risk- a moral hazard problem- whose cost was largely borne by the Federal Deposit 

Insurance Corporation ("FDIC"). Risk-taking incentives declined as capital 

increased, partly because banks bore the full cost of a loss if FDIC insurance was 

not triggered. Yet, risk taking increased again at higher capital levels as bank 

managers, whose banks were now sufficiently capitalized to protect against 

insolvency, chose to invest in riskier assets in order to offset higher costs. 55 The 

point is that, like the change in risk taking that occurred when risk capital 

requirements were introduced, a bank's managers may very well shift risk-taking in 

response to the Volcker Rule in order to offset the loss of the proprietary trading 

business.56 The resulting increase in default probabilities is an unintended consequence. 

All of the foregoing reflects the problem of having a static divide in a liquid 

market. Physically removing proprietary traders from banking entities may minimize the direct effect of their activities. But, in today's world, the indirect effects 

can be just as significant. 

A Rose By Any Other Name 

It was clear from the outset that implementing the Volcker Rule would be a 

challenge. One of the greatest hurdles has been identifying what constitutes proprietary trading in the first place. The reason for the challenge is the way in which 

"See Paul Calem & Rafael Rob, The Impact of Capital-Based Regulation on Bank Risk-Taking, 8 J. FIN. 

]NTERMED!ATION 317, 3 !8-20 (1999). 

!d. at 318-20, 329-31. 56 In fact, this is what also occurred following adoption of the Gramm-Leach-Biiley Act of 1999, Pub. L. 

No. 106-102, § 101, 113 Stat. 1338. 1341 (codified as amended in scattered sections of 12 and 15 U.S.C.) 

(the "GLB AcC). Even though the wall between bank and non-bank activities had eroded prior to passage 

of the GLB Act. it heralded the ability of commercial banks to compete directly with traditional investment 

banks in the capital markets. Commercial banks gained a sizeable share of the business, very often leveraging their ability to extend credit through traditional lending in order to secure capital markets mandates. 

To offset lost revenues, investment banks moved into new business lines, and grew the amounts they 

borrowed to finance them, taking on new risks with which they had only limited prior experience. For 

investment banks, combining the two new (and often greater) risk-taking and leverage was lethal and 

eventually triggered the 2008 t1nancial meltdown. See Charles K. Whitehead. Size Mailers: Commercial 

Banks and the Capital Markets, 76 OHIO ST. L..J. 765,775-802 (2015). 

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the Volcker Rule defines proprietary trading, in particular under the Purpose Test. 5

7 

It is inherently difficult to implement regulations that are tied to a trader's intent. 

How can this be objectively measured? Federal Reserve Governor Jay Powell 

recently commented, "What the current law and rule do is effectively force you to 

look into the mind and heart of every trader or every trade to see what intent is. Is 

it proprietary trading or something else? If this is the test you set for yourself, you 

are going to wind up with tremendous expense and burden."58 The result of tying 

proprietary trading to intent has been regulation that is overly complex and compliance programs that are costly to implement and administer59 and often inadvertently capture the beneficial activities that are expressly permitted by the Volcker 

Rule. 60 

Quantifj,ing Intent? 

Recall that the Final Rule requires banking entities to report quantitative 

metrics on each trading desk.61 Regulators have been collecting that data since July 

2014, one year prior to the Volcker Rule's effective date. When adopting the Final 

Rule, the regulators committed to "evaluate the data collected during the compliance 

period both for its usefulness as a barometer of impermissible trading activity and 

excessive risk-taking and for its costs."62 To date, the regulators have not announced 

the status of any analysis or any results, nor have they commented on how the data 

may be used to enforce compliance with the Rule. The silence is troubling, and may 

reflect the fact that the data is overwhelming, varying across asset classes, and from 

57 See supra notes 24-27 and accompanying text. 58 Steve Matthews, Ff>d's Powell Urges Congress to Take Another Look a/ Volcker Rule, BLOOMBERG.COM 

(Jan. 7, 20 17). 59 The Financial Stability Oversight Council (the ··FSOC") studied and provided recommendations on the 

Volcker Rule before the Final Rule was adopted. See FIN. STABILITY OVERSIGHT COUNCIL, STUDY & 

RECOMMENDATIONS ON PROIIIBITIONS ON PROPRIETARY TRADING & CERTAIN RELATIONSHIPS WITH 

HEDGE FUNDS & PRJV ATE EQOTTY FUNDS (20 II) (the "FSOC Study"). Among other things, the FSOC 

Study noted that banking entities would be required to develop new regulatory and supervisory tools beyond 

their current risk management systems. See id. at 31 (noting that current risk management frameworks, 

because they are designed principally to limit losses, will need to be redeveloped to prioritize compliance 

with the Volcker Rule's prohibitions). Regulators, as well, need significant resources to hire and train stalT 

with quantitative and market expertise, to develop and analyze data, and to review infonnation in order to 

identify prohibited activities. See id. at 43-44. In addition, banking entities are now required to collect and 

test new data, including mctrics to assess industry-wide trading on a desk-by-desk basis. See id. at 42. 60 See infi-a notes 64-65 and accompanying text; see also Greenwood et al., supra note t 5, at 11-12. 61 See supra notes 37-41 and accompanying text. 62 79 Fed. Reg. 5772. 

