The Board of Governors of the Federal Reserve System ("FRB") provided guidance as the process to be used by banking entities seeking a five-year extension to continue to retain investments in a narrow class of covered funds that qualify as "illiquid funds." The guidance supplements regulations issued by the FRB in 2011 which defined "illiquid funds" and set forth initial criteria for obtaining such an extension.
An illiquid fund is defined as a fund that is "principally invested" in illiquid assets and "holds itself out as employing a strategy to invest principally in illiquid assets," as of May 1, 2010. The FRB is authorized under the Dodd-Frank Act to provide up to an additional five years for banking entities to conform existing investments in certain illiquid funds. Under the existing regulations, the banking entity must have had a "contractual obligation" to invest in the fund, or to retain the investment, as of May 1, 2010.
The guidance describes the process by which banking entities may apply for such an extension. Banking entities should submit in writing (i) details about the funds for which an extension is requested, (ii) a certification that the funds meet the definition of illiquid fund, (iii) a description of the "specific efforts" to divest or conform the illiquid funds, and (iv) the plan to divest or conform each illiquid fund and the length of the requested extension. The request should be submitted at least 180 days prior to July 21, 2017.
The guidance simplifies the process for filing such requests. In particular, the guidance allows banking entities to submit the list of illiquid funds in chart form, and appears to abandon the prior requirement that banking entities address thirteen enumerated factors in the extension request. The guidance requires, however, that banking entities include a certification from its general counsel or chief compliance officer that the fund meets the definition of an "illiquid fund." The banking entity also must submit supporting documentation, including evidence that the "banking entity has made meaningful progress toward conforming the majority of its covered fund investments (including funds other than illiquid funds) as of the date of the extension request." The guidance allows the Federal Reserve Banks to process the illiquid funds extension requests on a delegated basis rather than requiring approval by the Board of Governors.
More significantly, the guidance relaxes the prior stance regarding the definition of "contractual obligation." The FRB's prior stance was that banking entities could not assert that a "contractual obligation exists" if the fund investment documents either contained a "regulatory out" clause or permitted the sale of the fund interest upon third-party consent and the banking entity had not sought such consent and had been denied. These conditions are being abandoned. Finally, the guidance permits banking entities to submit five-year extension requests on behalf of employees or directors that previously invested in covered funds, which funds since have been conformed to comply with the "asset management exception" fund in Section 11 of the regulations – notwithstanding Section 11's general prohibition that employees or directors may not invest in such funds unless the employee or director was providing services to the fund at the time of the investment.
The guidance notes that extension requests are expected to be acted on within 30 days after receipt, and that the FRB "expects that the illiquid funds of banking entities will generally qualify for extensions, though extensions may not be granted in certain cases—for example, where the banking entity has not demonstrated meaningful progress to conform or divest its illiquid funds, has a deficient compliance program under the Volcker Rule, or where the FRB has concerns about evasion."
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