When the Volcker Rule was proposed in 2011 by five federal agencies it prompted a rash of studies forecasting higher costs for corporate issuers, likely prompting some of them to exit the bond market. Now that the rule has been finalized in a stricter form than anticipated, the rubber will hit the road as the market moves toward the rule’s effective date in July 2015.
Dave Wilson, a partner at consultancy Treasury Strategies, said he had yet to analyze the rule in detail, but noted that attaching a wide range of restrictions to something as fluid as a capital market is bound to result in unintended consequences. He added that regulators, under pressure to come out with a final rule, appear to have done little analysis of what the impact could be.
Excessive restrictions, he said, typically result in at least one of two things happening. “Either banks provide fewer services for customers like corporate treasurers, or these activities move outside banks to unregulated entities,” Mr. Wilson said.
This sentiment echoed a statement by Commodity Futures Trading Commission’s Scott O’Malia, who Tuesday said the sloppy way in which the law was passed was the most egregious so far. With “the implementation of one of the most important mandates issued by Congress in response to the financial crisis, the Commission seems to have forgotten the basics of agency rulemaking,” Commissioner O’Malia said in a dissenting statement. “I am deeply troubled by the egregious abuse of process in this rulemaking. Without a doubt, it far surpasses all other previous transgressions to date.”
The rule is aimed directly at the Wall Street firms engaged in underwriting and making markets in those deals, but it appears likely to impact corporates indirectly by reducing liquidity and consequently raising premiums and the cost to issue bonds.
The US Chamber of Commerce said that since the rule was first proposed, “we have warned that [it] may harm the ability of businesses to raise the capital needed to grow and operate,” adding that it may “shut Main Street businesses out of some markets, raise the cost of capital, and place the United States at a competitive disadvantage in a global economy.”
The Chamber noted it must still examine the 900-page final rule in detail to consider more fully its impact on liquidity and market making, as did the Securities Industry and Financial Markets Association (SIFMA).
“SIFMA remains concerned that an overly restrictive Volcker Rule will inflict serious harm on our nation’s economy and American savers,” the trade association said in a statement.
In January 2012, Anthony Carfang, co-founder of consultancy Treasury Strategies, said in testimony before two US House financial subcommittees that the rule was likely to result in reduced access to credit, higher costs and less funding certainty for borrowers, and that could prompt companies to restructure their balance sheets.
“Stated differently, CFOs and treasurers would need to set aside and idle an additional $1 trillion in cash,” Mr. Carfang said, noting that amount is greater than either the Troubled Asset Relieve Program (TARP) or stimulus program in the wake of the financial crisis.
The rule puts restrictions on banks’ ability to hedge portfolios and invest in hedge funds and other alternative investments, and it requires CEOs to attest in writing annually that their banks’ compliance programs are adequate. The rule now permits banks to trade in all sovereign securities, however.
The most troubling portion for corporates concerns banks’ ability to underwrite and make markets in securities and swaps. The rule implements the Dodd-Frank Act’s statutory exemptions for those activities, as long as a list of requirements is met by the banks, including the establishment and enforcement of a compliance program. Banks are also expected to impose limits on positions, inventory and risk exposures to address the requirement that activities not exceed the reasonably expected near-term demands of clients, customers, or counterparties. There are also limits on the duration of holdings and positions, as well as data requirements seeking to ensure banks are not making market bets with their own capital.
The concern has been that the compliance burden will make lower rated or highly structured transactions overly burdensome from a compliance standpoint for banks to underwrite and make markets in, or the liquidity in those assets will fall further, resulting in wider spreads and high costs for issuers.
Oliver Wyman released a study a few year ago that estimated a 5 percent decrease in liquidity from the median would result in issuers paying a 16 basis-point yield premium; a 15 percent drop would result in a 55 basis point premium. That reduction in liquidity would in turn reduce the level of outstanding debt by 1.2 percent and 4.1 percent, respectively, or by $315 billion for the larger percentage.