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firm to firm and even desk to desk, suggesting that the Volcker Rule as implemented 

by the regulators is simply too complex for the regulators to effectively monitor.63 

Romulus and Remus: Proprietary Trading and Market-Making 

A particular difficulty has been distinguishing permissible activities, like 

market-making, from impermissible proprietary trading. As the Voleker Rule's 

notice of proposed rulemaking deseribed:64 

lt may be difficult to distinguish principal positions that appropriately 

support market making-related activities from positions taken for shortterm, speculative purposes. In particular, it may be difficult to determine whether principal risk is been retained because (i) the retention of 

such risk is necessary to provide intermediation and liquidity services 

for a relevant financial instrument or (ii) the position is part of a 

speculative trading strategy designed to realize profits from price 

movements in retained principal risk. 

In other words, although the intentions around market-making and proprietary 

trading are different, the activities are difficult to distinguish operationally. "Market 

making is inherently a form of proprietary trading. A market maker acquires a 

position from a client at one price and then Jays off the position over time at an 

uncertain average price. The goal is to 'buy low, sell high.' In order to accomplish 

this goal on average over many trades, with an acceptable level of risk for the 

expected profit, a market maker relies on his expectation of the future path of market 

prices."65 

One requirement for market-making is meeting reasonably expected nearterm customer demands.66 But predicting future demand can be difficult, and so 

market-makers may hesitate to acquire financial instruments in advance of an anticipated (but not guaranteed) rise. Likewise, it may be difficult to respond to a rapid 

pop-up in demand that exceeds a banking entity's internal compliance metrics. A 

trade that exceeds those limits "should not be permitted simply because it responds 

"'See Lee Reiners, Killing the Volcker Rule, TilE FlNREG 8LOG (Jan. 11, 2017). To the extent regulators 

do adopt metrics to separate permissible from impermissible activities, they must be sensitive to differences 

across firms that potentially could result in arbitrage opportunities as well as the need to adjust those 

metrics over time in order to reflect the changes in customer-oriented trading that are likely to occur. 64 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, 

Hedge Funds and Private Equity Funds, 76 Fed. Reg. 68,846,68.869 (Nov. 7. 2011). 65 Duffie, supra note 16. at 3-4. 66 12 U.S.C. § l85l(d)(l)(B). 

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to customer demand. Rather, a banking entity's compliance program must include 

escalation procedures that require review and approval of any trade that would 

exceed one or more of a trading desk's limits, demonstrable analysis that the basis 

for any temporary or permanent increase to one or more of a trading desk's limits is 

consistent with the requirements of this near term demand requirement and with the 

prudent management of risk by the banking entity, and independent review of such 

demonstrable analysis and approval."67 As a result, market-makers are likely to find 

it difficult to respond to rapid rises in customer demand. And dealers who fear violating the Volcker Rule may choose to forgo legitimate market-making because they 

are unable to properly manage their inventory. Ambiguity as to what is legal marketmaking and what is prohibited proprietary trading may push banking entities toward 

more conservative trading strategies.68 

The result is less market liquidity. In fact, a recent study concluded that bond 

market liquidity around ratings downgrades has deteriorated following adoption of 

the Volcker Rule. Alarmingly, the deterioration around those events has been as 

high during the post-Volcker Rule period as it was during the 2008 financial crisis. 

Consequently, the Volcker Rule may have serious consequences for the functioning 

of the bond markets during times of stress, precisely when liquidity is needed the 

most.69 

Of course, entities not subject to the Volcker Rule may step in as marketmakers. It is unclear, however, whether non-Volcker Rule dealers will be able to 

commit sufficient capital to make up the shortfall. 70 Hedge funds, as investors, may 

be subject to the same market fluctuations that their counterparties hope to mitigate, 

meaning that they are more likely not to buy or sell instruments at the time a marketmaker is most needed. The same is true for insurance companies and asset managers 

who, as investors, are not traditionally in the business of making a market in the 

instruments in which they invest. 

67 79 Fed. Reg. 5612. 68 See Duffie, supra note I 6, at 4. 69 See Bao et al.. supra note 16, at 29. The Division of Investment Management of the Securities and 

Exchange Commission also noted changes in the bond markets following adoption of the Volcker Rule: 

"This apparent reduction in market-making capacity may be a persistent change, to the extent it is resulting 

from broader structural changes such as fewer proprietary trading desks at broker-dealers and increased 

regulatory capital requirements at the holding company level. A significant reduction in deal marketmaking has the potential to decrease liquidity and increase volatility in the fixed income markets." Securities and Exchange Commission, Division of Investment Management, IM Guidance Update (Jan. 2014). 70 See id. at 23 ("Vo!cker-affected dealers tend to be larger than non-Volcker dealers and handled 93% of 

dealer-customer volume around stress events in the pre·[ financial] crisis period.''). 

