In November 2019, the financial services regulators responsible for the Volcker Rule regulations (the Board of Governors of the Federal Reserve Board, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission, collectively, the “Agencies”) issued final rules revising the proprietary trading restrictions placed on certain banking entities (the “2019 Rule”).

On February 28, 2020, the Agencies published a Notice of Proposed Rulemaking (“NPRM” or “proposal”) proposing changes to the “covered funds” side of the Volcker Rule. The comment period originally was supposed to end on April 1, 2020, but the Agencies issued a statement that they will accept comments submitted before May 1, 2020.

Under the Volcker Rule covered funds provisions, “banking entities” (generally, insured banks and their affiliates, and non-US banks with US banking operations) are prohibited from having an ownership interest in, or sponsoring a hedge fund or private equity fund (jointly, “covered funds”). The covered funds subject to the Volcker Rule are funds that come within the definition of an investment company in the US Investment Company Act, that meet no other exemption from registration under that Act except for section 3(c)(1)[generally the number of investors is less than 100 except for certain venture capital funds] or 3(c)(7) [consisting of “qualified purchasers” meeting certain asset thresholds].

2019 covered funds changes

Even though the 2019 Rule focused on the Volcker Rule’s proprietary trading provisions, it did address an important exemption for non-US banks: the “Solely Outside the United States” (SOTUS) exemption from the Volcker Rule’s restrictions on both proprietary trading and covered funds. The SOTUS exemption allows non-US banks to conduct certain activity outside the United States that otherwise could be subject to the Volcker Rule. With respect to the covered funds SOTUS exemption, a revision was made that eliminated the so-called Financing Prohibition, under which no financing for the banking entity’s purchase or sale of an interest in, or sponsorship of, a covered fund could be provided by any US branch or affiliate of the banking entity. In addition, the Agencies incorporated into the Volcker Rule regulations a 2015 Agencies interpretation that the marketing prohibition on a non-US covered fund being offered or sold to US residents applies only if the offering actually is targeted at US residents.


The proposed changes in the NPRM include the following:

  • Qualifying Foreign Excluded Funds: The Volcker Rule does not apply to a non-US bank’s investment in or sponsorship of non-US funds organized and offered only outside the United States. However, the definition of “affiliate” in the Volcker Rule, which is tied to the concept of “control” in the US Bank Holding Company Act, could result in a non-US banking entity being deemed to “control” the non-US fund because of a large ownership in the fund, or the non-US banking entity selects the board of directors of the fund, or acts as a general partner or trustee of the fund. If the non-US banking entity is deemed to “control” the non-US fund, that would make the non-US banking entity an affiliate of the fund (a “non-US affiliated fund”), and as a result, the non-US affiliated fund would be considered to be a banking entity itself and subject to all the restrictions of the Volcker Rule on covered funds. The federal banking agencies acknowledged this inadvertent consequence by issuing a temporary exemption to exclude certain non-US funds from the definition of “covered fund” provided that the non-US banking entity’s acquisition of the ownership interest in or sponsorship of a non-US affiliated fund met the requirements of the SOTUS exemption, and certain other conditions. The NPRM would incorporate this exemption into the regulations.
  • Foreign Public Funds: The original Volcker Rule regulations excluded certain foreign public funds, and was drafted so as to be similar to the exclusion for U.S. registered mutual funds. However, the banking industry has noted that some of the conditions required to qualify for this exclusion were limiting its usefulness. Under the NPRM, the proposed revisions take into account certain aspects of a foreign public fund that differ from a US registered mutual fund, such as revising the requirement that the non-US fund be sold predominantly to retail investors in the issuer’s home jurisdiction. It is not unusual for a foreign public fund to be formed in one jurisdiction and offered for sale exclusively in another jurisdiction, making the non-US banking entity unable to meet the condition for predominant sales in the jurisdiction in which it is formed.
  • Loan Securitizations: The proposal would allow funds meeting the current exclusion from the definition for loan securitizations to hold a small amount of non-loan assets in accordance with standard market practice. The proposed revisions also would incorporate Agencies’ staff guidance issued about this exclusion since the regulation was initially adopted.
  • Credit Funds: Funds that make loans, own an interest in debt or extend credit would be excluded from the definition of a covered fund provided that the debt activity was that in which a banking entity might engage directly.
  • Venture Capital Funds: An exclusion from the definition of covered fund would be added to exclude certain venture capital funds to the extent that the banking entity could engage in such activity under otherwise applicable law.
  • Family Wealth Management Vehicles: Investment management vehicles that manage an investment portfolio as part of providing family private wealth management services would be excluded from the definition of “covered fund,” provided certain conditions were met.
  • Limitations on Relationships With a Covered Fund: The so-called “Super 23A” provision in the Volcker Rule, which restricts a banking entity’s relationship with any fund for which it acts as investment manager, investment advisor, or sponsor, would be revised under the proposal to allow a banking entity to enter into transactions otherwise permissible without limit for a state member bank with an affiliate under Section 23A of the Federal Reserve Act (on which Super 23A is based) and allow the banking entity to enter into short-term extensions of credit with, and purchase assets from, a related covered fund in connection with payment, clearing, and settlement activities.
  • Ownership Interest: The proposal would exclude certain senior loans and debt instruments issued by a banking entity to a covered fund from being considered to be ownership interests in such fund.

The Agencies pose over 75 questions for commenters to consider, although comments on all aspects of the proposal are welcome.