'Volcker rule' finally at finish line

Former Federal Reserve chairman Paul Volcker with President Obama.

NEW YORK (CNNMoney) It's a moment Wall Street bankers have been anxiously awaiting for more than three years: Regulators are set to vote Tuesday on the so-called Volcker rule -- a key piece of the 2010 Dodd-Frank financial reform law.

Congress has long since passed the legislation. But the law's implementation has been slow-going, as regulators were tasked with crafting its specifics.

Of the 398 rules Dodd-Frank required to be drawn up, only 42% had been finalized as of last week, according to law firm Davis Polk. Around 30% are awaiting approval, with 28% yet to be proposed.

The Obama administration has faced a chorus of criticism from Republicans and the financial industry over the law's plodding progress. But the finalization of the Volcker rule will mark a big milestone.

The rule sounds simple enough in principle: Banks with federally insured deposits will be restricted from risky investment activities undertaken for their own benefit, a practice known as proprietary trading. It also prohibits them from taking ownership stakes in hedge funds and private equity funds.

Named for former Federal Reserve chairman Paul Volcker, the rule harkens back to the Glass-Steagall Act, a Depression-era law that separated commercial and investment banking but was repealed by Congress in 1999.

Reform advocates say that with federally insured banks reined in, taxpayers will be saved from having to bail out ailing financial institutions whose failure would hit the accounts of average citizens.

The proposal has generated furious lobbying from advocacy groups and big-spending Wall Street firms.

Regulators have received over 18,000 comment letters on the subject, among the highest for any provision of Dodd-Frank. They have also held dozens of meetings with interested parties, the vast majority of which were affiliated with the financial industry, according to a recent paper from Duke University law professor Kimberly Krawiec.

A key point of contention is how the rule will define proprietary trading, a task that bedeviled even Volcker himself. He once quipped in testimony before Congress that it was like "pornography -- you know it when you see it."

Banks say the rule must protect "market making," in which firms hold securities to facilitate customer transactions. Banks also want to preserve their ability to trade for! the purpose of hedging -- offsetting risks elsewhere.

Most major banks have already shut down their proprietary trading desks, which functioned like internal hedge funds. The problem is that even outside of proprietary trading desks, it can be difficult to tell when a trade is made for hedging or market making and when it's made for purely speculative purposes.

JPMorgan (JPM, Fortune 500), for example, claimed its $6 billion "London whale" trading loss last year resulted from a hedge. But the failed trade, which drew on federally insured deposits, prompted fresh concerns about the industry's stability, and government officials say it's exactly the kind of activity the Volcker rule will prevent.

"The rule prohibits risky trading bets like the 'London Whale' that are masked as risk-mitigating hedges," Treasury Secretary Jack Lew said last week. How exactly the rule writers define terms like hedging and proprietary trading will determine the provision's reach.

Regulators will also have to decide on a date for the rule to take effect, which might be several years from now. The rule could be held up by lawsuits from the financial industry, as other aspects of the Dodd-Frank law have been.