From the March 2012 issue of Treasury & Risk magazine

The Volcker Rule Dilemma

Are higher costs warranted to prevent future financial crises?

As regulators begin final deliberations on the so-called Volcker Rule, treasurers and their financial service providers mostly see the sky about to fall after a recent analysis showed costs to use financial products from bonds to foreign exchange contracts would increase significantly. The sky did nearly fall in late 2008, however, when Lehman Brothers’ collapse threatened a domino effect across Wall Street, which leaves regulators to decide which outcome is worse.

Formally known as Restrictions on Proprietary Trading and Certain Interest in, and Relationships With, Hedge Funds and Private Equity Funds, the Securities and Exchange Commission’s proposal—nicknamed for its most esteemed supporter—drew thousands of comments by the Feb. 13 deadline. The majority support the provision, including those from former Federal Reserve Chairman Paul Volcker and the California Public Employees’ Retirement System (Calpers), arguing that the increased costs are warranted to prevent future financial crises.

The SEC has long defined market making as being willing to sell covered financial positions in a security on a regular and continuous basis. Since the Volcker Rule only excludes trades matching that definition, less liquid markets, which tend to be especially important to midsize companies, will be impacted the most.

“You have to make continuous, two-sided markets [to be considered a market maker], and nobody does that in the private placement market,” including the medium-term-note market companies often use to fund their operations, says Hardy Callcott, a partner at the law firm Bingham McCutchen. “Companies have gotten liquidity there typically by going to a market maker, most of which are affiliated with banks, and asking it to buy the debt.”

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