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Five things you need to know about the Volcker Rule

Paul Volcker, a former chairman of the Federal Reserve, at his office in New York, May 28, 2013.

ROBERT CAPLIN/NYT

The final version of the Volcker Rule, arguably one of the most important pieces of financial legislation in decades, will be released Tuesday and is expected to be voted into law.

Here's a quick and dirty primer:

What is the Volcker Rule?

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In the wake of the financial crisis, U.S. lawmakers passed a sweeping piece of legislation, known as the Dodd-Frank Act, to reform Wall Street and crack down on bad behaviours. The Volcker Rule is one of the Act's key tenets.

The public is still waiting to see precisely what the final draft of the Act will include, but previous versions prohibited proprietary trading by big banks and prevented these same institutions from investing in hedge funds.

Proprietary trading is the act of buying and selling securities solely for the sake of making profits for the bank, rather than acting on behalf of clients. In simple terms, it's the equivalent of acting like a day trader, but with the bank's money. If enforced, the Rule will force banks to get back to their traditional roles, acting as intermediaries for clients.

There is also speculation that the Rule will enforce a new code on compensation, so that traders have less incentive to make risky bets.

Who, or what, is 'Volcker'?

Paul Volcker was the head of the U.S. Federal Reserve – the country's central bank – from 1979 to 1987, and he is often referred to as the inflation slayer, for jacking up interest rates during the 1980s in order to cool the country's runaway inflation.

Mr. Volcker served on President Obama's Economic Recovery Advisory Board from 2009 to 2011, and was therefore instrumental in crafting legislation to get the country's financial system in order. Disgusted with the risks created by proprietary trading – which he describes as pure speculation for the banks – he proposed a ban on these activities in 2009.

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Why has it taken so long for regulators to act on his advice?

First it took Congress some time to pass the overarching legislation – the Dodd-Frank Act. Then the Federal Reserve opened the Volcker Rule up to public comment in 2011. All the while there was much lobbying by financial institutions, and the regulators themselves fought with each other to hammer out what should be included in a final draft.

If passed, will the Rule dramatically change banking?

It's hard to tell. It really depends on the grit of the final draft, and what is classified as proprietary trading. For instance, when JPMorgan Chase & Co. lost $6-billion (U.S.) on its now infamous "Whale Trade," the bank argued the trade was simply made to hedge its positions, rather than to bet on the chances of an economic recovery. (This claim is widely contested.)

Will Canadian banks be affected?

Because the Volcker Rule is a piece of U.S. legislation, what happens here in Canada likely won't be affected. However, institutions such as Royal Bank of Canada have trading operations in the U.S. No one knows for sure exactly how the Rule will treat foreign firms, but there is a decent chance that it will impose the same tough standards on these firms' U.S. operations.

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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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