Current Commentaries

2017

A Counterproductive Constraint: How the Volcker Rule Undermines its Purpose by Discouraging Hedging

Renée Dudek

The Volcker Rule was designed to prevent banks from engaging in proprietary trading, which is investing for their own direct gain as opposed to earning commissions by trading on behalf of clients. The purpose is to insulate banks from the risks of proprietary trading. In theory, proprietary trading is distinct from hedging, a practice that reduces risk. However, there is no clear distinction between proprietary trading and hedging in practice. Classification largely depends on how a bank packages a transaction. Thus, it is unlikely that regulators could enforce the ban on proprietary trading while leaving hedging unscathed. By deterring hedging, regulators undermine the purpose of the Volcker Rule: to reduce banks’ exposure to risk. Yet, if regulators under-enforce the ban to encourage hedging, they will essentially fail to deter any proprietary trading. Banks will be able to artfully package their trading activity into compliance, with the Volcker Rule operating like a tax to be collected by bank lawyers.

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