Finalized in mid-December, the Volcker Rule prohibits banks from engaging in speculative securities trading, also called proprietary trading. Banks must demonstrate that every derivatives trade they make is designed to hedge a specific risk—except for trades made on behalf of clients. The banks’ CEOs must attest to their compliance with the rule.
The purpose is to improve financial market stability, but the Volcker Rule may have a big impact on corporate treasurers who use derivatives to hedge interest rate, foreign exchange, and other financial risks.
T&R: Are banks also likely to reduce the types of derivatives they offer on a bilateral basis?
BP: When you run a trading desk, you typically run a book of transactions. You don’t hedge transaction after transaction; you look at the whole portfolio of all the transactions that you have, and you make matches. Because of the Volcker Rule, banks may stop offering transactions where they aren’t able to offset all the risk.
T&R: Do you think companies will begin to have more options in terms of exchange-traded products, so that they will be able to find more precise hedges on the exchanges to offset their particular risks?
BP: That’s definitely a possibility. I would expect the exchanges are looking into what other kinds of products they can create. It all depends on whether they can create enough liquidity and enough instruments to create a strong trading market around it. In the past, there might have been more reluctance on the part of the banks to give up business to the exchanges, whereas now there might be more interest in having the exchanges take a larger role, and the banks might actually just begin trading on the exchanges. They have an incentive to do that.