-15-
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27369.173

To date, this new participation has not been enough to offset the decreased 

liquidity in bond trading.71 The resulting increase in investors' execution costs and 

the loss of market liquidity means that investors will demand higher yields on new 

bond issuances. The challenge is not how much capital is raised, but the incremental 

cost to issuers of raising it. The higher cost of new capital affects Main Street as 

much as it affects Wall Street. As a result, "all investors and savers will 

be affected. And investors and savers are not just large, complex financial institutions, but include workers whose pension funds and 40I(k)'s invest in these securities. Families will have less access to credit and thus less ability to buy homes, 

cars, and put children through college. Businesses will find it harder to borrow, 

which will make it harder for them to do research and development, make 

capital investments, and create jobs. Asset prices will be pushed down, which will 

punish investors and savers. It is not clear what problem this rule is meant to solve, 

making it likely that this aspect of the new regulatory regime for large, complex 

financial institutions strikes a poor tradeoff between the gains from the regulation 

and the impairment to markets and overall economic vitality." 72 

A Few Words About Funds 

The Volcker Rule restricts banking entities from sponsoring or investing in 

private equity funds and hedge funds, except under limited circumstances. The 

concern was that banking entities could continue to engage in proprietary trading 

through affiliated funds without those provisions. The restrictions were also meant 

to address reputational and market pressures that firms felt during the financial crisis 

to make investors whole or invest more capital into funds they had sponsored. 73 

In defining hedge funds and private equity funds, the Volcker Rule references 

two exemptions, §§ 3(c)(l) and 3(c)(7), from the definition of "investment 

company" under the Investment Company Act of 1940. 7

.j Although most hedge 

71 See id. at 29. 72 Phillip L. Swage!, Detecting and Avoiding Future Problems in the New Regulatory Regime (Dec.8, 

2011), http://blogs.rhsmith.umd.edu/financialpo1icy/2011/12/ (excerpt from the testimony of Phillip 

L Swage I, Fellow at the University of Maryland Center for Financial Policy and former Treasury official, 

before the Comm. on Banking. Housing, and Urban Aflitirs. Subcomm. on Fin. lnst. and Consumer 

Protection, Dec. 7, 2011). Professor Duffie at Stanford has raised a similar concern. "Homeowners. 

businesses, and some municipalities would face higher borrowing costs. Firms would face higher costs for 

raising new capitaL These increased costs would occur directly in the form of higher price impacts at the 

point of tinancing. and indirectly from the lower appetite of investors to own securities that would trade in 

thinner and more volatile secondary markets." Duffie, supra note 16. at 19. 73 See BARR, JACKSON & TA!!YAR, supra note 42, at 685. 74 12 U.S.C. § !85l(h)(2). 

-16-
215 


27369.174

funds and private equity funds rely on one of those exemptions, the references are 

overbroad and inadvertently pick up a range of vehicles outside what was originally 

anticipated. 75 

To the extent the ban on proprietary trading is repealed, the limitation on 

investing in or sponsoring hedge funds and private equity funds should be repealed 

as well. After all, as described above, short-term proprietary trading was not the 

culprit leading to the financial crisis/6 and removing that activity from banking 

entities has not removed its influence on banks.77 To the extent there are concerns 

that a bank will bail out a sponsored fund, there are more direct ways to address this 

possibility. For example, a simple ban on making customers whole (such as appears 

in some countries, like Japan) will be sufficient to bar banking entities from propping 

up the funds that they sponsor. 

Conclusion 

As I noted at the outset, the Volcker Rule addresses the wrong problem in the 

wrong way. There is certainly an argument for regulating risky trading activities. 

But the problems leading up to the financial crisis did not arise from short-term 

proprietary trading, and so - particularly in light of the Volcker Rule's substantial 

costs it is unclear why banning that activity from banking entities is necessary. 

Doing so inadvertently sweeps up a number oflegitimate trading businesses and, as 

a result, potentially raises the cost of new capital. 

The Volcker Rule should be replaced. In its place, there are other ways in 

which risk-taking can be regulated. A robust focus on risk-based capital requirements, designed to boost the amount of loss-absorbing common equity within a 

financial firm, may be the more appropriate tool. Imposing strict capital requirements on a banking entity's trading book, without trying to parse the difference 

between proprietary trading and market-making, will more efficiently accomplish 

the same ends- namely, a reduction in risk taking that the Volcker Rule originally 

set out to do. 

75 See BARR, JACKSON & TAllY AR. supra note 42, at 685-86. 76 See supra notes 2-6 and accompanying text. 

See supra notes 42-56 and accompanying text. 

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The Honorable Bill Huizenga 

Chairman 

Subcommittee on Capital Markets, 

Securities, and Investment 

2129 Rayburn House Office Building 

Washington, DC 20515 

March 28. 2017 

The Honorable Carolyn B. Maloney 

Ranking Member 

Subcommittee on Capital Markets, 

Securities, and Investment 

4340 Thomas P. O'Neill. Jr. Federal Building 

Washington. DC 20515 

Dear Chairman Huizenga and Ranking Member Maloney: 

On behalf of our nation's venture capital investors and the entrepreneurs they support, l 

write to express our thoughts on the Volcker Rule which will be the subject of a hearing before 

your subcommittee on Wednesday, March 29,2017 entitled, "Examining the Impact of the 

Volcker Rule on the Markets, Businesses, Investors. and Job Creators." 

As Congress undertakes a thorough review of the Volckcr Rule, we urge you and your 

colleagues to explore the impact of the rule on capital formation for startups. particularly in the 

Midwest and other areas of the country not typically associated with startup activity but 

nevertheless vital to the health of our national entrepreneurial ecosystem. Investing in venture 

capital does not create systemic risk. yet the V olckcr Rule has served to drive out investment in 

many venture capital funds \VIJO are not big enough to receive investment from major 

institutional pools of capitaL This is investment that could have been put to use building new 

companies and cr<:ating new job opportunities across the U.S. 

