On May 30, 2018, the Federal Reserve Board was the first of the five financial services regulators responsible for the Volcker Rule to approve proposed changes agreed by the regulators. Between May 31 and June 5, 2018, the Federal Deposit Insurance Corporation, the Comptroller of the Currency, the Commodity Futures Trading Commission and the Securities and Exchange Commission also approved the proposal.
Some of the highlights of the proposal include the following:
- Compliance Programs: Volcker Rule compliance program requirements would vary depending on a banking entity’s average gross sum of trading assets and liabilities on a worldwide consolidated basis over the previous consecutive four quarters (“average gross sum”);
- “Limited trading assets and liabilities” – the average gross sum is less than one million dollars: these banking entities would be presumed to be in compliance with the Volcker Rule and not be required to establish a Volcker Rule compliance program unless otherwise specifically ordered to do so by their primary federal regulator
- “Moderate trading assets and liabilities” the average gross sum is between one and ten billion dollars: these banking entities will be required to establish a more simplified compliance program but still will need to comply with the current CEO attestation requirement that the banking entity does not, directly or indirectly, guarantee, assume or otherwise insure the obligations or performance of the covered fund or of any covered fund in which such covered fund invests.
- “Significant trading assets and liabilities” – the average gross sum is ten billion dollars or more: these banking entities will be subject to the most detailed compliance program requirements, including written policies and procedures, internal controls, independent testing and audit, and recordkeeping requirements, in addition to the CEO attestation requirement.
- Definition of trading account: The proposal would eliminate the rebuttable presumption that a banking entity’s purchase or sale of a financial instrument is for its trading account if the banking entity holds the instrument for fewer than 60 days or substantially transfers the risk of the position within 60 days, and replace it with a test based on the accounting treatment of the purchase or sale.
- Permitted underwriting and market-making activities: Currently, underwriting and market-making transactions are permissible if they are designed “not to exceed reasonably expected near term demands of clients, customers or counterparties,” or RENTD. Revisions to this section would include creation of a presumption of compliance with the exemption if the banking entity establishes underwriting and market-making internal risk limits and implements, maintains and enforces those limits so they are not exceeded.
- The risk-mitigating hedging exemption: Revisions of this exemption would include elimination of the requirement for correlation analysis and reduction of certain enhanced documentation requirements.
- Solely outside the United States (SOTUS) exemption: Many foreign banks rely on this exemption from the proprietary trading and covered funds requirements of the Volcker Rule for such activity being conducted “solely outside the United States.” Revisions to the SOTUS exemption include elimination of the prohibition that no financing for the banking entity’s purchase or sale be provided by any US branch or affiliate of the banking entity.
- Covered fund underwriting and market-making: If a banking entity does not organize or offer interests in a covered fund, it will not be required to include any ownership interests in such fund in its aggregate fund limit and capital deduction for investments in covered funds relying on the underwriting or market-making exemptions.
- Covered fund risk-mitigating hedging activities: Revisions would expand the ability of a banking entity to acquire a covered fund interest as a hedge when acting as an intermediary on behalf of a non-banking entity customer so long as, among other requirements, the action is designed to facilitate the exposure by the customer to the profits and losses of the fund.
- Covered Fund SOTUS exemption: In addition to eliminating the prohibition on US financing (as noted above), the marketing prohibition on a non-U.S. covered fund being offered or sold to US residents would be clarified to apply only if the offering actually is targeted at U.S. residents.
- Super 23A: Under the Volcker Rule statute, a banking entity generally that serves as an investment manager, investment adviser, or sponsor to a covered fund may not enter into a transaction with that fund if the transaction would be considered a “transaction with an affiliate” for purposes of section 23A of the Federal Reserve Act. The statute did not include any of the exemptions contained in section 23A or its accompanying regulations; the proposal seeks comments on whether such exemptions should be included.
The proposal does not address any revisions that may be required in the Volcker Rule as a result of the regulatory reform bill signed into law by the President on May 24, 2018. One section in that legislation has the effect of potentially subjecting more private equity funds to the restrictions of the Volcker Rule by increasing the number of investors in certain private equity funds without the fund needing to be registered as a mutual fund; this amendment was made to one of the exemptions to the Investment Company Act that would make a fund a “covered fund” under Volcker. As a consequence, if a banking entity wants to sponsor or invest in a fund newly subject to the Volcker Rule as a result of this amendment, it will need an alternative legal authority for such sponsorship or investment in order to qualify for an exemption from the definition of a Volcker covered fund.
Once the joint notice is published in the Federal Register, the official government publication for proposed and final federal government rules, agency notices and presidential documents, there will be a 60 day comment period, which could well be extended. The agencies pose over 340 questions for people to consider when formulating their comments.