Last week’s move to ease the rules prohibiting U.S. banks from engaging in risky trading may enhance banks’ ability to compete in market making, but any move back to risky proprietary trading would be viewed negatively, says Fitch Ratings.
In a new report, the rating agency said that the U.S. regulators’ recent changes to the Volcker Rule — a post-crisis rule that aims to prevent U.S. banks from engaging in prop trading, and from controlling hedge funds and private equity funds — relaxes the rule’s compliance requirements, which may enhance banks’ market-making activities, boosting market liquidity.
Among other things, Fitch said that the revisions reduce the onus on banks to prove that their trading activities are not prohibited prop trading, allows more self-policing of compliance with the rule’s requirements and targets the rule’s application to smaller banks.
“Under the prior rule, banks were presumed guilty unless proven innocent. With Volcker 2.0, banks are more generally presumed to be innocent unless proven guilty” Christopher Wolfe, managing director at Fitch, said in a statement.
Fitch also noted that the new rule allows banks to use a broader range of financial instruments to manage liquidity, adds new exclusions from the rule and curbs its reach for trading activities that take place outside of the U.S.
Fitch said that the reforms could allow banks to engage in algorithmic trading that was not allowed under the previous rule, boosting their ability to compete in market-making against high frequency trading firms (HFTs).
“The regulators have opened the door for the larger U.S. banks to engage in selective risk taking, potentially with an eye toward enhancing market liquidity and levelling the playing field against HFTs,” said Monsur Hussain, senior director at Fitch.
Yet, at the same time, the rating agency said that it also views the Volcker Rule’s basic objective — banning banks from risky prop trading — as a ratings positive.
“We would negatively view any bank that increases directional trading activities that can be construed as proprietary trading or fails to self-police their trading activities appropriately,” it said, adding that increases in prop trading “may not generate adequate returns on capital nor be reflected in better stock valuation.”