WASHINGTON U.S. regulators are set on Tuesday to approve a rule to rein in risky trading by banks, a crucial part of their efforts to reform Wall Street and prevent another costly taxpayer bailout.
The Volcker rule, named after former Federal Reserve Chairman Paul Volcker, who championed the reform, prohibits banks from betting on financial markets with their own money, a practice known as proprietary trading.
The rule, which has now mushroomed into 800 pages, will also bar them from owning more than 3 percent of hedge funds or private equity funds.
The final version of the crackdown is expected to be tougher than when it was proposed two years ago, after JPMorgan Chase & Co's $6 billion loss in 2012 - nicknamed the London Whale after the bank's huge positions - highlighted the perils of speculative trading.
Banks worry the rule will erode profits, and make it harder to engage in businesses that are exempt under the law such as hedging against market risks, facilitating client trading - or market-making - and security underwriting.
"The challenge is to prevent the impermissible activities, while promoting the underwriting, the market making, everything that everyone regards as important to financial markets," said Robert Maxant, a partner at Deloitte & Touche.
The rule is one of the most hotly debated parts of the 2010 Dodd-Frank Wall Street reform act, aimed at preventing the taxpayer bailouts of large investment banks that happened during the 2007-2009 credit collapse.
The three U.S. bank regulators, as well as the Securities and Exchange Commission and the Commodity Futures Trading Commission, will unveil details of the final rule at 9.30 a.m. (1430 GMT).
They are then expected to adopt the rule later in the day, although some officials are expected to dissent to the way the final rule is crafted.
The rule could cost the largest investment banks billions in revenues, and lawyers will be poring over the details of the text to find any weaknesses that would enable them to sue regulators and get the courts to strike down the rule.
Banks will particularly focus on how strict the requirements are for them to prove that any risky positions they take on are on behalf of clients.
In market making, for instance, they have inventories of shares or other securities in order to quickly satisfy client orders, but banks fear new limits on how long they can hold these may make it harder to stock up.
Banks are also worried regulators will clip their wings when it comes to entering risky positions to mitigate financial risk arising in their business, so-called risk hedging.
This can still be done when there is a direct connection to the underlying risk, but banks are used to doing this in multiple and often loosely defined ways - so-called portfolio hedging - and fear this will no longer be allowed.
JPMorgan initially explained its London Whale trades as portfolio hedges and regulators have since made it clear the final rule will render such trades impossible.
While the narrowing of the Volcker rule trading exemptions is expected to bite, banks have already wound down their proprietary trading since the crisis.
Morgan Stanley in January 2011 said it would spin off its proprietary trading unit Process Driven Trading, which had 60 employees around the world.
Goldman Sachs Group Inc said it had shut down two proprietary trading desks, one known as GSPS and another that did global macro trading, by February 2011.
And Citigroup said it had shuttered a money-losing proprietary group that had traded stocks.
(Additional reporting by David Henry in New York; Editing by Karey Van Hall and Tim Dobbyn)