Treasury Strategies Testimony to U.S. House of Representatives on the Volcker Rule / Dodd-Frank
Examining the Impact of the Volcker Rule on Markets, Businesses, Investors and Job Creation Treasury Strategies’ Testimony to CongressU.S. House Subcommittee on Capital Markets and Government Sponsored Enterprises U.S. House Subcommittee on Financial Institutions & Consumer Credit January 18, 2012Treasury Strategies, Inc. was invited to testify at the Congressional hearing “Examining theImpact of the Volcker Rule on Markets, Businesses, Investors and Job Creation” by ChairmenGarrett and Capito, Ranking Members Waters and Maloney, and members of the subcommittees.This was a timely hearing, going to the heart of the stability of the financial system. Anthony J.Carfang, a founding partner, represented and served as spokesperson for the firm, and also forthe U.S. Chamber of Commerce.
Introduction institutions to scale back and even exit some of the critical services they provide. SimplyTreasury Strategies is the world’s leading put, after the Volcker Rule goes into effect,consultancy in the area of treasury when a business’ treasurer calls a bank tomanagement, payments and liquidity. Our raise the cash needed to pay the bills, willclients include the CFOs and treasurers of someone answer that phone call?large and medium sized corporations as wellas state and local governments, hospitals Besides reduced financing for Americanand universities. We also consult with the businesses, the Volcker Rule could actuallymajor global and regional banks that provide increase systemic risk by consolidatingtreasury and transaction services to these assets into the banking system, exacerbatingcorporations. In thirty years of practice, we too-big-to-fail.have consulted to many of the world’slargest and most complex corporationsand financial institutions. ”After the Volcker Rule goes intoThe purpose of the testimony was, on behalfof the U.S. Chamber of Commerce, to effect, when a business’ treasurer callsdiscuss the impact of the Volcker Rule onnon-financial businesses. a bank to raise the cash needed to payThe questions that have not been asked and the bills, will someone answer thatthat need to be answered by both the phone call? ”regulators and Congress are simply these:How does the Volcker Rule impact the abilityof non-financial companies to raise capitaland mitigate risk, and are we willing to livewith the adverse impacts of the Volcker Rule Summarythat will affect the competitiveness and theoverall efficiency of the U.S. economy? Businesses operating in the U.S. are the most capital-efficient and productive in theTreasury Strategies and our clients fully world. Thanks to our financial institutions andsupport well-thought-out efforts to improve existing banking frameworks, businesseseconomic efficiency and to reduce the and the U.S. economy benefit greatly from:likelihood of another systemic failure. TheU.S. Chamber’s position is the same and • Broadest, deepest and most resilientthey have advocated for stronger capital capital marketsrules, rather than a unilateral ban on • Best risk management products andproprietary trading, as a pro-growth means toolsof stabilizing the financial system and • Most robust liquidity marketsavoiding systemic failure. • Technologically-advanced cash management servicesHowever, collectively, we feel strongly that • Most efficient and transparentthe Volcker Rule, as currently constructed, payment systemswill not succeed in this effort. We believe thatit will make U.S. capital markets less robust, As a result, U.S. businesses are extremelyU.S. Businesses less competitive, and efficient. Consider the following Treasuryultimately reduce underlying economic Strategies analysis:activity. We believe that the lack of clarity inmany of the proposed regulatory provisions Companies doing business in the U.S.and the lack of a precise definition of operate with approximately $2 trillion of“propriety” trading itself will cause financial cash reserves. That represents only 14% 2
of U.S. gross domestic product. In None of these things are happening in contrast, corporate cash in the Eurozone a vacuum. is 21% of Eurozone GDP. In the UK, the ratio is even higher. Corporate treasurers must also contend with looming money market regulations that mayHighly liquid means of raising capital allow imperil 40% of the commercial paper market,treasurers to keep less cash on hand and Basel III lending requirements and expecteduse a just-in-time financing system that derivatives regulations.enables companies to pay the bills and raisethe capital needed to expand and create All of these efforts are converging in onejobs. place – the corporate treasury. The combined impacts of these measures haveShould the Volcker Rule be enacted in its not been thought through.present form, capital efficiency will decline,resulting in increased corporate cash buffers.Were cash to rise to the Eurozone level of21% of GDP, that new level would be $3 ”…Risk can neither be created nortrillion. destroyed, but only transformed.Stated differently, CFOs and treasurers …When you consider ways to reducewould need to set aside and idle an banking system risk, do not be trickedadditional $1 trillion of cash. into thinking that risk disappears. It • That $1 trillion is greater than the simply moves elsewhere. ” entire TARP program. • It’s more than the Stimulus program. • It is even greater than the Federal Reserve’s quantitative easing program, QE II. A common understanding among clientsSetting so much cash idle would seriously regarding financial risk is that, like energy,slow the economy to the detriment of risk can neither be created nor