Agencies issue more Volcker Rule guidance on covered funds

With the deadline for Volcker Rule compliance arriving in a little over a month, on June 12, 2015, the US financial regulators issued additional guidance to the industry on the application of the Volcker Rule’s prohibition on sponsoring or acquiring ownership interests in certain private funds. The agencies clarified the applicability of the rule to foreign public funds sponsored by a banking entity and to the “joint venture” exclusion from the definition of funds subject to the rule.

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

Foreign public funds

US registered mutual funds are excluded from the definition of “covered fund” and the exclusion of foreign public funds was an attempt to exclude foreign funds that were similar to US mutual funds. The covered fund prohibition in the Volcker Rule is aimed at less-regulated private funds.

To qualify for the exclusion, the foreign public fund must (i) be organized or established outside the United States, (ii) be authorized to offer and sell ownership interests to retail investors in the foreign public fund’s home jurisdiction and (iii) sell such ownership interests predominantly in public offerings outside of the United States.

Unlike US mutual funds, with foreign public funds, some jurisdictions allow the sponsors of such funds to select a majority of the fund’s trustees or directors, or otherwise to engage in activities that, under the US Bank Holding Company Act, could constitute “control” of the funds. Questions had been raised whether these relationships between a foreign public fund and the banking entity as its sponsor that are specifically permissible under applicable foreign law would nevertheless prohibit a banking entity from being able to rely on the foreign public funds exclusion.

The agencies stated that a foreign public fund sponsored by a banking entity or its affiliate would continue to meet the exclusion from the definition of covered fund (and the foreign public fund would not be deemed to be a banking entity itself) so long as, consistent with the provisions of the Volcker Rule, the foreign public fund meets the definition of such term in the regulations, a banking entity that sponsors the fund does not own, control, or hold with the power to vote 25 percent or more of the voting shares of the foreign public fund (after a permissible initial “seeding period”), and the banking entity provides investment advisory, commodity trading advisory, administrative, and other services to the fund in compliance with applicable limitations in the relevant foreign jurisdiction.

Joint venture exclusion from the definition of covered fund

Joint ventures are not considered to be covered funds for purposes of the Volcker Rule so long as the joint venture entity meets certain conditions:

It is comprised of no more than ten unaffiliated co-venturers;
It is in the business of engaging in activities that are permissible for the banking entity or affiliate, other than investing in securities for resale or other disposition; and •
It is not, and does not hold itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in securities for resale or other disposition or otherwise trading in securities.

The limitations of the joint venture exclusion are to ensure that it is not used as a means to evade the covered funds prohibition in the Volcker Rule. Questions had been raised as to when an issuer of what would otherwise be a covered fund may rely on the joint venture exclusion.

In the FAQ, the agencies described different scenarios to which the joint venture exclusion would not be applicable:

The exclusion is not met by an issuer that raises money from a small number of investors primarily for the purpose of investing in securities, regardless of whether the securities are intended to be traded frequently, held for a longer duration, held to maturity, or held until the dissolution of the entity.
The exclusion is not met by an entity that raises money from investors primarily for the purpose of investing in securities for resale or other disposition or otherwise trading in securities merely because one of the purposes for establishing the vehicle may be to provide financing to an entity to obtain and hold securities, as opposed to conducting a business or engaging in operations or other non-investment activities.

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

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