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


  • 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.


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.


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.

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