1. The Business Model of Banking and how institutions will have to adapt themselves to the new regulatory environment
2. Investments in capital and human resources
3. Changes/improvements to the Banks’ technology capacity and structure
4. Business Profitability, Staff Compensation and Competitiveness
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Volcker Rule Challenges for Covered Banking Entities
1. THE VOLCKER RULE AND THE CHALLENGES AHEAD
BY OSCAR VANEGAS - SENIOR REGULATORY AND COMPLIANCE CONSULTANT
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2. BACKGROUND
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• The Volker Rule was constituted as section 619 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act
• Final ruling was implemented on December 10th, 2013 by five federal agencies –
the Federal Reserve, the Office of the Comptroller of the Currency (OCC), the
Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange
Commission (SEC) and the Commodity Future Trading Commission (CFTC)
• In its core principle, the rule was implemented to promote and enhance the safety
and soundness of banking entities; protect taxpayers and consumers and promote
financial stability by minimizing the risk associated with unsafe and unsound
activities
• The rule introduces a tiered compliance program that requires enhanced
processes and controls; banks with the largest trading businesses have began
reporting quantitative measurements on June 30, 2014 and bring trading activities
into full compliance by July 21, 2015
3. OVERVIEW
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• The rule is intended to reduce the risks associated with short-term proprietary trading and limits
investment activities in covered funds, prohibiting the acquisition and retention of any equity,
partnership, or other ownership interest in or sponsor a hedge fund or a private equity fund
• What is proprietary trading? - engaging as a principal for the trading account of the banking
entity in any purchase or sale of one or more financial instruments
• What is “sponsoring”? - generally serving as GP, managing member or trustee, electing or
controlling majority of directors, trustees or management of fund sharing name with the
covered fund
• The final rule includes critical refinements that reduces the threat to market liquidity, trading
revenues, and the safety and soundness of the covered banking entities and other
systematically important financial institutions (SIFI)
• Coverage of activities conducted within the limits of the United States and its affiliated territories
• Coverage of transactions performed by foreign banking agencies that derived a considerably
portion of their profits while being conducted within the limits of the United Sates, or that such
covered transactions involve the participation therein of a U.S Citizen
4. CHALLENGES - THE BUSINESS MODEL
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Covered Activities –
Business Model Re-
design
The core principles affected: investment
compliance, funding through market-making and
profitability of proprietary trading activities
• Maintain a very limited inventory Bank
customers will have lower market liquidity for
their securities higher financing costs
diminishing credit access
• Reduction in market making will obstruct the
ability to determine the quality of securitized
loans and the offering of credit facilities
New operational and risk management conditions:
identify transactions where the institution is taking
principal market risk from speculative proprietary
trading or investment risk – risk metrics and
reporting at the trading desk level
5. CHALLENGES – COMMITMENT IN CAPITAL INVESTMENTS AND
RESOURCES
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Considerable efforts in
Capital Investment,
Human Capital and
Resources
• Design and implement an enhanced
compliance program
• Risk Metrics and Reporting
• Auditing activities and training of trading
personnel
• Reassessment of liquidity, market and
counterparty risk models enhanced capital
requirements Base III and CCAR
• Mitigate exposure to illiquid markets in
“stressed” conditions considerable swings
in volatilities in the markets
• dramatic changes in portfolio Value-at-Risk
measurements
Identification and Controls of covered activities:
• Serving as market makers and underwriters
only to meet the near term demands of
customers
• Standing ready to cover an incomplete side of a
trade
• Hurdles to arbitrage trading activities that
promote liquidity or price transparency
6. CHALLENGES – TECHNOLOGICAL CAPACITY AND STRUCTURE
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Enhanced data provisioning
and market intelligence
systems
Identification, segregation and
delivering at the transactional
level
(including non-U.S txns)
Enhanced
Technological
Structure
Revamped
Technical
Capacity
Consolidate data
warehousing
Top-of-the-line transactional
data systems
Audit trials across multiple
trading desks
Consolidation of KRI and
metrics
Risk Management models
Validation
Advanced regulatory and
management reporting
Trading desks’ transactional
volume and income
generation
Trading personnel training
and systems’ support
7. CHALLENGES – BUSINESS PROFITABILITY, STAFF COMPENSATION AND
COMPETITIVENESS
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Consolidate data
warehousing
Top-of-the-line transactional
data systems
Audit trials across multiple
trading desks
Consolidation of KRI and
metrics
Risk Management models
Validation
Advanced regulatory and
management reporting
Trading desks’ transactional
volume and income
generation
Trading personnel training
and systems’ support
• Minimum scope to profit from products’ inventories (market-
maker inventory is designed not to exceed the reasonably
expected near term demands of clients)
• Limited opportunities to profit from market movements and
volatilities
• Potential losses through incomplete trades
Business
Profitability
• Compensation schemes focused on trading volumes as
opposed to the more attractive profitability of the institution’s
own trading books
• Losing talented traders to the non-regulated hedge fund
industry
Compensatio
n
• Reduced global trading market restricted by extraterritorial
reach
• Restrictions to participate in OTC markets
• Considerable investments in technology, systems, audits,
controls and enhanced compliance programs
• Funding of investment vehicles going to unregulated markets
Competitivenes
s
8. COMPLIANCE PROGRAM – ILLUSTRATIVE STRUCTURE OF THE ENHANCED
COMPLIANCE PROGRAM
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Governance
