(In June 15 item, corrects calculation of threshold in paragraph 12)

FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S. June 13, 2018. REUTERS/Brendan McDermid

WASHINGTON (Reuters) - A proposal to simplify a rule banning banks from proprietary trading, rather than making life easier for Wall Street, could ensnare billions of dollars’ worth of assets not currently caught by the regulation.

This little-noticed wrinkle, if it were to make it into the final rule, could prompt Wall Street firms to overhaul their treasury, trading and merchant banking operations and change their accounting practices, lawyers and executives told Reuters.

On May 30, U.S. regulators unveiled a plan to modify the so-called Volcker Rule introduced following the 2007-2009 financial crisis, aiming to make compliance easier for many firms and relieving small banks altogether.

Wall Street has long complained about the complexity and subjectivity of the rule, which bans banks that accept U.S. taxpayer-insured deposits - such as Goldman Sachs Group IncGS.N, JPMorgan Chase & Co JPM.N and Morgan Stanley MS.N - from engaging in short-term speculative trading.

Republicans, the business lobby and analysts initially welcomed the proposal as a long overdue move to streamline and clarify the rule, while consumer advocates and progressive Democrats criticized it as a risky Wall Street giveaway.

But after digesting the 494-page consultation, financial industry executives and lawyers said it could actually create new headaches for big banks by banning a swath of trades and long-term investments not currently covered by the rule.

“It’s going to capture trades that wouldn’t be captured by the current regulation and that’s the bogeyman people would want to avoid in this proposal,” said Jacques Schillaci, a banking lawyer at Linklaters LLP who has studied the proposal.

The draft is subject to a 60-day consultation period during which industry participants will lobby for changes, with a final version, which is likely to be substantially revised, expected around January.

One of the most-hated aspects of the Volcker Rule presumes purchases and sales of instruments within 60 days count as proprietary unless the bank can prove they qualify for an exemption, such as market making or hedging.

This part of the rule aims to identify short-term trades that are intended to be speculative in nature, but banks say it is too subjective because it would require second-guessing traders’ intentions.

Regulators have proposed replacing it with a more objective test, based on the accounting treatment of the instruments traded.

Under the new test, trading activity by desks that daily book net realized or unrealized gains and losses that exceed $25 million at any point over a 90-day period, is only allowed if the bank shows that trading qualifies for the rule’s exemptions.

Since the crisis, however, banks have applied this mark-to-market or “fair value” accounting treatment to a range of longer-term investments to better manage their risk.

As a result, the proposal would bring under the rule the vast majority of equity investments, derivatives and a range of fixed income securities that banks hold for many years but not to maturity.

While some of these investments, such as U.S. treasuries, other government-related securities and some derivatives, would qualify for exemptions, many would end up being prohibited given the relatively low $25 million threshold, the industry experts said.

This could disrupt how bank groups structure their trading desks and manage their strategic investments and risk. The proposal may also prompt banks to elect not to mark-to-market some assets.

Spokespeople for the Federal Reserve, Securities and Exchange Commission, Commodity Futures Trading Commission and the Federal Deposit Insurance Corporation declined to comment.

A spokesman for the Office of the Comptroller of the Currency said the agency looked forward to reviewing stakeholder comments.

HIDDEN RISKS

The rewrite of the Volcker Rule comes amid a broader push by President Donald Trump-appointed regulators to boost bank lending and economic growth by relaxing regulations.

Brought into law by the 2010 Dodd Frank Act, the Volcker Rule is one of the most politically sensitive post-crisis rules and any changes will be closely-watched by Democratic critics, who warn tinkering with it could increase risks to the financial system.

But the accounting snag also underscores the hidden risks of rewriting complex financial rules for the banking industry, which could confront a new set of problems - and costs - if the effort does not go as they had hoped.

“Tinkering with these rules, and regulatory change, imposes cost in and of itself,” said Cliff Stanford, a banking regulation lawyer at Alston & Bird.

Regulators have said they are very open to feedback on how to refine the draft and the banking industry will lobby aggressively on this particular issue, the executives and lawyers said.

While the banks may push the regulators to narrow the scope of the new accounting test, expand the current exemptions, or raise the $25 million limit, scrapping the test altogether will be a tough sell.

Regulators see it as a failsafe that prevents firms evading the rule and believe focusing on the accounting treatment is clearer and more enforceable than the current 60-day intent test.

“There isn’t such a thing as a perfect fix for what they’re trying to do with this aspect of the rule,” said Schillaci.