This year’s biggest lobbying fight won’t take place in the halls of Congress. Instead, Wall Street heavyweights will spend the next several months battling U.S. financial regulators over implementation of the Volcker Rule.

The stakes are enormous. At the least, for big banks such as JPMorgan Chase & Co. and Goldman Sachs Group Inc., the rule — a prohibition on proprietary trading for a bank’s own profit — could mean billions of dollars annually in lost revenue. But the fight is about more than just bank profits; it’s about the basic mechanisms of borrowing money in the modern financial system.

Those critics, including governments in England, Japan and Canada, say it could weaken the entire financial system by raising borrowing costs for everyone from manufacturers to countries. Big banks, in their role as “primary dealers,” serve as the financial middlemen when it comes to securities of all stripes, including Treasury bills, short-term corporate paper and English government bonds.

Many companies and governments say they are able to borrow seemingly at will, at reasonable prices, because they know the banks will help snap up their debt — either for their own purposes, on behalf of clients or to pass along to other customers. In modern banking parlance, this is called “market making.”

All of which is well and good, according to Sen. Jeff Merkley (Ore.) — who along with another Senate Democrat, Carl Levin (Mich.), championed the inclusion of the language in the 2010 financial services regulatory overhaul known as Dodd-Frank. (The provision is named for its most prominent advocate, former Federal Reserve Chairman Paul Volcker.) That’s why the Senators included an exemption in the law for market-making and underwriting activities at the banks. They say the statutory language recognizes the important role played by the Wall Street houses and sufficiently protects market-essential activity.

But they drew a line at short-term trading in securities aimed at turning a profit. Volcker Rule supporters say the banks have branched out into ever riskier activities, threatening their own safety and taxpayer money in the event of a failure. In their view, banks should stick closer to traditional activities such as making loans and credit available for other businesses.

They make no apologies for wanting to reshape the industry. In fact, Merkley and Levin say, that’s exactly what they intended. They want the rule “to be a modern version of the Glass-Steagall Act,” which barred banks from proprietary trading for more than 60 years before it was repealed in 1999.

All of which brings us back to the regulators and where things get complicated. A draft rule issued this past summer made nobody happy. The financial industry launched an all-out war on the draft, arguing that the 300-page proposal was Byzantine, riddled with too many unanswered questions and impossible to implement. Levin and Merkley slammed the proposal as well, deriding it as too soft on the industry and bending over backward to make sure banks didn’t have to roll up any significant parts of their operations.

Bright-Line Distinctions

At some level, the real problem is trying to figure out exactly what proprietary trading is. In principle, it’s easy enough to explain. But when that principle is applied to the vast tapestry of securities trades made every day, it gets a lot harder to distinguish what’s a strictly for-profit trade and what isn’t.

The rule “defines permitted activities far too narrowly and subjects banking entities to a conceptually difficult and operationally expensive set of requirements, the costs of which cannot be justified based on their benefits,” the Securities Industry and Financial Markets Association wrote in a comment letter on the draft. “These requirements may paralyze effective market making, which is far from the statute’s intent.”

Merkley and Levin drew the exact opposite conclusion. “As a starting point, we think the proposed rule is simply too tepid,” they wrote in their comment letter. “The proposed rule does not fulfill the law’s promise. Instead, the proposed rule seems focused on minimizing its own potential impact.”

Then there’s the question of whether the draft rule is feasible to implement. Sheila Bair, the iconic former head of the Federal Deposit Insurance Corp., has serious doubts. “I believe that the regulators should think hard about starting over again with a simple rule based on the underlying economics of the transaction, not on its label or accounting treatment,” she said in recent testimony to a Senate Banking subcommittee.

But it’s hard to imagine Bair’s suggested remedy would win her many fans in the banking industry: “If it makes money from the customer paying fees, interest and commissions, it passes. If its profitability or loss is based on market movements, it fails,” she said.

Regulators are clearly struggling with the statute’s requirements. Their proposal included hundreds of questions and employed a relatively complex set of interrelated standards that banks would apply to every trade to determine if it was permitted market-making activity or banned proprietary trading. Based on their first draft, it seems regulators will have a hard time finding a bright-line distinction between the two.

It’s precisely that gray area that has the banks worried. They say the rule will have a contagion-like effect in securities markets, causing banks to move away from any trading that could run afoul of the new rule. If it’s hard to tell exactly what’s allowed and what isn’t, they say that will exacerbate the retreat from securities buying and will further curtail liquidity.

Allies Raise an Alarm

Knockdown fights between Congress, regulators and the banking industry are nothing new. But the Volcker Rule has moved beyond that arena, earning scathing criticisms (by finance minister standards) from allies in Europe and elsewhere.

Foreign governments, many of them already facing sagging interest in their debt, are worried that a broad ban would further push down demand and raise their borrowing costs. Interestingly, Dodd-Frank includes an exemption for U.S. sovereign debt (treasuries and the like), in part as a recognition of the key role played by the federal government’s borrowing practices in financial markets. But there’s some thought that U.S. bonds are exempt also to ensure that the federal government wouldn’t have to pay higher interest rates.

Foreign governments want the same exemption for themselves. The statute allows regulators to exempt a security if they think the new carve out would “promote and protect the safety and soundness of the banking entity and the financial stability” of the United States. That’s a pretty high bar to meet.

Still, while the statutory language for crafting new exemptions seems narrow at first blush, regulators have taken expansive views of their powers when pressed, most recently during the 2008 financial crisis. One possibility: Bank overseers could argue that holdings of foreign debt are essential for reducing risk with a diverse portfolio.

Perhaps more problematically for governments looking to get a Volcker Rule pass, U.S. regulators will be loath to carve out such a huge chunk of the securities market from Volcker’s reach, for fear of making a mockery of the ban. And the failure of commodity brokerage MF Global, largely the result of big bets on sovereign debt, lends some credence to the argument from Volcker supporters that banks shouldn’t bet on those same securities just for short-term profit.

The march of financial industry heavyweights into the offices of the Federal Reserve, Commodity Futures Trading Commission and FDIC will continue this spring. But given how poorly the regulators’ first pass at the rule has fared, there is some reason to think they may take another crack at it before making any final decisions.

Regulators are caught in a bind. A move to significantly address any of the complaints — either from foreign powers, the industry or Merkley and Levin — would almost certainly entail major revisions to the draft that’s now circulating. Even the act of filling in the blanks suggested by the hundreds of questions included in their first rule would be a fundamental rewrite of the original proposal.

All of which suggests regulators may have to take another crack at the rule by reproposing it, a relatively unusual step. “First, the changes to the Proposal needed to correctly implement the Volcker Rule mandate and to avoid serious harm to our financial markets are so extensive that reproposal will be required as a matter of administrative law,” SIFMA wrote.

The real threat, of course, is that without a reproposal, regulators would give the financial industry cause and ammunition for a legal challenge of the rule (though the industry is almost sure to challenge the rule, no matter what final shape it takes). “Commenters will not have a legally sufficient opportunity to comment on the final rule without a further opportunity to review the necessary changes,” SIFMA noted.

With so much uncertainty, it’s hard to predict exactly what will happen next. What is clear, however, is that this fight is far from over, and there’s every likelihood that it will drag on for the next year, if not longer.