The Obama administration, currently stumbling through the health care overhaul, has reached a critical stage in its other signature effort: reining in Wall Street.
The push to reshape financial oversight hinges on negotiations in the coming weeks over the so-called Volcker Rule, a regulation that strikes at the heart of Wall Street risk-taking. The rule, which bans banks from trading for their own gain, has become synonymous with the Dodd-Frank overhaul law that Congress adopted after the financial crisis.
Treasury Secretary Jacob J. Lew has strongly urged federal agencies to finish writing the Volcker Rule by the end of the year — more than a year after they had been expected to do so — and President Obama recently stressed the importance of the deadline.
While regulators are optimistic they will complete the rule soon, even after facing a lobbying onslaught from Wall Street, they have little time to overcome the internal wrangling that has stymied them for years.
The tension among regulators — five agencies are writing the rule — has centered on just how stringent to make it.
Some regulators are pushing to close potential loopholes, saying the rule will prevent future trading blowups at big banks, a concern that gained traction when JPMorgan Chase sustained a $6 billion trading loss in London. Yet some officials at other agencies, including the Federal Reserve and the Securities and Exchange Commission, have at times worried that the rule might inhibit banks from activities that are considered important for their health and the functioning of markets.
The tenor of the negotiations underscores how the Volcker Rule has emerged as a litmus test of the strength of Dodd-Frank, especially after regulators weakened other rules under that 2010 law. And although the Volcker Rule is only one of 400 regulations to arise from the sweeping overhaul, its symbolic significance has captivated Washington and Wall Street alike.
“Banks and their lawyers are all looking at the calendars wondering when the financial regulatory agencies are going to issue the Volcker Rule,” said Donald N. Lamson, a partner at the law firm Shearman & Sterling.
Mr. Lamson, who helped write aspects of Dodd-Frank while working at the Treasury Department, said that delays were inevitable, given the involvement of five agencies: the Federal Reserve; S.E.C.; Commodity Futures Trading Commission; Federal Deposit Insurance Corporation; and Office of the Comptroller of the Currency. The Fed has driven the process, operating as something of a broker between the agencies.
“Regulators like to be perceived as a monolith, but they each look at markets differently,” Mr. Lamson said.
Kara M. Stein, a Democratic commissioner at the S.E.C. who favors a strict Volcker Rule, recently submitted a four-page list of requested changes to a current draft of the rule, according to the officials briefed on the negotiations who were not authorized to speak publicly. Ms. Stein could hold the swing vote in the five-member commission, with the two Republican commissioners unlikely to support it.
Gary Gensler, head of the Commodity Futures Trading Commission, also wants to make it harder for banks to disguise speculative wagers as permissible trading done for customers, according to the officials briefed on the discussions. Underscoring the tension, other regulators privately groused that Mr. Gensler’s agency — which spent most of the last few years completing dozens of other new rules under Dodd-Frank — was too slow to raise concerns about the Volcker Rule.
“This is one of the most challenging rules to get done in a balanced way, but everyone is working in good faith along that path” Mr. Gensler said in an interview. Mr. Gensler is leaving his agency when his term expires at the end of the year.
In recent weeks, officials say, regulators have added language stricter than the initial version of the rule. Mr. Lew, according to officials, recently told Wall Street executives at a private meeting that the rule would be tougher than banks once thought.
Even at this late stage, the Volcker Rule is a work in progress. While the agencies have reached a broad agreement on most issues, a new version of the draft is being circulated among regulators nearly every day, officials say. The draft, with all its varied edits, spans about a thousand pages. And agencies might ultimately split off and vote separately.
“This is not an easy task, but we are heartened by the progress of the five rule-writing agencies,” a spokeswoman for Mr. Lew said in a statement. “Secretary Lew has clearly stated his desire to see a final rule by the end of the year, and we are optimistic that we will reach that goal.”
From the outset, the Volcker Rule was the product of compromise. The Obama administration declined to favor legislation forcing banks to spin off their turbulent Wall Street operations from their deposit-taking businesses. At the same time, it did not want regulated banks, which enjoy deposit insurance and other forms of government support, trading for their own profit. That business, known as proprietary trading, had long been a lucrative, albeit risky, business for Wall Street banks.
Paul A. Volcker, a former chairman of the Federal Reserve who served as an adviser to President Obama, urged that Dodd-Frank outlaw proprietary trading. And over the objections of Wall Street, the administration inserted into Dodd-Frank what became known as the Volcker Rule.
The rule, however, does not ban types of trading that are thought to be part of a bank’s basic business. Banks can still buy stocks and bonds for their clients — a practice called market making — and place trades that are meant to hedge their risks.
For regulators, the headache comes with finding practical ways to distinguish proprietary trading from the more legitimate practices. If they wrote the exemptions for market making and hedging too loosely, the banks might find loopholes. If they made them too strict, banks might not be able to engage in activities that Congress had said were permissible.
Now, just weeks away from the administration’s deadline to finish the rule, regulators are still struggling to strike a balance.
Mr. Gensler, officials briefed on the negotiations said, wants to insert language that would tighten the market making definition. In the real world of Wall Street, traders at a bank might keep buying shares of Apple until they have a substantial position in the company.
On the surface, that might look like market making, since clients have in the past wanted to buy Apple shares. But the bank may have actually amassed the position because it thinks the shares will rise in the future, effectively making it a speculative proprietary position. To prevent that sort of maneuver, Mr. Gensler’s agency is pushing to limit the ability of banks to stockpile such large positions.
Mr. Gensler also argued recently that the rule offered too broad an exemption for hedging, officials said, warning that it would fail to prevent a repeat of the JPMorgan trading loss episode. As regulators compromised and strengthened the language last week, officials said, Mr. Gensler withdrew his objection.
But other aspects of the hedging exemption might still concern supporters of the rule. The Fed sent out a draft last month that removed a sentence that required hedging to be “reasonably correlated” with a bank’s risks, according to three people briefed on the negotiations. Other agencies saw this as a weakening of the rule because it could make it easier for a bank to pass off speculative trading as hedging. After some debate, the words were reinserted, though it was not clear whether they would carry the same weight in the final draft.
The Volcker Rule takes other steps to stamp out proprietary trading. The final version is expected to contain a provision that requires bank chief executives to attest that they are not doing proprietary trading, officials say, a victory for the rule’s supporters. The tougher version of this provision would have a chief executive make this certification in the bank’s public securities filings, which are audited and are expected to have a high degree of accuracy. A more modest version would have the executive attest to a bank’s board of directors.
The Volcker Rule also addresses traders’ compensation. The final wording is likely to require that traders engaged in market making and hedging not be paid on the basis of simply how much money their units made. Instead, the risks involved in taking positions would also have to be considered.
Since the Volcker Rule was first proposed in 2011, regulators have had to contend with a fierce lobbying campaign by the banks. But that effort lost momentum last year, after JPMorgan’s trading debacle revealed that its traders were placing enormous speculative bets under the guise of hedging.
“I think you’re going to have a reasonable interpretation of the law,” Mr. Volcker said about the rule last year. “And an interpretation that can be reasonably followed by the banks and enforced by the regulators.”