Factbox: Federal Reserve kicks off 'Volcker Rule' rewrite

By Pete Schroeder

WASHINGTON (Reuters) - The Federal Reserve on Wednesday will propose changes to the so-called Volcker Rule banning banks from making risky bets with their own cash, kicking off a lengthy effort to rework one of the central rules introduced following the 2007-2009 financial crisis.

WHAT IS THE VOLCKER RULE?

The Volcker Rule is part of the 2010 Dodd-Frank financial reform law. It is named after Paul Volcker, the former Federal Reserve chairman and economic adviser to President Barack Obama, who first conceived it.

Finalized by regulators in 2013, the rule attempts to prevent banks from making risky market bets while accepting taxpayer-insured deposits. The U.S. government lent banks billions of dollars in bailouts stemming from the financial crisis.

The rule addresses concerns similar to those that motivated the Glass-Steagall Act. That 1933 law, repealed in the 1990s, created a legal firewall between commercial banking and investment banking. Big bank critics, including U.S. Senator Elizabeth Warren, have called for its return as a way to curb bank risk.

WHAT ARE KEY FEATURES OF THE RULE?

The rule bars banks from engaging in proprietary trading whereby they bet their own cash in pursuit of short-term profits, but offers safe harbors for activities such as facilitating client trades and hedging risks.

The rule also restricts banks' ability to own or invest in so-called covered funds, such as hedge or private equity funds, in order to restrict their indirect exposure to risk.

WHO OVERSEES THE RULE?

The job of writing and implementing the rule falls to five separate regulators who share joint authority: the Federal Reserve, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, Securities and Exchange Commission and Commodity Futures Trading Commission.

WHAT DO CRITICS SAY ABOUT THE RULE?

Banks have complained that the Volcker Rule is overly complex and its definitions are vague, and that as a result it is excessively burdensome and often has unintended consequences.

The rule is highly unusual in that it assumes a bank is guilty until proven innocent, meaning all short-term trades are considered proprietary unless the bank can prove they qualify for a safe harbor.

However, proving to regulators that a trade qualifies for one of the safe harbors can be extremely taxing, requiring lots of form-filling and documentation. The rule places a strong emphasis on the intention of the trader when placing the trade, a point that banks say is highly subjective, confusing and would require a psychologist to prove.

The rule is also highly extraterritorial, affecting banks' businesses outside the United States and in some cases the overseas businesses of foreign banks. It also bluntly applies to all institutions above $10 billion in size, even though many smaller banks do very little trading.

Banks also complain about having to meet demands of five regulators which sometimes take opposing positions on enforcement.

HOW IS THE VOLCKER RULE LIKELY TO CHANGE?

Regulators are expected to scrap the presumption that short-term trades are proprietary unless banks prove otherwise, make it more clear which types of funds banks are banned from investing in and permanently exempt some foreign funds from the rule.

Regulators are also expected to more closely tailor the application of the rule to the size and complexity of each bank, with smaller banks that do not have active trading operations enjoying more leniency.

Wednesday's proposal is just the first step in reworking the rule. The other four regulators will also need to sign off on the proposal, receive comments from the public and consider additional changes. Analysts expect it could be months before an edited version of the rule is finalized.

(Reporting by Pete Schroeder; Editing by Michelle Price and Meredith Mazzilli)