* Banks beg to differ, say exemption too narrow
* They want greater leeway to manage risk
By Alexandra Alper
WASHINGTON, Aug 29 Banks are urging U.S.
authorities to broaden a little-noticed exemption in the Volcker
rule's trading curb that critics say could blind regulators to
the next version of the JPMorgan Chase & Co Whale trade.
The forthcoming Volcker rule to curb proprietary trading is
one of the most hotly debated measures called for in the 2010
Dodd-Frank financial reform law.
Advocates say the rule is needed to make sure banks that
receive government backstops like deposit insurance don't make
risky bets that could blow up and create the need for a taxpayer
bailout. Wall Street has pushed back, saying the rule is too
severe and will prevent banks from managing their operations,
especially their ability to hedge risk.
At the center of debate are hedging and market-making
exemptions tucked into the proposal that regulators issued in
Concerns about exemptions grew in May when JPMorgan revealed
that a botched hedging strategy had "morphed" into a risky bet
at a London unit that was supposed to be balancing the bank's
overall credit exposure, costing the bank at least $5.8 billion.
The trader was nicknamed the "London Whale" for the giant
positions he took.
But another exemption designed to protect banks' ability to
manage liquidity risk has mostly escaped the glare.
The exemption covers a special type of account, designed to
prevent the kind of cash crunches that took down Bear Stearns
and Lehman Brothers in the heat of the 2007-2009 financial
Banks want an even broader exemption. But critics say the
proposed rule, as is, already excludes liquidity trades almost
entirely from the Volcker rule, expected to be finalized later
As is, the liquidity exemption "deeply undermines the
applicability of the Volcker firewall," Democratic Senator Jeff
Merkley, one of the authors of the Dodd-Frank provision
authorizing the rule, said in an interview.
Banks, he said, could use the carveout to disguise risky
bets that could lead to deep losses like the one created by
JPMorgan's now infamous "Whale" trade.
The banking industry is taking a completely opposite view of
the exemption, saying it is so narrow that even true liquidity
management practices will be caught up in the crackdown.
In a letter to regulators earlier this year, the American
Bankers Association and the Clearing House, two major bank
lobbying groups, argued that the plan could have the unintended
consequence of "undermining the safety and soundness of banking
organizations and making the U.S. and global financial systems
more vulnerable to liquidity stresses."
GAPING LOOPHOLE, OR KEY TO SOUNDNESS?
Liquidity -- and the lack of it -- played a central role in
the financial crisis.
Plunges in the value in the mortgage-backed securities and
other real-estate assets shattered market confidence in heavily
exposed banks like Lehman Brothers, which were then unable to
get the short-term funding they needed to meet obligations.
Even now, regulators are still working to define how much
liquidity banks need to withstand a financial panic.
Banks have lobbied regulators to replace the liquidity
account exemption with a wider one, which would carve out a
broader category of accounts dedicated to "asset liability
management," or ALM.
Asset liability management is a bank's strategy for handling
any maturity mismatch between assets and liabilities. Foreign
exchange, interest rates, and liquidity issues can all drive the
Under the proposed rule, banks would have to submit a plan
reassuring regulators that the account's securities are highly
liquid, aimed at resolving the bank's near-term funding needs,
and are not for short-term resale or profit.
JPMorgan, before the trading loss came to light, lobbied for
a broader exemption. "The (liquidity) exclusion is so narrow in
scope and restrictive in operation that it would not even permit
many bona fide liquidity management activities," JPMorgan wrote
to regulators in February.
Ina Drew, former head of JPMorgan's Chief Investment Office,
which was responsible for the trading loss, met with Federal
Reserve officials in February to discuss "the exiting treatment
of positions taken for liquidity management purposes," under the
Volcker rule proposal, according to the central bank's website.
More recently, a group of regional banks including PNC
Financial Services and Capital One Financial
specifically brought up the liquidity exemption when responding
to a request from House Financial Services Chairman Spencer
Bachus for Volcker rule alternatives.
In a letter earlier this month, the banks warned "banks may
scale back even traditional lending if associated risks cannot
be appropriately hedged."
Mark Jarsulic, chief economist at Better Markets, a reform
advocacy group, isn't buying the banks' argument and said the
proposal already gives banks too much authority to dictate what
trades provide liquidity.
But some banking industry experts say there is some truth in
the banks' dire predictions.
"The more tightly you draw (the Volcker rule) to avoid
loopholes with regard to liquidity risk management, the harder
you make it for banks to control one of the most significant
systemic risks," said Karen Petrou, managing partner of Federal
Financial Analytics, a Washington-based financial services
Petrou would like to see the exemption maintained, but with
fewer requirements to prove that accounts are solely for
near-term funding needs. "It is vital that the Volcker rule be
crafted in a way that it in no way undermines liquidity risk