What Investors Need to Know About Volcker Rule

A part of the 2010 Dodd-Frank Act, Volcker rule is just one of the ways the act attempts to put a cap on risky investing. Volcker rule prohibits banks from engaging in speculative trading for their own gains. In theory, the rule sounds simple, but figuring out how it will be enforced has been laborious. That’s why it has taken so long to revamp the rule—regulators finally approved the new version Tuesday, December 11. Even so, Volcker rule won’t  go into full effect till mid 2015.

It’s tough to say exactly what influence Volcker rule will have on banks in the long term. However, investors should have an idea of how things will be changing as Volcker rule goes into effect. Here are a few things to keep in mind.

What changes have been made since the Dodd-Frank Act was passed in 2010?

In the process of figuring out the logistics of Volcker rule, Wall Street lobbyists from  firms like Goldman Sachs and JPMorgan have managed to make a sizable impact. The result is that Volcker rule is far less stringent than banks had initially feared.

Many changes to Volcker rule focused on dealing with the largest gray area of the regulation: how do you prove that a bank’s activities are for its own gain rather than the client’s? Under the new Volcker rule, a bank will have to prove that it’s actions are for the benefit of the customer. Bloomberg Businessweek speculates that this will mean a lot more paperwork and just about the same amount of profit-amplifying trade that Wall Street firms are accustomed to.

Will Volcker rule still bar banks from all proprietary trading?

Not entirely. Though that’s is the aim of the rule, the revamped version makes several exceptions. Still allowed is the trading of most government bonds and some foreign sovereign securities. Banks are also still able to underwrite securities for companies preparing to sell stocks or bonds, and to engage in “market-making” activities on the client’s behalf. Ultimately, speculating isn’t ok, but hedging is—as long as banks can justify their actions as a risk-reducing choice for the benefit of customers.

Will Volcker rule prevent the same type of activity that led to the financial crisis?

It depends on who you ask. The Seattle Times quotes Benn Steil of the Council on Foreign Relations as saying that Volcker rule “would have done nothing to mitigate the worst financial crisis since the Great Depression.” Similarly, The Financial Crisis Inquiry Commission has not traced the crisis to banks’ speculative trading. But supporters of Volcker rule counter that speculative trading was a serious—though indirect—contributor, and that Volcker rule will help prevent future crises.