Young companies, many of which are supported by venture capital investment and 

mentorship, create an average of 3 million new jobs a year and have been responsible t<.x almost 

all net new job creation in the U.S. in the last forty years. From Fed EX to Gcnentech. startup 

entrepreneurs have fueled economic growth and expanded opportunities for the American 

worker. The American entrepreneurial spirit is key to expanded economic opportunity in the 

U.S., but is not being fully realized due to the unintended consequences of the Volcker rule on 

venture capital fund formation. Without modifications. the Volcker Rule will stand in the way of 

interested investors deploying capital to venture capital funds across the country who can use 

that capital to support the growth of the next generation of innovative American companies. 

Whether intentional or not, the Volcker Rule has significantly hurt venture capital fund 

formation. reducing opportunities for young startups across the U.S. to receive the investment 
217 


27369.176

and support they need to take their companies to the next level. As your subcommittee 

continues to explore modifications to the Volcker Rule, NVCA and our over 300 members firms 

stand ready to work constructively with you on commonsense areas of reform. Thank you for 

your attention to this important matter. We are encouraged by the conversation and excited to 

work with you on solutions to address the problem. 

Sincerely, 

Bobby Franklin 

President and CEO 

27369.177

Federal Reserve December 2016 St

Report 

''Our main finding is that the 

Volcker Rule has a deleterious 

effect on corporate bond liquidit

and dealers subject to the Rule 

become less willing to provide 

liquidity during stress times." 

27369.178

Federal Reserve December 2016 St

Report 

111ndeed, we find the disturbin

result that illiquidity in stress 

periods is now approaching 

levels seen during the financia

crisis." 
220 


27369.183

HFSC CM Subcommittee Hearing entitled 

"Examining the Impact of the Volcker Rule on Markets, Businesses, Investors, and Job Creators" 

March 29, 2017 

Questions for the Record from Congressman Huizenga (R-MI) 

Mr. Ronald J. Kruszewski 

I. In your testimony before the Committee you discussed the impact that the Volckcr Rule has 

on liquidity in the tinancial markets. You state: "Since the financial crisis, several rules have 

been implemented which have significantly increased the quantity and quality of the capital and 

increased internal liquidity of our financial institutions, most more stringent than internationally 

agree standards. But the Volcker Rule doesn't do anything to increase capital or internal liquidity 

at firms, but it does impact firms' ability to make markets and provide liquidity, particularly in 

times of stress, as the Federal Reserve itself has written." 

Based on this, can you elaborate on the impact the Volcker Rule has on liquidity and how this 

impact could be exacerbated during times of stress? 

You briefly discuss the Federal Reserve report, can you elaborate on the data that they provide 

on how liquidity has been impacted? Is there any additional data that demonstrates how liquidity 

has been impacted? 

Response: 

;\ key function of financial intern1cdiarics is proYiding m;ltkct n1aking sen-ices to cu~torncrs. 

Rc:;tricting such sen· ices through cwcrly con1plcx and intent~based rules lessens the ability of 

flnancial internwdiaries to proYide rhis necessary SC!Ticc to custon1ers ... As noted throughout t11y 

written testimony, the Volckcr Rule lessens licjuidity-particularly in c"·cr~thccounter (OTC) 

tnarkct~-·--b~- creating a con1pliancc structure that forces tlrn1s. to take an oYeri:- conscrYatiYc 

approach C'\-e!l to the pern1itted acti,-irics such as 1narkct tnaking to retnain ·within the connJsJJW 

p;muncrcrs of the Rule. The Rule presumes that all acti,·ity is prohibited trading 

then requires tirn1s to prn'(:e that the acti,-ity n1ccts the refjuircn1cnts of an or an 

exen1ption. The prcscriptin: conditions f()r cnga~ing in n1arket n1aking h,,,-c led n1any financi:1l 

institutions subject to tl1e Rule to scale hack their operations as \\·ell ;-ts inYentorics of 

financial asset:' to rcrDain 'vVilhin tbt: Rule's snict _\s I've noted, rnarkz.::t lnakers pro\'idc 

EtJuidity by and holding infrequently traded financial products in inn~nrory, granting 

bu\'crs and in transactions that tna\· not be othen,·isc aYaiJabk. . . 

\\"hilc \\T arc seeing the impact ofYolcker in the current benign trading en,·ironn1cnt through 

reduced in,·cntories of ---n1ost notably---corporate bonds, a stressed tnarkct situation will only force 

finns to further wlthdra,,- fron1 acriYc custon1cr facilitation actiYitics. l)uring tin1es of stress. 

financial imtitutions will be disincentiYizcd from proYiding liquidity, precisch· \\·hen so could 

stcn1 a nascent crisis, if in a stressed cn'i-iroru11ent subject thcn1 to cornplex anJ 

ncgatin· presumptions. The effect introduced bY the \'olckcr Rule could cause problems in 
221 


27369.184

one part of the financial sector to 

haYe bct>n absorbed b\~ the tnarket 

l}Uick.ly to the broader econon1y when it othcnYisc could 

pro-cyclical effect that could cx;lcerbatc any crisis. 

