Examining the Impact of the Volcker Rule on the Markets, Businesses, Investors, and Job Creators

Statement of David W. Blass
General Counsel
Investment Company Institute 

U.S. House of Representatives Committee on Financial Services
Subcommittee on Capital Markets, Securities, and Investment

March 29, 2017
Washington, DC

As prepared for delivery.

Thank you, Chairman Huizenga, Ranking Member Maloney, and members of the subcommittee, for inviting me to testify today.

My name is David Blass and I am the general counsel of the Investment Company Institute. Our members are mutual funds, exchange-traded funds (ETFs), and other registered funds. They have a unique perspective on the Volcker Rule because funds are both investment vehicles that may be subject to the rule and “buy-side” investors in the capital markets affected by the rule.

We applaud the Subcommittee for reviewing the impact of the Volcker Rule on the capital markets, businesses, investors, and job creators. We support appropriately tailored regulation to ensure a resilient and vibrant financial system, and we support revisiting the Volcker Rule to determine whether it is appropriately tailored. Regretfully, we conclude that it is not.

By all acknowledgements, the Volcker Rule was never meant to apply to stock and bond mutual funds, ETFs, and other investment funds registered under the Investment Company Act of 1940.

One reason is that the Investment Company Act already provides a comprehensive framework of regulation that serves both to protect fund investors and to mitigate risks to the financial system, including the kinds of risks that go to the heart of the policy rationale for the Volcker Rule.

Registered funds are transparent. They are not highly leveraged. Their assets are held in separate custody by bank custodians, and any transactions with affiliates are either prohibited outright or are highly restricted. And boards of directors—typically with a majority of independent directors—oversee the funds.

But registered funds and their investment advisers have been left to sort through the many consequences of the Volcker Rule and its impact on the capital markets. I would like to highlight three of those for you today:

First, the final regulations failed to provide a full carve-out for registered funds. As a result, many of these funds were captured by the term “banking entity.” This could happen in the case of a newly launched mutual fund whose investment adviser is affiliated with a bank. Solely by reason of the adviser’s investment of start-up capital—referred to as “seed money”—the new fund itself could be subject to the Volcker Rule’s trading and investment limits, as if the fund were a bank. The effect was to place new restrictions on longstanding, common practices that, to the best of our knowledge, have never raised any regulatory concerns. It is clear that Congress did not intend this result.

The agencies charged with implementing the Volcker Rule ultimately issued much-needed guidance shortly before the rule’s compliance date. What it took to obtain that guidance, however, exposes just how cumbersome the rule is to administer. To further compound the problem, the guidance was not issued under a transparent rulemaking process and presumably could be changed at the whim of the agencies’ staff.

Second, the final regulations create competitive inequalities. For example, they exclude from the Volcker Rule’s restrictions “foreign public funds”—the foreign equivalents to US registered funds. This exclusion is entirely appropriate. But some US firms and their affiliates also rely on this exclusion, and the agencies placed onerous restrictions on them. Those restrictions do not apply to foreign firms offering very similar funds.

Third, the Volcker Rule is overly broad and insufficiently tailored to its policy objective. Regulations that sweep too broadly introduce friction that influences how important market participants access the capital markets and provide liquidity.

The Volcker Rule’s implementing regulations are extraordinarily complex and are built upon a presumption that all short-term principal trading is “proprietary trading.” To overcome this presumption, a banking entity must be prepared to demonstrate that its transactions are for market-making purposes—a very high bar, and subject to second-guessing.

Many variables affect capital markets activity and the liquidity in those markets. Clearly, however, the kind of friction created by overly broad and ambiguous regulation, like the Volcker Rule, can and does influence the ways in which many entities—including dealers and their trading partners, such as funds—participate in the capital markets.

For these reasons, among others, we strongly support the committee’s examination of the Volcker Rule and its consideration of the capital markets more broadly. Thank you for your attention, and I will be happy to address your questions.