In the aftermath of the financial crisis of 2008, the government sought to put in a variety of rules in order to prevent such a collapse from ever happening again. At the center of this process was the Dodd-Frank regulations which came into being in 2010.
However, many of the key provisions of this law have yet to be drafted, such as the so-called ‘Volcker Rule’, which was in the Dodd-Frank bill, but has been going back and forth among regulators and financial entities since then. Finally, it appears as if the variety of financial regulators have agreed on a way forward with this rule, giving banks until July 2015 to meet the terms of the provision (see all the Financial ETFs here).
Volcker Rule in Focus
The new guidelines look to prevent traditional lending companies from engaging in proprietary trading and a variety of high risk activities with depositor money. The idea behind this being that if a prop desk crashes, it won’t bring down the whole bank and force the government to get involved in order to bailout innocent depositors.
The law will also require CEO attestation of the effectiveness of compliance programs so that traders cannot run rouge and blow up a trading system on their own. This was obviously a huge issue when JP Morgan faced some trouble from its ‘London Whale’ debacle, which could have easily taken down a smaller financial institution, a risk that this requirement is looking to reduce.
The move may also hit bank profits, while it could also curtail market making activities. Some also are concerned that regulators will not be able to tell the difference between some types of hedging and other types of lower risk bets which are actually reducing exposure levels, a potential unintended consequence of the new provisions.
The real key to the law will be the implementation and how deep the Volcker Rule concerns really go, and if it curtails bank profits. Either way, the following three financial ETFs look to be ones to watch in the months ahead, as they could be the most impacted by this new rule:
PowerShares KBW Bank Portfolio (NYSEARCA:KBWB)
The law is targeted right at the banking industry, seeking to separate deposits and perceived higher-risk trading activities. For this reason, any bank-focused ETF could be heavily impacted by the news, such as KBWB.
This PowerShares product tracks the KBW Bank Index, holding about 25 companies in its basket. The biggest weights include some of the most-likely impacted firms, such as C, BAC, and (JPM), though smaller, regional banks are also included as well, though large caps make up 67% of the total assets.
Thanks to its large cap value focus, the fund does have a risk rating of ‘low’ so it shouldn’t be too volatile even if trading issues arise. Meanwhile, the fund does have a Zacks ETF Rank #2 (Buy), and with a 36% gain over the past year it has certainly seen a strong performance over the past 52 weeks, so hopefully Volcker Rule issues don’t derail this solid trend.
iShares US Broker-Dealers ETF (NYSEARCA:IAI)
If there are reduced trading levels, companies that are brokers and dealers of securities could see sluggish volumes. And with reduced volumes, revenues—and thereby profits—could slump for companies in this market segment thanks to the Volcker Rule.