On July 21, 2017, the Federal Reserve Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation (the “US Banking Agencies”), along with the Securities and Exchange Commission and the Commodity Futures Trading Commission, issued a joint press release indicating that they were coordinating their review of the applicability of the Volcker Rule to certain non-US funds and the US Banking Agencies issued a joint statement (“Statement”) stating that it will not take action for the next year against non-US banking entities that could be deemed under the current version of the Volcker Rule regulations to “control” those funds.
The Volcker Rule, enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and its regulations, adopted by five financial regulators in December 2013, generally prohibit banking entities and affiliates from engaging in proprietary trading or sponsoring or acquiring ownership interests in certain private equity funds (“covered funds”). The statute and the regulations contain several exemptions. “Banking entities” generally include US banks and their holding companies and affiliates, as well as non-US banks that maintain banking operations in the United States (such as a branch, agency or US bank subsidiary) and their subsidiaries and affiliates.
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, given the definition of “affiliate” in the Volcker Rule itself, if a non-US banking entity has a large ownership in the non-US fund, or selects the board of directors of the fund, or acts as a general partner or trustee of the fund, it may be deemed to “control” the fund, making it an affiliate of the fund (a “non-US affiliated fund”), and as a result, the non-US affiliated fund will be considered to be a banking entity itself and subject to all the restrictions of the Volcker Rule on covered funds.
This result with respect to these non-US affiliated funds has had “possible unintended consequences and extraterritorial impact,” as the Statement notes. Non-US banking entities have pointed out that there is a competitive advantage for non-US funds that are not affiliated with a non-US banking entity subject to the Volcker Rule over those non-US funds that are considered affiliates of a non-US banking entity subject to the Volcker Rule due to the relationships between the non-US banking entity and the non-US fund.
The Banking Agencies also note that a non-US banking entity with such a non-US affiliated fund could use that fund to conduct activity prohibited under the Volcker Rule which could provide that non-US banking entity with a competitive advantage over US banking entities.
The Statement indicates that the US Banking Agencies are considering how best to address this situation and whether regulatory or statutory revisions are necessary. For the time being, the US Banking Agencies announce in the Statement that “it would not propose to take action during the one-year period ending July 21, 2018,” against a non-US banking entity that has an non-US affiliated fund or the non-US affiliated fund itself under the following circumstances:
(I) The non-US banking entity’s acquisition or retention of any ownership interest in or sponsorship of a non-US affiliated fund would meet the requirements of the “Solely Outside the United States” (“SOTUS”) exemption under the Volcker Rule regulations if the non-US affiliated fund were subject to the Volcker Rule (under certain circumstance, a non-US banking entity can make an investment in a covered fund that otherwise would be prohibited under the Volcker Rule, if no ownership interest in the covered fund is offered for sale or sold to a resident of the United States and the activity or investment occurs solely outside of the United States without US financing, accounting or decision-making regarding the investment); and
(II) the fund in question qualifies as a “qualifying foreign excluded fund” which is defined as an entity that:
(1) Is organized or established outside the United States and the ownership interests of which are offered and sold solely outside the United States;
(2) Would be a “covered fund” for Volcker Rule purposes were the entity organized or established in the United States, or is, or holds itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in financial instruments for resale or other disposition or otherwise trading in financial instruments;
(3) Would not otherwise be a “banking entity” for Volcker Rule purposes except by virtue of the non-US banking entity’s acquisition or retention of an ownership interest in, or sponsorship of, the entity;
(4) Is established and operated as part of a bona fide asset management business; and
(5) Is not operated in a manner that enables the non-US banking entity to evade the requirements of the Volcker Rule or its implementing regulations.