United States: The Final Volcker Rule Begins To Emerge

We issued a client memorandum on December 9 listing the major topics to look for when the five financial regulatory agencies agreed to finalize the Volcker Rule, which generally prohibits banking organizations from engaging in proprietary trading and investing in or sponsoring private investment funds, subject to a host of exceptions and details. The agencies issued the final version of the Rule yesterday, but clearly its requirements will take years to unfold.

In the meantime, following are our preliminary responses to the questions that we posed:

  • The definition of market-making. The scope of permissible market-making is generally broader than in the original proposal. The final Rule will rely to a greater extent than expected on a program designed by each banking organization to limit, monitor and measure its market-making activities in such a way as to show that it is not engaged in impermissible proprietary trading. Thus, while restrictions remain, and monitoring and reporting systems will be required (see below), banks will have somewhat more control over their design.
  • The definition of hedging. The requirements surrounding permissible hedging are similarly grounded in a program designed by each bank to limit, monitor and measure its hedging activities. However, as press reports had indicated, so-called "portfolio" hedging is not permitted, and each transaction must hedge one or more "specific, identifiable" risks. In certain cases, those risks must be documented at the time of the transaction. Hedges must be subject to ongoing monitoring and "recalibration," and banks must conduct analysis and independent testing of their hedging models. These requirements will likely impose a difficult burden on large banks.
  • Recordkeeping, monitoring and reporting requirements. The amount and type of data points that banks must obtain has been scaled back in number of categories of information, the size of operations for which they must be obtained, and the frequency of reporting. Again, the particular data points will depend in part on the program for market-making and hedging designed by the bank. For example, rather than seventeen data points relating to trading activities, such as profit and loss for each trading unit, fee income and the like, seven will be required for the largest banks, and reporting will be monthly rather than daily in most cases. The reported amounts are explicitly stated not to be the sole basis for determining whether a bank has crossed the line into impermissible proprietary trading.
  • Inclusion of non-US sovereign debt. The final Rule authorizes US banks' non-US subsidiaries (but not non-US branches) to engage in proprietary trading of sovereign debt in non-US subsidiaries within that sovereign's jurisdiction; for example, the UK bank subsidiaries of US banks may engage in proprietary trading of UK Government securities. In addition, US affiliates of non-US banks may do the same with Government securities of their home countries. This liberalization may address many concerns of non-US governments about the potential effect on their home country sovereign debt markets. However, it appears that a US bank's London subsidiary would not be authorized to engage in proprietary trading in sovereign debt of other European countries.
  • Permissible organization of private funds for fiduciary customers. The final Rule retains the limit of 3 percent, after one year, of total investments in a private fund that a bank may hold in its funds organized for fiduciary customers. The proposal's recognition that investors could become fiduciary customers by virtue of investing in such a fund is retained.
  • The scope of permissible non-US activities of non-US banks. The final Rule is less restrictive than proposed in interpreting the exception for non-US bank activities "solely outside of the United States" (called "SOTUS"). It allows non-US banks to use the services of US exchanges to conduct transactions for anonymised order book or cleared trades, and appears to allow US personnel to give advice on particular transactions so long as the decision to engage in a transaction is made by non-US personnel.
  • Coverage of non-US mutual funds. The final Rule states that funds organized and distributed outside the United States that are the rough equivalent of US mutual funds are generally exempt from the prohibition on banks' investing in or sponsoring private funds.
  • Limits on transactions with permissible sponsored private funds. The final Rule does not change the proposed limits on transactions by a bank with its permissible private funds (called "Super 23A"). There is no explicit exemption for a non-US bank's relationships with its own non-US funds, but that is because other definitional changes make clear that such funds are not covered by the Rule's prohibition on private fund involvement. The final Rule excludes "loan securitizations" from the definition of covered funds, so Super 23A would not apply to them; however, many existing CLOs have baskets for securities which would render them ineligible for this exclusion.
  • CEO attestation of compliance. The requirement that a bank's chief executive officer attest to compliance with the Rule, as had been reported by the press, is part of the final Rule. However, the attestation is to the appropriate US regulatory agency. There is no discussion of potential civil liability or of possible actions by an agency if it determined that the attestation was not truthful.
  • Time period to conform existing operations. As expected, the conformance period has been extended one year to July 21, 2015. The largest banks will be required to begin to submit various data on market-making activities beginning in July 2014, and the agencies' staffs will review that data prior to the conformance data.
  • International implications. There is no significant indication in the document that international implications of the Rule had much effect on its overall design. At the open Federal Reserve meeting, Governors asked staff about the potential competitive implications of the Rule on US banks vis-a-vis foreign banks. Staff noted that there has not been a movement by other countries to adopt Volcker-like restrictions, noting that the Vickers and Liikanen proposals in the United Kingdom and European Union, respectively, would "ring-fence" proprietary trading and market-making outside of the retail bank but not exclude them from the banking organization as a whole. We therefore still face a situation in which US rules prohibit banks from conducting particular activities while UK and EU rules would instead ring-fence particular activities from retail banks. For international banking groups, these differing approaches have the potential to result in certain activities neither being prohibited under the Volcker Rule nor permitted within an EU deposit-taking institution, and hence for multiple layers of subsidiarisation.

We continue to analyze the more detailed implications and practical ramifications for our clients and will be providing updates shortly.

NOTE: The text of the Volcker Rule and explanatory memoranda are available at http://www.federalreserve.gov/ newsevents/press/bcreg/20131210a.htm. You may wish to review our December 9 client note "Ready for the Volcker Rule? What to Look For," available at http://www.shearman.com/~/media/Files/NewsInsights/Publications/2013/12/ ReadyfortheVolckerRuleWhattoLookForFIAFR120813.pdf, and our December 10 note providing a comparison version of the final Rule against the proposal of October 2011, available at http://www.shearman.com/~/media/Files/News Insights/Publications/2013/12/TheVolckerRuleAComparisonFIAFR121013.pdf

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.

Authors
Barnabas W.B. Reynolds
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

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