Prop. Trading may be monitored like Money Laundering!!!

Future may see proprietary trading by banks being treated almost like money laundering by the regulators. FT reported on 6th January that US regulators want to use techniques pioneered in the fight against money-laundering to crack down on “proprietary trading” by banks as part of new financial reforms.

The question of how to define trading done with banks’ own funds is one of the thorniest for the US authorities in the post-crisis regulatory overhaul as it is difficult to differentiate such activities from market-making on behalf of clients.

The “Volcker rule”, proposed by the former Federal Reserve chairman Paul Volcker and included in last year’s Dodd-Frank law, aims to reduce banks’ risk-taking by forbidding them from placing short-term trading bets.

After months of internal discussions and talks with banks, which have mounted a vigorous lobbying campaign, regulators are leaning towards a “multi-tiered test” like those used to detect illegal money transfers.

The first tier would involve automated “tripwires” that alert banks’ compliance departments. Depending on the market and the trade, “tripwires” could be the length of time a trader holds a position, its size, riskiness, or other measurable criteria (In detecting money laundering, banks look at “filters” such as size and provenance of a transfer).

The second tier may see internal compliance and risk management departments quiz the trader on the nature of the position.

Finally, regulators will also be able to see the “tripwires” and monitor both traders and compliance departments. There may be suitable reporting requirements to the regulators.

Banks are likely to welcome this approach, after arguing that a strict definition of proprietary trading based on one-size-fits-all metrics would have cut off liquidity to large swaths of global capital markets.

Experts say that  a multi-tiered test would make sense if coupled with surprise visits to trading desks by regulators. They are of the view that spot checks by regulators should be part of the package. Regulators should make sure traders know they are not waiting to act until after the cow is out of the barn.

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