After two and a half years of labour, the Volcker Rule finally tumbled into the world yesterday. And it looks like Canada can live with it. That’s because the final draft of the rule, which U.S. regulators officially backed yesterday, won’t affect U.S. trading in Canadian government bonds, a crucial exemption that wasn’t part of earlier incarnations.
“We’re happy,” says Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC), the securities industry’s national association. “We, the Bank of Canada, the Department of Finance had written letters and argued pretty strenuously that there should be a carve-out for those securities,” he recalls.
The Volcker Rule, part of President Obama’s Dodd-Frank Wall Street reform bill of 2010, prohibits U.S. banks and U.S. affiliates of foreign banks from engaging in proprietary trading. In other words, they can’t make bets with their own money rather than on clients’ behalf. It also bans banks from owning hedge funds. The idea is to prevent financial institutions insured by the U.S. government from taking financial gambles that could blow up and require taxpayer-funded bailouts. But while the initial draft of the rule contained an exception for U.S. Treasuries — considered safe enough to be exempted from the ban proprietary trading — it did not extend the same courtesy to non-U.S sovereign debt securities. U.S. banks, would be free to buy and sell U.S. government bonds but not any other country’s.
This sent off alarm bells north of the border. Twenty percent of Canadian government bonds are held by non-residents, with two-thirds of them being held residing with U.S. financial institutions, former Bank of Canada Governor Mark Carney noted in a letter to Fed Chairman Ben Bernanke. Carney, Finance Minister Jim Flaherty and Canada’s banks worried the the Volcker Rule could diminsh demand for Canadian government bonds, pushing up borrowing costs for Ottawa and the provinces. It could also make the the Canadian sovereign debt market more illiquid, potentially threatening the stability of the country’s financial system. British and Japanese officials were similarly apprehensive.
The version of the Volcker Rule unveiled on Tuesday shows U.S. regulators heeded to those concerns, says Russell. “We had made an argument for a carve-out, similar treatment to U.S. Treasuries,” he tells Canadian Business, “and that’s the result that we got.”
The critical revision likely means that the costs of playing by the new rules will be “fairly low” for Canadian financial institutions with U.S. operations, Russell adds. “The principal securities that are sold in the United States by our foreign affiliates would be Canadian government securities … that’s what most of the business is by far,” he notes. By contrast, U.S. banks are expected to face high compliance costs in order to ensure that their operations do not violate the tough restrictions. The rule demands that large U.S. banks institute a “detailed compliance program, including a required CEO attestation,” according to a fact sheet circulated yesterday by U.S. financial regulators.
Though the revised regulation appears far tougher than Wall Street would have liked, the carve-out for foreign government bonds represents a small defeat for Paul Volcker, the former Fed chairman and godfather of the namesake rule. Volcker, who personally advised President Obama to include the trading curbs in Dodd-Frank, had publicly dismissed concerns about banning U.S. banks from trading foreign government bonds, predicting that other financial players exempted from the new restrictions would step up to the plate. In the end, however, Canada seems to have won that argument.
Erica Alini is a reporter based in Cambridge, Mass., and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.