The Federal ResenT report illustrates the impact the Volckcr Rule has hac! alreach- on liguidity 

conditions in the OTC markets and illustrates, in a real-world situation, concerns around the 

during ~tressed rnarkct conditions. By looking at a narrow set of circutnstancesof specific corporate bonds frcnn it1\-estrncnt grade to spcculati,-e-gradc-thc 

Federal Rcscrw report could assess Volcker Rule-specific impacts. The conclusion of the report 

was clc~1r: ·'bond liquidity· deterioration around rating downgrade:-;. has worscncJ follO\\-ing the 

implcmcmarion of the \'olckcr Rule.'' !\lost the data that formed the basis of the 

is nor publich· anilable) allowed an analrsis that was able to isolate the impact of 

Rule on this market b,- stripping out the effects of Basel Ill and CC\R on the acti,·itics 

of cntitic~ subject ro the Volcker Rule. 

2. During questioning, you commented on the charts that Ms. Maloney put up during her opening 

statement: "I believe that this very debate and the -- and the confusion in this debate was 

highlighted by putting up charts on VaR, which is value at risk-- and then using that to make an 

argument about Volckcr." 

·'I find it to be apples and oranges at best. VaR is risk on the balance sheet. And what we're 

talking about is the mechanisms to provide liquidity in the plumbing of capital markets. And 

Volcker absolutely hinders that." 

What is the purpose ofVaR? Is it meant to measure liquidity? 

Ms. Maloney claimed that the two charts she displayed demonstrate that Volcker has not had an 

impact. Do you agree or disagree? How would you read the charts? 

RESPONSE: 

,\s I notccl during c1ucstioning, \'aR is not a measure of liquiditY and adcls nothing to a discussion of 

the impact of the Yolckcr Rule on market lic1uiditT. YaR is a risk measure_ not a liguiditr mcamrc. 

Indeed, the gcneral1y accepted definition of\'aR docs not look at liquiditY at all: \'aR is a statisticd 

tcchniLJl.W U:'ed lo n1easure and quantify the le\Tl of financial risk \\·ithin a finn or inYesnncnt 

portfollo O\"tT tin11..:. Thu:::;~ tlw charts shown by Congresswon1an )vlaloncy· show;~ steadiness in risk 

oYer the period sun· eyed (ic, n C}Wll1lificatjon of potential losses o\ver a gi\~cn ti1nc-fran1c) \Yhilt:~ 

s:1ying nothing about willingness to pro,-iJc lic1uidity through tnarkct n1aking. ~\higher or a lower 

\'aR O\'t'r tirne tdls us ycry· liLLie about a finn's "\Vi1lin~nc:::s to n1ert a custorner's e:;pecuuions of 

immcdiac\· and ;n-ailabilitY. ,\s the Federal Rcsen-e report bas shown, firms ha\-e, in iact, been less 

\villing, particularly during a stress cTcnt, to pruddc the necessary custon1cr facilitation since 

\'olckcr. 

I bclicn' that the charts fail to illuminate ;mything around the impact of\'olcker on either the 

ri:-:kincs..;:, of the finn-:' acriviric;:; or the willingnc:;s tu cuntinuc cu~rnn1cr facihr-.?..tion acti..-irics. and 
222 


27369.185

theref(,rc bil to illuminate anything around the impact ofVolckcr on market liquiditY. The charts 

rct1ecl the riskiness of the trading desks~ position::; and the potential loss that could be taken. ~one 

of this indicates a wi.Uingncss to provide immediacy or to keep in inventory corporate bonds for 

CUSt0111CfS. 
223 


27369.179

Hearing entitled "Examining the Impact of the Volcker Rule on the Markets, Businesses, Investors, and 

Job Creators" 

Capital Markets, Securities, and Investment 

March 29, 2017 10:00 AM in 2128 Rayburn HOB 

Question for the Record for Marc Jarsulic 

Submitted by Rep. Keith Ellison 

In recent months, Republicans have repeatedly cited a September 2016 Federal Reserve staff study, 

which examined a sample of corporate bonds that were downgraded to junk status and sold between 

January 2006 and March 2016. Based on the increased intermediation costs for these sales during times 

of issuer stress, the authors found "the Volcker Rule has a deleterious effect on corporate bond liquidity 

and dealers subject to the Rule become less willing to provide liquidity during stress times." However, 

as critics of the study have pointed out, the implications of the paper for liquidity in the overall 

corporate bond market are limited. 

Will you discuss the limits of the study and how it came up with a conclusion contrary to the vast 

majority of research on the Volcker Rule's impact on corporate bond market liquidity? 

Response by Marc Jarsulic 

Vice President, Economic Policy 

Center for American Progress 

Representative Ellison, I appreciate the opportunity to respond to your question. As you correctly point 

out, the Federal Reserve staff working paper by Bao et al. (2016) on the Volcker Rule's impact on market 

liquidity came up with a conclusion counter to a wide array of research on the subject1 1t is useful then, 

to first briefly outline the substantial evidence on the current state of corporate bond market liquidity 

before turning to the results of the Bao et al. study. 

