Wall Street banks will need to prove to regulators their trades are done on behalf of clients or to protect against market risks and are not speculative bets for their own profit, under the Volcker rule approved by U.S. officials on Tuesday.
The rule - which five regulatory agencies, including the Securities and Exchange Commission and the Commodity Futures Trading Commission, adopted during the day - appears to more sharply crack down on so-called proprietary trading than when it was proposed two years ago, likely disappointing banks hoping for more leeway.
Named after former Federal Reserve Chairman Paul Volcker, who championed the reform, the rule prohibits banks from betting on financial markets with their own money and is a crucial part of the efforts to reform Wall Street.
Regulators have struggled for years to agree on a text that, while prohibiting such risky activity, would still allow banks to take on risk on behalf of clients as market-makers, to hedge risk, or when underwriting securities.
In the final wording, banks could still engage in market making and take on positions to help clients trade, but their inventories should not exceed "the reasonably expected near-term demands of customers", the regulators said.
The regulators also seek to put an end to so-called portfolio hedging, a practice in which banks entered all kinds of trades that were supposed to hedge risk elsewhere in the business but that could be used as veiled speculation.
"The rule would prohibit so-called 'macro-hedging' that has caused large speculative losses at institutions in the past," Martin Gruenberg, the head of the Federal Deposit Insurance Corp, said in a statement.
The provision is designed to prevent a repeat of such trading debacles as JPMorgan's $6 billion trading loss in 2012, dubbed the "London Whale" because of the huge positions the bank took in credit markets.
Other changes from the originally proposed rule include a wider exemption for the trading of government bonds, which will now be permitted for foreign sovereign fixed income instruments and not just for U.S. bonds, after complaints from Europe.
Implementation of the changes would be delayed by a year until July 2015, the regulators said, a widely expected move after they repeatedly missed deadlines for the rule, which has now mushroomed into almost 900 pages.
The chief executives of the biggest banks would have to attest their banks have appropriate programs in place to achieve compliance with the rule, but would not themselves have to confirm their banks are in compliance.
Large investment banks have such sprawling legal structures engaging in different financial activities that the rule needed to be adopted by a patchwork of U.S. agencies: three bank watchdogs and two market regulators.