destroyed,businesses and consumers alike. To raise but only transformed. Therefore, when youthis extra $1 trillion cash buffer, companies consider ways to reduce banking systemmay have to downsize and lay off workers, risk, do not be tricked into thinking that riskreduce inventories, postpone expansion and disappears. It simply moves elsewhere.defer capital investment. Obviously, theeconomic consequences would be huge. To truly minimize the probability of future financial crises, we must understand howWhy would treasurers have to idle so much this risk transforms and where it will show upmore cash? next. Risk is managed most efficiently when it is transparent, properly understood and theThe Volcker Rule, as currently proposed, will market responds with robust, efficient andincrease administrative expenses for banks, liquid hedging solutionsand create a subjective regulatory scrutiny oftrades, making a company’s ability to raisecapital more expensive and time consuming. Specific Unintended ConsequencesThese changes will raise costs for some of the Volcker Rulecompanies, make foreign capital marketsmore attractive for some and will shut some The ambiguity surrounding provisions of thecompanies out of debt markets entirely. Volcker Rule is likely to have a chilling effect on precisely those banking services that account for U.S. competitiveness, capital 3
efficiency and financial stability. This issue is activities, banks would be unable or unwillinga concern for U.S. businesses, large and small. to underwrite these public and private bonds. Thus, if banks can no longer hold inventory,Some of the unintended consequences, in it will be much more difficult for businesses,addition to a general slowdown in economic municipalities and schools to raise capital.activity, include: Bank trading activities are what create • Impaired market liquidity and reduced market liquidity and enable the market to access to credit provide an efficient clearing price. Without • Higher costs and less certainty for these activities, markets take a giant step borrowers backward to bilateral “deals” and, in effect, a • Restricted trading in proper and barter or auction system. allowable businesses • Competitive disadvantage for U.S. Higher costs and less certainty for borrowers businesses and financial institutions • Increased compliance costs for non- The Volcker Rule will increase the cost of financial businesses capital for all companies. With reduced • Higher bank fees for consumers and market liquidity, transaction spreads widen, businesses risks increase and price changes become • Less access to capital for small more volatile. To compensate for these new business and start ups risks, investors will demand higher rates. • Shifting of risks to other sectors of the economy Because banks can currently underwrite a • Capital flows into offshore markets bond issue for a customer and hold any unsold bonds in inventory, creditworthyLet’s examine these consequences one borrowers can be reasonably assured ofby one. timely access to credit. However, under the Volcker Rule in its current form, banks may not be able to hold that inventory. TheyImpaired market liquidity and reduced therefore, may instead decide to defer oraccess to credit delay underwriting those bonds for their customers until buyers are found in advance.The Volcker Rule will impair the ability ofbanks to function as market makers. Banks Imagine a municipality or a hospital facing aact as significant buyers and sellers of critical funding need. Under the Volcker rule,securities to ensure that borrowers can find they would go bankrupt while waiting for ainvestors and investors can find investments. bank to line up the funding. Or, they would end up paying a crippling rate.As market makers, banks hold inventory.This inventory could be in various investmentinstruments, treasury debt, customer Restricted trading in proper and allowablesecurities and foreign currencies. However, businessesthe Volcker Rule significantly constrains theirability by dictating how banks should The proposed rule is inherently complicatedmanage their inventory, which will reduce the and forces regulators to define the intent of adepth and liquidity of our capital markets. trade. Worse, they require banks to “prove” the intent of each trade. This proof cannot beFor example, corporations, municipalities, done in any reliable and consistent way. Onehealthcare providers, and universities rely entity’s proprietary trade is another entity’supon the “market making” activities of banks “market making” activity. “Proprietaryin order to secure affordable funding in the trading” defies a symmetrical definition.bond market. Without these “market making” 4
The complexity and vagueness of the Finally, most companies will still haveVolcker Rule will force banks to adopt the financial risks that need to be managed. U.S.most conservative interpretation of the rule business will increasingly turn to foreignand the least favorable “intent” of any trade. banks in overseas markets – which wouldWith the burden of proof on the banks, the simultaneously weaken U.S. banks whilecompliance costs become prohibitive. The strengthening foreign banks.net result will likely be the elimination ofperfectly acceptable “market making”activities. Eliminating these activities could Increased compliance costs for non-result in banks exiting or scaling back such financial businessesroutine activities as commercial paperissuance, cash management sweep The reach of the Volcker Rule can extend toaccounts and multi-currency trade finance. non-financial businesses, although theyThese are services which all Treasury present no systemic risk