Several different widely used indicators of market liquidity show that the corporate bond market is as 

liquid, and according to some indicators more liquid, than prior to the financial crisis. The bid-ask spread 

1 Sao, Jack, Maureen O'Hara, and Alex Zhou, ''The Volcker Rule and Market-Making in Times of Stress," Finance 

and Economics Discussion Series, Division of Research & Statistics and Monetary Affairs, Federal Reserve Board, 

December 2016, available at https://www.federalreserve.gov/econresdata/feds/2016/files/2016102pap.pdf. 
224 


27369.180

and price impact of trades-two frequently used measures of market liquidity-are both very low 

compared to pre-crisis levels, after spiking significantly during the financial crisis. While trade size has 

not recovered to pre-crisis levels, the decline in the price impact of trades suggests that smaller trade 

sizes are not a reflection of decreased liquidity. Even though the corporate bond inventories at brokerdealers have fallen sharply since the financial crisis, analysts at Goldman Sachs have pointed out that 

private label mortgage backed securities were counted as corporate bonds in the inventory calculation. 2 

The precipitous drop in private label mortgage backed securities accounts for the drop in dealer 

inventories following the crisis and does not reflect a steep drop in traditional corporate bonds. 

Based on these and other data, the general conclusion of several studies is that 

there has not been a significant reduction in corporate bond liquidity between the pre-crisis 

and post-crisis periods-' Moreover, researchers at the Federal Reserve Bank of New York also 

determined that liquidity risk, the extent to which corporate bond market liquidity is vulnerable to 

market shocks, is below pre-crisis levels' 

The conclusion presented in the Federal Reserve staff working paper from Bao et al. runs counter to the 

evidence cited above. The paper asserts that the corporate bond markets have less liquidity under 

conditions of stress in the post-Volcker period, relative to the period before the financial crisis. 

However, the statistical evidence which supports this conclusion is contradicted by a statistical 

robustness check that is also reported in the paper. Hence the paper really presents no good reason to 

believe that liquidity has declined. 

2 Goldman Sachs Credit Strategy Research, "Primary dealer data overstate decline in corporate bond inventories," 

The Credit Line, March 17, 2013. 3 Adrian, Tobias et al., "Market Liquidity after the Financial Crisis," Federal Reserve Bank of New York Staff Reports, 

October 2016, available at 

https:(/www.newyorkfed.org/medialibrary/media/research/staff reports/sr796.pdf?la=en; Mizrach, Bruce, 

"Analysis of Corporate Bond Liquidity," FINRA Office of the Chief Economist Research Note, December 2015, 

available at https://www.finra.org/sites/default/files/OCE researchnote liquidity 2015 12.pdf; Trebbi, Francesco 

and Kairong Xiao, "Regulation and Market Liquidity," Working Paper, University of British Columbia, 2016, available 

at http://faculty.arts.ubc.ca/ftrebbi/research/tx.pdf; Bessembinder, Hendrik et al., "Capital Commitment and 

Illiquidity in Corporate Bonds," Working Paper, Arizona State University and Southern Methodist University, 2016, 

available at http://finan ce. bus. u tk.ed u/UTSMC/ documents/Bill Maxwell P apertopresent0420 16. pdf. 4 Adrian, Tobias et al., "Has Liquidity Risk in the Corporate Bond Market Increased?" 

liberty Street Economics, Federal Reserve Bank of New York, October 6, 2015, available at 

http:/llibertystreeteconomics.newyorkfed.org/2015/10/has-liguidity-risk-in-the-corporate-bondmarketincreased.html. 
225 


27369.181

The authors consider liquidity when bonds are under stress, using regression analysis to show that 

immediately after large credit downgrades, the price declines experienced by corporate bonds are larger 

in the "Post-crisis" (May 1, 2009- July 20, 2010), "Post-Dodd Frank" {July 21, 2010- March 31, 2014), 

and "Post-Volcker" (April1, 2014- March 31 2016) periods when compared to the "pre-Crisis" period 

(January 1, 2006-June 30, 2007). They find these results are statistically significant at the 5 percent 

confidence level. They also find that the price decline measure in the "Post-Volcker" period is greater 

than in the immediately preceding "Post-Dodd Frank" period, and not statistically significantly different 

from the effects in the "Crisis" and "post-Crisis" periods. This, they say, means that bond markets have 

less liquidity under conditions of stress, Post-Volcker, in comparison to the pre-Crisis period. 

However, their own regression analysis of the impact of the same downgrades on the bid-ask spread for 

these bonds tells a different story. The bid-ask spread is a standard measure of asset market liquidity. 

And when Bao et al. measure liquidity under stress using the bid-ask spread as the independent variable 

in their regressions, the statistical support for the claim of deteriorating liquidity in the Post-Volcker 

period vanishes. 

Using this standard liquidity measure, Bao eta!. cannot reject the hypothesis that there is no impact of 

bond downgrades on the bid-ask spread for any time period other than the Crisis period at the 5 percent 

confidence level. That is, none of the coefficients that measure impact in subsequent periods is 

statistically significantly different from zero at the 5 percent confidence level. 5 Moreover, the difference 

between the post-Dodd Frank and post-Volcker coefficients is no longer statistically significant at the 5 

percent confidence fevel. 6 

Since the bid-ask spread is a standard measure of asset market liquidity, a detached observer would 

conclude that the authors' results do not provide consistent statistical support for the claim that 

liquidity has declined, even when restricting attention to bonds that have experienced significant ratings 

downgrades. The regression results for two measures of liquidity point to different conclusions-which 

is exactly why economists look for robustness when analyzing policy changes. 

