Will Dodd-Frank Be DOA With GOP Congress? Don’t Bet on It

Another interesting argument is that Dodd-Frank and the Volcker Rule really won't have any impact on business because banks will simply integrate proprietary activities among client activities and no one, including the regulators, will be able to discern proprietary activity from client activity. We don't buy it. We believe that this line of reasoning began as opinion and through many rounds of discussion has turned into purported fact.

First, as noted above, the facts support that banks, where they have done away with proprietary activities likely to be axed by Dodd-Frank, have shed - not transferred - personnel. Second, despite arguments to the contrary, it is possible to mete out proprietary "activity" - not necessarily trades - from a company's books . From a common sense standpoint, this doesn't make sense to us either.

Proprietary strategies are often higher risk than client-oriented strategies. This is because expected return is proportional to risk. Traders undertaking strategies on behalf of the firm often have greater return expectations and risk tolerance than those facilitating agency transactions that are usually intended to reduce or eliminate risk.

Returning to the discussion about hiding proprietary trading within client books, traders embedding true proprietary trading strategies are unlikely to be able to hide this activity among client trades. Customer trading is, for the most part, risk reducing, or at least risk neutral, whereas proprietary trading is additive to the risk of a book. Even in an active customer book, this distinction is fairly obvious. Trades put on the book that increase risk or fail to hedge exposure are likely to stand out to the properly trained auditor or examiner.

Accordingly, specific trades are not the focus of whether or not a book is traded proprietarily but rather the overall way in which the book is managed. So, just "slipping" proprietary traders on to the client side of the business and having them conduct business as usual is not likely to pass muster. Yet it all depends on how regulators choose to define proprietary trading, how audits are planned, and how rigorously rules are enforced.

In summary, we believe that the Dodd-Frank Act is far from dead. Despite inflammatory talk and chatter to the contrary, elements pertaining to the capital markets are definitely enforceable and apt to significantly impact deposit-taking institutions.

The wild card is really in oversight and the means by which regulators will oversee practitioners. Though espoused by some in the industry, we believe that banks are not likely to shift proprietary traders to agency desks to continue business-as-usual because their activities will readily stand out to the discerning eye.

In all, Dodd-Frank, and particularly the Volcker Rule, are just as much alive as they day the Act was signed into law and we expect it will have some "teeth" in efforts to curtail systemic risk.

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