As widely anticipated in the press, federal regulators have issued final rules implementing Section 619 of the Dodd-Frank Act, commonly called the Volcker Rule. This is the portion of the Dodd-Frank Act that limits proprietary investment and trading activity on the part of banking entities that benefit from federal deposit insurance. All five of the pertinent agencies–the Federal Reserve, OCC, FDIC, SEC and CFTC–adopted substantively identical rules. Further review of the rules and the promulgating preambles will no doubt reveal interesting nuances. Below are the key aspects that are evident on initial examination. We will cover specific topics of interest in future newsletters.
Key elements of interest in the final rules:
- Hedges, to avoid treatment as impermissible proprietary investment and trading activity, must hedge a specific identified and quantified risk. Ideas proffered by industry representatives to allow hedges that are considered to hedge the whole portfolio were not accepted. A whole-portfolio hedge will not avoid treatment as a proprietary investment.
- Market-making activities and underwriting are exempt. Positions in the market-making book will have to be justified on the basis of reasonable customer demands for the specific securities.
- As in the proposed regulation, there is a presumption that an investment that is held for 60 days or more is not part of a “trading account” and accordingly is not prohibited.
- As in the proposed regulation, trading on behalf of customers’ accounts, including fiduciary relationships, falls outside the regulation’s restrictions.
- In addition to exempting U.S. Treasury securities, there are exemptions for securities of foreign governments when purchased by U.S. affiliates of foreign banks and by foreign affiliates of U.S. banks.
- Investments in private equity and hedge funds are prohibited. Exceptions that were in the proposed rules, for small-percentage ownership positions in these funds, and for securitization holdings, have been retained. In addition, an exemption is added for higher-percentage interests in very small funds.
- Compliance programs must be created to demonstrate compliance with the regulations. This is not required, however, for community banks that do not engage in any of the covered activities, as defined in the regulations.
- The chief executive officer will be required to attest in writing to the banking entity’s compliance with the regulation.
As in the proposed regulation, these limitations apply to banking entities, broadly defined. This includes bank holding companies and other entities that are affiliates or subsidiaries of a bank or other insured depository institution, or of an entity that controls an insured depository institution.
Although the effective date of the regulation is April 1, 2014, there are several delayed compliance periods. The Federal Reserve has extended the conformance period until July 21, 2015. Also, banking entities of different sizes will have until as late as December 31, 2016, to commence reporting regarding compliance. Larger banks must comply sooner, with the earliest required reporting date–for banking entities of $50 billion or more in consolidated trading assets and liabilities–coming on June 30, 2014.