whatsoever. ManyStrategies clients view as critical solutions to businesses offer financing services to theirexecute sound financial management. customers. They may own a bank, have a commercial or consumer finance subsidiary or have a credit card company. TheseCompetitive disadvantage for U.S. businesses will incur increased costs andbusinesses and financial institutions higher compliance burdens. Some will pass these costs on to their customers. Others willThe United States’ major trading partners simply discontinue the financial or cardhave rejected the Obama Administration’s services. In any event, the result is higher-request to follow the Volcker rule. This cost credit for those willing to pay and lessrejection puts American businesses and credit for most small businesses and consumers.financial institutions at a disadvantage. Byeliminating a core revenue stream from U.S.banks, the Volcker Rule would effectively Higher bank fees for consumers andreduce the ability for U.S. banks to compete businessesand grow. Additionally, in order to avoid theterritorial jurisdiction of the Volcker Rule, The cumulative effect of regulatory changesforeign financial firms may retreat from the such as the Volcker Rule and Basel III willU.S., further depriving American businesses reduce or eliminate core banking revenue. Atof capital and degrading the ability of U.S. the same time, the Volcker rule willregulators to oversee and regulate financial materially increase the costs of regulatoryactivity. compliance. In order to continue providing high quality, technologically-advanced banking services, U.S. banks will need to increase banking fees on a wide range of services. They may also need to become”U.S. Businesses will increasingly turn more selective in the customer segments they choose to serve, thereby reducing theto foreign banks in overseas markets – general availability of banking services.which would simultaneously weakenU.S. banks while strengthening foreign Less access to capital for small business and start upsbanks. ” As banks restrict the availability of their services and increase the price, an inevitable “crowding out” will occur. The very highest- 5
rated corporations and those who transact in their treasury technology. Their intent is tothe highest denominations will still have get a real-time view of their cash, andaccess to credit and risk management implement automated tools to easily moveproducts. However, the less creditworthy that cash around the globe. In thiscustomers and start-ups will be left out. frictionless environment, cash can easily beMany traditional services will be no longer moved to the most favorable jurisdictions.cost effective. Some may not be available tothose segments at all. Many U.S. multinational companies are already selecting lead banks for each region of the globe, eroding the dominance of theShifting of risks to other sectors of the U.S. banks. Many companies areeconomy establishing regional treasury centers for functions traditionally housed in the U.S.As stated earlier, risk is neither created nor This regional structuring leads to capitaldestroyed. It can only be transformed. A flowing out of the U.S. and competitivenesscorporate CFO whose company imports a declining.raw material from the Far East, for example,must manage currency risk, commodity pricerisk, interest rate risk and operational Process Issuesshipping risk. Simply precluding a bank fromhelping the company hedge those risks, the Now that we have discussed the impacts ofVolcker Rule does not make those risks go the Volcker Rule upon non-financialaway. Indeed, the risk becomes less companies, let us consider regulatorytransparent and thus more potent. process issues that make it extremely difficult, if not impossible, for businesses toCFOs and treasurers will undoubtedly understand how the Volcker Rule will impactconclude that some risk management their ability to raise capital.techniques and some previously efficienttransactions will no longer be cost effective. The Federal Reserve (“Fed”), FederalThey will decide to “go naked” and retain that Deposit Insurance Corporation (“FDIC”),risk internally. The upshot is that they will Office of the Comptroller of the Currencyhold even more precautionary cash on their (“OCC”) and Securities and Exchangebalance sheets as a buffer. This added buffer Commission (“SEC”) proposed their portionwill take money out of the real economy. of the Volcker Rule implementing regulations in October, and these were published in the Federal Register on November 7, 2011. TheCapital flows into offshore markets Commodities and Futures Trading Commission (“CFTC”) voted on its proposalCorporate treasury is the financial nerve last week, but has not yet published itscenter of the firm, daily facing and managing proposal in the Federal Register.the complexities of the global markets. Mosttreasurers select a lead bank as their Each of these regulators looks at a separateprimary source of capital, information and portion of the markets, so it is only possibleadvice. That bank must be one that cannot to understand the full scope and impacts ofonly give the company global visibility, but the proposed regulations when onecan seamlessly operate in markets far and examines the interrelationships of thewide. The Volcker Rule would virtually proposed rules and the markets themselves.eliminate U.S. banks from contention for that While the CFTC is expected to close itsimportant “lead” role. comment period 60 days after publication in the Federal Register, the other regulators’Many companies have recently engaged comment period will close on February 13,Treasury Strategies to assist in upgrading 2012. 6