On November 20, 2015, the US financial regulators issued additional guidance regarding (i) exiting permissible marketing making activities under the Volcker Rule and (ii) when a banking entity must observe the Volcker Rule prohibitions on certain transactions between the banking entity and covered funds.

The Volcker Rule and its regulations generally prohibit banking entities and affiliates from engaging in proprietary trading or sponsoring or acquiring ownership interests in certain private funds (“covered funds”). In order to assist affected entities in complying with the rule, the agencies that issued the regulations have been issuing guidance periodically in the form of Frequently Asked Questions (FAQ) that appear on each of the agencies’ websites. In order to achieve consistency in interpretations, industry inquiries on Volcker Rule compliance are referred to a committee of representatives of the regulators that issued the rules, with one answer then being adopted by all the regulators. The November 20 issuance brings to 20 the total number of questions that they have addressed.

Exiting market-making

The agencies clarified how a banking entity may sell or unwind its residual positions when it ceases permissible market-making activities.

In that event, the banking entity may hold and dispose of its residual market-making positions provided that the banking entity both hedges the risks of any such positions using the Volcker Rule’s risk-mitigating hedging exemption and sells or unwinds such positions as soon as commercially practicable. If a banking entity holds residual market-making positions and does not hedge the risks of such positions in accordance with the risk-mitigating hedging exemption, then the subsequent sales of those residual positions generally would be considered impermissible proprietary trading under Volcker. When hedging the risks of the residual market-making positions, the banking entity again must comply with the requirements of the risk-mitigating hedging exemption, not the market-making exemption.

Prohibitions on certain transactions between a banking entity and a covered fund

The agencies also clarified when a banking entity had to begin observing the prohibitions on certain transactions (“prohibited transactions”) between a banking entity and a covered fund with which it has certain relationships.

The extended conformance period to comply with the requirements of the Volcker Rule was extended to July 21, 2015. Thus, generally speaking, on or after July 21, 2015, a banking entity may not enter into a prohibited transaction with a covered fund with which it has certain relationships.

This prohibition would apply to any increase in the amount of, extension of the maturity of, or adjustment to the interest-rate or other material term of, an existing extension of credit, one of the transactions subject to the prohibition. The agencies clarify in a footnote that a floating-rate loan does not become a new prohibited transaction whenever the interest rate changes as a result of an increase or decrease in the index rate. However, if the parties amend the loan agreement to change the interest rate term or reference index, that will be considered a new transaction subject to the prohibition.

In addition, with respect to any existing transactions that now would be prohibited after July 21, 2015, a banking entity should evaluate whether the transaction impermissibly guarantees, assumes or otherwise insures the obligations or performance of the covered fund (or of any covered fund in which such covered fund invests).

The conformance period for legacy investments in and relationships with a covered fund (i.e., investments made and relationships entered into by a banking entity prior to December 31, 2013) currently ends on July 21, 2016.  Banking entities will be expected to engage in good-faith efforts during the conformance period to ensure that its investments in and relationships with legacy covered funds conform to the prohibitions in the final rule by the end of the applicable conformance period.

Access the banking, securities and commodities regulators’ Frequently Asked Questions.

Previous Regulation Tomorrow posts on the Volcker Rule’s Frequently Asked Questions:

  1. Agencies address questions on Volcker Rule compliance programs and CEO certifications
  2. Agencies clarify Volcker Rule applicability to banking entity ownership of excluded funds
  3. Agencies issue more Volcker Rule guidance on covered funds
  4. Agencies provide clarification on the “SOTUS” Volcker Rule exception
  5. Regulators issue additional Volcker Rule guidance
  6. Regulators clarify FOIA treatment for certain Volcker rule reports
  7. Regulators provide more Volcker guidance
  8. Volcker Rule FAQs updated by Federal Reserve Board and OCC
  9. Volcker Rule FAQs and examination guidelines released