United States: The Volcker Rules For The Volcker Rule

A fundamental principle underscoring the Dodd-Frank Wall Street Reform and Consumer Protection Act of 20101 ("Dodd-Frank" or the "Act") is the perceived necessity to curb the proprietary trading and other risk-taking activities of banks, and to divest banks of risky assets, including interests in hedge funds and private equity funds. The markets have dubbed this principle the "Volcker Rule" in acknowledgment of the efforts of Paul Volcker, the former chairman of the Federal Reserve System, to promote it.2 The Act entrusted five regulatory agencies3 with the task of promulgating rules to transform principle into regulation. Under a barrage of industry comment and criticism,4 the final rules have emerged, surprisingly close to the restrictions envisioned in the Dodd-Frank provisions.

Proprietary Trading

The regulators have cast a wide net in defining proprietary trading activities subject to the Act's prohibitions. Under the rules, proprietary trading includes any engagement as a principal for the trading account of a bank to purchase or sell a broad range of financial instruments. "Trading account" is defined broadly as (i) any account for the purchase or sale of financial instruments for short-term trading purposes, (ii) any account maintained by certain banks under market risk capital rules established by banking regulators, and (iii) any account used by a bank in its capacity as dealer, swap dealer or securities-based swap dealer to maintain positions in connection with its dealing activities. Any position held for less than 60 days will be presumed to be held in a trading account. These definitions contain a limited number of exceptions.5 The rules make clear that the prohibitions do not apply to agency, brokerage or custodial transactions for unaffiliated third parties.

Given the breadth of the prohibitions, the exemptions for proprietary trading are crucial to the banks. The Volcker Rule permits underwriting and market-making activities, but the rules are designed to limit such activities on the basis of positions, inventory and risk exposure. Both underwriting and market-making activities must be "client facing" and must not exceed the reasonably expected near-term demands of clients, based upon an analysis of historical and projected customer demand. In addition, in order to qualify for the exemption, the underwriter or market-maker may not have compensation arrangements designed to reward or incentivize prohibited proprietary trading and must develop and maintain a compliance program, as described below.

Underwriting activities are exempted so long as, in addition to the requirements described above, the banking entity acts as an underwriter for an offering of securities (public or private), and the relevant trading desk's underwriting position relates to such distribution. In addition, the bank must make reasonable efforts to sell or otherwise reduce the underwriting position within a reasonable period. Reasonableness is determined by taking into account the liquidity, maturity and depth of the market for the relevant type of security.

To rely on the market-making exemption, a market maker must, in addition to the requirements described above: (i) stand ready to purchase and sell financial instruments for its own account to the market, (ii) adopt certain policies for individual trading desks, including a description of the financial instruments in which the trading desk makes a market, actions the trading desk will take to hedge its financial risk, limits on inventory, financial exposure and hedging and internal controls monitoring the market-making activity. In addition, large banking entities relying on this exemption must collect and report data regarding trading desk revenue and other metrics.

Banks are also permitted to engage in risk-mitigating hedging activities, but only for "specific, "identifiable" risks, as opposed to more generalized risks associated with assets or liabilities generally or risks associated with general market movements or broad economic conditions. Again, hedging activities are required to be subject to strict compliance programs that include internal controls, monitoring and authorization procedures. As with other exemptions, employees engaged in this exemption may not be compensated so as to reward prohibited trading. Other exemptions from proprietary trading, for trading to implement liquidity management programs, trading in certain government obligations, trading on behalf of customers, trading by a regulated insurance company and trading by certain foreign banking entities are similarly delineated. The rules also contain a catch-all that prohibits proprietary trading activities that may otherwise qualify for an exemption, but would (i) pose a threat to the safety and soundness of the bank or to the financial stability of the U.S., (ii) involve a material conflict of interest with customers, or (iii) involve high-risk assets or trading strategies. A "material" conflict of interest would exist if a bank's interests were materially adverse to those of the client in a transaction or activity, unless proper disclosures were made to the client and information barriers were implemented to manage the conflict.

