Behind the Volcker Rule

Volcker Rule hearing

Volcker Rule hearing (Photo credit: Medill DC)

Submitted by Brendon Weiss. Brendon joined NYSE Euronext in September 2010 as Vice President, Legal and Government Affairs. In this position, Brendon works with Capitol Hill, the SEC and other government agencies on issues of interest to the company.  

Everyone in the financial services industry is or should be focused on the Volcker Rule. The intensity of the impact this one rule might have on the equities, options and fixed income markets could result in the largest shift in the “who, when, and how” of market structure since the shakeup in the equities markets with decimalization and Reg NMS. But although the rule as proposed raises some serious concerns that NYX believes should and likely will be resolved, why is everyone feeling so bruised and beat up by it? This is one question we tried to answer at the recent STANY Conference in NY during opening week of MLB.

Again, everyone is or should be focused on the Volcker Rule; after all, the Rule is said to result in less liquidity, more fragmentation and higher compliance costs – all ending in a higher cost of capital for job creators and now according to economist Daniel Yergin…higher gas prices. But the real reason why everyone seems so down is because there is going to be change, significant change, and the answers as to who, when and how other market participants will step up is as unpredictable as a Red Sox World Series. As Ed Provost with CBOE alluded to, although hedge funds are valued clients of any exchange, they just aren’t able or have the desire to step in and fill the liquidity gaps that will be widened by the dissolution of BHC prop desks combined with tighter market making restrictions on BHCs. Adding to the debate, Brad Hintz with Sanford Bernstein & Co. said the likely impact will be a greater dependence on regional broker dealers and new proprietary trading firms that are either started organically or spun out from BHCs.

Then it struck me that although the Volcker Rule will be a market structure play, particularly in the fixed income markets, it’s an even larger technology play due to the increased level of technology that will be required for the fixed income liquidity providers to connect each of those dispersed pools of liquidity to make it feel like one large competitive pool of liquidity, similar to what has been established in the equities and options markets over the past 10 years. Sean Owens with Woodbine Associates said the Volcker Rule in combination with Title VII of DFA (derivatives) will definitely have a dramatic impact on how corporate bonds are traded going forward, particularly as we see mandatory multilateral trading of swaps.

Although we’ve all witnessed this series of events unfold in the equities and options markets with both positive and negative impacts for markets and investors, it seems clear that we’re on a one way track to a series of disruptions and innovations to the fixed income market structure. With the exception of regulators making changes around the margins to the primary concerns, no rule will ever be perfect leaving all market participants to decide if they want to slide-in head-first and be ready to rub some dirt on their wounds or vacillate and risk being left behind.

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