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Canadian banks’ murky disclosure makes Volcker Rule effect hard to read

A Bay Street sign, the main street in the financial district in Toronto.


Canadian banks are grappling with tough new rules that will fundamentally alter how they operate in the United States.

A new law, known as the Volcker Rule, was approved by five different regulators Tuesday, preventing banks from trading purely for their own profits, as well as from investing in hedge funds and private equity funds. The rule goes into effect on April 1, 2014, but the formal compliance date is delayed for a year to July 21, 2015.

It is hard to determine the extent to which Canadian banks are exposed. Their disclosures in lengthy financial documents are sparse, making it difficult to assess just how much so-called "proprietary trading" they participate in, or the amount of money they have invested in newly prohibited funds.

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This uncertainty is the very reason the Volcker Rule was put in place. While global banks have increased their disclosures since the financial crisis, their proprietary trading operations are still considered to be black boxes – something proven by JPMorgan Chase & Co.'s now infamous "Whale Trade" that caught the market by storm and ultimately cost the bank $6.2-billion (U.S.) in 2012.

Some banks are better at disclosing their activities than others. Bank of Montreal, for instance, clearly discloses its participation in the affected type of trading. BMO "assumes proprietary positions with the intent of earning trading profits," the bank said in its latest quarterly financial documents.

Toronto-Dominion Bank noted that it engages in trading activities to meet the needs of its clients, and also "less frequently, by taking trading positions with the objective of earning a profit."

Royal Bank of Canada's language is much vaguer. "Our trading securities are related to both client market-making activities and our funding and liquidity management needs" – the latter being hard to decipher.

During an investor day in 2012, Doug McGregor, RBC's capital markets head, said proprietary trading "is an important outlet for us to manage our liquidity and to profitably deploy surplus capital." RBC makes less than 2 per cent of its total earnings from this type of trading.

Still, it is difficult to determine how much proprietary trading is conducted by Canadian banks in the United States. This type of trading is still legal in Canada, and will continue to be, according to the Office of the Superintendent of Financial Institutions, the Canadian banking watchdog. The small disclosures in financial statements combine both Canadian and U.S. activity.

Options for the Canadian banks under the new U.S. rules include spinning out their proprietary trading arms, or shifting the business to other locations, such as Toronto or London, where the Volcker Rule does not apply. However, it will take time for the financial institutions to make these decisions. TD executives, for instance, are tied up in meetings Tuesday to decipher the ruling and weigh alternatives.

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"We are reviewing the rule and will ensure that we adjust our business to comply with it while continuing to deliver strong returns," RBC said in a statement.

Once the Volcker Rule is implemented in 2015, banks will also be required to set up internal compliance programs to ensure they stay within the guidelines. Banks are also forced to adjust their compensation measures to deter against proprietary trading and taking excessive risks.

The Volcker Rule has been debated for almost four years, and financial institutions lobbied hard to block its implementation, or at the very least water it down. "There was a lot of hope," said Bjorn Pettersen, a managing director at Accenture Finance and Risk Services in New York and also a former derivatives trader. "Hope's never really a good strategy."

While many banks did prep work, including selling off trading portfolios, "I wouldn't say that many of them are far along" when it comes to implementing the new ongoing compliance standards, Mr. Pettersen added.

The new legislation has been met with mixed feelings from Canadian bank executives over the years, with TD chief executive officer Ed Clark being the most vocal proponent of its core idea. "If you want to speculate, don't call yourself a bank, call yourself a hedge fund," Mr. Clark said in an interview with Bloomberg News in 2012.

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More


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