CHICAGO--(BUSINESS WIRE)-- This week's publication of proposed regulations governing proprietary trading by U.S. financial institutions opens an extended period of public comment on Volcker Rule provisions and the ultimate definition of restricted trading activities. If implemented as proposed, Fitch sees the potential for the new rules to have far-reaching financial implications for securities firms and universal banks.

While returns on equity and revenue growth rates would be cut if the proposals are implemented, the rules could also improve the risk profile of the affected institutions by potentially reducing trading inventory and the volatility of trading revenues. Similarly, the capping of investments in hedge funds and private equity firms would serve to reduce illiquid assets and earnings volatility.

Fitch believes that strictly enforced limits on market making activity, particularly if fixed income inventory levels are highly regulated, could have a material impact on the long-run revenue growth and margin potential of the major U.S. financial institutions with substantial trading operations. As proposed, the rule would constrain firms' ability to engage in flow trading or to profit from price moves in securities held to facilitate market making.

Many core activities, including government bond trading and derivative trading linked clearly to hedging, will not be restricted under the proposal. Furthermore, precise definitions of what is permissible in the execution of market-making activity may be refined before implementation.

Industry opposition to the proposal will likely fuel a lengthy debate in Washington regarding the ultimate scope and precise implementation of the Volcker Rule, which was originally set forth in the Dodd-Frank Act. There is a real possibility that controversy surrounding the proposal could delay the precise definition of restricted trading, particularly in a presidential election year when partisan debate over financial regulation will be intense.

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