The backlash against the Volcker Rule has officially gone global. While U.S. banks are still up in arms about how regulators propose to implement the trading ban, the protests sound just as loud from foreign institutions and even their governments, which fear the U.S. is stepping outside its jurisdiction.
"The proposed rule appears to extend well beyond U.S.-insured depository institutions and imposes significant restrictions on Canadian banking entities by limiting their use of U.S.-based resources, personnel and market infrastructure and by preventing them from trading with U.S. counterparties," Mark Carney, governor of the Bank of Canada and chairman of the Financial Stability Board, said in a letter to Federal Reserve Board Chairman Ben Bernanke.
Other countries represented in the thousands of comment letters submitted for the U.S. proposal include France, Germany, Mexico and Japan. They not only share concerns with their banks that the rule could unintentionally harm liquidity, widen spreads and increase volatility at foreign institutions, but they also argue foreign sovereign debt should get the same favorable treatment the rule gives U.S. Treasury bonds.
Foreign officials said U.S. regulators should limit foreign banks' compliance with the rule to their U.S. operations.
"The reach of the draft rule is too wide and the exemptions too narrow," Luc Monty, Quebec's deputy finance minister wrote.
It is unusual for a foreign government to give feedback on a U.S. rulemaking. But the far-reaching implications of the rule — enacted in the Dodd-Frank Act to curb not only banks' proprietary trading but also their interests in private-equity and hedge funds — has prompted international alarms ever since regulators released their proposal in November. (Dodd-Frank authorized the Fed, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Securities and Exchange Commission to implement the ban.)
"We are of the opinion that the Volcker Rule is likely to have detrimental effects on market liquidity and will make raising capital harder, both in the U.S. and abroad," wrote Guido Ravoet, chief executive of the European Banking Federation. "The Volcker Rule will generally impair the ability of banks to make markets in their clients' bonds."
While governments sound supportive of the overall goals of the Volcker Rule — named for former Fed Chairman Paul Volcker, who first proposed the trading ban — one of their chief concerns is an exemption in the proposal for banks operating "solely outside of the U.S.". They say Dodd-Frank meant for the exemption to be broader, including non-U.S. risk exposure, even if the institution had U.S. operations in some other form.
In their letters, governments implored regulators to amend the exemption, which they said was an unintentional mistake and not what Congress had in mind. If it is unchanged, commenters argued, the scope of the rule could end up covering a wide range of non-U.S. trading and fund activities that go far beyond the intent of the statute.
"Instead of focusing on the location of the trading activity and the participants involved, the proposal should take into account the location of risk-taking — which in our understanding ought to be the rationale behind the Volcker Rule," wrote Sabine Lautenschlager, deputy president of Germany's central bank, Deutsche Bundesbank.
Meanwhile, governments and foreign banking groups also called for a change in the rule to allow banks to invest in foreign government debt securities, just as the law now exempts U.S. government debt from the trading ban. They said the current proposal would create a disparity in how countries are able to raise liquidity.
"Disequilibrium and unfairness could cause global financial turbulence, and the destruction of the supply-demand balance in the bond market could result in an unstable market environment around the world," the Japanese Bankers Association said in its comment letter.
European countries similarly argued the rule — as currently drafted — would hamper banks' ability to trade European bonds and could threaten nations' liquidity. By exempting only U.S. government securities, they said, the rule could also interfere with banks' management of liquidity requirements.
"To the best of our knowledge, we believe that there is no economic rationale against extending the exemption to other government bonds with a similar risk structure as U.S. government bonds," Lautenschlager wrote. "A rule that draws on economic criteria for designating exempted bonds would help to minimize distortions on international capital markets and enhance efficiency."
Monty said U.S. regulators could include in the exemption foreign government securities on the basis of their receiving high credit ratings from a recognized rating agency, or alternatively a list of qualified issuers could be maintained by the regulatory agencies.
"Restricting the availability of high quality investment grade securities such as those issued by Quebec or its agencies will not, in our submission, advance the goal of promoting and protecting the safety and soundness of banking entities and the financial stability of the United States," he said.
Without clear changes in the rulemaking, governments said U.S. regulators would be overstepping their bounds in dictating how foreign governments should regulate.
"If this is the outcome, this is an infringement on Canadian regulatory jurisdiction and risks contravening Canadian regulation, adding unwanted uncertainties and potential inefficiencies in the Canadian capital markets," Kevin Falcon, British Columbia's minister and deputy premier wrote.
Governments and their respective banking trade associations also argued the U.S. rule could lead to inconsistencies and overlaps with countries already participating in the financial reform effort under the auspices of the Group of 20 nations for regulation of large global companies.
"We already apply the highest and most stringent regulatory standards in terms of market risk supervision … and will implement as well the agreed standards on the treatment of globally systemic banks," wrote Ramon Fernandez, the head of the Treasury within France's Ministry of the Economy, Finance and Industry.