Oliver Wyman, a subsidiary of Marsh & McLennan, released a study in December putting numbers on the Volcker Rule's potential impact on bond market liquidity. It estimates a 5% decrease in liquidity from the median would result in issuers having to pay a 16-basis-point yield premium, while a more significant 15% drop would ramp up the yield premium to 55 basis points. Those liquidity reductions, in turn, would reduce the level of outstanding debt by 1.2% and 4.1%, respectively, with the larger percentage amounting to an estimated decline of $315 billion.

The liquidity drop's impact on corporate bonds would vary according to their credit ratings. A 15% drop in liquidity, for example, would mean a relatively minor increase of five basis points in the liquidity premium on AAA-rated bonds, but a 116-basis-point jump in the premium for high-yield bonds.

The study calculates that drop in liquidity would result in an earnings drag of 3% for Caterpillar, 14.1% for Harley- Davidson and 19.6% for Delta Air Lines.

Based on the $1 trillion of high-yield and investment-grade bond issuance in 2010, the study estimates issuers would pay upwards of $6 billion in additional interest the first year, as investors demand higher returns on less liquid securities. Oliver Wyman estimates that over time, that number could rise to as much $43 billion, as a greater proportion of outstanding bonds are affected.

"Without a doubt, increased costs will prompt midsize and smaller companies to avoid the bond market," says Marie Hollein, CEO of Financial Executives International.

Alexander Marx, head of global bond trading at Fidelity Investments, which manages $1.5 trillion in assets, notes the Volcker Rule's exemptions for market making, underwriting and hedging but adds that regulators have interpreted them too strictly. "Fidelity is concerned," Marx says, "that these exemptions are too narrowly crafted, include too many conditions to be workable in practice, and rest on the presumption that critical market practices that occur today should be prohibited unless the onerous criteria are met."

As a result, banking intermediaries are likely to cut back significantly on their mainstay liquidity-providing functions such as maintaining inventories of securities to facilitate customer transactions and underwriting large trades.

"The adverse financial impact of the proposed rule to corporate issuers in this respect would be concrete, and would be significant to our financing decisions," writes Charlie Bracken, co-CFO of Liberty Global, which operates cable systems and was one of the few nonfinancial companies to submit a comment letter. "As a corporate issuer, we would be exposed to a risk of price volatility and a likely increase in our cost of funding were we to access the capital markets throughout the United States."

The SEC has long defined market making as being willing to sell covered financial positions in a security on a regular and continuous basis. Since the Volcker Rule only excludes trades matching that definition, less liquid markets, which tend to be especially important to midsize companies, will be impacted the most.

"You have to make continuous, two-sided markets [to be considered a market maker], and nobody does that in the private placement market," including the medium-term-note market companies often use to fund their operations, says Hardy Callcott, a partner at the law firm Bingham McCutchen. "Companies have gotten liquidity there typically by going to a market maker, most of which are affiliated with banks, and asking it to buy the debt."

In the absence of market makers, investors would have to plan on holding those investments to maturity, potentially a problem for pension funds and other institutional investors that may have to sell assets to meet funding obligations in the interim.

Callcott notes that the same dynamics would apply to the less liquid spectrum of the public fixed-income market, as well as equities and options. Even if a bank's trading fit within the market maker definition, he says, it would have to monitor trades against a long list of metrics, creating costs that it would likely pass on to customers.

A company may want to sell a block of stock quietly in the secondary market, or an institution may seek a big block of a specific security. If opportunistic traders learn about the trade, however, they may seek to profit off the price momentum, driving the price even further from the buyer or seller's target. Banks using their own capital to facilitate such block trades can hide the institution's intentions. But if banks fear being unable to sell part or all of the block quickly enough, or otherwise running afoul of the Volcker Rule, then they're likely to be more wary about providing that service.

Hollein, a former executive at nonfinancial companies and global banks, says it could be especially problematic for companies if banks hesitate to facilitate large foreign-exchange transactions, perhaps to support an acquisition. "A company needs to be able to lay off that risk almost immediately, because FX prices are constantly moving," she says. "The larger the block, the more at risk the company is."

In his comment letter, Volcker addressed several of the criticisms levied against the proposal, including "the thorny issue of guidance with respect to defining the character of 'market making' for customers" that regulators must confront.

He points to one characteristic that regulators could consider to determine whether banks' securities holdings, including market-making inventories, are proprietary or not. "Holding substantial securities in a trading book for an extended period obviously assumes the character of a proprietary position, particularly if not specifically hedged," Volcker writes.

If the proposed rule reduces liquidity, that may not be all bad, he argues. "At some point, great liquidity, or the perception of it, may itself encourage more speculative trading, even in longer-term instruments," Volcker writes. "Presumably conservative institutional investors are tempted to turn over positions much more rapidly, at the expense of careful analysis of basic values.

Calpers, which is one of the largest institutional investors and manages more than $234 billion in assets, says that the proposal's benefits outweigh its costs.

 "The Volcker Rule will help reduce the risks brokerage operations pose to their financial holding companies and, if effectively implemented, will help mitigate the risks SIFIs (Systemically Important Financial Institutions) pose to the overall financial system," writes Janine Guillot, chief operating investment officer at Calpers.

Guillot says that institutions such as hedge funds and mutual funds will be more negatively impacted by increased transaction costs than longer-term investors such as pension funds, and she predicts alternative matching networks will develop to match sellers with buyers, lessening the need for market makers.

The pension fund has some concerns about the Volcker Rule, such as a decline in bank proprietary trading that could result in increased volatility in the corporate bond market and the need to implement the rule globally for it to be effective.

Overall, however, the rule moves in the right direction, Guillot says. "The present system of bank regulation allows too much downside risk in the financial system, and we applaud the agencies' efforts to minimize that risk."