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PROPRIETARYTRADINGRegulators Will NeedMore ComprehensiveInformation to FullyMonitor Compliancewith New RestrictionsWhen Implemented
Report to Congressional Committees
July 2011
GAO-11-529
United States Government Accountability Office
GAO
 
 
United States Government Accountability Office
Highlights of GAO-11-529, a report tocongressional committees
July 2011
PROPRIETARY TRADING
Regulators Will Need More ComprehensiveInformation to Fully Monitor Compliance with NewRestrictions When Implemented
 Why GAO Did This Study
In addition to trading on behalf of customers, banks and their affiliateshave conducted proprietary trading,using their own funds to profit fromshort-term price changes in assetmarkets. To restrain risk-taking andreduce the potential for federal supportfor banking entities, the Dodd-FrankWall Street Reform and Consumer Protection Act (the act) prohibitsbanking entities from engaging incertain proprietary trading. It alsorestricts investments in hedge funds,which actively trade in securities andother financial contracts, and privateequity funds, which use debt financingto invest in companies or other less-liquid assets. Regulators mustimplement these restrictions byOctober 2011. As required by Section989 of the act, GAO reviewed (1) whatis known about the risks associatedwith such activities and the potentialeffects of the restrictions and (2) howregulators oversee such activities. Toconduct this work, GAO reviewed thetrading and fund investment activitiesof the largest U.S. bank holdingcompanies and collected selected dataon their profits, losses, and riskmeasures. GAO also reviewedregulators’ examinations and other materials related to the oversight of thelargest bank holding companies.
 What GAO Recommends
As part of implementing the newrestrictions, regulators should collectand review more comprehensiveinformation on the nature and volumeof activities potentially covered bythe act. Treasury and the financialregulators agreed to consider this aspart of their rulemaking.
 What GAO Found
Proprietary trading and investments in hedge funds and private equity funds, likeother trading and investment activities, provide banking entities with revenue butalso create the potential for losses. Banking entities have conducted proprietarytrading at stand-alone proprietary-trading desks but also have conducted suchtrading elsewhere within their firms. GAO determined that collecting informationon activities other than at stand-alone proprietary trading desks was not feasiblebecause the firms did not separately maintain records on such activities. As aresult, GAO did not analyze data on broader proprietary trading activity butanalyzed data on stand-alone proprietary-trading desks at the six largest U.S.bank holding companies from June 2006 through December 2010. Compared tothese firms’ overall revenues, their stand-alone proprietary trading generallyproduced small revenues in most quarters and some larger losses during thefinancial crisis. In 13 quarters during this period, stand-alone proprietary tradingproduced revenues of $15.6 billion—3.1 percent or less of the firms’ combinedquarterly revenues from all activities. But in five quarters during the financialcrisis, these firms lost a combined $15.8 billion from stand-alone proprietarytrading—resulting in an overall loss from such activities over the 4.5 year periodof about $221 million. However, one of the six firms was responsible for both thelargest quarterly revenue at any single firm of $1.2 billion and two of the largestsingle-firm quarterly losses of $8.7 billion and $1.9 billion. These firms’ hedgeand private equity fund investments also experienced small revenues in mostquarters but somewhat larger losses during the crisis compared to total firmrevenues.Losses from these firms’ other activities, which include lending activities andother activities that could potentially be defined as proprietary trading, affectedtheir overall net incomes more during this period than stand-alone proprietarytrading and fund investments. Some market participants and observers wereconcerned that the act’s restrictions could negatively affect U.S. financialinstitutions by reducing their income diversification and ability to compete withforeign institutions and reducing liquidity in asset markets. However, with littleevidence existing on these effects, the likelihood of these potential outcomes wasunclear, and others argued that removing the risks of these activities benefitsbanking entities and the U.S. financial system.Financial regulators have struggled in the past to effectively oversee bankholding companies. While the act’s restrictions reduce the scope of activitiesregulators must monitor, implementing them poses challenges, including how tobest ensure that firms do not take prohibited proprietary positions whileconducting their permitted customer-trading activities. Regulators have yet togather comprehensive information on the extent, revenues, and risk levelsassociated with activities that will potentially be covered, which would help themassess whether expected changes in firms’ revenues and risk levels haveoccurred. Without such data, regulators will not know the full scope of suchactivities outside of stand-alone proprietary trading desks and may be less ableto ensure that the firms have taken sufficient steps to curtail restricted activity.
ViewGAO-11-529or key components.For more information, contact Orice WilliamsBrown at (202) 512-8678 or williamso@gao.gov.
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