The Volcker rule limits banks from speculative Proprietary Trading including High Frequency Algorithmic Trading. The rule reduces conflict of interest, and requires transparency by disclosing any bank relationships with Hedge Funds. The total of all of the banking entity’s interests in hedge funds or private equity funds cannot exceed 3% of the Tier 1 capital of the banking entity.
In short, the rule generally prohibits banks from:
- Engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account.
- Owning, sponsoring, or having certain relationships with hedge funds or private equity funds, referred to as covered funds.
In order to regulate risk capital, the Volcker Rule says that regulators are required to impose upon institutions capital requirements that are “countercyclical”, so that the amount of capital required to be maintained by a company increases in times of economic expansion and decreases in times of economic contraction,” to ensure the safety and soundness of the organization.
In response to the Volcker Rule and in anticipation of its ultimate impact, a number of commercial banks and investment banks operating as bank holding companies have downsized or disposed of their proprietary trading desks.