Thursday, January 6, 2011

Three-Tiered Obfuscation and Nullification of the Volcker Rule

It suddenly dawned on me that the regulations are not there to regulate. They are spelled out so that the participants - the industry (like financials) and politicians fed by the industry - can do everything and anything that is NOT written and the regulators can safely look the other way.

Case in point: the Volcker Rule (prop trading regulation) in the Dodd-Frank (or DONK) financial "reform" bill.

Financial Times reports:

US regulators want to use techniques pioneered in the fight against money-laundering to crack down on “proprietary trading” by banks as part of new financial reforms, according to bankers and officials.

The question of how to define trading done with banks’ own funds is one of the thorniest for the US authorities in the post-crisis regulatory overhaul as it is difficult to differentiate such activities from market-making on behalf of clients.

The “Volcker rule”, proposed by the former Federal Reserve chairman Paul Volcker and included in last year’s Dodd-Frank law, aims to reduce banks’ risk-taking by forbidding them from placing short-term trading bets.

Draft guidelines for the Volcker rule are being circulated among members of the Financial Stability Oversight Council, the body of regulators charged with defining the rules of the road for the financial system. Publication of a final version is planned in the next two weeks.

After months of internal discussions and talks with banks, which have mounted a vigorous lobbying campaign, regulators are leaning towards a “multi-tiered test” like those used to detect illegal money transfers.

The first tier would involve automated “tripwires” that alert banks’ compliance departments.

People involved in the talks said that, depending on the market and the trade, “tripwires” could be the length of time a trader holds a position, its size, riskiness, or other measurable criteria. In detecting money laundering, banks look at “filters” such as size and provenance of a transfer.

The second tier would see internal compliance and risk management departments quiz the trader on the nature of the position. Finally, regulators, that keep inspectors on banks’ premises, will also be able to see the “tripwires” and monitor both traders and compliance departments.

Banks are likely to welcome this approach, after arguing that a strict definition of proprietary trading based on one-size-fits-all metrics would have cut off liquidity to large swaths of global capital markets.

So, in summary, the three steps are:
  1. "Tripwires" - length of the trade, size, riskiness, and other measurable criteria to be automatically triggered;

  2. Bank's internal compliance and risk management departments ask the trader about the trade;

  3. Regulators may see the "tripwires" and monitor the bank.

I have to laugh out loud. They almost read like sort of a reverse-manual of what to avoid so as to prevent the "tripwires" from being triggered. Besides, how are they going to regulate traders when 80% the trades are done by HFT algo bots? Are they going to regulate only the carbon-based traders?

No wonder Wall Street banks are happy, and Mr. Volcker is leaving the White House.

But not to worry. Obama will be well-managed by his new handler, aka chief of staff, from J.P.Morgan Chase to restore confidence. CONfidence.


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