5 The relevant statistical results are in Bao et al. {2016), Table 5. 6 Sao et al. {2016), p. 19. 
226 


27369.182

In addition, there are important methodological issues the that authors of this paper overlook in their 

analysis of price impacts. For example, the regression analysis of price impacts does not adequately 

control fort he composition of the sample in different time periods, a concern that is amplified because 

the bid-ask spread analysis points in a different direction. We know that many of the firms downgraded 

in the study's post-2014 sample (at least 19 out of 55) are tied to the oil and gas sectors, which were 

under considerable stress during this period-' Hence the observed bond price declines may be a function 

of large embedded losses in oil and gas bonds that are not fully captured by changes in ratings, rather 

than diminished market making capacity. There should be an explicit control for this and other sectoralrelated events, to more accurately account for that fraction of price changes that have nothing to do 

with overall bond market liquidity. 

Moreover, the study does not take into account the reality that banks began to respond to the Volcker 

Rule well before 2014. Banks began reducing proprietary trading well before that, as news reports from 

2010 and 2012 indicate. 8 As a consequence, price changes in the period defined as "Post-Dodd Frank," 

actually correspond to a period in which the Volcker Rule had an effect on the behavior of market 

participants. So any differences in the regression coefficients estimated for the "Post-Volcker" and 

"Post-Dodd Frank" periods cannot be attributed unambiguously to the operation of Volcker Rule. 

Hence, based on evidence presented by the authors themselves, and on consideration of 

methodological issues they did not address, there is little reason to conclude that this paper provides 

sound evidence that bond market liquidity has been negatively affected by the operation of the Volcker 

Rule. 

Thank you, Representative Ellison for the chance to respond to your question on this important topic. 

7 Sam Goldfarb, "Moody's Ratings Downgrades Become Another Thorn in Oil Patch," The Wall Street Journal, April 

17, 2016, available at https:/(www.wsj.com/articles/moodys-another-thorn-in-oil-patch-1460937835. 

8 For example, see Tommy Wilkes, "Banks move high risk traders ahead of U.S. rule," Reuters, April3, 2012, 

available at http://www.reuters.com/articl~-volckerrule-trading-idUSBRE8320GS20120403; Nelson Schwartz, 

"Bank of America Cuts Back Its Prop Trading Desk," The New York Times, September 29, 2010, available at 

https://dealbook.nytimes.com/2010/09/29/bank-of-america-cuts-back-its-prop-trading-desk/; Kevin Roose, 

"Citigroup to Close Prop Trading Desk," The New York Times, January 27, 2012, available at 

https://dealbook.nytimes.com/2012/01/27 /citigroup-to-close-prop-trading-desk/. 
227 


27369.186

\!Congre£is of tfJe (!Jltdteb $tates 

i[)ousc af i~rprcstntatrllcs 

i!ltl.lshmgton. ID<C 20515-3212 

August 29,2016 

The Honorable Janet L Yellen 

Chair 

Board of Governors of the Federal Reserve System 

20'h Street and Constitution Avenue NW 

Washington, DC 20551 

The Honorable Martin l Gruenberg 

Chairman 

Fedeml Deposit Insurance Corporation 

550 17'h Street NW 

Washington, DC 20429 

The Honomble Timothy Massad 

Chairman 

U.S. Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21"' Street NW 

Washington, DC 20581 

The Honorable Thomas l Curry 

Comptroller of the Currency 

Office of the Comptroller of the Currency 

250 E Street SE 

Washington, DC 20219 

The Honorable Mary Jo White 

Chair 

Securities and Exchange Commission 

1 00 F Street NE 

Washington, DC 20549 

Dear Chair Yellen, Comptroller Curry, Chairman Gruenberg, Cbair White, and Chairman 

Massad: 

I am writing with regard to the ongoing implementation of the Volcker Rule, and to request an 

update on the quantitative trading metrics that your agencies have been collecting pursuant to the 

rule. As you know, the Volcker Rule prohibits U.S. banking entities from engaging in proprietary 

trading, while permitting legitimate market-making and hedging activities. 1 The prohibition on 

proprietary trading took effect on July 21, 2015. 2 

To help the agencies distingnish permitted market-making and hedging activities from prohibited 

proprietary trading, the final rule requires banks with significant trading operations to report a 

1 See 12 C.F.R. 248.3(a) (prohibiting banks from engaging in proprietary trading); 12 C.F.R. 248.4(b) (allowing 

banks to engage in "market making~related activities"); 12 C.F.R. 248.5 (allowing banks to engage in "riskmitigating hedging activities"). The rule also allows banks to engage in legitimate underwriting activities. See 12 

C.F.R. 248.4(a) (allowing banks to engage in "underwriting activities·'). 

