United States: Observation 1.0 On The Volcker Rule

Last Updated: December 17 2013
Article by Frank A. Mayer, III and Jonathan L. Levin

'You Know It When You See It'1 – Or Do You?

This is first in Pepper's series of Client Alerts dealing with specific effects of the 'Volcker Rule' on various market segments.

On December 10, 2013, after more than three years of intensive development, the Board of Governors of the Federal Reserve System (FRB), Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) adopted final regulations implementing the "Volcker Rule," added to the Bank Holding Company Act of 1956 by Section 619 of the Dodd-Frank Act, which prohibits banking entities and nonbank financial companies from engaging in proprietary trading and severely restricts their relationships with hedge funds and private equity funds. In taking this action, the agencies have caused a sea change in the way many financial institutions will conduct their operations.

This Alert provides an overview of the significant features of the Volcker Rule. Future Alerts will include a discussion of the following issues:

  • affiliated transaction restrictions under Section 23A of the Federal Reserve Act and conflicts of interest under Dodd-Frank Section 621, Section 27B of the Securities Act of 1933, Rule 127B and affiliated covered funds
  • money market mutual funds
  • private pools of capital
  • government-sponsored enterprises
  • foreign banking organizations: exemption planning for trading in foreign sovereign debt and extra-territorial issues potentially beyond congressional intent
  • syndicated loans and asset-backed securities
  • compliance/CEO certifications, and
  • acquisition and disposition of non-conforming trading businesses and bank-affiliated funds.

With a regulation of 71 pages and an explanatory preamble running well over 800 pages, the only certainty is that waves of agency guidance and interpretations will fill the coming months and years. As new as the regulations may be, several industry groups are threatening legal challenges. Calls for delay or re-proposal are coming from Capitol Hill and dissenting regulatory officials. Because of the complexities of the regulations, even proponents fear that enforcement will be inconsistent across the agencies and harmful dislocations will occur in the financial markets. How much compliance infrastructure will be required to understand and green-light a business line and a transaction? Since more than three years have passed since the Volcker Rule became law, banking entities already have begun to adjust their business models. Expect that the regulations will create new opportunities for nonbanking entities to take over spin-offs of nonconforming trading businesses and bank-affiliated funds.

Who Is Covered by the Regulations?

The regulations apply to "banking entities." That term is defined to include generally all insured depository institutions (IDIs), all companies that control IDIs or are otherwise treated as bank holding companies, and all affiliates and subsidiaries of those entities.

Who Is Not Covered by the Regulations?

"Banking entities" generally will not include a hedge fund or private equity fund that is not a banking entity, a portfolio company held by a financial holding company under its merchant banking powers that is not a banking entity, a portfolio concern controlled by a small business investment company (SBIC) that is not a banking entity, and the FDIC acting as a conservator or receiver.

What Do the Regulations Prohibit or Restrict?

Proprietary Trading. The regulations prohibit a banking entity from engaging in "proprietary trading," which generally means engaging as principal for the trading account of a banking entity in any transaction to purchase or sell specified types of financial instruments. A "trading account" generally refers to three classes of positions taken by a banking entity – the purchase or sale of financial instruments for short-term (usually less than 60 days) gain or hedging of other trading accounts, the purchase or sale of financial instruments treated as "covered positions and trading positions" under federal banking agency market risk capital rules, and the purchase or sale of financial instruments in connection with activities for which the banking entity is licensed as a dealer, swap dealer or security-based swap dealer.

Covered Funds. The regulations also prohibit or restrict a banking entity from acquiring and retaining an ownership interest in, or having certain relationships with, a covered fund. A "covered fund" generally means a hedge fund or private equity fund characterized by its being (a) an issuer that is exempt from the Investment Company Act of 1940 because it does not propose to make a public offering of its securities and is beneficially owned by no more than 100 persons or is owned exclusively by "qualified purchasers," (b) a commodity pool that is exempt from the Commodity Exchange Act because its participation units are not publicly offered and are owned by "qualified eligible persons," or (c) a foreign-based entity owned by a U.S. banking entity that raises money to invest in securities for resale or otherwise trade in securities.

What Activities Are Exempt from the Regulatory Restrictions?

Proprietary Trading. Proprietary trading does not include certain repurchase and reverse repurchase arrangements, securities lending transactions and securities acquired for liquidity management purposes. Financial instruments that are not subject to the proprietary trading prohibition include loans, spot foreign exchange and spot physical commodities. Underwriting and market making-related activities are not restricted, provided that the banking entity establishes and enforces a targeted compliance program; limits its positions, inventory and risk exposure to ensure that they do not exceed the reasonably expected near-term demands of customers and counterparties; institutes internal controls and independent testing of compliance; makes senior management accountable; and ensures that compensation arrangements for trading desk personnel are designed not to reward or incentivize prohibited proprietary trading. Risk-mitigated hedging is permitted, provided the hedging rationale is documented, a robust compliance program is maintained, and quantitative measurements are reported. Also unrestricted are trading in U.S. government obligations; state and municipal government obligations, with no distinctions made among the various types; trading on behalf of customers; trading by insurance companies; and trading outside the United States by certain foreign banking entities.

