The Fed has given Trump cover to unwind a key Wall Street rule

It’s the talk of Wall Street.

The prospect of deregulation following the election of Donald Trump, and specifically some kind of softening of the Volcker rule, is being discussed far and wide.

Now, it seems the Federal Reserve has provided some “political cover” for Trump’s nominees to go soft on the rule.

The Federal Reserve released a staff paper on December 22 focused on the Volcker rule, which bans proprietary trading, and its impact on market liquidity.

In short, the staff paper found that the rule had had a negative impact on corporate bond liquidity, or the ease with which buyers can find sellers and vice versa. The staff paper said:

“Our main finding is that the Volcker Rule has a deleterious effect on corporate bond liquidity and dealers subject to the Rule become less willing to provide liquidity during stress times. While dealers not affected by the Volcker Rule have stepped in to provide liquidity, we find that the net effect is a less liquid corporate bond market.”

It’s important to note that bond market liquidity has been a hot topic on Wall Street for some time, with dealers and investors often complaining that post-crisis regulations have made it harder to transact in the bond market. The Federal Reserve, meanwhile, has previously appeared sanguine about the impact of regulation on bond liquidity.

According to Isaac Boltansky at research firm Compass Point, the paper could be used as “political cover” for Trump and his team as they look to peel away some of the post-crisis financial regulation on Wall Street. Boltansky said:

“In practical terms, our view is that this paper will provide political cover for President-elect Trump’s nominees to de-emphasise enforcement of the Volcker Rule in the near-term and could ultimately serve as cannon fodder in the impending battle over legislatively repealing the rule.”

And:

“Although this paper represents staff findings rather than the Federal Reserve’s official policy position, our sense is that Volcker Rule opponents will use it as definitive proof that the rule should be administratively and legislatively unwound.”

Boltansky added that he expects President-elect Trump’s financial regulatory nominees to “de-emphasise supervisory compliance with the rule early in their appointments,” and that he believes “a Volcker Rule repeal effort will be part of the legislative conversation in 2017.”

That said, he remains unconvinced that Volcker will be repealed, as the deregulation effort is likely to focus on lightening the load for smaller banks, rather than making life easier for large market-making investment banks.

In addition, several senior bankers have said that the repeal of the Volcker Rule would have little impact on how they conduct business. Daniel Pinto, CEO of the corporate and investment bank at JPMorgan, told Business Insider:

“There is a lot of noise about the Volcker rule, whether that stays or goes. We will not do anything differently at all if the rule is eliminated. The way we would do business would not change. We may avoid some of the bureaucracy around all the reporting and checking and all of these things, but the way we do business would not change.”

Citigroup CFO John Gerspach said in December meanwhile that “we don’t want to do proprietary trading, but I also would love to work with regulators to lessen the burden of proving that we are not engaging in proprietary trading.”

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