Earlier this month on CBS’s "60 Minutes," Federal Reserve Chairman Jerome Powell sat down for an interview with longtime correspondent Scott Pelley. While the interview was light on actionable investment advice, it did offer a unique look into the mindset of the 71-year-old chairman.
Powell was reluctant to celebrate a victory over inflation and noted his concerns over rising debt. The Fed’s tight money policy has echoed the era of Paul Volcker, who served as Fed chair from 1979 to 1987 and faced a similar task in defeating inflation. But Volcker’s tenure at the Fed isn’t why prop traders should know his name — it’s the banking rule that bears his moniker.
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Separating Speculation From Banking
The Bank Holding Company Act of 1956 was designed to prevent large national banks from taking market share from smaller local banks by defining which institutions could operate across state lines. The legislation gave the Federal Reserve more authority over the banking industry and has been altered several times. Still, prop traders will be interested in one of the more recent changes.
After the Great Recession, the Dodd-Frank Act implemented financial reforms that attempted to strengthen the United States’s financial plumbing. Dodd-Frank created several new federal offices, like the Consumer Financial Protection Bureau (CFPB), and altered several existing pieces of legislation. One of the Dodd-Frank reforms was attached to the Bank Holding Company Act, initially proposed by Volcker in 2010.
In a New York Times op-ed, Volcker questioned the role speculative trading played in the significant bank disruptions during the Great Recession. Appointed by President Barack Obama to his 2009 Economic Recovery Board, Volcker argued that too many banks (including the so-called Too Big To Fail institutions) engaged in risky investments and trading practices, few of which were in the best interest of the banks’ clients. According to Volcker, proprietary trading and complex derivative investments weren’t suitable for these institutions, which the public depended upon as a source of safety, not speculative excess.
Implementation And Criticism
Dodd-Frank officially adjusted section 13 of the Bank Holding Company Act, which was then nicknamed the Volcker Rule after its initial proposer. The Volcker Rule severely limited the types of speculative investments banks could make. Proprietary trading systems were to be shuttered, and risky bets using derivatives like collateral debt obligations (CDOs) were to be unwound. Additionally, bank investments with hedge funds and private equity were to be limited or prohibited altogether.
The Volcker Rule was hotly criticized by banks that didn’t want their investment options limited, but it went into effect in July 2015 and set dates for when banks needed to unwind their riskier trades. However, the backlash was swift, and many banks immediately began requesting extensions or loopholes to allow some types of riskier trading to occur.
Efforts to neuter parts of the Volcker Rule have been successful in recent years. In June 2020, the Federal Deposit Insurance Corp. (FDIC) voted to allow commercial banks to invest in venture capital funds. However, regulators did achieve their goals — commercial banks and proprietary trading went their separate ways as many of the industry’s most prominent traders left their banks to form hedge funds.
Commercial banks and proprietary systems may not mix, but plenty of other firms are still seeking top trading talent. Prop trading programs have become popular for experienced investors to get their feet wet in this field. For example, Trade The Pool’s Funded Trader Program provides paper capital to prospective traders for a small upfront fee and then offers tools, training and analysis to maximize profit potential. But remember — only the top traders will make it through the evaluation phase into the funded account phase.
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The Volcker Rule generally restricts banking entities from engaging in proprietary trading and from owning, sponsoring, or having certain relationships with a hedge fund or private equity fund.
The Volcker rule generally prohibits banking entities from engaging in proprietary trading or investing in or sponsoring hedge funds or private equity funds.
Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act added a new section 13 to the Bank Holding Company Act of 1956 ("BHC Act"), commonly referred to as the Volcker rule, that generally prohibits insured depository institutions and any company affiliated with an insured depository institution ...
A bank may be excluded from the Volcker Rule if it does not have more than $10 billion in total consolidated assets and does not have total trading assets and liabilities of 5% or more of total consolidated assets.
Section 13 of the Bank Holding Company Act establishes prohibitions and restrictions on proprietary trading and on investments in or relationships with covered funds by certain banking entities, including state member banks, bank holding companies, savings and loan holding companies, other companies that control an ...
Institutions such as brokerage firms, investment banks, and hedge funds frequently have proprietary trading desks. However, there are restrictions against large banks engaging in prop trading, designed to limit the speculative investments that contributed the 2007-2008 financial crisis.
Proprietary Trading Definition: In proprietary trading, traders buy and sell securities using the firm's own money to make a profit; the trading may be directional (betting that a security's price will go up or down) or market-making (acting as both the buyer and seller of securities and making a profit on the bid- ...
The Volcker Rule generally restricts banking entities from engaging in proprietary trading and from owning, sponsoring, or having certain relationships with a hedge fund or private equity fund.
Exclusions: The final rules exclude from the definition of covered fund certain entities with more general corporate purposes such as wholly-owned subsidiaries, joint ventures, and acquisition vehicles, as well as SEC-registered investment companies and business development companies.
Loosely put, the Rule defines a covered fund as anything considered an investment company in the Investment Company Act, including private equity and hedge funds, as well as commodity pools with certain exclusions, and funds sponsored by a US banking entity where the affiliate holds ownership interests.
Personal Risk: One of the significant drawbacks of prop trading is the potential personal financial risk. If a trader doesn't perform well, they may lose their deposit, and in some cases, their job. Loss Limitations: Prop firms often implement daily loss limits to protect their capital.
Banks that have total consolidated assets equal to $10 billion or less and total trading assets and liabilities equal to 5 percent or less of total consolidated assets are generally exempt from the Volcker rule.
§ 255.3 Prohibition on proprietary trading. (a) Prohibition. Except as otherwise provided in this subpart, a banking entity may not engage in proprietary trading. Proprietary trading means engaging as principal for the trading account of the banking entity in any purchase or sale of one or more financial instruments.
A bank holding company could operate branches in multiple states. These branches could be considered independent banks and therefore in compliance with the law. Bank holding companies had another advantage—they could own nonbank firms, such as manufacturing, transportation, or retail businesses, in addition to banks.
Further, Congress intended Section 106 to permit claims beyond those available under general antitrust law: Any prohibited tie could result in the bank being fined. Worse, Section 106 grants a private cause of action to any person (e . g., a customer) affected by a violation of Section 106.
Section 13 contains certain restrictions on the ability of a banking entity or nonbank financial company supervised by the Board to engage in proprietary trading and have certain interests in, or relationships with, a hedge fund or private equity fund.
The Volcker Rule generally restricts banking entities from engaging in proprietary trading and from owning, sponsoring, or having certain relationships with a hedge fund or private equity fund.
The Volcker Rule is section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. It places strict limitations on federally insured depository banks from investing in stocks and other securities with the bank's own money. This is known as proprietary trading.
Proprietary trading (also known as prop trading) occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money (instead of using depositors' money) to make a profit for itself.
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