United States: A Review Of, And Insights Into, The Volcker Rule Regulations

Last Updated: January 8 2014
Article by Charles Horn, William Iwaschuk, Julie A. Marcacci and Kaitlyn L. Piper

EXECUTIVE SUMMARY

  • The final regulations (Regulations) adopted by the five federal financial regulatory agencies (Agencies) on December 10, 2013 to implement the proprietary trading and private fund prohibitions of the Volcker Rule have made a number of material changes to the proposed rules (Proposed Rules) published by the Agencies in late 2011, while preserving the basic prohibitions and major exclusions and exceptions of the Volcker Rule.
  • In many respects, the changes to the Regulations, with the exception of their treatment of hedging activities (discussed below), are reasonably accommodating to banking industry concerns with the impact and burdens associated with the Proposed Rules.
  • The Regulations will become effective on April 1, 2014, but affected banking organizations generally will have until July 21, 2015 to bring their proprietary trading and private fund activities into conformance with the Volcker Rule and the Regulations. Banking organizations are expected to engage in "good faith efforts" to bring all of their covered activities into compliance by the July 2015 conformance date.

Prohibition on Proprietary Trading

  • The key statutory exemptions for underwriting, market making, risk-mitigating hedging activities, liquidity management, trading in government obligations, trading on behalf of customers, insurance company general account transactions, and trading by foreign banking entities that occurs "solely outside of the U.S." are incorporated in the Regulations.
  • The final definition of "proprietary trading" in the Regulations conditionally excludes a number of discrete transactions and activities of banking entities, including repo and securities lending activities, liquidity management activities, transactions as agent for customers, certain clearing transactions, employee benefit plan transactions, and transactions in a DPC capacity.
  • Underwriting.The Agencies adopted the statutory underwriting exemption substantially as proposed, but with several changes and clarifications relating to the contours of the exemption to better align the exemption with the benefits that underwriting activities provide to clients, counterparties and the financial markets, and with key concepts embodied in the federal securities laws.
  • Market Making.The Regulations' implementation of the statutory exemption for market making activities makes several changes and clarifications relative to the exemption contained in the Proposed Rules, including a more flexible consideration of the liquidity, maturity and depth of the market for a given financial instrument in applying the exemption, and the removal of the previously proposed Appendix B.
  • Risk-Mitigating Hedging.The Regulations exempt a banking entity's risk-mitigating hedging activities in connection with and related to positions, contracts or other holdings that are designed to reduce the specific risks associated with such positions, contracts or holdings. Banking entities, however, may only hedge risks that are specific and identifiable under this exemption, and may not engage in hedging to reduce general risks, such as general market movements and broad economic conditions.
  • The Regulations implement the statutory exemption for proprietary trading that is done for the purposes of liquidity management through an exclusion from the definition of "proprietary trading." Permitted trading under this exclusion must be effected under a liquidity management plan, and does not extend to broad assetliability management, earnings management or scenario hedging.
  • The Regulations implement the statutory exemption for trading by a regulated insurance company in the general account, and also permit trading in qualifying insurance company separate accounts.
  • The Regulations permit foreign banking entities located outside of the United States that are not directly or indirectly controlled by a bank organized under U.S. laws or the laws of any state to engage in proprietary trading, provided that certain conditions are met. In addition, foreign banking organizations may execute and clear transactions generally through established U.S. exchange, trading and clearing facilities.

Prohibition and Restrictions on Ownership Interests in, and Certain Relationships with, Covered Funds

  • The statutory Volcker Rule generally covers any entity that is exempt under Investment Company Act section 3(c)(1) or 3(c)(7), or such similar funds as the Agencies may, by rule, determine. The Regulations extend the definition of "covered fund" to certain exempt commodity pools and foreign private funds that are sponsored or owned by a U.S. banking entity.
  • The Regulations contain a number of important exclusions from the definition of a "covered fund," which means that these excluded activities not only are not subject to the private fund prohibition, but also will not be subject to the strict prohibition on certain transactions between banking entities and covered funds, and the conflicts of interest and high-risk transactions limitations. Exempt activities include joint ventures, acquisition vehicles, foreign pension funds, qualifying asset-backed commercial paper conduits, covered bonds, registered investment companies, and SBIC and public welfare investments.
  • Securitizations.Qualifying loan securitizations are excluded from the coverage of the Volcker Rule, but non-loan securitization transactions, as well as loan "resecuritizations," will be subject to the covered funds restrictions if they satisfy the "covered fund" definition.
  • Funds "Organized and Offered."The Regulations implement the key covered funds statutory exemption that permits a banking entity to acquire and retain an ownership interest in a covered fund in connection with the bona fide "organizing and offering" of a covered fund to its fiduciary and asset management clients so long as certain requirements are met. Banking entities are not required to have a preexisting relationship with these customers in order to rely on this exemption.
  • Investments in Funds. The Regulations permit a banking entity to acquire ownership interests in a covered fund under the "organized and offered" exemption so long as (i) its investment in the fund does not, after one year from the date the fund is established, exceed 3% of the total outstanding ownership interests in, or value of, the fund (the "per-fund limitation"), and (ii) the aggregate value of all investments in all covered funds does not exceed 3% of its tier 1 capital (the "aggregate funds limitation"). In addition, a banking entity must account for an investment in a covered fund for purposes of the per-fund and aggregate funds limitations only if the investment is made by the banking entity or another entity controlled by the banking entity.
  • The Regulations allow a banking entity to acquire or retain an ownership interest in a covered fund as a risk-mitigating hedge, but only with respect to an ownership interest that is designed to "demonstrably reduce" or "significantly mitigate the specific, identifiable risks" to the banking entity in connection with a compensation arrangement with an employee of the banking entity that directly provides investment advisory or other services to the fund.
  • The Regulations conditionally exempt the acquisition or retention by an insurance company, or an affiliate thereof, of any ownership interest in, or the sponsorship of, a covered fund for its general account or for one or more separate accounts.
  • The Regulations create a conditional exclusion for the sponsorship of, and acquisition of ownership interests in, "foreign public funds" that are widely sold outside of the United States.
  • The Regulations liberalize the conditions contained in the Proposed Rules under which a foreign banking organization may acquire or retain an ownership interest in, or act as sponsor to, covered funds that are organized and sold "solely outside of the U.S."

