Volcker Rule: Agencies Release Limited Volcker Rule Guidance

Sullivan & Cromwell LLP - June 10, 2014
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This afternoon, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation (collectively, the “Banking Agencies”) and the Securities and Exchange Commission (the “SEC”) released substantially identical Frequently Asked Questions (“FAQs”) addressing six topics regarding the implementation of section 13 of the Bank Holding Company Act of 1956, as amended, commonly known as the “Volcker Rule.”

The Volcker Rule imposes broad prohibitions on proprietary trading and investing in and sponsoring private equity funds, hedge funds and certain other investment vehicles (“covered funds”) by banking entities (as that term is defined under the Volcker Rule) and their affiliates.  These prohibitions are subject to several exemptions for permitted activities.  The final rule implementing the Volcker Rule, issued by the Banking Agencies, the SEC and the Commodity Futures Trading Commission (collectively, the “Agencies”) on December 10, 2013 (the “Final Rule”), raised a number of interpretive issues with respect to the structure and conduct of many business activities of both U.S. and non-U.S. banking entities, which have prompted numerous requests by banking and other organizations for interpretive guidance from the Agencies.  One of the first definitive pronouncements, the FAQs provide very limited guidance on six topics out of the many issues that have been raised and do not attempt yet to address a significant number of issues viewed as critical by the industry.

Specifically, the FAQs clarify the following, which generally confirm pre-existing industry expectations with respect to the application of the Final Rule:

  • for those banking entities subject to reporting of quantitative trading metrics, the initial metrics collecting and reporting dates (including the time periods for which metrics must be collected during the initial reporting periods) and the treatment of weekend and holiday reporting deadlines;
  • the treatment of trading desks that span multiple affiliated banking entities, including that metrics for such trading desks “should be calculated at the level of the entire desk” and “should be reported to each Agency that has authority under section 13 of the BHC Act over any of the affiliated entities that compose the trading desk so that the Agency may understand the context of the trading activity and discharge its responsibility for the legal entity that the Agency supervises or regulates”;
  • that a banking entity is not required to deduct investments in covered funds from its tier 1 capital prior to the end of the conformance period (currently July 21, 2015);
  • that permitted “servicing assets” under the loan securitization exception to the covered fund restrictions are generally limited to cash equivalents (high quality, highly liquid short term investments) that are expected to meet the funding obligations of the loan securitization vehicle;
  • that a seeding vehicle formed and operated pursuant to a written plan to become a qualifying foreign public fund will not be treated as a covered fund during the seeding period, provided that certain conditions are met that mirror those applicable to registered investment companies or business development companies (including that the plan provides that the entity will be converted into a foreign public fund within one year from the date of establishment); and
  • that a covered fund would generally be considered to share the same name or a variation of the same name with a banking entity for purposes of the prohibitions on name sharing if the name of the fund features the same root word, the same initials or a logo, trademark or other corporate symbol that is also used by, or that clearly references a connection with, the banking entity, including any affiliate of the banking entity.
The FAQs issued by each Banking Agency note that the Agencies have been working together on the FAQs, and that while the FAQs issued by each Agency apply to banking entities for which that Agency has jurisdiction under the Volcker Rule, the FAQs “have been developed by staffs of the Agencies and substantively identical versions will appear on the public websites of each Agency.”  A copy of the FAQs issued by the Federal Reserve is attached as Appendix A.