Under the Volcker Regulations (Regulations),1 banking entities are sharply restricted in their ability to invest in and sponsor entities that are treated as “covered funds.”2 During the rulemaking process, the Volcker Agencies (Agencies)3 decided to exclude a range of entities from being treated as covered funds.
An important category of entities that are excluded from covered fund treatment is a qualified joint venture. This exclusion has been attracting increasing interest from banking entities as well as their potential partners. The qualifying joint venture option allows a banking entity to expand its activities and market presence by pooling its resources and capital with one or more partners in order to operate a banking-related business, such as a lending business.
The Regulations on their face provide only limited guidance as to what entities will be treated as qualifying joint ventures. Recently, the Agencies issued a Frequently Asked Question (FAQ) providing significant additional guidance regarding the requirements for qualifying joint ventures.4 The key points for establishing a qualifying joint venture are:
- It must be comprised of no more than 10 unaffiliated co-venturers.
This limitation is intended to allow banking entities some flexibility in structuring a joint venture, without allowing the joint venture to become so broad that it would appear to be a fund established for investment purposes.
- It must be engaged in activities that are permissible for the banking entity or an affiliate, other than investing in securities for resale or other disposition.
- It is not, and does not hold itself out as being, an entity or arrangement that raises money from investors primarily for the purpose of investing in securities for resale or other disposition or otherwise trading in securities.
These provisions are intended to ensure that a qualifying joint venture is not an investment vehicle. While the Regulations deny the joint vehicle exclusion where an issuer is engaged in investing in securities for resale or other disposition or otherwise trading in securities, the FAQ takes a far broader approach to the prohibited conduct. It provides that the exclusion is not available where an issuer raises money from a small number of investors primarily for the purpose of investing in securities, regardless of whether the securities are intended to be traded frequently, held for a longer duration, held to maturity or held until the distribution of the entity.5
In discussing their general vision of a qualifying joint venture, the Agencies explain that the exclusion is intended to allow a banking entity to more efficiently manage the risks of its banking operations, such as by sharing complementary banking business expertise with other joint venture partners. In the Agencies’ view, an issuer that raises funds from investors primarily for the purpose of sharing in the benefits, income, gains or losses from the ownership of securities – as opposed to conducting a business or engaging in operations or other non-investment activities – would be raising money from investors primarily for the purpose of investing in securities, even if the vehicle may have other purposes. Such arrangements would not qualify for the joint venture exclusion.
The operating structure and governance of an issuer is another important factor in obtaining qualified joint venture status. There is no definition of a joint venture in the Regulations, but the Agencies note that the basic elements of a joint venture are well recognized. Joint ventures are commonly structured as LLCs. In our experience, joint ventures provide ample flexibility to structure a business in a way that is efficient for the partners – including taking into account governance, financing needs, tax planning and risk allocation.
Issuers seeking qualified joint venture status should seek to maximize the operating business characteristics of the joint venture and seek to assure that each partner has a meaningful and active role in the management of the joint venture. In this regard, a partner that does not have some degree of control over the business of an entity likely would not be considered by the Agencies to be participating in a joint venture for purposes of the exclusion in the Regulations.
If a qualifying joint venture is deemed to be controlled by a banking entity, then the joint venture itself would be deemed to be a banking entity.6 A joint venture that is a banking entity would be required to comply with the same proprietary trading and covered fund restrictions that apply to all banking entities.