Private Funds

Under the Volcker Rule, banks are prohibited from (i) acquiring or retaining, as principal, any ownership interest in any covered fund or (ii) sponsoring any covered fund. A "sponsor" is an entity that serves as a general partner, managing member, or trustee of a covered fund, or selects or controls a majority of the directors, trustees or management of the covered fund, or shares the same name (or a variation thereof) with the covered fund for marketing, promotional or other purposes.

"Covered funds" are generally investment vehicles, such as hedge funds and private equity funds, and "similar funds", which also include certain commodity pools and certain foreign funds offered outside the U.S. Certain entities are exempt from the definition of covered fund, including entities that can or could rely on an exception or exemption from the definition of "investment company" under the Investment Company Act, other than Section 3(c)(1) or 3(c)(7). This means that many real estate funds will be exempt. Certain entities are explicitly excluded from the definition of covered fund, including foreign public funds6, wholly-owned subsidiaries of a banking entity, certain joint ventures, acquisition vehicles formed solely for engaging in a bona fide merger or acquisition, and issuers of asset-backed securities to the extent the underlying assets are limited exclusively to permitted asset categories.7

The rules state that a bank does not act a "principal" in the following circumstances: (i) when a bank is acting solely as agent, broker or custodian, subject to certain conditions, so long as the activity is for the account of or on behalf of a customer and the bank and its affiliates do not retain beneficial ownership; (ii) when a bank holds the interest through a deferred compensation, stock-bonus, profit-sharing or pension plan and acts as a trustee for the benefit of its current or former employees; (iii) when a bank retains an ownership interest in the ordinary course of collecting a debt previously contracted in good faith, provided that the bank must divest the interest as soon as practicable; and (iv) the bank acts on behalf of a customer as trustee or a similar fiduciary capacity for a customer that is not a covered fund, so long as the activity is for the account of or on behalf of a customer and the bank and its affiliates do not retain beneficial ownership.

A bank may acquire or retain an ownership interest in or sponsor a covered fund in connection with the organization and offering of such covered fund if, among other things, (i) the covered fund is organized and offered only in connection with the bank's bona fide trust, fiduciary, investment advisory or commodity trading advisory services and the covered fund is only offered to customers of such services (this restriction does not apply if the covered fund is an issuer of asset-backed securities), and (ii) any ownership interest in a covered fund constitutes a "permitted investment", as defined below. The bank must have a written plan outlining how it intends to provide advisory or similar services to its customers and must maintain separateness from the fund, including (i) making mandated disclosures to investors that, among other things, emphasize the separateness of the fund from the bank and discourage expectations that the bank will stand behind the fund's losses, (ii) not having the same name (or a variation thereof) as the covered fund, and (iii) not guaranteeing the fund's performance.

A "permitted investment" in a covered fund includes acquiring or retaining an ownership interest in such covered fund for the purpose of providing initial seed capital to attract investors or retaining a de minimis investment in the fund. In the case of seed capital, within 1 year of the establishment of the fund, the bank must reduce its (and its affiliates') ownership to no more than 3% of the total outstanding ownership interests or the fair market value of the covered fund. A de minimis investment may not exceed 3% of the total outstanding ownership interests or the fair market value of the covered fund. In addition, a bank's aggregate interests in all covered funds that it organizes and offers may not exceed 3% of its tier 1 capital.8 There are additional exceptions from the general prohibition, including certain underwriting and market making in ownership interests of a covered fund, certain investments that constitute permitted risk-mitigating hedging activity and certain foreign banking activities. A bank's officers and directors may only hold interests in a covered fund if they are directly engaged in providing the fund with services at the time they take the interests. The ownership of employees may be attributed to the bank itself if the bank or any of its affiliates extends credit or guarantees against loss in connection with such ownership. The rules also provide for exemptions from the prohibition against acquiring and retaining an ownership interest in a covered fund in connection with certain underwriting and market making-related activities involving such covered fund.