" Board of Governors of the Federal Reserve System, Board Order Approving E:r:tension of Conformance Period 

(December lO, 20 13). 
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27369.187

series of quantitative trading metrics to the regulators.3 Specifically, the final rule requires these 

banks to report-· for each trading desk- seven different quantitative metrics: ( l) risk and 

position limits and usage; (2) risk factor sensitivities; (3) value-at-risk (VaR) and stress VaR: (4) 

comprehensive profit and loss attribution; (5) inventory turnover; (6) inventory aging; and (7) 

customer facing trade ratios.4 These metrics are intended to help the agencies identifY trades that 

warrant further scrutiny in order to determine whether a bank ha~ engaged in prohibited 

proprietary trading. 5 

The agencies have been collecting these quantitative metrics on the trading activities of large 

banks since July 2014.6 Thus, the agencies currently have nearly two years of quantitative 

trading data, spanning periods both before and after the effective date of the proprietary trading 

ban. 

l believe that these quantitative trading metrics can provide important information not only about 

the efllcacy of the Volcker Rule, but also about the general trading activities of U.S. banks, and 

the degree to which these trading activities have changed over the past two years. For example, 

there has been a vigorous debate about the liquidity of certain U.S. fixed-income markets, such 

as coryorate bonds, and about whether the liquidity of these markets has deteriorated in recent 

years. Data on the inventory turnover. inventory aging, and customer-facing trade ratios in the 

fixed-income market-making units of the large banks could prove particularly informative in this 

debate. 

Moreover, the agencies stated in the final rule that they intended to '·evaluate the data collected 

during the compliance period both tor its usefulness as a barometer of impermissible trading 

activity and excessive risk-taking and for its costs."8 The agencies indicated that they would 

"revisit the metrics and determine, based on a review of the data collected by September 30, 

2015, whether to modify, retain or replace the metrics."9 

1 See 12 C.F.R. 248, Appendix A. 

4 /d. 

'See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge 

Funds and Private Equity Funds, 79 Fed. Reg. 5765 (January 31, 2014) (noting that the quantitative metrics '·will be 

used to monitor panems and identify activity that may \Varrant further review:'). 

"'See Board of Governors of the Federal Reserve System, Folcker Rule: Frequent(v Asked Queslions (last updated 

March 4. 2016) (noting that banks had to start recording daily metrics on July 1, 2014, and had to report these daily 

metrics to the 2014). available at 

e.g.. Settlements~ Committee on the Global Financial System, Fixed Income lt4arker 

Liquidity (January 21, 20 16): JPMorgan. US Fixed Income Weekly: U.S Corporate Bond .Harker Liquidity- An 

Upda!e (April 4. 20 15): Blackrock. Addressing Market Liquidity (July 10. 20 15); Bare lays. The Decline in Financial 

Market Liquidity (June 16, 20 15): Citi, The Liquidi(!' Paradox: The More Liquidiiy Central Banks Add !he Less 

There Is in Markets (May 4, 2015): see also Richard Barley, "Liquidity Haunts Corporate-Bond Markets." 

I I, 20 15), available !]l~~.~~~~;~;,;;~~;;t~~~~,:;;~~~~£i~;~~;~~;~~~~~~·~c': thli!iJ:lllill:K£1~:)~2,.'J:.0j'J.:J.IJ.i>ii!P;~\;I;:l.IJl)\"'Jl.ll\: Eric P 

·· Financial Times (April 6. 20 16), uvailable al 

'79 Fed. Reg. 5772 (January 31.2014). 9 Id; see also id at 5765 ("The Agencies will review the data collected and revise this collection requirement as 

appropriate based on a review of the data collected prior to September 30, 20 15.""). 
229 


27369.188

Accordingly, I respectfully request an analysis of the quantitative trading metrics collected 

pursuant to the Volcker Rule --properly tailored to protect confidential supervisory information 

that addresses the following issues: 

• The extent to which the data showed significant changes in banks' trading activities 

leading up to the July 21, 2015 effective date for the prohibition on proprietary trading. 

To the extent that the data did not show a significant change in the banks' trading 

activities leading up to the July 21, 2015 effective date, whether the agencies believe this 

is attributable to the banks having ceased their proprietary trading activities prior to the 

start of the mctrics reporting in July 2014. 

• Whether there are any meaningful differences in either overall risk levels or risk 

tolerances- as indicated by risk and position limits and usage, VaR and stress VaR, and 

risk factor sensitivities for trading activities at different banks. 

• Whether the risk levels or risk tolerances of similar trading desks are comparable across 

banks reporting quantitative metrics. Similarly, whether the data show any particular 

types of trading desks (e.g., high-yield corporate bonds, asset-backed securities) that have 

exhibited unusually high levels of risk. 

• How examiners at the agencies have used the quantitative metrics to date. 

• How often the agencies review the quantitative metrics to detem1ine compliance with the 

Volcker Rule, and what form the agencies' reviews of the quantitative metrics take. 

• Whether the quantitative me tries have triggered further reviews by any of the agencies of 

a bank's trading activities, and if so, the outcome of those reviews. 

Any changes to the quantitative metrics that the agencies have made, or are considering 

making, as a result of the agencies' review of the data received as of September 30, 2015. 

• Anything else in the data that any of the agencies-- either individually or collectively 

consider to be notable or important from a policymaking perspective. 

The Volcker Rule's prohibition on proprietary trading is critically important, and I strongly 

support the agencies' efforts to implement this rule. I would appreciate a response no later than 

October 30, 2016. If you have any questions about this request, please contact Ben Harney on 

my staff at (202) 225-7944. 

Sincerely, 

Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

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