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EU Red-Flags ‘Volcker’

Planned U.S. Rule on Banks’ Bets Is Seen as Threat to Worsen Debt Crisis


DAVOS, Switzerland—The European Commission will complain to Treasury Secretary Timothy Geithner that proposed U.S. regulations could discourage banks from trading European sovereign bonds, potentially increasing funding costs for the Continent’s governments and worsening its credit crunch.

Michel Barnier, the European commissioner for the internal market, said in an interview that he plans to raise objections with Mr. Geithner next month about the potential impact of the so-called Volcker rule, which would restrict U.S. banks from making bets with their own capital.

“I will talk to Mr. Geithner next month.…We can’t accept extraterritorial consequences or Europe will be tempted to do the same thing,” Mr. Barnier said.

The issue is particularly sensitive because many European countries are struggling to raise funds at affordable rates amid the euro zone’s debt crisis.

While Mr. Barnier didn’t spell out the details of the commission’s objections, European officials said the concerns were that the Volcker rule could hamper U.S. banks’ ability to buy and sell European sovereign bonds on behalf of customers, reducing liquidity in those markets.

The commission’s objection comes after George Osborne, the U.K. Chancellor of the Exchequer, raised concerns with Mr. Barnier at a meeting Monday, the commissioner said. Mr. Osborne couldn’t be reachedfor comment.

A spokeswoman for the U.S. Treasury Department declined to comment. A spokeswoman for the Federal Reserve, which has played a key role in writing the Volcker rule, said, “All comments received will be evaluated before the board acts on the rule.”

Mr. Barnier’s move will add to the pressure on the U.S. government to revise the proposal, following similar complaints by Japan and Canada.

In a joint letter sent to U.S. regulators on Dec. 28, the Bank of Japan and Japan’s financial-services regulator complained that restrictions on trading of foreign sovereign bonds in the Volcker rule would “impose a significant burden and higher costs on foreign banks, including major Japanese firms.”

The planned rule, named after former Fed Chairman Paul Volcker, is one of the most contentious elements of the Dodd-Frank financial-overhaul law of 2010. The rule is designed to keep banks with government-insured deposits from making bets that can backfire and require large federal bailouts.

The rule also has met with opposition from several U.S. banks, which have complained that it is difficult to distinguish between trading for their own accounts, called “proprietary trading,” and buying and selling on behalf of clients.

Mr. Volcker so far has declined to comment at length on the criticism of the rule. He plans to issue a comment letter to regulators in the near future, according to a person familiar with his thinking.

One of the concerns expressed by the European Commission, Japan and Canada is that the Volcker rule exempts U.S. government bonds from the ban on proprietary trading, and not those of other countries.

Jaret Seiberg, senior policy analyst with Guggenheim Securities, said the foreign officials’ complaints make it increasingly likely that U.S. regulators will move away from trying to micromanage how market making—the activity of buying and selling assets on behalf of clients—is conducted by banks.

“When foreign governments are complaining that a rule could have systemic ramifications, that has to be a message that regulators hear,” he said. “The irony is that Volcker was intended to reduce the risk of a systemic crisis, yet we’re hearing from foreign governments that it could actually provoke one by reducing liquidity in the trading of sovereign debt.”

The Volcker rule could particularly hamper smaller European nations seeking to borrow money by issuing sovereign debt, said one Wall Street executive. Some countries that have thinly traded bonds rely heavily on big banks that serve as primary dealers to buy their debt at auctions. But those dealers may pull back from those markets, said the executive, because they often don’t have buyers at the ready for such securities and could fear violating Volcker-imposed restrictions on holding debt inventory.

“Anything that has a prospect of limiting the Volcker rule would have an impact,” said an executive at a major U.S. bank. “But is it real? That is the question. Is this something Geithner looks at and says ‘we have to get the European economy moving again’ or is it just more complaining that they will ignore?”

The Volcker rule is being crafted by five regulators, including the Fed, the Securities and Exchange Commission and the Commodity Futures Trading Commission. The current proposal is likely to be changed before a final rule is adopted. The financial industry has ramped up pressure on government officials to scale back the rule, which is set to be implemented in July.

The defenders of the Volcker rule point out that trading in foreign sovereign bonds played a central role in bringing down MF Global Holdings Ltd. They also say that if large banks back away from some trading of government bonds, smaller firms will step in and fill the gap.

The European Commission’s Mr. Barnier also said his group was looking at options for structural changes in the banking sector, including the Volcker rule and the recent Vickers report in the U.K., which recommended ring-fencing, or roping off, bank’s domestic retail deposits from the rest of their operations.

“The Volcker rule is a law which I am interested in, just as I am interested in the Vickers report and the way the Japanese are handling this question,” he said.