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
 
In association with
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
Check to state you have read and
agree to our Terms and Conditions

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.

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 by clicking here .

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.