The Volcker Rule, finalized just last week, is already having a big effect on the Wall Street—with banks losing commodity derivatives business to non-bank companies like BP, Cargill, and Koch Industries. The regulation prevents banks from speculating in derivatives for their own profit, and though it doesn’t bar them from selling these instruments to clients, it does prevent those banks from using information gleaned from being a big derivatives dealer to make speculative profits.
“In the past, the information was worth something to a bank if you had a proprietary desk,” Eric Melvin, ahead of Houston-based risk-advisory firm Mobius Risk Group, told Reuters. According to Melvin, corporate competitors of investment banks now account for about 40% of the oil and gas hedging business, whereas they had little market share a few years ago. Other restrictions on compensation are also enabling non-bank firms to outcompete Wall Street for top trading talent.
So should we be worried that the derivatives business is migrating from Wall Street to Main Street? Not necessarily. The point of the Volcker Rule is to make the financial system safer by making vital banks safer. Derivatives are risky business, but an oil company with a small financial services arm isn’t going to pose a threat to the financial system. That being said, investors and regulators will surely be watching this development closely. A study released last year from the Kellog School of Management found that six out of ten firms analyzed in the study used derivatives for purposes other than hedging risks, like trying to boost earnings to meet analyst expectations.