Other Volcker Rule Requirements

  • The Regulations implement without major changes from the Proposed Rules the statutory Volcker Rule prohibition on activities and investments that pose a threat to the safety and soundness of a banking entity or to the financial stability of the United States, or an activity or investment that involves a "material conflict of interest between a banking entity and its clients, customers, or counterparties" or "high-risk assets or trading strategies."

Compliance and Reporting Requirements

  • The Regulations require banking entities engaged in proprietary trading or covered fund activities and investments to develop and provide for the continued administration of a compliance program reasonably designed to ensure and monitor compliance with the Volcker Rule and the Regulations.
  • In general, the Regulations reduce the amount of information and data that banking entities must collect and report, but preserve the core elements of a required compliance program.
  • In addition, the Regulations seek to reduce compliance burdens on community banks and banks that do not engage in covered trading and private fund activities.

INTRODUCTION

The Regulations1 adopted by the Agencies2 on December 10, 2013 under section 619 of the Dodd-Frank Wall Street Accountability and Consumer Protection Act (Dodd-Frank Act)—known as the Volcker Rule—are the culmination of a controversial and sometimes contentious multi-agency effort to implement what, in turn, is one of the most controversial provisions of the Dodd-Frank Act. Even with the publication of the Regulations, the controversy over the Volcker Rule and the Agencies' actions to implement it apparently will continue at least for the short term, compliments of the current dustup over the impact of the Regulations on the value of collateralized debt obligations (CDOs) backed by trust preferred securities (TruPS) held by approximately 250 community banks (see discussion at the end of this analysis), and the legal actions just filed by the banking industry against the three federal banking agencies to challenge this impact. The TruPS CDO controversy notwithstanding, however, at long last the Agencies have released the final Regulations, and the financial services industry now can concretely assess the Volcker Rule's and the Regulations' impact on its activities.

Generally, the Volcker Rule prohibits, subject to important exceptions, (i) proprietary trading in securities and other financial instruments by "banking entities," and (ii) banking entities from sponsoring or acquiring an ownership interest in private equity and hedge funds (collectively, "covered activities"). In addition, the Volcker Rule prohibits a banking entity from engaging in a covered activity or making an investment if the activity or investment would pose a threat to the safety and soundness of the banking entity or to the financial stability of the United States, or if the activity or investment involves a "material conflict of interest between a banking entity and its clients, customers, or counterparties" or "high-risk assets or trading strategies." In turn, the statutory Volcker Rule charged the Agencies with the challenging task of implementing its requirements through regulation.

The Agencies responded to the statutory direction first by publishing the Proposed Rules in October 2011.3 These highly complex and question-laden proposals drew more than 18,000 comments (albeit a large number of them essentially were form comments), many of them critical of the Proposed Rules' possible negative impact on legitimate and long-established bank activities, the costs and burdens associated with complying with the regulations, and the possible adverse competitive impact on the U.S. financial services industry. Notably, the Proposed Rules generated highly detailed and substantive comments from a large number of trade groups and criticisms from several foreign financial regulators that questioned the Proposed Rules' potential extraterritorial impact.

The ensuing two-year regulatory process of moving the Proposed Rules from proposed to final form was, in a word, tortuous. The Agencies were confronted with an avalanche of comments, both substantive and non-substantive, that they needed to address. Complicating the task were intervening events in the financial sector, including certain trading and other misadventures occurring in the wholesale banking sector, that materially increased the political pressure on the Agencies to come out with a "tough" set of final rules. In addition,

widespread reports of substantive disagreements among the Agencies over the nature and content of the final rules were further indications of the depth of the Agencies' difficulties in creating final rules.

The Regulations, however, have now been published, and banking organizations now have at least the benefit of knowing what the final requirements are, if not how they will be construed and applied by multiple regulatory agencies over the coming months and years. The Regulations, amounting to over 70 pages of actual rules and almost 900 pages of commentary, are anything but the soul of wit, but the Regulations do create the outline of a concrete regulatory framework that banking organizations can address.

We now turn to the Regulations to review their requirements and assess their consequences.

To read this Review in full, please click here.

Footnotes

1. View the Regulations at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20131210a1.pdf.

2. The Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC).

3. View the Proposed Rules at http://www.gpo.gov/fdsys/pkg/FR-2011-11-07/pdf/2011-27184.pdf.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

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
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Shearman & Sterling LLP
K&L Gates
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Shearman & Sterling LLP
K&L Gates
Related Articles
 
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 (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.

Disclaimer

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.

General

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