Flaherty expresses concern about proposed Volcker Rule

Canadian firms, and the authorities, including the governor of the Bank of Canada, Mark Carney, and the Superintendent of Financial Institutions, Julie Dickson, have also expressed concerns about the possible impact of the proposed rule. As well, Finance Canada notes that a number of countries, including the UK and Japan, have voiced similar concerns about the draft rule.

The letter from Flaherty says that that, while Canada supports the underlying policy objective of the proposed rule, it would have “an unprecedented extraterritorial reach that could adversely affect Canadian financial institutions and markets and conflict with Canada’s own approach to financial sector regulation.”

The letter says that the government is particularly concerned that the proposed rule could severely impact the liquidity of Canadian government debt markets and interfere with the risk management practices of banks in Canada. Which are criticisms that have also been voiced by OSFI and the banks.

It notes that U.S. government securities are excluded from the rule’s restrictions on proprietary trading due to the importance of the market-making function in ensuring adequate liquidity in government bond markets, and the significant role played by government bonds in traditional banking activities.

“This same logic should apply to government-issued and government-guaranteed securities in other jurisdictions, including Canada. Moreover, the draft rule proposes an onerous reporting regime that risks withdrawing market makers from a wide range of Canada’s financial markets, including our corporate bond and equity markets,” it says.

It also says that the rule could apply to transactions between Canadian banks that are simply facilitated by U.S.-based financial infrastructure, such as U.S. clearing houses, which could force foreign banks to clear and settle transactions in non-U.S. jurisdictions, or to avoid U.S. exchanges altogether.

“I am concerned that the extraterritorial application of the proposed Volcker rule, by creating conflicting requirements and unnecessary compliance burdens, will interfere with Canadian efforts to strengthen our domestic financial system,” Flaherty says in the letter.

And, it points out that the draft rule could also have serious unintended consequences for Canadian bank-sponsored mutual funds, hampering their ability to provide services to their Canadian clients. The letter notes that the rule effectively treats Canadian mutual funds, which are largely similar to U.S. mutual funds (which are exempt from the proposed rule), on par with hedge funds and private equity funds.

“Without a change to the rule, a Canadian covered banking entity could be precluded from continuing to sponsor such a fund if it had unitholders resident in the U.S., even temporarily. This would be inconsistent with the longstanding regulatory practice of the Securities and Exchange Commission to allow Canadian mutual funds to deal with Canadians temporarily resident in the U.S.,” it notes.

“I am sure that it is possible to place limits on risk-taking within U.S. financial institutions and to reduce the potential risks to U.S. taxpayers without imposing significant constraints on the Canadian financial sector or conflicting with Canada’s own proven regulatory model,” the letter concludes.

The Volcker rule is scheduled to be implemented in July. In late December, U.S. regulators extended the comment period on the proposed rule by 30 days until February 13.

Carney letter

In his letter, BoC governor Carney echoes the concerns about the impact of the proposed rule on the liquidity of Canadian government bond markets, and, he warns that Canadian banks may limit their hedging, market-making and underwriting activities involving U.S.-based resources and U.S. counterparties to avoid potential non-compliance with the proposed rule.

“The difficulty of distinguishing legitimate market-making activities from prohibited proprietary trading could reduce trading activity and could severely disrupt the liquidity and resilience of Canadian financial markets,” he says in his letter; adding that the banks, “market-making activities are essential to maintaining deep and liquid markets that support the ability of Canadian corporations and public entities to obtain timely and cost-effective funding.”