December 10, 2013

Both this blog and “Cheverny Strategic Perspectives” have previously addressed the so-called Volcker Rule and its potential benefits for users of the financial system. As the Volcker Rule finally emerges from its creation-by-committee (perhaps only in the U.S. would a regulation governing the financial industry require five independent regulatory fiefs to negotiate, squabble, scheme and then draft a 1000 page rulebook) it is perhaps worth noting that this will not remove conflicts of interest on Wall Street. Bay Street will be even less altered by the advent of this new framework.

Mr Paul Volcker, the esteemed former Chairman of the U.S. Federal Reserve and instigator (in his role as adviser to the Obama Administration) of the eponymous rule, viewed a curb on banks trading in markets for their own account as a means of increasing financial stability. This rule was subsequently embedded in legislation (The Dodd Frank Act of 2010), drafted (2010-2013) and is now only slated for implementation in mid-2015. The underlying notion is that proprietary trading (banks using their capital to trade for their own account) is a demonstrated mechanism for accentuating volatility, crisis and even financial contagion.

Many observers contend that the Volcker Rule will face a variety of threats (from abuse of loopholes to attempts to amend the legislation to legal challenges) and that full implementation may never happen. That said, it should nonetheless make a dent in the ability of an investment bank to trade actively against its clients. Naturally the bank can still lend to a company and its rivals, underwrite debt- and equity securities for a client and its rivals, own shares in a client and its rivals through an asset management arms and provide M&A or other advice to a client and/or its rivals (even at the same time).

The rule will apply to all banks, domestic and foreign, operating in America. The U.S. operations of Canadian banks, who have happily deployed capital in proprietary trading for years, will be caught in the net. Mr Boyd Erman, writing in the Globe & Mail reports that this ban on so-called “prop desks” could require the Royal Bank of Canada Capital Markets to shed a 125 person team (based in the New York office) that generates as much as $1 billion in revenue annually. RBC apparently, the article noted, examined moving the team to Toronto. This was rejected on the grounds of diminished information flow and the impact of distance on high-speed proximity-trading strategies. The bank is now looking at alternatives for the trading unit.

It is therefore worth underscoring that in Canada a client that chooses the investment banking arm of a bank for M&A advice is stepping into a scenario riddled with the numerous conflicts of interest listed above, a scenario where even the basic protections of the Volcker Rule against the conflicts inherent in proprietary trading do not exist. Canada justly had a good financial crisis (the Bank of Nova Scotia’s rescue of DundeeBank aside), but let us not confuse financial stability with a conflict-free playing field. That this may read as shameless marketing of the virtues of an independent, partner-owned advisory firm does not alter the reality of the situation.