Senior Management CEO Board of Directors
• Approve, implement & enforce
• Periodic review for effectiveness
• Remediation and Board reporting
• Attestation that processes are in place
to ensure compliance with final rule
• Establish culture of compliance
• Supervise senior management team
• Align resources & incentives
• Approve program
Risk Management Analytics & Reporting Legal and Compliance
• Risk limit framework
• Robust analytics to set risk limits
• Model validation & documentation
• Exception policy (and monitoring)
• Escalation procedures
• Production & monitoring of metrics
• Robust analytics to set thresholds
• Exception policy (and monitoring)
• Escalation procedures
• Reporting
• Training
• Recordkeeping
• Conflicts of interest
• Remediation
Front Office Controls
• Define mission (i.e. trading activity) and strategy (i.e. trading method) for each trading desk
• Define authorized activities, products, and counterparties for each trading desk
• Policies and procedures for establishing limits, measuring activity, and enforcing compliance
• Policies and procedures for compensation, limiting incentives for prohibited proprietary trading or excessive risk taking
Independent Testing, Auditing and Staff Training
9. COMPLIANCE PROGRAM DESCRIPTION
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INTERNAL POLICIES AND PROCEDURES: written policies and procedures reasonably
designed to document, describe, monitor and limit exempted trading activities conducted
by the banking entity
INTERNAL CONTROLS & MANAGEMENT FRAMEWORK—RESPONSIBILITYAND
ACCOUNTABILITY that clearly delineates responsibility and accountability; includes
appropriate review of trading limits, strategies, hedging activities, investments, incentive
compensation
INDEPENDENT TESTING and internal audit of the effectiveness of the compliance
program conducted periodically by qualified personnel of the banking entity or by a
qualified outside party
TRAINING for trading staff and managers, as well as other appropriate personnel, to
effectively implement and enforce the compliance program.
RECORDKEEPING sufficient to demonstrate compliance, which a banking entity must
promptly provide to regulators upon request and retain for a period of no fewer than 5
years. This must include records in connection with risk-mitigating hedging, underwriting
and market making permitted activities
10. REPORTING METRICS
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Consolidate data
warehousing
Top-of-the-line transactional
data systems
Audit trials across multiple
trading desks
Consolidation of KRI and
metrics
Risk Management models
Validation
Advanced regulatory and
management reporting
Trading desks’ transactional
volume and income
generation
Trading personnel training
and systems’ support
• Risk and Position Limits and Usage
• Risk Factor Sensitivities
• Value at Risk (VaR) and Stress Value at Risk (Stress
VaR)
Risk Management
• Comprehensive Profit and Loss AttributionSource of Revenue
• Inventory Turnover
• Inventory Aging
• Customer-Facing Trade Ratio – Trade Count Based
and Value Based
Customer-Facing
Activity
11. CONCLUDING OBSERVATIONS
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Consolidate data
warehousing
Top-of-the-line transactional
data systems
Audit trials across multiple
trading desks
• Increased market volatility, price uncertainty and the reduced capacity for
institutions to raise capital and/or hedge risk
• Impaired U.S. competitiveness, and potential vulnerability to legal challenges,
given the rule’s global scope of prohibitions
• Vulnerabilities around liquity, credit availability, funding and market & investment
risks
• Dedicate a considerable portion of their capital investments and resources to
address and implement all required elements in the final rule
• Compromise time and resources to coordinated several tasks with deferent
objectives between business strategy, compliance, finance and technology
• Business units consultative support is critical to implement a firm-wide Volcker
framework to ensure the complete validation and attestation of the covered
baking entities’ trading and fund investment businesses with the compliance
controls set-forth by the federal agencies.
13. KEY PROCEDURES AND LOGISTICS
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Reporting Required / Optional
Reporting Required: metrics in respect of trading conducted
pursuant to the underwriting-related, market making-related,
risk-mitigating hedging and U.S./foreign government obligation
permitted activities
Reporting optional: metrics in respect of trading excluded from
the scope of proprietary trading, on behalf of customers,
regulated insurance company or foreign bank permitted
activities
Level of Measurement
Metrics reporting at the single trading desk level; each trading
desk, defined as the smallest discrete unit that purchases or
sells financial instruments for the trading account of the
banking entity or an affiliate of the banking entity.
Regulatory Reporting Frequency
For banking entities with $50 billion or more in trading assets
and liabilities: for each calendar month, within 30 days of the
end of the relevant month (beginning with information for
January 2015, within 10 days of month end)
For other banking entities: for each calendar quarter, within 30
days of quarter end
Record Retention
5 years; records documenting preparation/content of reports
submitted
14. TIMING AND APPLICABILITY OF COMPLIANCE PROGRAM AND METRICS
REPORTING
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STANDARD COMPLIANCE PROGRAM– NO METRICS for Banking entities with more than
$10 billion but less than $50 billion of total consolidated assets and less than $10 billion of
trading assets and liabilities Compliance required: July 21, 2015
ENHANCED COMPLIANCE PROGRAM– NO METRICS for Banking entities with $50 billion
or more of total consolidated assets but less than $10 billion of trading assets and liabilities.
Compliance required: July 21, 2015
• ENHANCED COMPLIANCE PROGRAM WITH METRICS for Banking entities with total
consolidated assets of $50 billion or more, enhanced program effective: July 21, 2015
• Phase-in for metrics reporting requirements for banking entities with $10 billion or more in
trading assets and liabilities:
• For those with trading assets and liabilities of $50 billion or more: metrics June 30, 2014
• For those with trading assets and liabilities of between $25 billion and $50 billion: metrics
April 30, 2016
• For those with trading assets and liabilities of between $10 billion and $25 billion metrics
December 31, 2016