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Volcker Rule Could Change 2014 Financial Sector Landscape Significantly

Jan. 28, 2014 4:30 PM ET
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Toward the tail end of 2013, financial news outlets were buzzing with discussions on the approval of the Volcker Rule. The rule, which was introduced in response to the 2008 financial crisis, sets to rein in banks risking trading practices by prohibiting speculative trading for their own accounts. In cases where trading must occur, it must be reasonably tied to client needs.

The only exception with regard to the Volcker Rule's unending restrictions is market-making, the function that provides liquidity by maintaining a market for securities. However, still the amount of securities held by banks is not allowed to exceed the reasonably expected near-term demand of customers.

Admittedly, financial institutions will need legal expertise to interpret some of the more intricate elements in the Volcker Rule. This is undoubtedly a boon for Wall Street's $1000 an hour lawyers. However, for big banks the Volcker Rule is a mixed bag. On one hand, it will rebuild the public's confidence in banks. On the other, big banks may lose out on great business opportunities.

Lost Business

The Volcker Rule is essentially moving speculative trading away from highly regulated investment banks to less regulated hedge funds. The withdrawal of banks from risky markets will give hedge funds more legroom to cement their positions. Stephen Hoopes of IBISWorld, a leading publisher of business intelligence, notes that banks have already started losing some of their best traders to hedge funds.

Some of the hedge funds which have shown their delight with tighter regulations include Pine River Capital Management. The fund, which manages assets valued at $14 billion, expects to benefit from investment banks' withdrawal from risky markets.

Speaking in response to the Dodd-Frank Wall Street reforms, the Volcker Rule and the Base III framework, Colin Teichholtz, co-head of fixed income trading at Pine River, feted the tight regulations. "All of these rules are basically sending the same message to big banks - you have got to reinvent your fixed income business," he said in a report published on Reuters. "From my perspective that means there's a lot less competition from Wall Street for the trades I want to do," he added.

Litmus Test

However, the Volcker Rule is not all gloom for banks. The rule will provide a crucial lift for the retail side of banking. Big banks will increase exposure in retail banking in order to offset any swings brought about by the underlying restructures in the investment wing.

Customer satisfaction rankings released by the American Customer Satisfaction Index in December indicate that consumer confidence is increasing throughout the retail banking sector. All the big banks, including JPMorgan Chase (NYSE: JPM), Citigroup (NYSE: C), Wells Fargo (NYSE: WFC), and Bank of America (NYSE: BAC) recorded gains compared with previous rankings. Citigroup, for instance, scored a ranking of 74, up 6 percent from the previous ranking. Banks can take advantage of the positive sentiment among retail customers to spruce things up in the retail segment in 2014.

Ultimately, the litmus test for the Volcker Rule will be whether its prevention of tax payer losses outweighs the costs of less liquid markets. Notwithstanding, the rule will change the financial sector landscape significantly in 2014.

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