An important caveat: A banking entity may not rely on any exemption if the activity would result in a conflict of interest, result in exposure to high-risk assets or trading strategies, or threaten the safety and soundness of the entity or the financial stability of the United States.

Covered Funds. In general, excluded from the restrictions on ownership of, and relationships with, covered funds (subject to certain conditions) are foreign public funds, wholly-owned subsidiaries, joint ventures, foreign pension or retirement funds, acquisition vehicles, insurance company separate accounts, bank-owned life insurance, public welfare investment funds, loan securitizations, qualifying asset-backed commercial paper conduits, and qualifying covered bonds that are debt obligations of foreign banking organizations. Performance compensation for services provided by a banking entity to a covered fund is not a prohibited ownership interest in that fund. An exemption also is made for organizing and offering a covered fund in connection with trust, fiduciary, investment advisory, or commodity trading advisory services to customers of the banking entity or its affiliates, including master-feeder fund and fund-of-funds investments, subject to de minimis limits after the first year and exclusion from Tier 1 capital. Additionally, subject to certain conditions, investment is permitted in covered funds involved in underwriting, market making-related activities, and risk-mitigating hedging activities.

An important caveat: Certain transactions between a banking entity and a covered fund that are covered transactions under Section 23A of the Federal Reserve Act (transactions with affiliates) are prohibited; all other transactions with covered funds are subject to the market terms requirement under Section 23B; and reliance on any exemption is prevented when it would lead to the same adverse results as noted for proprietary trading.

What Reporting Requirements Are Imposed by the Regulations?

Banking entities having significant trading activity must prepare and submit to its primary regulatory agency regular reports on an array of quantitative measurements for each trading desk. Entities with more than $50 billion in trading assets and liabilities must begin reporting on June 30, 2014; entities with $25 billion or more, on April 30, 2016; and entities with $10 billion or more, on December 31, 2016. Measurements must be calculated for each trading day, with $50 billion entities reporting monthly and entities from $10 billion to $50 billion reporting quarterly.

What Compliance Requirements Are Imposed by the Regulations?

A banking entity engaged in covered trading or fund activities must institute a program that ensures and monitors compliance with the new regulatory restrictions. Entities of $10 billion to $50 billion in total assets must adopt written policies and procedures with limits on underwriting and market-making; install internal controls; provide for management accountability in reviewing trading limits, hedging activities, strategies, and incentive compensation; conduct independent testing and audits; train trading personnel and maintain sufficient records. Entities with total assets of $50 billion or more and smaller entities that are subject to metrics reporting must adopt an enhanced compliance program. Especially noteworthy: the CEO of such an entity must attest that a program is in place that is reasonably designed to achieve compliance, but, unlike Sarbanes-Oxley, it appears this attestation is not a certification of the accuracy of any information or documentation.

When Do the Regulations Take Effect?

The regulations take effect on April 1, 2014. The Federal Reserve has exercised its discretionary authority under the Dodd-Frank Act to extend the deadline by which banking entities must conform their activities to the regulations until July 21, 2015.

Pepper Point: Affected enterprises need to continue to drill down into their business practices, market and administrative structures, and competition policies, and confirm compliance. Boards have substantial oversight responsibility. We will be issuing industry-specific alerts including recommendations concerning assessment, processes, and procedures to support necessary CEO compliance certifications in the near future. Compliance burdens at the enterprise level differ depending upon the size of the enterprise, the covered activity, and exemption planning, including, for example, whether collateralized loan obligations and similar loan securitization vehicles, including bridge loan facilities, are exempt from the definition of "covered funds."

Pepper Point: The rulemaking process veered from Federal Reserve Chairman Paul Volcker's recommendation. Specialized rules and exemptions have been crafted by the regulators. Will Congress seek to simplify and bring back a version of the Glass-Steagall Act in light of the interconnectedness of international markets?


1. See former Federal Reserve Chairman Paul Volcker's testimony "It's like pornography: you know it when you see it ..." Senate Banking, Housing and Urban Affairs Committee testimony, February 2, 2010. Also see, threshold test used by Justice Potter Stewart in his concurring opinion in Jacobellis v. State of Ohio, 378 U.S. 184 (1964).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Frank A. Mayer, III
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Cadwalader, Wickersham & Taft LLP
Shearman & Sterling LLP
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Cadwalader, Wickersham & Taft LLP
Shearman & Sterling LLP
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions