Rolling back some elements of the Volcker rule that target fixed-income markets might make headlines, sources said, but liquidity and trading costs won't improve in the corporate bond market because Basel III requirements aren't going away.
"I think people have misinterpreted the impact of the Volcker rule," said Anthony J. Perrotta Jr., CEO of TABB Group LLC, New York. "While the Dodd-Frank Act and the Volcker rule capture a lot of headlines, their impact on bond market liquidity and trading has been marginal relative to the capital adequacy requirements" of Basel III's liquidity coverage ratio. "You can repeal Volcker tomorrow and I am not certain anything would change, or banks would act differently."
Added Adam Sussman, head of market structure and liquidity partnerships at Liquidnet Holdings Inc., New York, "The Volcker rule isn't the be-all or end-all. On the institutional side, there's bigger fish to fry. The negative impact of Volcker is less on market making and liquidity and more on the entities — especially smaller banks — that were forced to comply with a rule over practices that they didn't engage in."
The Volcker rule, proposed by former Federal Reserve Board Chairman Paul Volcker as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, banned U.S. banks from certain speculative investments and most proprietary trading deemed not in their customers' interest. On June 13, the Treasury Department in a report called for "substantial amendment" to the Volcker rule, including not subjecting banks with less than $10 billion in assets to it, and removing proprietary trading restrictions on larger banks, allowing them to "more easily hedge their risks and conduct market-making activities."
On Aug. 2, the Office of the Comptroller of the Currency announced it was seeking public comment on possible changes to the rule. The OCC is one of five federal agencies charged with enforcing the rule, along with the Federal Reserve, the Commodity Futures Trading Commission, Federal Deposit Insurance Corp. and the Securities and Exchange Commission.
While the Volcker rule's reach extends to proprietary trading in a variety of securities, derivatives, commodity futures and options, fixed-income investors were particularly concerned when the rule was imposed that it would dry up secondary liquidity at a time when bonds were already hit by low rates. But Volcker as well as Basel III regulations in total have not stopped the availability of fixed-income securities on the secondary market. SEC economists in a report issued Aug. 8 said there hasn't been a decline in total issuance of securities since the enactment of Dodd-Frank. But they have made trading those securities much more expensive — particularly for hedging transactions commonly made by pension funds. Amending the Volcker rule won't change that.
"The jury is out whether the Volcker rule has any impact on markets," said Mr. Perrotta, "but there is no denying Basel III has reduced risk and leverage. The industry has reduced its capital leverage from roughly 30-to-1 in 2007 to about 7-to-1 in 2017."