If a bank or any of its affiliates serves, directly or indirectly, as an investment manager, investment advisor, commodity trading advisor or sponsor of a covered fund that was organized or offered by that bank or in which the bank holds an ownership interest, the bank is prohibited from entering into transactions with that covered fund that would be covered transactions under Section 23A of the Federal Reserve Act. These so-called "Super 23A" restrictions prohibit banks from entering into the following transactions with their related covered funds: (i) extending of credit; (ii) purchasing any investment in securities issued by a related covered fund; (iii) purchasing assets; (iv) issuing a guarantee, acceptance or letter of credit on behalf of the related covered fund; (v) borrowing or lending securities (to the extent such transaction causes the bank to have credit exposure to the related covered fund); and (iv) engaging in certain derivative transactions that cause the bank to have credit exposure to the related covered fund.

Compliance and Reporting Requirements

Banks engaging in proprietary trading or in permissible funds activities must implement a compliance program for the Volcker Rule. The requirements for compliance programs vary based on the size and complexity of the bank. Banks with assets of $10 billion or less may satisfy the compliance program requirement by adding applicable Volcker Rule requirements to their existing compliance policies, while banks with assets of $10 billion or more must establish separate policies that incorporate the regulations in full. For these larger entities, the rules mandate six compliance program elements: (i) trading and exposure limits; (ii) internal controls; (iii) management responsibility for compliance; (iv) independent testing and audit; (v) training and (iv) recordkeeping. Banks with U.S. assets of $50 billion or more (including banks headquartered outside the U.S.) must satisfy additional requirements related to risk management, independent testing and certification by the chief executive officers of the banks.

The Volcker Rule imposes detailed reporting requirements on all banks with significant trading assets and liabilities. The goal is to help regulators identify prohibited trading and high risk trading strategies. Information is required for each trading desk of a banking entity and for each trading date (although the reports are done on a monthly or quarterly basis). The rules specify seven categories of quantitative information for mandatory reporting, and for each category the rules set out a detailed description, calculation guidelines, and the relevant calculation period: (i) risk and position limits and usage; (ii) risk factor sensitivities; (iii) value-at-risk and stress value-at-risk; (iv) comprehensive profit and loss attribution; (v) inventory turnover; (vi) inventory aging; and (vii) customer-facing trade ratio.

Compliance Deadlines

Banks must be in full compliance with the Volcker Rule by July 21, 2015; however, certain reporting requirements will apply to larger institutions as early as June 30, 2014. The July 21, 2015 deadline is a one-year extension from the deadline contemplated under Dodd-Frank, and accordingly the Federal Reserve has stated that it expects banks to make "good faith" efforts to comply without further extensions.

Developments So Far

Regulators have already revised one requirement under the Volcker Rule in response to criticism from the banking industry.9 Under the Volcker Rule as originally adopted, collateralized debt obligation investments (CDOs) backed by trust-preferred securities ("TruPS") were considered to be securities issued by "covered funds", and therefore banks were required to divest themselves of ownership of TruPS-backed CDOs. Banking industry insiders claimed that this would result in significant losses and write-downs, especially for regional banks.10 A much cited example was Zions Bank's projection that it would have to post an estimated $387 million loss as a result of divestment.11 A petition was filed in federal court by the American Banking Association to stall the implementation of certain related provisions of the Volcker Rule. Lawmakers also publicly criticized the treatment of TruPS under the Volcker Rule. It was reported in the press that the chairman of the House Financial Services Committee was planning to propose a bill stating that nothing in the Volcker Rule should be construed to require the divestiture of any TruPS-backed CDOs issued before a set date.12 In response to this vocal criticism and controversy, regulators adopted an interim final rule which permits banks to retain an ownership interest in, and to sponsor, any issuer of TruPS-backed CDOs if three conditions are met: (i) the issuer was established, and the interest was issued, prior to May 19, 2010, (ii) the bank reasonably believes that the offering proceeds received by the issuer were invested primarily in TruPs or subordinated debt instruments issued by a depository institution holding company that had total assets of less than $15 billion or a mutual holding company, and (iii) the bank acquired the interest on or prior to December 10, 2013, or acquired the interest in the course of a merger with or acquisition of a bank that itself acquired the interest or before that date.

