Volcker Rule: Regulatory Testimony Raises Concerns over the Scope of the Volcker Rule Exemptions for Covered Funds

Sullivan & Cromwell LLP - January 20, 2012

At a joint hearing on the Volcker Rule held by two subcommittees of the House Committee on Financial Services on January 18, a panel of regulators was asked whether the agencies intended to exempt insurance companies from Volcker Rule restrictions on hedge funds and private equity funds (referred to in the proposed regulations as “covered funds”). In response, the Chairman of the SEC made the following statement: “[I]t’s quite clear on proprietary trading that insurance companies can engage in trading, but not investing in covered accounts, covered funds … the statute does exempt from the proprietary trading ban trading by an insurance company for its general account, and -- but it does not do that for insurance company investments in covered funds . . . [i]n order for us to create that exemption, we would have to meet a very high threshold to show that it would promote the safety and soundness of the banking institution or the financial stability of the United States.” None of the other regulatory agency witnesses responded to this particular question, nor did any of them comment on the SEC Chairman’s response. The Chairman’s response raises a concern, insofar as it suggests that the apparent position in the proposed rule may continue to be taken on the insurance company exemption in the final rule. Moreover, it would be particularly troubling because, if the same interpretative approach were applied to other key Volcker Rule exemptions, it could severely limit the permissible underwriting and market making activities of banking entities in shares of covered funds and the customer driven transactions of banking entities in such shares.