The Volcker Rule and Proprietary Trading Restrictions

Introduction

The Volcker Rule, codified as Section 619 of the Dodd-Frank Act, prohibits banking entities from engaging in short-term proprietary trading and restricts their investments in hedge funds and private equity funds. Named after former Federal Reserve Chairman Paul Volcker, who argued that taxpayer-insured deposits should not fund speculative trading, the rule fundamentally reshaped how universal banks generate trading revenue. For FIG bankers, the Volcker Rule is essential context for understanding why bank trading desks operate as client-facing businesses rather than as proprietary profit centers, and why the risk profiles (and revenue volatility) of large banks differ markedly from the pre-crisis era.

The Volcker Rule targets two categories of activity by banking entities (any federally insured depository institution, its holding company, and their subsidiaries or affiliates).

Proprietary trading: Banks cannot engage in short-term trading of securities, derivatives, commodity futures, or options for their own account. "Short-term" is defined by intent: positions taken with the purpose of selling in the near term to profit from price movements, rather than to facilitate customer activity. The 2020 revisions added a 60-day safe harbor: positions held for 60 days or longer are presumed not to be short-term proprietary trades, reversing the original rule's rebuttable presumption that any position held under 60 days was proprietary.

Covered fund restrictions: Banks cannot acquire or retain ownership interests in hedge funds or private equity funds (collectively, "covered funds") beyond 3% of the fund's total ownership interests and 3% of the bank's Tier 1 capital in aggregate across all fund investments. Banks also cannot engage in certain transactions with covered funds that they manage (such as lending or guaranteeing obligations), reflecting the concern that banks were using fund structures to take proprietary risks off-balance-sheet.

Proprietary Trading vs. Market-Making

The distinction between prohibited proprietary trading and permitted market-making is the Volcker Rule's central compliance challenge. Proprietary trading involves taking directional positions to profit from price movements. Market-making involves holding inventory to facilitate client order flow, standing ready to buy and sell, and earning the bid-ask spread. In practice, both activities involve the bank holding risk positions, and the line between them can be subjective. The rule requires market-making desks to demonstrate that their inventory is "designed not to exceed the reasonably expected near-term demands of clients." Banks must maintain detailed compliance programs documenting why each trading desk qualifies as market-making rather than proprietary.

The Volcker Rule exempts several categories of trading activity that regulators deemed essential to bank operations and capital markets functioning.

These exemptions are broad enough that most of the trading revenue large banks generate today falls within permitted activities. In Q3 2025, the four largest US bank trading operations (JPMorgan, Goldman Sachs, Morgan Stanley, Bank of America) generated approximately $15-18 billion in combined quarterly trading revenue, all from permitted client-facing and market-making activities.

In June 2020, five federal agencies (the Fed, OCC, FDIC, SEC, and CFTC) finalized revisions that simplified Volcker Rule compliance significantly.

The revised rule introduced the 60-day presumption (positions held longer are presumed non-proprietary), streamlined the compliance program requirements based on bank size (eliminating CEO attestation requirements for smaller institutions), and clarified several exclusions. Banks with less than $10 billion in total assets and limited trading activity now face minimal compliance obligations.

Under the current administration, the deregulatory stance extends to Volcker Rule enforcement. While no formal repeal has been proposed (which would require congressional action), the lighter supervisory approach means fewer examinations focused on the proprietary trading prohibition and less aggressive interpretation of what constitutes permitted market-making versus prohibited prop trading.

The Volcker Rule represents one dimension of Dodd-Frank's broader reshaping of bank business models. Alongside capital requirements, stress tests, and resolution planning, it constrains how banks deploy their balance sheets, pushing risk-taking toward less regulated parts of the financial system while making the banking sector itself more stable and predictable.