From the time of its conception, the Volcker Rule has been controversial with banks and much discussed in the banking industry. The TruPS issue will very likely not be the only controversy to arise as banks digest the full impact of the Volcker Rule, and regulators and Congress react to the banking industry's ongoing concerns.


1 12 U.S.C §§ 5301 et seq.

2 "Banks, Agencies Draw Battle Lines Over 'Volcker Rule'", by Ryan Tracy, James Sterngold and Stephanie Armour, December 11, 2013, The Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304202204579252592600657058).

3 The Department of the Treasury, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodities Futures Trading Commission.

4 "Regulators Set to Approve Toughened 'Volcker Rule'", by Scott Patterson, December 3, 2013 (http://online.wsj.com/news/articles/SB10001424052702304579404579236170945418460 ); "Volcker Rule Sets New Hurdles for Bank", by Scott Patterson, December 10, 2013, The Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303560204579248584111312074).

5 "Financial instruments", for example, do not include loans, spot foreign exchange or spot physical commodities. Proprietary trading excludes certain repurchase and reverse repurchase arrangements, securities lending transactions, and other transactions undertaken for bona fide liquidity management purposes.

6 A "foreign public fund" is one that is organized outside the U.S., is authorized to offer and sell ownership interests to retail investors in the issuer's home jurisdiction, and sells ownership interests predominantly outside the U.S. through public offerings that satisfy enumerated criteria.

7 The Volcker Rule provides an exclusion from the definition of "covered fund" for issuers of asset-backed securities whose underlying assets or holdings are composed exclusively of (i) loans (not including any securities or derivatives), (ii) any rights or other assets designed to assume the servicing or timely distribution of proceeds to security holders or related or incidental to purchasing or otherwise acquiring and holding the loan, (iii) certain interest rate or foreign exchange derivatives, and (iv) certain special units of beneficial interest and collateral securities. An eligible loan securitization may not hold (i) any securities (other than certain cash equivalents and securities received in lieu of debts previously contracted with respect to the loans supporting the asset-backed securities), (ii) most types of derivatives, or (iii) commodity forward contracts.

8 Tier 1 capital is composed of the core capital of the bank, consisting primarily of common stock and retained earnings, but may also include other assets. Tier 1 capital is the primary measure used by regulators to determine a bank's financial strength.

9 "Regulators Ease Volcker Rule Provision on Smaller Banks", by Matthew Goldstein, January 14, 2014, (http://dealbook.nytimes.com/2014/01/14/regulators-ease-provision-of-volcker-rule/?_php=true&_type=blogs&_r=0, last visited January 31, 2014).

10 "Volcker Rule Provision Will Hurt Community Banks" by Andrew R. Johnson, December 25, 2013, The Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303290904579278282716876784).

11 "House Financial Services Chairman to Seek Volcker Rule Change" by Floyd Norris, January 7, 2014, The New York Times (http://dealbook.nytimes.com/2014/01/07/representative-to-propose-bill-to-tweak-volcker-rule/).

12 "House Financial Services Chairman to Seek Volcker Rule Change" by Floyd Norris, January 7, 2014, The New York Times (http://dealbook.nytimes.com/2014/01/07/representative-to-propose-bill-to-tweak-volcker-rule/).

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.

In association with
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
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.


    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.


    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.


    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.


    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.


    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.


    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 .


    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