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Regulations of Prop Firms

Under MiFID I, prop traders were exempt insofar as no other investment services or activities were provided or performed. However, the exemption was further restricted under MiFID II. Under MiFID II, all market makers are subject to license obligations, including those who are active on the derivatives market.

The Volker Rule

Prop traders and hedge funds were among the financial institutions that were accused of causing the financial crisis of 2008. The Volcker Rule, a federal regulation, was introduced in April 2014 to regulate how proprietary traders operated.

The Volker Rule aims to restrict firms from making speculative investments that do not directly benefit their clients. These high-speculation investments were believed to be the cause of market instability. A major concern was avoiding possible conflicts of interest between firms and their clients.

The Volker Rule also aims to limit the amount of risk that financial institutions can take. It banned banks and institutions that own a bank from engaging in certain investment activities with their own accounts, such as prop trading, or investing in or owning a hedge fund or private equity fund.

As a result, most major banks have either separated the prop trading side of their core banking activities or closed them entirely. Specialised prop firms now offer the standalone service. The Volker Rule is generally viewed unfavourably across the financial services industry.

In June 2020, Federal Deposit Insurance Corporation (FDIC) officials said the agency would relax some restrictions of the Volker Rule.

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