Defining the Future of Prop Trading

As reported by Advanced Trading’s  Ivy Schmerken, as regulators delay writing the final rules for the sweeping Dodd-Frank financial reforms, the Volcker Rule’s ban on proprietary trading continues to cause confusion among the investments banks that must comply with the rule. Analysts say there is a lot of uncertainty and angst in the industry over how regulators will distinguish between proprietary trading and other types of market making or principle trading in which the broker buys or sells a security with its own capital in order to match buyers and sellers.

“The challenge of the Volcker Rule is, how do you draw the line between who is doing proprietary trading versus positioning for a future customer transaction, because they look identical in some cases,” says Sean Owens, director, fixed income, at Woodbine Associates.

Several major investment banks — including Goldman Sachs, Morgan Stanley, JP Morgan, Citi and Bank of America — already have shed pure proprietary trading desks to begin to comply with the Volcker Rule. Some of the same firms, however, are waiting for the specific requirements to be finalized before spinning off all of their prop desks, hoping that the final interpretation of the rule will allow them to hold on to those businesses.

Increasing the confusion, the Volcker Rule includes exemptions for certain “permitted activities” — such as market making, hedging for risk mitigation, transacting in government securities and underwriting. But market observers say the lines are blurry. In fact, an 81-page study by the Financial Stability Oversight Committee (FSOC), published in January, warned regulators that proprietary trading could take place within these permitted areas.

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